20–24 A flowchart of steps for each type of test is given below (requirements
a., b., and c.):
TESTS OF CONTROLS
OR SUBSTANTIVE TESTS
OF TRANSACTIONS
TESTS OF DETAILS
OF BALANCES
5
4
2
7
9
8
6
3
1
20–25
a.
INTERNAL
CONTROL DEFICIENCY
b.
TYPE OF MISSTATEMENT
1.
The foreman should not hire
employees.
The foreman may hire unqualified
employees, friends, or possibly a fictitious
person to be paid through the payroll
system.
2.
The foremen should not
recommend wages for
employees.
The foreman may provide inappropriate pay
rates or pay rates that are split between
an employee and the foreman.
3.
Time cards should not be left in
a box that employees have
access to.
Employees, including the foreman, can take
extra time cards and clock in for other
employees or fictitious employees.
4.
The foreman collects and
approves the time cards as
well as the duties described
in 1–3. (Note: It is appropriate
for the foreman to approve
times cards if he has none of
the other duties described in
1–3.)
The foreman can include fictitious time
cards for check preparation.
5.
There is no internal verification
of the payroll clerk’s input of
names or hours into the
payroll system.
The payroll clerk can make mistakes
entering the hours or names.
20–25 (continued)
a.
INTERNAL
CONTROL DEFICIENCY
b.
TYPE OF MISSTATEMENT
6.
The controller compares two
output records and fails to
compare the output to any
input records.
The controller will not find any existing
mistakes made by the payroll clerk.
7.
The foreman receives the
payroll checks for distribution.
The foreman can keep checks for which he
has submitted time cards for nonexistent
employees.
8.
The foreman mails checks to
absent employees.
Nonexistent or former employees who had
someone else prepare their time cards will
receive a check in the mail.
9.
The controller hires and
approves wages for salaried
employees and signs their
checks.
The controller can submit information for a
nonexistent employee, open a checking
account in the person’s name and receive
the direct deposit. She can also submit
the improper salary rate to the payroll
clerk and split the payment with the
employee.
10.
The controller has sole access
to pay rates.
The controller can include any pay rates
she desires, for herself or others,
including fictitious employees and friends
who will split the amounts with her.
11.
The payroll clerk can add
names to the payroll records.
The payroll clerk can add fictitious names
for either salaried or hourly employees.
She can set up a checking account in the
same manner discussed in 9.
12.
An accounting clerk does the
bank reconciliation each
month.
The person is unlikely to be qualified to
do quality bank reconciliation and will
thereby be unlikely to find the frauds
included previously.
20–26
a.
TRANSACTION–RELATED
AUDIT OBJECTIVE NOT MET
b.
CONTROL EFFECTIVE IN PREVENTING
OR DETECTING MISAPPROPRIATION
1.
Accuracy (unauthorized pay
rates)
Only the human resource function, which is
separate from the payroll function, can
change employee pay rates.
2.
Occurrence (fictitious
employee)
Only the human resource function, which is
separate from the payroll function, can
add employees to payroll.
3.
Accuracy (fictitious hours)
All payroll hours or payroll overtime hours
must be approved by the employee’s
supervisor.
4.
Accuracy (fictitious hours)
Approval of time records by supervisor.
Require employees to sign in using
personal identification.
5.
Occurrence (failure to remove
a terminated employee)
Require notification of human resources on
termination of employees.
Surprise payroll payoff.
c. The surprise payroll payoff is effective in detecting fictitious employees
that have been placed on the payroll, or terminated employees
that were not properly removed from the payroll (occurrence). If
20–27
DEPARTMENT
EXTENT
OF INCREASE
OR DECREASE
IN PAYROLL
EXPENSE
EXPLANATION FOR
EXPECTED CHANGE IN
DEPARTMENT’S PAYROLL EXPENSE
Warehouse
and Shipping
Department
Extensive
Increase
Each online sale must be individually
processed for shipment to single, stand–
alone customers. The time and effort to
process, package, and ship goods to each
online customer will significantly increase the
warehouse and shipping department payroll
expense.
20–27 (continued)
DEPARTMENT
EXTENT
OF INCREASE
OR DECREASE
IN PAYROLL
EXPENSE
EXPLANATION FOR
EXPECTED CHANGE IN
DEPARTMENT’S PAYROLL EXPENSE
IT Department
Little Change
Because the company outsourced the creation
and support of the online sales system, payroll
expense would likely increase minimally (e.g.,
some increase would occur despite the
outsourcing). However, consulting expense
would be expected to increase extensively.
Accounts
Receivable
Department
Little to Moderate
Increase
Because online sales are applied to customer
credit cards, most of the collection of the
receivables would be handled by the credit
card agencies, not by Archer Uniform’s
accounts receivable department. Some
increase in payroll expense may occur, if
there are disputes between Archer Uniforms
and the credit card agencies over the
amounts processed throughout the month.
Additional time may be required to reconcile
the processing of cash payments by the
credit card agencies and the recording of
sales in Archer Uniform’s financial statements.
Accounts
Payable
Department
Moderate
Increase
Assuming total sales significantly increase due
to the new online offering, the volume of
inventory purchases will increase. This
increase in inventory purchasing will result in
an increase in vendor payments to be
processed. Thus, payroll expense for the
accounts payable department may increase
moderately. Some efficiencies may be
obtained by processing larger bulk orders in
a single vendor payment. However, new
products may be offered and additional
vendors may be used, which in turn will
increase the volume of processing required
in accounts payable.
Receiving
to the new online offering, the volume of
Extensive
Assuming total sales significantly increase due
inventory purchases to be received and
correspondingly increase.
Executive
Management
Little Change
Most of the work associated with the new
online sales offerings will be the
20–27 (continued)
DEPARTMENT
EXTENT OF
INCREASE OR
DECREASE IN
PAYROLL
EXPENSE
EXPLANATION FOR
EXPECTED CHANGE IN
DEPARTMENT’S PAYROLL EXPENSE
Marketing
Moderate
Increase
The extent of increase in payroll expense for
this department will be dependent on the
amount of advertising that Archer Uniforms
creates to promote its new Web site.
Assuming some advertising is created, there
would be a moderate increase in marketing
payroll expense. Other advertising expenses
may increase for ads generated through
external ad agencies and through Web site ad
contracts.
20–28 a. The compensation components for the David C. Novak, Chairman
and CEO, for 2014 consists of the following:
Salary $ 1,450,000
Stock Awards $ 1,925,037
Option/SAR Awards $ 5,228,142
satisfying the completeness and rights and obligations balance–
related audit objectives.
c. The auditor would examine the minutes of a board of directors
transaction–related audit objectives.
20–16
20–28 (continued)
methodologies used by the company to value the awards.
According to Note 14 in the consolidated financial statements for
the year ended December 27, 2014, the company estimates the
fair value of each stock option and SAR award as of the date of
compensation specialist to assist with the examination of the stock
option and SAR computations.
e. Presentation and disclosure audit objectives are important for
financial statements as well as in proxy statements for publicly
traded companies.
Case
following:
Personnel records
Deduction authorization forms
Rate authorization forms
Time cards and job time tickets
20–29 (continued)
form is not a problem, as long as the service bureau has
adequate backup and recovery controls.
The above analysis reflects the fact that Leggert’s internal
controls in the payroll area are generally good. There is good
and reports are comprehensive and well–designed.
The only potential deficiency in internal control is that errors
b.
PAYROLL
TRANSACTION–
RELATED
AUDIT OBJECTIVE
PROCEDURES
TYPE OF
PROCEDURE
1. Recorded payroll
payments are for
work performed by
existing employees
(occurrence).
a. Observe existence of
personnel files in president’s
care.
b. Observe use of time clock
and control of time cards by
clerk.
c. Examine time cards for
president’s approval.
d. Observe distribution of
payroll checks by president.
e. Examine cancelled checks
for proper endorsement.
f. Compare cancelled checks
with personnel records.
g. Examine cancelled check for
president’s signature.
Test of control
Test of control
Test of control
Test of control
Substantive test of
transactions
Substantive test of
transactions
Test of control
2. Existing payroll
transactions are
a. Account for the numerical
sequence of payroll checks.
Test of control and
substantive test of
20–29 (continued)
PAYROLL
TRANSACTION–
RELATED
AUDIT
OBJECTIVE
PROCEDURES
TYPE OF
PROCEDURE
3. Recorded payroll
transactions are for
the amount of time
actually worked
and at the proper
pay rate;
withholdings are
properly calculated
(accuracy).
a. Observe use of time clock
and control of time cards by
Clark.
b. Observe Clark rechecking
hours.
c. Recompute gross pay,
deductions, and net pay.
d. Trace rates and
authorizations to personnel
file.
e. Examine payroll journal or
listing for approval by Clark.
f. Compare rates in payroll
journal or listing with
personnel files to determine
that rate actually paid is
authorized.
Test of control
Test of control
Substantive test of
transactions
Substantive test of
transactions
Test of control
Substantive test of
transactions
4. Payroll
transactions are
properly classified
(classification).
a. Review chart of accounts.
b. Examine payroll journal or
listing for approval by Clark.
c. Compare classification with
chart of accounts or
procedures manual.
Test of control
Test of control
Substantive test of
transactions
5. Payroll
transactions are
recorded on the
correct dates
(timing).
a. Observe collection and
processing of time cards by
Clark.
b. Examine payroll journal or
listing for approval by Clark.
c. Observe posting of ledger by
Clark.
d. Observe preparation of
payroll bank reconciliation by
president.
e. Compare date of check
recorded in payroll journal
Test of control
Test of control
Test of control
Test of control
Substantive test of
transactions
20–29 (continued)
PAYROLL
TRANSACTION–
RELATED
AUDIT OBJECTIVE
PROCEDURES
TYPE OF
PROCEDURE
6. Payroll
transactions are
properly included in
the employee
earnings record;
they are properly
summarized
(posting and
summarization).
a. Observe re–adding of payroll
journal or listing and posting
by Clark.
b. Examine payroll journal or
listing for approval by Clark.
c. Observe posting of ledger by
Clark.
d. Trace postings from payroll
journal to general ledger.
Test of control
Test of control
Test of control
Substantive test of
transactions
c. Procedures in performance format:
d) Posting of general ledger.
2. Make observations of the following activities by the president:
a) Maintenance of personnel files.
activities:
4. Select a sample of payroll check numbers and:
c) Examine checks for proper endorsement.
d) Compare cancelled checks with personnel records.
listing and perform the following steps:
20–29 (continued)
and deductions.
c) Recompute gross pay, deductions, and net pay.
steps:
a) Examine payroll journal for approval by Clark.
b) Trace postings to general ledger.
d. A sampling data sheet follows. Note that this sampling data sheet
sizes will vary.
DESCRIPTION OF ATTRIBUTES
PLANNED AUDIT
INITIAL
SAMPLE
SIZE***
EPER*
TER**
ARO**
1. Payroll check number accounted
for
2. Payroll check signed by president
3. Time card approved by president
4. Time card hours agree with payroll
journal or listing
5. Personnel file is complete
6. Pay rate and deductions supported
by authorization
7. Gross pay, deductions, and net pay
correctly computed
0%
0%
1%
1%
0%
1%
0%
5%
4%
6%
6%
6%
4%
5%
5%
5%
5%
5%
5%
5%
5%
59
74
78
78
49
156
59
* These amounts are arbitrary to complete data sheet.
Information to determine actual appropriate amounts is not given in problem.
** These amounts are judgments and are not the only acceptable amounts.
*** Determined from attributes sampling tables.