CHAPTER 15

THE HUMAN RESOURCES MANAGEMENT AND PAYROLL CYCLE

Learning Objectives:
1. Describe the major business activities and related information
processing operations performed in the human resources management
(HRM)/payroll cycle.
2. Explain the key decisions to be made in the HRM/payroll cycle, and
identify the information required to make those decisions.
3. Identify the major threats in the HRM/payroll cycle, and evaluate
the adequacy of various internal control procedures for dealing
with them.

Introduction
The human resources management (HRM)/payroll cycle is a recurring set of
business activities and related data processing operations associated
with effectively managing employee workforce. The more important tasks
include:
1. Recruiting and hiring new employees
2. Training
3. Job assignment
4. Compensation (payroll)
5. Performance evaluation
6. Discharge of employees due to voluntary or involuntary termination
Tasks 1 and 6 are performed once and tasks 2 through 5 are performed
repeatedly.
This chapter focuses primarily on the payroll system.

Overview
The HRM provides information on hirings, terminations, and pay-rate
changes due to pay raises and promotions.
The various departments provide data for the hours worked.
The government provides the tax information and requirements.
The principal output for the payroll cycle is checks.

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Although direct labor costs are a small portion of the total

manufacturing costs, employees are a key cost driver when it comes to
their performance which affects the quality of the products being
manufactured.
Some believe that the value of employees skills and knowledge is
several times greater than the value of a companys tangible assets.
However, accounting and the AIS have not traditionally measured or
reported this value of the employees.
The only value of the employee has been the wage and salary expense for
direct labor, which is included in the work-in-process inventory.
However, some companies have made changes in the late 1990s to develop a
method to report on the intellectual assets and human resources. For
example, Skandia Group experimented with including human resources
information in their annual report.
Recognizing the value of employees knowledge and skills can help
companies better understand the true costs associated with excessive
turnover.
Experts estimate that the cost of replacing employees is 1.5 times
greater then that of an employees annual salary.
For example, consider two companies with 1,500 employees earning
on the average $40,000.
One company has an employee turnover rate of 20 percent and the
other only 5 percent.
The company with the 20 percent rate would need to replace
300 employees each year (1,500 X 20%). The companys cost
for each employee would be $60,000 ($40,000 X 20%). This
would result in an annual cost of $18 million (300 employees
X $60,000)
As for the company with the 5 percent turnover rate, they
would only need to replace 75 employees; their annual cost
would only be $4.5 million (75 employees X $60,000).
Employee morale is also important. A Gallup survey found that an
employees attitude affects profitability.
The survey found that there are four key attitudes:
1. Employees believe they have the opportunity to do
what they do best.
2. They believe their opinions count.
3. They think that coworkers are committed to quality.
4. They understand the connection between their jobs
and the companys mission.

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Focus 15-1 on page 439 describes the value of understanding

employee jobs and attitudes.
Senior executives are now spending time in the trenches to
better understand job duties and pressures.
For example, the CEO of Loews Hotels spent time working as a
bellman, pool attendant, and housekeeper.
The vice president of DaVita Inc. spent three days working
in one of the companys clinics.
Most important, these senior executives acted on their
findings to improve working conditions.
Figure 15-2 on page 437 provides the integration of Payroll and HRM
functions in a typical ERP system.

Payroll Cycle Activities

Figure 15-4 on page 442 shows the seven basic activities performed in
the payroll cycle:
1. Update payroll master file.
2. Update tax rates and deductions.
3. Validate time and attendance data.
4. Prepare payroll.
5. Disburse payroll.
6. Calculate employer paid benefits and taxes.
7. Disburse payroll taxes and miscellaneous deductions.
Payroll is an AIS application that is processed in the batch mode.

Update Payroll Master File

Updating the payroll master file includes changes such as 1) new hires,
2) terminations, 3) changes in pay rates, and 4) changes in
discretionary withholdings (circle 1.0 in Figure 15-4).
It is important that all payroll changes are entered in a timely manner
and are properly reflected in the next pay period.

Update Tax Rates and Deductions

This update is shown in circle 2.0 in Figure 15-4. These type of changes
occur infrequently.

Validate Time and Attendance Data

This validation is shown in circle 3.0 in Figure 15-4.

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Pay Schemes
Most employees are paid either on a fixed salary or on an hourly
basis (wages).
For those paid on an hourly basis, many companies use a time card
which is used to record the hours worked. The time card also
includes the total hours worked for a pay period.
Employees who earn a fixed salary seldom record their labor
efforts on a time card. Instead, their supervisors monitor their
presence on the job.
Sales staff often are paid either on a straight commission or on a
salary plus commission basis.
Nucor Corporation, a large steel company, pays its steelworkers an
hourly rate at approximately 60 percent of the industrial average,
plus a bonus based on the tons of steel (tonnage) they produce.
Focus 15-2 on page 445 explains that accountants should be
involved in reviewing a companys compensation practices.
The FASB issued new rules requiring that stock options be
expensed and the major U.S. stock exchanges now require
companies to obtain shareholder approval of all equity-based
compensation.
Efficiency Opportunities Using Information Technology
Payroll processing can be made more efficient by collecting
employee time and attendance data electronically instead of on
paper documents.
Those data are then automatically fed to the payroll processing
system.
Also, electronic time clocks can transmit time and attendance data
directly to the payroll processing system.

Prepare Payroll
The fourth step in the payroll cycle is preparing payroll (circle 4.0 in
Figure 15-4.
Procedures
1. The payroll transaction file is sorted by employee
number.
2. The sorted time-data file is then used to prepare
employee paychecks.
3. Next, all payroll deductions are summed and the total is
subtracted from gross pay to obtain net pay.

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4. Once net pay is obtained, the year-to-date fields for

gross pay, deductions, and net pay in the payroll master
file are updated.
5. Finally, the payroll register and employee paychecks are
printed.
The payroll register is a report that lists each
employees gross pay, payroll deductions, and net pay.
Note that the employees whom worked in excess of 40 hours
received overtime pay of 1.5 times the hourly rate. As a
result, you cannot multiply the hours times the pay
rate to get the gross pay.
Sometimes the payroll register is accompanied by a
deduction register which lists the miscellaneous
voluntary deductions for each employee.
Figure 15-8 on page 447 provides an example of both reports.
Employee paychecks also typically include an earnings statement,
which lists the amount of gross pay, deductions, and net pay for
the current period and year-to-date totals.
Table 15-2 on page 448 describes some of the additional reports
produced by the payroll system; especially for government
agencies.
Figure 15-9 on page 448 shows that most payroll and HRM software
provides extensive support for meeting the reporting requirements
of federal, state, and local governments.

Disburse Payroll
The next step is actual disbursement of paychecks to employees (circle
5.0 in Figure 15-4). Most employees are paid by either check or direct
deposit.
Procedures
The following procedures are followed:
1. Once paychecks have been prepared, the payroll register is
sent to the accounts payable department for review and
approval.
2. A disbursement voucher is then prepared to authorize the
transfer of funds from the companys general checking
account to its payroll bank account.
3. The disbursement voucher and payroll register are then sent
to the cashier.

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4. The cashier reviews the payroll register and disbursement

voucher and then prepares and signs a check transferring
funds to the companys payroll bank account. The cashier
also reviews, signs, and distributes the employee paychecks.
5. The payroll register is then returned to the payroll
department.
Efficiency Opportunity: Direct Deposit
Direct deposit is one way to improve the efficiency and reduce the costs
of payroll processing.
Direct deposit provides savings to employers by eliminating the cost of
purchasing, processing, and distributing paper checks, not to mention
reducing bank fees and postage.

Calculate Employer-Paid Benefits and Taxes

The employer pays some payroll taxes and employee benefits directly
(circle 6.0 in Figure 15-4).
The IRS Circular E, Employers Tax Guide, provides detailed instructions
about employers obligations for withholding and remitting payroll
taxes, and for filing reports.
Employers often contribute some or all of the amounts to pay for their
employees health, disability, and life insurance.
Many employers also offer their employees flexible benefit plans, under
which the employee receives some minimum coverage in medical insurance
and pension contributions.

Disburse Payroll Taxes and Miscellaneous Deductions

The final activity in the payroll process is paying the payroll tax
liabilities and the other voluntary deductions of each employee (circle
7.0 in figure 15-4).
Companies either prepare checks or use electronic funds transfer to pay
the taxes and deductions.

Outsourcing Options: Payroll Service Bureaus and Professional

Employer Organizations
In an effort to reduce costs, many organizations are outsourcing their
payroll and HRM functions.
A payroll service bureau maintains the payroll master file for each of
its clients and performs the payroll processing activities.
A professional employer organization (PEO) not only processes payroll
but also provides HRM services such as employee benefit design and
administration.

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When organizations outsource payroll processing, they send time and

attendance data along with information about personnel changes to the
payroll service bureau or PEO at the end of each pay period.
Payroll service bureaus and PEOs are especially attractive to small and
midsize businesses for the following reasons:
1. Reduced costs
2. Wider range of benefits
3. Freeing up of computer resources

Key Decisions and Information Needs

The payroll system must be designed to collect and integrate cost data
with other types of HR information to enable management to make the
following kinds of decisions:
1.

Future workforce staffing needs

How many employees are needed in the next five years to

accomplish the organizations strategic plans?

Which employees possess the needed skills?

Which skills are in short supply?

Which skills are in oversupply?

How effective are current training programs in maintaining

and improving employee skill levels?

2. Employee performance

Which employees should be promoted or receive pay raises?

Who should be discharged?

Is overall performance improving or declining?

Is turnover excessive?

Is tardiness or absenteeism a problem?

3. Employee morale

What is the overall level of employee morale and job

satisfaction?

How can the compensation scheme be used to improve morale,

satisfaction, and performance?

What additional fringe benefits, if any, should be offered?

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4. Payroll processing efficiency and effectiveness

How frequently should employees be paid?

Are labor costs being accurately allocated to products and

other cost centers?

Are all applicable tax reporting requirements being met?

How easily can employee requests for information be

answered?

Internally and externally generated information is needed to make these

decisions.
Access to current, accurate information about employee skills and
knowledge can also provide an organization with strategic benefits.
A second strategic benefit of an integrated HRM/payroll data model is
that staff can perform many HRM activities more efficiently, thereby
reducing costs. Online resumes are being used for hiring new employees.
A well-designed HRM database also can be used to reduce recruiting
costs.

Control Objectives, Threats, and Procedures

A second major function of the AIS in the HRM/payroll cycle is to
provide adequate internal controls to ensure meeting the following
objectives:
1. All payroll transactions are properly authorized.
2. All recorded payroll transactions are valid.
3. All valid, authorized payroll transactions are recorded.
4. All payroll transactions are accurately recorded.
5. Applicable government regulations regarding remittance of taxes
and filing of payroll and HRM reports are met.
6. Assets (both cash and data) are safeguarded from loss or theft.
7. HRM/payroll cycle activities are performed efficiently and
effectively.
Simple, easy-to-complete documents with clear instructions facilitate
the accurate and efficient recording of payroll transactions.
Appropriate application controls, such as validity checks and field
(format) checks, further increase the accuracy of data entry when using
electronic documents.

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Providing space on both paper and electronic documents to record who

completed and who reviewed the form gives evidence that the transaction
was properly authorized.
Prenumbering all documents facilitates checking that all transactions
have been recorded.
Restricting access to programs that create documents and, if paper
documents are still used, to blank documents reduces the risk of
unauthorized transactions.
Table 15-1 on page 439 lists the major threats in the HRM/payroll cycle
and the applicable control procedures.

Employment Practices
The objective of the HRM function is to efficiently hire, develop,
retain, and dismiss employees.
Threat 1Hiring Unqualified or Larcenous Employees
Hiring unqualified employees can increase production expenses, and
hiring a larcenous employee can result in theft of assets.
Skill qualifications for each open position should be stated explicitly
in the position control report.
It is especially important to verify a job applications skills and
references, including college degrees earned, because research shows
that approximately 30 percent of resumes contain false information.
Background checks should also be conducted.
Threat 2Violation of Employment Law
The government imposes stiff penalties on firms that violate provisions
of employment law.
The best control procedure is careful documentation of all actions
relating to advertising, recruiting, and hiring new employees and
dismissal of employees.

Payroll Processing
The objective of payroll processing is to efficiently and effectively
remunerate employees for the services they provide.
Threat 3Unauthorized Changes to the Payroll Master File
Unauthorized changes to the payroll master file can result in increased
expenses if wages, salaries, commission, or other base rates are
falsified.
Proper segregation of duties is the key control procedure for dealing
with this threat.

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Only the HRM department should be able to update the payroll

master file for hirings, firings, pay raises, and promotions.
Controlling access to the payroll system is also important. The system
should be programmed to compare user IDs and passwords with an access
control matrix that:
1. Defines what actions each employee is allowed to perform
2. Confirms what files each employee is allowed to access
Threat 4Inaccurate Time Data
Inaccuracies in time and attendance records can result in increased
labor expenses and erroneous labor expense reports.
Automation can reduce the risk of unintentional inaccuracies.
The data entry program should include the following edit checks:
1. Field checks for numeric data in the employee-number and hours
worked fields
2. Limit checks on the hours worked field
3. A validity check of the employee number
Proper segregation of duties can reduce the risk of intentional
accuracies.
Time clock data, used for calculating payroll, also should be reconciled
to the job time ticket data.
Threat 5Inaccurate Processing of Payroll
The complexity of payroll processing makes it susceptible to errors.
Processing errors can lead to penalties if the errors result in failure
to remit the proper amount of payroll taxes due the government.
Three types of control procedures address the threat of payroll errors:
1. Batch totals should be calculated at the time of data entry and
then checked against comparable totals calculated during each
stage of processing.
Hash totals of employee numbers are particularly useful. If
the original and subsequent hash totals of employee numbers
agree, it means that:

All payroll records have been processed.

Data input was accurate.

No bogus time cards were entered during processing.

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2. Cross-footing the payroll register

3. A payroll clearing account
The payroll clearing account is a general ledger account that is
used in a two-step process to check the accuracy and completeness
of recording payroll costs and their subsequent allocation to
appropriate cost centers.
The recordings for each pay period include:
Debit to payroll account
Credit to deductions payable
Credit to cash for net pay
Then when direct and indirect labor is used in manufacturing the
recording is:
Debit to work-in-process for direct labor
Debit to manufacturing overhead for indirect labor
Credit to payroll account
The amount credited to the payroll account should be equal to the
initial debit to the payroll account. This internal check is
called a zero-balance check.
Companies hire temporary employees or outside help to get around a
hiring freeze.
The IRS provides a check list of questions that can be used to
determine if a worker should be classified as an employee or an
independent contractor.
Threat 6Theft or Fraudulent Distribution of Paychecks
Another major threat is the theft of paychecks or the issuance of
paychecks to fictitious or terminated employees.
The controls related to other cash disbursements, discussed in
Chapter 11, also apply to payroll:
1. Access to blank payroll checks and to the check signature
machine should be restricted.
2. All payroll checks should be sequentially prenumbered and
periodically accounted for.
3. The cashier should sign all payroll checks only when
supported by proper documentation (the payroll register
and disbursement voucher).
4. Someone independent of the payroll process should
reconcile the payroll bank account.
A separate payroll bank account provides additional protection
against forgery or alteration.

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It is also important that someone who does not authorize or record

payroll should distribute paychecks and control the transfer of
funds for direct deposit.
Special procedures should be used to handle unclaimed paychecks
because they indicate the possibility of a problem, such as a
nonexistent or terminated employee.

General Controls
As for other disbursements, there are two general threats: 1) the loss,
alteration, or unauthorized disclosure of data and 2) poor performance.
Threat 7Loss, Alteration, or Unauthorized Disclosure of Data
Backup and disaster-recovery procedures provide the best controls for
reducing the risk of payroll data loss.
Physical and logical access controls are important preventive measures
to mitigate this threat.
Access and processing integrity controls are also needed to ensure the
confidentiality and accuracy of payroll cycle data transmissions.
Finally, protecting the privacy of employee data also is important.
Threat 8Poor Performance
Preparing and reviewing performance reports is an effective means of
addressing the threat of poor performance.
Careful monitoring of employees productivity is necessary to determine
if the employee is working the hours in which they are getting paid for.
Also, that the employees are not conducting personal business during
working hours, such as using the companys computer to send personal emails or shopping on the Internet.
Training is also important. It is estimated that training costs
represent 2 percent of total labor costs for manufacturing companies.
Online classes provide a means to reduce training costs.

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