Audit of the Payroll and Personnel Cycle

Chapter 20

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Learning Objective 1
Identify the accounts and transactions in the payroll and personnel cycle.

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Accounts in the Payroll and Personnel Cycle

The overall objective in the audit of the payroll and personnel cycle is to evaluate whether the account balances affected by the cycle are fairly stated in accordance with generally accepted accounting principles.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Accounts in the Payroll and Personnel Cycle

Cash in Bank Payment for salaries Payment for payroll taxes Accrued Wages, Salaries, Bonuses, and Commissions Payment Beginning balance

Direct Labor

Earned wages, salaries, etc. Ending balance

Withheld Income Taxes and Other Deductions Payment Beginning balance Payroll withholding Ending balance

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Accounts in the Payroll and Personnel Cycle

In most systems the accrued wages and salaries account is used only at the end of an accounting period.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Learning Objective 2
Describe the business functions and the related documents and records in the payroll and personnel cycle.

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Business Functions in the Cycle and Related Documents and Records

The payroll and personnel cycle.

Begins

Personnel Hiring Payments

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Ends
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Personnel and Employment

Personnel records
Deduction authorization form Rate authorization form

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Timekeeping and Payroll Preparation

Time Card Job Time Ticket Payroll Transaction File

Payroll Journal

Timekeeping and Payroll Preparation

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Payroll Master File

A payroll master file is used for recording each payroll transaction for each employee and maintaining total employee wages paid for the year to date.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Payment of Payroll
Payroll check Payroll bank account reconciliation

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Preparation of Payroll Tax Returns and Payment of Taxes

W-2 Form
Payroll tax returns

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Learning Objective 3
Understand internal control and design and perform tests of controls and substantive tests of transactions for the payroll and personnel cycle.

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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Methodology for Designing Controls and Substantive Tests

Understand internal control payroll and personnel Assess planned control risk payroll and personnel Determine extent of testing controls Design tests of controls and Audit procedures substantive tests of transactions Sample size for payroll and personnel to meet Items to select transaction-related audit Timing objectives
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Understand Internal Control Payroll and Personnel Cycle

Adequate separation of duties

Proper authorization Adequate documents and records Physical control over assets and records Independent checks on performance

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Payroll Tax Forms and Payments

Preparation of payroll tax forms Timely payment of the payroll taxes withheld and other withholdings

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Inventory and Fraudulent Payroll Considerations

Relationship between payroll and inventory valuation Tests for nonexistent employees

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Methodology for Designing Tests of Balances for Payroll Liabilities

Identify client business risks affecting payroll liability accounts Phase I

Set tolerable misstatement and assess inherent risk Phase I for payroll liability accounts Assess control risk for the Phase I payroll and personnel cycle
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Methodology for Designing Tests of Balances for Payroll Liabilities

Design and perform tests of controls and substantive tests Phase II of transactions for the payroll and personnel cycle

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Methodology for Designing Tests of Balances for Payroll Liabilities

Design and perform analytical procedures Phase III for the payroll and personnel cycle Design tests of Audit procedures details of payroll Sample size accounts balances to satisfy Items to select balance-related Timing audit objectives
2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Phase III

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Learning Objective 4
Design and perform analytical procedures for the payroll and personnel cycle.

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Analytical Procedures for the Payroll and Personnel Cycle

Analytical procedure Possible misstatement

Compare payroll expense account balances with previous years Compare direct labor as a percentage of sales with previous years

Misstatement of payroll expense accounts Misstatement of direct labor and inventory

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Analytical Procedures for the Payroll and Personnel Cycle

Analytical procedure Compare commission expense as a % of sales with previous years Possible misstatement Misstatement of commission expense and commission liability

Compare payroll tax expense as a % of salaries and wages with prior year Compare accrued payroll tax accounts with prior year

Misstatement of payroll tax expense and payroll tax liability Misstatement of accrued payroll taxes and expense
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2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Learning Objective 5
Design and perform tests of details of balances for accounts in the payroll and personnel cycle.

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Two Major Balance-related Audit Objectives

1. Accruals in the trial balance are stated at the correct amounts (accuracy). 2. Transactions in the payroll and personnel cycle are recorded in the proper period (cutoff).

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Tests of Details of Balances for Liability Accounts

Amounts withheld from employees pay

Accrued salaries and wages Accrued commissions

Accrued bonuses
Accrued vacation pay, sick pay, or other benefits Accrued payroll taxes

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Tests of Details of Balances for Expense Accounts

Officers compensation Commissions

Payroll tax expense

Total payroll Contract labor

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Presentation and Disclosure Objectives

Required disclosures are not extensive Some complex transactions require footnote disclosure

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Types of Audit Tests for the Payroll and Personnel Cycle

Cash in Bank Payments
Audited by TOC, STOT, and AP

Payroll Liabilities

Direct Labor and Payroll Expenses Expenses

Audited by TOC, STOT, and AP

Ending balance

Ending balance

Audited by AP and TDB

TOC + STOT + AP + TDB = Sufficient appropriate evidence per GAAS

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End of Chapter 20

2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

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