McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Auditing the Human Resource Management Process Chapter Twelve

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Overview of the Human Resource Management Process The human resource process starts with the establishment of sound policies for hiring, training, evaluating, counseling, promoting, compensating and taking remedial actions for employees. The main concern of the auditor involves payroll transactions once an employee has been hired.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Flowchart for EarthWear Clothiers Human Resource Departments By date  OperatingPayroll Initiates personnel changes Payroll master file changes Reviews master file change report Review Payroll master file changes Time sheets Approved by supervisor  Time sheets Input Error corrections From IT To IT

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Flowchart for EarthWear ClothiersDepartments PayrollIT Payroll master file Error report Payroll processing Payroll cheques Payroll register Error corrections Payroll register Review by date Payroll master file changes report Payroll reporting General ledger Periodic payroll reports Tax reports and forms

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Two types of transactions are typically processed through the human resource management process: 1.Payments to employees for services rendered. 2.Accrual and payment of payroll-related liabilities arising from employees’ services, including liabilities for payroll taxes and pensions. Types of Transactions and Financial Statement Accounts Affected

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Financial Statement Accounts Affected

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Types of Documents and Records

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 The Major Functions

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Segregation of Duties

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Inherent Risk Assessment In assessing inherent risk the auditor may want to consider the effect of economic conditions on payroll costs, the supply of skilled workers and the frequency of employee turnover. The auditor should be familiar with any existing labour contracts and the impact of regulation on the company. The inherent risk associated with non-officers of the company is generally considered low. The inherent risk associated with officers of the company may not be considered low because of the ability to take advantage of their high position.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Control Risk Assessment Understand and document the human resource management process based on a reliance approach. Set and document the control risk for the human resource management process. Plan and perform tests of controls on payroll transactions.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Control Activities and Test of Controls – Payroll Transactions Occurrence of Payroll Transactions The auditor want assurance that payments for payroll-related services are being made to valid employees for time actually worked. Controls must be in place to ensure that no payments are made to fictitious employees and payments to valid employees are stopped once the employee is terminated.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Control Activities and Test of Controls – Payroll Transactions Authorization of Payroll Transactions The client must have controls for hiring and terminating employees, setting pay rates, making withholdings, awarding benefits, making direct deposits to employees’ accounts and issuing payroll cheques.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Control Activities and Test of Controls – Payroll Transactions Accuracy of Payroll Transactions The auditor’s main concern is that the employee’s gross pay and payroll deductions may be incorrectly computed.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Control Activities and Test of Controls – Payroll Transactions Classification of Payroll Transactions If payroll expense is charged to the wrong accounts, the financial statement may be misstated. If payroll expense is not properly classified between direct and indirect labour, inventory and cost of goods sold may not be valued properly.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Relating the Assessed Level of Control Risk to Substantive Procedures If the results of the tests of controls for the payroll system support the planned level of control risk, the auditor conducts substantive procedures of payroll-related accounts at the assessed level. If the tests do not support the level of control risk, the nature and extent of substantive testing will be increased.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Auditing Payroll-Related Accounts Substantive Analytical Procedures

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Tests of Detail of Transactions, Account Balances and Disclosures

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Tests of Detail of Transactions, Account Balances and Disclosures

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Tests of Detail of Transactions, Account Balances and Disclosures

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Payroll Expense Accounts Payroll transactions affect many expense accounts, including direct and indirect manufacturing expense, general and administrative salaries, sales salaries, commissions and payroll tax expenses. If the entity’s internal control is reliable, the auditor does not need to conduct detailed tests of all these payroll expense accounts. Additional testing is necessary only when control deficiencies exist.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Accrued Payroll Liabilities The entity incurs a number of liabilities including payroll taxes withheld, medical and life insurance premiums, pension and other miscellaneous deductions. Accrued wages and salaries Accrued payroll taxes Accrued commissions Accrued bonuses Accrued benefits (vacation & sick pay)

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Accrued Payroll Liabilities Cut-off An examination of supporting documentation for the accruals provides evidence on the proper period for recording the expense or liability.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Accrued Payroll Liabilities Existence and Valuation To verify the existence and valuation of an accrued payroll liability, the auditor can trace the amounts included on the account analysis working paper to supporting documentation such as payroll tax reports.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Accrued Payroll Liabilities Completeness The auditor must be aware of the normal payroll-related taxes that are paid by the entity and therefore should be able to determine if accruals have been made for payroll taxes such as social security taxes.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Accrued Payroll Liabilities Presentation and Disclosure Completeness Assertion

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 Evaluating the Audit Findings The auditor compares the aggregated identified misstatement to materiality to determine if the identified misstatement would affect the audit. The auditor requests the client to correct the identified misstatements and then compares the uncorrected misstatements with materiality to conclude whether the financial statements are fairly stated. If uncorrected misstatements in payroll-related accounts, and when considered together with other uncorrected misstatements, are less than materiality, the auditor may accept that the financial statements are fairly presented. Conversely, if the uncorrected misstatement exceeds the materiality, the auditor should conclude that the financial statements are not fairly presented.

McGraw-Hill/Irwin © The McGraw-Hill Companies 2010 End of Chapter 12