Payroll and Production CAS 265 – Communicating deficiencies in internal control to those charged with governance and management CAS 300 – Planning an audit of financial statements CAS 315 – Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment CAS 320 - Materiality in Planning and Performing an Audit CAS 330 - The Auditor’s Response to Assessed Risk CAS 500 – Audit Evidence CAS 530 – Audit Sampling

Risk Assessment Production accounting requires flexibility and judgement. A main source of risk in the production process. The main risk related to payroll relates to the ownership assertion.

Production Process The production cycle includes transactions that flow through the following business activities: Most of the transactions in a production cycle are cost accounting allocations, unit cost determinations and standard cost calculations. Think of the audit of inventory as two phases:

Production Process Start Here Determine cost of goods sold Production planning Production Process Cost accounting Inventory planning Produce goods and services

Authorization of the Production Process Production planning starts with a sales forecast and interacts with inventory planning to create production orders.

Custody of Production Items Supervisors and workers have physical custody of materials, equipment and labour while production work is performed.

Cost Accounting When production is complete, production records including the production orders and materials and labour records are sent to the cost accounting department.

Periodic Reconciliation As with financial accounting records,

Documentary Audit Evidence Production accounting systems produce timely reports to supervise and control production. These can be used as supporting evidence for assertions:

Control Risk Assessment Accounts include:

General Controls Proper segregation of responsibilities for authorization, custody, recording and reconciliation: Controls should produce evidence to allow for detail control checking procedures. Complex computer systems could be used extensively The use of Internal Control Questionnaires.

Test of Controls Tests of controls should address all of the control objectives required for the audit What should these tests include:

Direction of Testing - completeness Bill of materials. Labour hour needs. Match details START Sample of production orders Issue slips. Materials-used report. Production cost reports Trace bill of materials to the documents. Labour reports. Production cost reports Trace labour hours to the documents. Check the sample documents are authorized. Production Planning Department Cost Accounting Department

Direction of Testing - validity Recalculate costs. (Accuracy) Find cost reports for the sample Issue slips. Materials-used report. Vouch materials. (Validity) Sample of Production cost reports START Materials requisitions. Bill of materials General Ledger Inventory Account Vouch labour costs. (Validity) Vouch overhead. (Accuracy, validity) Compare materials. (Accuracy) Labour reports. Overhead schedules Production Cost Accounting Department

Final Assessment of Controls The purpose of testing controls is to determine nature, extent, and timing of substantive procedures. i.e. The same as the other cycles

Substantive Procedures of the Production Process. What are substantive procedures, and what do they do? The auditor’s assessment of risk is used to adapt the procedures to the audit engagement. This will include analytical procedures Tests of transactions and balances. E.g. RM - Select items from the inventory balance WIP – OH –

The Payroll Cycle Personnel management and the payroll accounting process include transactions that affect the wage and salary accounts and a number of related accounts: Personnel and Labour Relations: Hiring and firing. Supervision: Approval of work time. Timekeeping and cost accounting: Payroll preparation and cost accounting. Payroll Accounting: Cheque preparation and related payroll reports. Payroll Distribution: Actual custody and distribution to employees.

Payroll Process Start Here Cash disbursement Personnel hiring / firing Payroll distribution Payroll Process Compensation determination Payroll accounting Supervision, attendance, and work

Authorization of the Payroll Process A personnel department independent of other functions should have authority for hiring and terminating employees. Direct supervisors should approve

Custody Custody for the payroll process includes Access to documents

Recordkeeping The payroll accounting function should prepare the cheques and related tax reports.

Periodic Reconciliation Payroll bank accounts can be reconciled like any other bank account. In addition, payroll tax returns, and labour reports prepared for production provide other avenues for reconciliation

Sources of Audit Evidence Payroll systems produce numerous reports that can be used as supporting evidence for assertions. Personnel Files - Detailed individual employees files (existence). Timekeeping Records - Detailed records of hourly workers’ time. Payroll Register - A special journal containing detailed pay information. Labour Cost Analysis - Labour cost information used for purposes such as reconciliation and distribution of labour rates. Government and Tax Reports year-to-date earnings records employee T-4 reports

Control Risk Assessment The major risks in the payroll cycle are

General Control Considerations Proper segregation of responsibilities Custody of payroll distribution by persons Recordkeeping is performed by

Computer-Based Payroll With computer-based payroll, various records and approval signatures may not exist. Information about payroll is often gathered

Detailed Test of Controls Tests of controls should address all of the control objectives. Tests include: Note dual direction of testing for completeness and validity

Testing of Payroll – dual direction Trace rates. Trace to authorizations Vouch rates Sample of Personnel Files Sample of Payroll Registers Authorization Files Trace deductions Vouch deductions Personnel Department Payroll Department

Computerized Payroll Processing Payroll processing and payroll register preparation are usually the first computer applications a business implements.

Control Risk Assessment The purpose of testing controls is to determine Good controls – low control risk: Poor controls – high control risk:

Substantive Procedures of the Payroll Process. What do substantive procedures do? Analytical procedures

Substantive Procedures of the Payroll Process. Tests of transactions and balances For a sample of employee payroll payments:

Sample of payroll register entries Problem EP 13-5, Page 739 The diagram below describes several payroll test of control procedures. It shows the direction of the tests, leading samples of time cards, payrolls, and cumulative year-to-date earnings records to rectangles. Required: For each of the red rectangles, write a payroll test of controls and describe the evidence it can produce. Trace time (1) Sample of clock cards Trace (6) Year-to-date records Payroll register Recalculate (3) Reconcile all (6) Vouch time (2) Sample of payroll register entries Management reports Clock Cards Trace (7) Vouch cheques (4) Vouch transfer (5) General Ledger Trace (7) Bank statement

Problem EP 13-8, Page 741 The diagram below describes several cost accounting test of control procedures. It shows the direction of the tests, leading samples of cost accounting analyses, management reports, and the general ledger. Required: For each of the rectangles, write a cost accounting test of controls and describe the evidence it can produce. Clock Cards (2) Payrolls (1) Management Reports (3) Sample of cost accounting analyses General Ledger Cost Accounting Analyses (4) Sample from GL Sample of management reports Vouch time Trace Reconcile Vouch supporting analyses