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AUDITING CHAPTER 14 Control & Substantive Tests in Personnel & Payroll
By David N. Ricchiute
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TOPICS Nature personnel, payroll functions
Controls over personnel, payroll activities Auditor’s consideration of controls Substantive tests of payroll accounts Earnings manipulation in payroll, postretirement benefits GBW 8th ed., Ch. 14
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NATURE OF PERSONNEL, PAYROLL CYCLE
Resources (services) acquired in exchange for obligations to pay Obligations to employees are paid GBW 8th ed., Ch. 14
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PERSONNEL, PAYROLL DOCUMENTS
Personnel records Time record Payroll register Employee earnings record GBW 8th ed., Ch. 14
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PERSONNEL RECORDS Salary or wage rates Payroll deductions
Employee signatures Job classification Performance evaluation GBW 8th ed., Ch. 14
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INTERNAL CONTROL OBJECTIVES
Authorization Execution Recording Access to assets Segregation of duties GBW 8th ed., Ch. 14
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AUTHORIZATION: Objective, Errors, Procedure
Objective Error Procedure Employees hired according to criteria Excessive training, relocation costs; equal opportunity Clear hiring policies, procedures; updated records Compensation deductions according to authorization Excessive labor costs; violation union contracts; inaccurate accruals Updated listings pay rates, deductions; review, approval Adjustments authorized Increased pay, overstated labor costs Clear adjustment policies, procedures GBW 8th ed., Ch. 14
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EXECUTION: Objective, Errors, Procedure
Objective Error Procedure Payroll, personnel procedures authorized Misappropriated cash from paychecks for terminated, fictitious employees Personnel, payroll procedures manual Periodically verify employee assignments All payroll disbursements for recognized liability Misappropriated cash, overstated labor costs Prenumber, control time records, paychecks, adjustment forms; dual signatures GBW 8th ed., Ch. 14
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RECORDING: Objective, Errors, Procedure
Objective Error Procedure Amounts due employees at proper amounts, time periods, classification Payroll costs inaccurate; misstated expenses; details do not agree Document account distribution procedures; reconcile ledgers, journals; physical barriers unused documents, forms GBW 8th ed., Ch. 14
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ACCESS: Objective, Errors, Procedure
Objective Error Procedure Access to personnel, payroll records, forms, documents restricted to authorized personnel Records, forms, documents misused; unauthorized labor costs Prenumber, control forms, documents; Segregate authorizing, executing, recording; maintain listings authorized signatories GBW 8th ed., Ch. 14
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CONSIDERING INTERNAL CONTROL: Payroll
Obtain understanding Preliminary review Document system Perform transaction walk-through Determine whether controls are potentially reliable in assessing control risk below maximum Test controls GBW 8th ed., Ch. 14
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TESTS OF CONTROLS: Personnel & Payroll
Obtain payroll register Verify mathematical accuracy Obtain payroll summary, labor distribution Verify accuracy of summaries; compare totals to payroll register Trace totals to GL & cost accounting records Select random sample employees & obtain personnel file Examination for completeness, authorization Compare pay rates, deductions Trace from register to employee records GBW 8th ed., Ch. 14
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TESTS OF CONTROLS: Distribution Paychecks
Obtain sample canceled payroll checks Trace details to payroll register Compare endorsements to signatures in file Personally distribute checks to properly identified employees GBW 8th ed., Ch. 14
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ASSESS CONTROL RISK Review system documentation
Review results of controls tests Determine whether existing controls are Effective Can be relied upon to Assess control risk below maximum Assess detection risk above minimum Restrict substantive tests of payroll GBW 8th ed., Ch. 14
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SUBSTANTIVE TESTS: Payroll
Obligations, Valuation Determine by analytical procedures, reasonableness Obligations, Valuation, Completeness Determine reasonableness of accruals Presentation & Disclosure Review to determine classification, adequate disclosures GBW 8th ed., Ch. 14
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ANALYTICAL PROCEDURES: Payroll & Accruals
Compare ratios Total payroll expenses & accrued expense with prior years; & adjusted for pay rate changes Direct labor to budgets, sales, prior years Commissioned sales payroll: sales X average commission rates Payroll tax expense to payroll with prior years GBW 8th ed., Ch. 14
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MANIPULATED EARNINGS: Capitalized Costs at Safety-Kleen
CEO, CFO, others capitalized payroll costs to “unrealized contingent-contract claims” to understate period expenses Board investigation reduced income for 1997 – 1999 by $534 million SEC filed suit alleging management falsely represented financial statements GBW 8th ed., Ch. 14
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POST RETIREMENT BENEFITS: Health Care
Benefits based on estimates Off-balance sheet financing Pay-as-you-go system Management incentives to minimize for little earnings effect Auditor incentives to ensure fair presentation GBW 8th ed., Ch. 14
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AUDIT JUDGMENT Required for
Postretirement benefits other than pensions Health care obligations GBW 8th ed., Ch. 14
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