Planning

Planning the
the Audit
Audit of
of the
the
Personnel
Personnel Services
Services Cycle
Cycle
An entity’s personnel services cycle involves
the events and activities that pertain to
executive and employee compensation. The
types of compensation include salaries,
hourly and incentive (piecework) wages,
commissions, bonuses, stock options, and
employee benefits. The major class of
transactions in this cycle is payroll
transactions. The accounts affected by
these transactions are shown in Figure 16-9.
Control
Control Risk
Risk Assessment
Assessment Considerations
Considerations
for
for Payroll
Payroll
Figure
Figure 16-9
16-9
Selected
Selected Specific
Specific Audit
Audit Objectives
Objectives for
for the
the
Personnel
Personnel Services
Services Cycle
Cycle
Figure
Figure 16-10
16-10
 Planning
Planning the
the Audit
Audit of
of the
the
Personnel
Personnel Services
Services Cycle
Cycle
Using the Understanding of the
Business and Industry to Develop
Audit Strategy
Personnel services may vary in
importance to various manufacturers,
wholesalers, and retailers. Some
industries may vary widely on the labor
intensiveness of the manufacturing
process.
 Planning
Planning the
the Audit
Audit of
of the
the
Personnel
Personnel Services
Services Cycle
Cycle
Before proceeding with the audit of personnel
services, it is important for the auditor to
understand:
1. The importance of personnel services to the
overall entity.
2. The nature of compensation, as hourly
compensation requires a different control system
than salaried compensation.
3. The importance of various compensation
packages such as bonuses, stock options and
stock appreciation rights, and pension
agreements.
 Planning
Planning the
the Audit
Audit of
of the
the
Personnel
Personnel Services
Services Cycle
Cycle
Materiality
For software companies and service firms
such as banks, insurance companies, and
professional firms, personnel services is a
major expense. The growth of the service
sector in the U.S. economy and the
importance of human capital to the value
of many technology and software
companies makes the personnel services
cycle a material audit area for many
companies.
 Planning
Planning the
the Audit
Audit of
of the
the
Personnel
Personnel Services
Services Cycle
Cycle
Inherent Risk
The auditor is rarely concerned about the
completeness assertion in the payroll cycle as
most employees quickly follow up with their
employers if they are not paid. However,
payroll fraud (existence or occurrence) is a
major concern for the auditor. Fraud may
occur at 2 levels. Employees involved in
preparing and paying the payroll may process
data for fictitious employees and then divert
the paychecks to their own use.
 Planning
Planning the
the Audit
Audit of
of the
the
Personnel
Personnel Services
Services Cycle
Cycle
Alternatively, management may overtly
misclassify or “pad” labor cost in government
contract work to defraud the agency.
Inherent risk may be high for the existence or
occurrence, valuation or allocation, and
presentation and disclosure assertions.
 Planning
Planning the
the Audit
Audit of
of the
the
Personnel
Personnel Services
Services Cycle
Cycle
Analytical Procedures
The auditor will normally perform analytical
procedures early in the audit of the
personnel services cycle because they are
cost effective. Examples of analytical
procedures that the auditor might use are
presented in Figure 16-11. Analytical
procedures may be useful in identifying
potential fraud such as when gross payroll
per employee exceeds the auditor’s
expectations.
Analytical
Analytical Procedures
Procedures Commonly
Commonly Used
Used to
to
Audit
Audit the
the Personnel
Personnel Services
Services Cycle
Cycle
Figure
Figure 16-11
16-11
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
Common Documents and Records
The following documents and records are important in
executing and recording payroll transactions:
1. Personnel authorization. Memo issued by personnel
department indicating the hiring of an employee and
each subsequent change in the employee’s status for
payroll purposes.
2. Clock card. Form used by each employee to record
hours worked daily during a pay period. It is used with
time clocks that record the time on the card. This and
the following form may be replaced in modern systems
with an employee badge that is inserted into a terminal
to cause an electronic record of the time to be made.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
3. Time ticket. Form used to record time worked by an
employee on specific jobs. Time worked is often
machine imprinted.
4. Payroll Register. Report showing each employee’s
name, gross earnings, payroll deductions, and net pay
for a pay period. It provides the basis for paying
employees and recording the payroll.
5. Imprest payroll bank account. Account to which a
deposit equal to the total net payroll is made each pay
period, and on which checks for salaries and wages for
employees are drawn.
6. Payroll check. Order drawn on a bank to pay an
employee. It is accomplished by a detachable memo
indicating gross earnings and payroll deductions.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
7. Labor cost distribution summary. Report showing the
account classifications for gross factory earnings for
each pay period.
8. Payroll tax returns. Forms prescribed by tax
authorities for filing with payments of taxes withheld
from employees and employer’s payroll taxes for social
security and federal and state unemployment.
9. Employee personnel file. Holds pertinent employment
data for each employee and contains all personnel
authorizations issued for the employee, job evaluations,
and disciplinary actions, if any.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
10. Personnel data master file. Computer file containing
current data on employees needed for calculating
payroll such as job classification, wage rate, and
deductions.
11. Employee earnings master file. Computer file
containing each employee’s gross earnings, payroll
deductions, and net pay for the year to date by pay
periods.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
Functions and Related Controls
The processing of payroll transactions involves
the following payroll functions:
1. Initiating payroll transactions, including:
 Hiring employees.
 Authorizing payroll changes.
2. Receipt of services, including:
 Preparing attendance and timekeeping
data.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
3. Recording payroll transactions, including:
 Preparing and recording the payroll.
4. Paying payroll, including:
 Paying the payroll and protecting
unclaimed wages.
 Filing payroll tax returns.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
Obtaining an Understanding and
Assessing Control Risk
The procedures used to obtain and document
the understanding of the internal control
components for payroll transactions are the
same as for the other major classes of
transactions. The process of assessing
control risk for payroll transactions begins
with identifying potential misstatements and
necessary controls.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
In assessing control risk, the auditor realizes
that misstatements in payroll may result from
unintentional errors or fraud. Of particular
concern is the risk of overstatement of payroll
through the following:
1. Payments to fictitious employees
2. Payments to actual employees for hours not
worked
3. Payments to actual employees at higher
than authorized rates
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
2 tests of controls pertaining to
control risk for the existence or
occurrence assertion are:
1. the test for terminated
employees and
2. witnessing a payroll
distribution.
 Control
Control Activities
Activities —
—
Payroll
Payroll Transactions
Transactions
In witnessing the distribution of payroll
checks, the auditor observes that:
1. Segregation of duties exists between the
preparation and payment of the payroll
2. Each employee receives only one check
3. Each employee is identified by a badge or
employee ID card
4. There is proper control and disposition of
unclaimed checks
 Substantive
Substantive Tests
Tests of
of
Payroll
Payroll Balances
Balances
Determining Detection Risk
Factors contributing to high inherent risk for existence or
occurrence and valuation or allocation assertions related
to payroll transactions have been noted earlier. However,
evidence of effective controls over these risks in many
cases permits low assessments of control risk, resulting
in moderate or high acceptable levels of detection risk for
most or all payroll assertions. Consequently, substantive
tests of payroll balances are often limited to applying
analytical procedures to the expense accounts and related
accruals, and limited tests of details. If the analytical
procedures reveal unexpected fluctuations, more
extensive tests of details will be required.
 Substantive
Substantive Tests
Tests of
of
Payroll
Payroll Balances
Balances
Designing Substantive Tests
Audit program considerations for accrued
payroll liability balances are similar to those
identified in Figure 15-10 for accounts payable.
However, the auditor does not confirm payroll
liabilities. When no unexpected fluctuations are
revealed by analytical procedures, the auditor
has obtained evidence in support of audit
objectives related to the existence or
occurrence, completeness, and valuation or
allocations assertions.
 Substantive
Substantive Tests
Tests of
of
Payroll
Payroll Balances
Balances
Text explanations of specific substantive
tests for payroll balances are limited to
the following procedures:
1. Recalculating accruals
2. Auditing employee benefits and
pension plans
3. Auditing stock options and stock
appreciation rights
4. Verifying officers’ compensation
Value-Added
Value-Added Services
Services in
in the
the
Personnel
Personnel Services
Services Cycle
Cycle
Personnel management is a core process for
many companies. The primary issue is how the
auditor uses the knowledge obtained during the
audit to provide value-added services to his or
her client. When performing the audit, many
CPAs monitor revenue per employee and
evaluate performance relative to others in the
industry. CPAs who understand the industry
can often help clients identify opportunities
that may exist in growing revenue per
employee.
Value-Added
Value-Added Services
Services in
in the
the
Personnel
Personnel Services
Services Cycle
Cycle
When auditing expenses and profitability, a CPA
will often evaluate employee productivity
statistics. CPAs are often skilled at developing
means to hold responsibility centers
accountable for their use of resources — in this
case, the payroll resource. CPAs may assist
clients by:
1. suggesting appropriate measures of employee
productivity or by
2. Identifying steps that a client may take to
improve employee productivity.