Lecture 9

Auditing of Payroll Cycle

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Learning Outcomes

 Design and explain the analytical

procedures for payroll
 Identify the accounts and transactions
in the payroll and personnel cycle
 Describe the business functions and
the related records in the payroll and
personnel cycle.
 Design and perform tests of controls
and substantive tests of transactions
and balances for the payroll and
personnel cycle.
 Perform analytical procedures for the
payroll and personnel cycle.
Payroll transactions

 A payroll transaction usually begins with an

employee performing some job and recording
the time spent on a time card or job ticket.
 The time card is approved by a supervisor
before forwarding to payroll department.
 The data are then reviewed and sent to IT
department for processing.
 Finally payment is made directly to the
employee or TT to the employee’s bank
account
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.
Accounts in the Payroll and
Personnel Cycle
Accrued Wages, Salaries, Direct
Bonuses, and Commissions Labor
Payment Beginning
Cash in Bank balance
Payment for Earned wages,
salaries salaries, etc.
Payment for Ending balance
payroll taxes
Withheld Income Taxes
and Other Deductions
Payment Beginning
balance
Payroll
withholding
Ending balance
 Accounts in the Payroll and
Personnel Cycle
Withheld Income Taxes
and Other Deductions
Payment Beginning
Cash in Bank balance
Payment for Payroll
salaries withholding
Payment for Ending balance
payroll taxes
Accrued Payroll
Payroll Tax Expense Tax Expense
Payment Beginning
balance
Payroll
tax expense
Ending balance
Payroll and accounts
related transactions
1)Types of transactions-Payroll
 Accounts affected: Cash, Inventory, direct and indirect
expense, various payroll-related liability and expenses
2)Types of transactions-accrued payroll liability
transactions
 Accounts affected: Cash, various accruals (such as EPF,
Socso and pension costs)
Types of documents and
records
 Personnel Records
 Deduction authorisation form
 Time card
 Payroll cheque
 Payroll Journal /Register
 Payroll Master File
 Payroll Master file changes report
 Periodic Payroll Reports
 Various Tax Reports and Forms
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.
Objectives of a wages system
(control objectives)
 Employees are only paid for the work that they have
done
 Correct payments made to the Inland Revenue
 Wages and salaries have been calculated correctly
 Only real employees are paid
Major Functions

 Personnel- Authorisation of hiring,

firing, wage-rate and salary
adjustments, salaries and payroll
deductions
 Supervision-Review and approved of
employees’ attendance and time
information, monitoring of employee
scheduling, productivity and payroll
cost, variances
 Timekeeping-Processing of employees’
attendance and time information and
coding of account distribution.
Major Functions

 Payroll processing-Computation of gross pay,

deductions and net pay, recording and summarisation of
payments and verification of account distribution.
 Disbursement-Payment of employees’ compensation
and benefits
 General ledger-Proper accumulation, classification and
summarisation of payroll in the GL
Business Functions in the Cycle and Related
Documents and Records

The payroll and personnel cycle….

Begins Hiring of personnel

Ends Payments
Controls over hiring employees,
authorising payroll changes and
preparing attendance and
timekeeping
 data.controls are needed to
Hiring employees:
prevent the creation of fictitious
employees through which wages can be
redirected to the perpetrator of the
fraud.
 Authorising payroll changes: changes such
as promotions and pay rate increases
provide a fraud threat through the
overpayment of wages.
 Preparing attendance and timekeeping
data: employees need to clock on and off
in a way that ensures they are only paid
for hours actually worked. The payroll
may be prepared straight from this data.
i. Personnel and Employment

 Personnel records

 Deduction authorization form

 Rate authorization form

ii. Timekeeping and Payroll
Preparation
Time Card
Job Time Ticket
Payroll Transaction File
Payroll Journal

Timekeeping and
Payroll Preparation
iii. Payment of Payroll

 Payroll cheques / Telegrahic Transfer

 Payroll bank account reconciliation

iv. Preparation of payroll tax
returns and payment taxes

-EA form
-Payroll tax returns
 Methodology for Designing
Controls and Substantive Tests
Understand & document internal control – HRM process

Planning (Assess planned control risk )

Determine extent of testing controls

Audit procedures
Design tests of controls and
substantive tests of transactions Sample size
for payroll and personnel to meet Items to select
transaction-related audit objectives/assertions
Timing
Understand and document Internal
Control –Payroll and Personnel Cycle
-Refer to the 5 components
 Adequate separation of duties
 Proper authorization
 Adequate documents and records
 Physical control over assets and records
 Independent checks on performance
Examples of control
environment
 The entity’s organizational structure, its
personnel practices and its methods
used to assign authority and
responsibility must be examined.
 The entity should have sound policies
hiring, training, promoting and
compensating employees (includes
specific authority & responsibilities for
hiring & firing of employees, for setting
wage rates & making salary changes &
establishing benefits).
Payroll Tax Forms and
Payments
 Preparation of payroll tax forms

 Timely payment of the payroll taxes

withheld and other withholdings
Inventory and Fraudulent
Payroll Considerations
 Relationship between payroll
and inventory valuation

 Tests for nonexistent employees

 Methodology for Designing
Tests
of Balances
Identify for Payroll
client business
Liabilities
risks affecting Phase I
payroll liability accounts

Set tolerable misstatement

and assess inherent risk Phase I
for payroll liability accounts

Assess control risk for the

Phase I
payroll and personnel cycle
 Methodology for Designing
Tests
of Transactions/Balances
Design and perform for
Payroll
tests Liabilities
of controls and
substantive tests
Phase II
of transactions
for the payroll and
personnel cycle
 Methodology for Designing
Tests
of Balances
Design for Payroll
and perform
Liabilities
analytical procedures
Phase III
for the payroll and
personnel cycle
Design tests of Audit procedures
details of payroll
accounts balances Sample size
Phase III
to satisfy Items to select
balance-related
audit objectives Timing
 Analytical Procedures for the
Payroll and Personnel Cycle
Analytical procedure Possible misstatement

Compare payroll expense Misstatement of payroll

account balances with expense accounts
previous years

Compare direct labor as a Misstatement of direct

percentage of sales with labor and inventory
previous years
 Analytical Procedures for the
Payroll and Personnel Cycle
Analytical procedure Possible misstatement

Compare commission expense Misstatement of

as a percentage of sales with commission expense
previous years and commission liability

Compare payroll tax expense Misstatement of payroll

as a percentage of salaries and tax expense and payroll
wages with previous years tax liability

Compare accrued payroll tax Misstatement of accrued

accounts with previous years payroll taxes and expense
 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
Tests of Details of Balances
for Expense Accounts
 Officers’ compensation
 Commissions

 Payroll tax expense

 Total payroll
 Contract labor
Presentation and Disclosure
Objectives
 Required disclosures are not extensive

 Some complex transactions require

footnote disclosure
An imprest payroll account

An imprest payroll account is a separate

payroll bank account in which a constant
balance, either zero or small, is
maintained. When a payroll is paid, the
exact amount of the net payroll is
transferred by check or electronic funds
transfer from the general account to the
imprest account. The purpose and
advantage of an imprest payroll account is
that it limits the company's exposure to
payroll fraud by limiting the amount that
may be misappropriated.
End of Lecture