Auditing the Payroll Cycle

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Auditing the Payroll Cycle
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Transactions

• Personnel services or payroll cycle involves the
  activities that pertain to executive and employee
  compensation.
• The type of compensation include salaries, hourly
  and incentive (piecework) wages, commissions,
  bonuses, stock options, and employee benefits
  (e.g., health insurance and paid vacations).

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Audit Objectives

• Existence or occurrence
• Transactions
• Recorded payroll expenses and payroll tax
  expenses relate to compensation for services
  rendered during the period
• Accounts balances
• Accrued payroll and payroll tax liability
  balances represent amounts owed at the balance
  sheet date.

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Audit Objectives

• Completeness
• Transactions
• Recorded payroll expenses and payroll tax
  expenses include all such expenses incurred for
  personnel services during the year.
• Accounts Balances
• Accrued payroll and payroll tax liabilities
  include all amounts owed to personnel and
  governmental agencies at the balance sheet date.

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Audit Objectives

• Rights and obligations
• Transactions
• All recorded transactions represent the
  obligations or the rights of the entity.
• Accounts Balances
• Accrued payroll and payroll tax liabilities are
  obligations of the reporting entity.

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Audit Objectives

• Valuation or allocation
• Transactions
• Payroll expenses and payroll tax expenses are
  accurately computed and recorded.
• Accounts Balances
• Accrued payroll and payroll tax liabilities are
  accurately computed and recorded.
• Factory labor distributions are correctly
  computed and recorded.

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Audit Objectives

• Presentation and disclosure
• Transactions
• Payroll expenses and payroll tax expenses are
  properly identified and classified in the income
  statement.
• Accounts Balances
• Accrued payroll and payroll tax liability
  accounts are properly identified and classified
  in the balance sheet.
• The financial statements include appropriate
  disclosures for pension and other benefit plans.

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Inherent Risks

• Employees involved in preparing and paying the
  payroll may process data for fictitious employees
  and divert the paychecks to their own use.
• Management may overtly misclassify or pad labor
  cost in government contract work to defraud the
  agency.
• Pay periods may be weekly, bimonthly, or monthly,
  and in each case the volume of payroll
  transactions may be high.

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Inherent Risks

1. Gross earnings may be based on time and/or
   productivity, thus the computations may be
   complex and inherent risk for the valuation or
   allocation assertion may be high.
2. When there is frequent turnover of personnel,
   there is the risk that a terminated employee is
   continued on the payroll.
3. Companys benefit plans that involve stock
   options, stock appreciation rights, or pension
   plans involve both significant measurement and
   disclosures issues.

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Analytical Procedures
Ratio Formula Audit Significance
Average payroll cost per employee classification Total payroll costs for an employee group divided by the number of employees in the group Reasonableness test of gross payroll for group of employees.
Revenue per employee Total revenue the number of full time employees This is may be a measure of productivity per employee. This is particularly important in services industries and would be compared with industry statistics.
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Analytical Procedures
Ratio Formula Audit Significance
Total payroll costs as a percentage of revenues Total payroll expenses total revenues Reasonableness test of payroll costs. This is often compared with industry statistics.
Payroll tax expense as a percen-tage of gross payroll Total payroll tax expenses gross payroll Reasonableness test of payroll taxes. This can often be compared with standard tax rates.
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Analytical Procedures
Ratio Formula Audit Significance
Comparison payroll expenses with prior-year balances or budgets. Current-year payroll expenses prior-year payroll expenses Reasonableness test for payroll expenses if the ratio is significantly different from 1.0.
Compare current-year payroll liability with prior-year payroll liability. Current-year payroll tax liability prior-year payroll tax liability adjusted for growth in payroll volume Reasonableness test for payroll liability if the ratio is significantly different from 1.0
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Analytical Procedures
Ratio Forumula Audit Significance
Compute ratio of payroll tax expense to total payroll expenses Payroll tax expense total payroll expense Reasonableness test for payroll tax expense based on prior-year ratio of payroll tax expense to total payroll.
Employee benefits expenses as a percent of gross payroll Total benefits expenses gross payroll Reasonableness test of benefits expenses. This is often compared with industry statistics..
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Documents and Records

• Personnel authorization. Memo issued by personnel
  department indicating the hiring of an employee
  and each subsequent change in the employees
  status for payroll purposes.
• Clock card. Form used by each employee to record
  hours worked daily during a pay period.
• Time ticket. Form used to record time worked by
  an employee on specific jobs.
• Payroll register.

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Documents and Records

• Imprest payroll bank account
• payroll check
• Labor cost distribution summary
• Payroll tax returns
• Employee personnel file
• Personnel data master file
• Employee earnings master file

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Payroll Functions

1. Initiating payroll transaction, including (a)
   hiring employees, (b) authorizing payroll
   changes.
2. Receipt of services, including preparing
   attendance and timekeeping data.
3. Recording payroll transactions, including
   preparing and recording the payroll.
4. Paying payroll, including (a) paying the payroll
   and protecting unclaimed wages, (b) filing
   payroll tax returns.

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Substantive Tests

• The Types of Procedures
• Initial Procedures
• Analytical Procedures
• Tests of Details of Transactions
• Tests of Details of Balances
• Tests of Details of Balances Accounting
  Estimates
• Presentation and Disclosure

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Substantive Tests

• Initial Procedures
• Obtain understanding of business and industry and
  determine
• The significance of payroll costs to the
  business.
• Key economic drivers that influence payroll
  costs.
• The extent to which the client has defined
  benefit pension plans or uses other incentive
  compensation plans.

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Substantive Tests

• Initial Procedures
• Perform initial procedures on payroll balances
  and records that will be subjected to further
  testing.
• Trace beginning accrued payroll balances to prior
  years working papers.
• Review activity in payroll accounts and
  investigate entries that appear unusual in amount
  and source.
• Verify total of payroll registers and other
  subsidiary ledgers for agreement with general
  ledger balances.

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Substantive Tests

• Analytical Procedures
• Perform analytical procedures
• Review industry experience and trends
• Examine analysis of payroll costs
• Review relationship of payroll costs to recent
  production sales activities.
• Tests of Details of Transactions
• On a test basis, vouch payroll transactions to
  supporting documentation.
• On a test basis, vouch payroll tax transactions
  to supporting documentation.

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Substantive Tests

• Tests of Details of Transactions
• Verify officer compensation to board of director
  authorization.
• On a test basis, trace data from time cards and
  contracts to the payroll register.
• Test payroll cut-off at the end of the month
  (year) based on time periods worked and payroll
  accrual if month (year) end and the end of the
  payroll period do not match up.

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Substantive Tests

• Tests of Details of Balances
• Recalculate accrued payroll liabilities at
  year-end to underlying payroll records.
• Recalculate accrued payroll tax liabilities and
  vouch to subsequent cash disbursements.
• Determine the accrued payroll payables are the
  obligations of the entity.

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Substantive Tests

• Tests of Details of Balances Accounting
  Estimates
• Determine method of accounting of stock options,
  and recalculate stock option expense (or
  disclosure information)
• Presentation and Disclosure
• Compare statement presentation to GAAP
• Review presentation and disclosure
• Estimate completeness of presentation and
  disclosure
• Evaluate classification and understandability.

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Thank You