CHAPTER THREE

3. AUDIT OF PAYROLL AND PERSONNEL CYCLE

What Is a Payroll Audit?
A payroll audit is a breakdown of a company’s payroll processes. It looks at aspects of a
company’s payroll such as the number of wages, employee pay rates, active employees, and
tax withholdings.
Businesses should carry out a payroll audit annually at least. This helps to check their
processes are accurate and legally compliant.
Introduction
As Government sets aside substantial amounts for salaries and allowances, the systematic and
proper management of the same should be ascertained by the audit of salaries and
allowances.
3.1 An Overview of the cycle

1
3.1.1 Documents and Records

o Personnel records – a document that records an employee’s data such as the date of
employment, rates of pay, authorized deductions, performance appraisal and termination
of employment, etc.
o Deductions authorization form – a form signed by the employee authorizing deduction
from his wages or salaries for contribution to superannuation plan, loan repayment or
others.
o Rate authorization form – a document authorizing the rate of pay (per hour, day, month)
of the employee by management, or, in the case of top management, by the board of
directors.
o Time card – a document indicating the starting and the ending time within which the
worker works each day. It is usually used for daily or hourly paid worker for calculating
the total hours of work each day.
o Job time card – a document indicating the particular job on which the worker has spent
on during a given period of time.
o Payroll cheque – It is usually issued for factory workers whose wages are not fixed
monthly.
o Bank transfer advice – a written advice to the company’s bank showing the names of
employees, their respective monthly salaries, bank account numbers and the total amount
to be transferred from the company’s payroll account to the employees’ accounts.
o Payroll journal – a journal for posting total payroll expense for the period to general
ledger account.
o Pay slip/salary slip – a document prepared individually for all employees for a particular
week or month showing the gross pay, deductions and net pay.
3.1.2 Control Risks Assessment of Payroll and Personnel Cycle
3.1.2.1 Importance of payroll and personnel cycle
The payroll and personnel cycle is important for several reasons:
(a) Salaries, wages and other staff costs are one of the major expenses in most
companies.
(b) Labor cost is one of the components of inventory costs in manufacturing and
construction companies.
(c) The improper classification and allocation of labour cost may have material
misstatement of net income.
(d) Significant resources can be lost because inefficiency or are susceptible to
fraud.
Assertions used by the auditor in payroll and personnel cycle
Classes of payroll transactions
2
 Assertions Descriptions
1. Occurrence Wages and salaries are only paid to non-fictitious
employees and for their work performed.
2. Completeness All existing payroll transactions are recorded in the
payroll and accounting records.
3. Accuracy Wages and salaries should be calculated based on work
performed and terms of employment.
4. Cut-off Payroll transactions should be recorded in the correct
period.
5. Classification Payroll transactions should be properly classified.

Classes of payroll expenses and related accruals

Assertions Descriptions
1. Existence Payroll expenses are valid and related accruals are valid
liabilities.
2. Rights and Recorded payroll expenses and related accruals are expenses
obligations and obligations of the entity.
3. Completeness All payroll expenses and related accruals have been recorded.
4. Valuation and Payroll expenses and related accruals are properly valued and
allocation allocated in accordance with accounting standards.

Payroll presentation and disclosure

Assertions Descriptions
1. Rights and All disclosed transactions relating to payroll expense and
obligations related accruals have occurred and pertain to the entity.
2. Completeness All payroll expenses and related accruals have been recorded in
the financial statements.
3. Classifications Financial information relating to payroll expense and related
accruals is appropriately presented and disclosed.
4. Valuation and Payroll expenses and related accruals are disclosed fairly and
allocation at appropriate amounts.
3.2 Key Internal control system
All public bodies should maintain an appropriate internal control system with regard to
controlling salaries and allowances including the following: -

3
 A. Personal files of employees
 ascertaining that the personnel section maintains adequate records regarding employees’
salary information (e.g. information originating from staff recruitment, the salary of
incoming and outgoing staff; changes in salary scales; changes in personal circumstances
that have an impact on salary, deductions and allowances; the amount of approved
deductions and the formal documents supporting the current level of payments);
 ensuring that staff employment, transfer, departure, change in salary, details of deductions
and the like are approved under the signature of an authorized official and sent to payroll
section before the payroll sheet is prepared;
 Ascertaining that the personal files of employees are in the safekeeping of a designated
staff member who is not part of the Accounts Division and Payroll Section.
B. Attendance sheet
 ensuring the accuracy of attendance sheets (or other documents confirming the
performance of distinct duties) and their approval by designated officials;
 ensuring that documents confirming entitlements to over-time or other monetary benefits
are signed by the immediate superior of the employee (the superior must not be engaged
in payroll preparation and effecting of salary payment);
 Verifying that duties such as ascertaining the accuracy of attendance sheets and the
preparation of payroll are not carried out by the same staff.
C. Payroll sheet
 checking that gross pay, deductions, allowances and unclaimed salary have been
computed accurately and on the basis of current scales and eligibility;
 ascertaining that the accuracy of payroll calculations is verified by a staff member
other than those preparing the payroll;
 Checking that staff engaged in payroll preparation and the computations of pay are
independent of staff engaged in the keeping of personnel files.
D. Deductions from salary
o Ensuring that deductions of a repetitive nature such as those for personal income tax,
pension, repayment of loan and the like, are allocated separate columns in the payroll
sheet;
o ascertaining that deductions other than those determined by law (such as deduction
for edir contribution, resettlement bank loan, family allowance, and the like) are
deducted from the salary of an employee only after a written application from the
employee is authorized by the concerned official and that such documents are kept in
the personal file of the employee;
o Checking that collections from salary deductions are paid to the concerned public
bodies and other beneficiaries in full and in a timely manner.
E. Payment of salary
4
  Checking that any changes to staff salaries, arising from such factors as the
employment of new staff, promotion, dismissal, fine or court judgment, are
communicated to the payroll section before the preparation of the payroll sheet;
 Assuring when allowances are paid in addition to basic salary, that documents exist in
the individual personnel files of officials and ordinary staff members receiving
allowances, which certify their eligibility to the allowances;
 Ascertaining that the payroll sheet prepared for effecting the payment of wages to
daily laborers is supported by contracts of employment and a signed attendance sheet;
 Confirming that the different duties in the payroll section ranging from initiation of
payroll calculations to delivering the payroll sheet for the effecting of salary payment
are carried out by different persons;
 Checking that the various staff members who are engaged in preparing, reviewing and
approving the payroll sign in their respective places on the payroll sheet;
 Ascertaining that the accuracy of details in the payroll sheet such as names, working
hours, over time, salary scale and the computation of deductibles, is verified by a staff
member who is entirely independent of those who have prepared the payroll sheet;
 Ensuring that the total salary payment for each month is compared with the payment
made in the previous month and that the causes of any difference are identified and
explained.
3.2.1 Internal controls and test of controls
Examples of internal control procedures for payroll and personnel cycle are as follows:
Assertions Internal Control Procedures Test of control
1. Occurrence  Proper segregation of duties  Observe and evaluate proper
between processing and segregation of duties; e.g.
personnel functions; persons authorizing employee
adequate personnel files are benefits costs are not
maintained; and work/time responsible for recording.
record are approved by  Check the authorization by
person of appropriate level. appropriate for all additions,
changes and deletions of
personnel records and the
authorization for payments of
employee benefit costs.
2. Completeness  Updated record for starters  Check the numerical sequence
and leavers should be of the time/work records and
maintained by personnel the reconciliation of payroll
office and payroll processing summary and starters and

5
 function is provided with leavers recorded in personnel
updated information about records.
leavers.
3. Accuracy  Internal verification to  Examine the client’s record to
ensure that the calculation of see whether the client has
wages and salaries is in checked the arithmetical
agreement with records of accuracy of employee benefit
work performed and terms of costs to ensure the amounts are
employment. in accordance with
employment contracts.
4. Cut-off  Notices of additions,  Examine indication of internal
terminations, and changes in verification and test
pay rates, and deductions procedures for processing
reported promptly to payroll time/work record and for
processing function. recording liabilities.
5. Classification  Proper internal verification  Review client’s procedures
and approval for accounts and inspect their records to
charged to payroll. verify there has been proper
classification of employee
benefit costs.

3.3 Substantive Procedures for Payroll and Personnel Transactions

3.3.1 Analytical procedures

Examples of the analytical procedures for payroll and personnel payments

(a) Compare current-year balances in payroll expense account with prior

years’ balances after adjustment for changes and number of employees.
(b) Compare payroll costs as a percentage of sales with prior years’ and
industry data.
(c) Compare budgeted payroll expense with actual payroll expenses.
(d) Compare current-year balances in payroll related accruals with prior years’
balances after adjusting for changes in conditions.
(e) Compare labour cost as a component of inventory cost with that of previous
years.
(f) Estimate sales commissions by applying commission formulas to recorded
sales totals.
(g) Test reasonableness of accrual balances.

6
3.3.2 Substantive procedures – payroll transactions
Examples of substantive tests for payroll transactions are as follows:
Assertions Substantive procedures
1. Occurrence  Review the payroll summary, payroll journal and
general ledger for unusual items and check to the
supporting documents.
2. Completeness  Reconcile the total disbursement in the payroll journal
with the payments on the bank statement and cash
disbursement journal.
3. Accuracy  Agree pay rates on the payroll summary with payroll
record;
 examine evidence of internal verification; and
 Recomputed the mathematical accuracy of selected
payroll transactions.
4. Cut-off  Compare dates of acknowledgement receipt by
employees or bank transfer to date of transaction in payroll
journal.
5. Classification  Select transactions from the payroll journal and check their
classification with chart of accounts.

The main issue of internal controls over payroll and personnel cycle is the potential fraud
of unauthorized payments to fictitious employers or the payment of wages or salaries
without work performed. The following audit procedures are designed to identify this
type of fraud.
Types of fraud Substantive procedures
1. Non-existence  Tracing the selected transactions recorded in the payroll
employees journal to the personnel department to determine whether
the employees were actually employed during the payroll
period.
2. Terminated  Selecting several files from the personnel records for
employees employees who were terminated in the current year to
determine whether each received his or her termination
pay in accordance with company policy.
 Examining the payroll records in the subsequent period
to ascertain that the employee is no longer being paid.
3. Unclaimed wages  Requesting a surprise payroll payoff where each

7
 employee must pick up and sign for his or her cheque in
the presence of a supervisor and the auditor.
 Investigating those unclaimed wages to determine whether
an unclaimed cheque is fraudulent.
4. Fraudulent hours  Reconciling the total hours paid according to the payroll
record with an independent record of the hours worked.
 Examining evidence of proper authorization for payroll
since it is ordinarily easier for the client to prevent this type
of defalcation by adequate controls than for the auditor to
detect it.

3.3.3 Substantive procedures – payroll expense and accruals balances

Assertions Substantive procedures

1. Existence  Vouch selected payroll accruals from payroll summary to
the supporting documents such as personnel file,
work/time record, etc.
2. Rights and obligations  Review supporting documents to determine that the entity
has obligation to pay.
3. Completeness  Search for unrecorded payroll liabilities and check the
calculation of commission payable or entitlement of
commission accrued against the terms of employment and
company policy.
4. Valuation and allocation  Test reasonableness of accrued payroll expenses and
compare amounts accrued to supporting documents.
5. Presentation and  Discuss with management and review benefit contracts
disclosures for proper disclosure of payroll accruals.

3.4 Tests of Details of Balances

3.4.1 Audit objectives Details of Balances
The objectives of the audit of salaries and allowances include but are not limited to the
following:
 To ascertain that there is a strong internal control system to prevent theft and fraudulent
acts during the preparation of payroll sheet, recording and effecting of salary payment;
 To ascertain that deductions from salaries are made in accordance with the existing
proclamation and other relevant legislation;
 To ascertain that the salary payment being effected is for services rendered by employees

8
 and to ensure that the persons who receive salaries actually exist, and are in fact entitled
to the payment of salary;
 To ascertain that the payment of allowances is effected strictly in accordance with the
relevant legislation;
 To ensure that the arrangements made with respect to unclaimed salary are in accordance
with regulations and that the unpaid sums are correctly retained and properly recorded;
 To ensure that the necessary controlling mechanisms exist to prevent unclaimed salary
being utilized improperly.
3.4.2 Audit procedures
The following audit procedures should be followed in order to ensure the proper control of
salaries and wages: -
3.4.2.1 Personal file of employees
 See whether the personnel section holds employees’ personal files, which contain
information such as letter of engagement, letter of resignation, notification letter of salary
scale, documents related to special deductible items, and other relevant information;
 Ensure that employees’ engagement, resignation, change in salary scale and details of
special deductible items have been approved by a designated official and that appropriate
instructions are sent to the payroll section before the payroll for the month is prepared;
 Check that documents kept in employees’ personal files have been signed by officials
who are not involved in payroll preparation;
 Ascertain that employees’ personal files are kept in the custody of a staff member who is
not part of the accounts division or payroll section.
3.4.2.2 Attendance sheet
 Ensure that the accuracy of attendance sheets (or similar documents for those under
contract) have been approved by appropriate officials not involved in the preparation of
payroll;
 Ascertain that staff members who are responsible for ensuring the accuracy of attendance
sheets are not involved in the preparation of payroll;
 Check that documents giving an entitlement to the payment of overtime and other
benefits are signed by the immediate superior of the employee who is eligible for that
entitlement (and that such superior is not involved in the preparation of payroll and
effecting of salary payment).
3.4.2.3 Computation of Payroll
Ascertain that the payroll clerk does not have direct access to employees’ personal files;
Ensure that the computation of gross pays and deductibles have been made in
compliance with the present scales of pay and eligibility;
Check that the staff member, who verifies the accuracy of the computation of payroll,
has no involvement in payroll preparation.
9
3.4.2.4 Deductions from salary
See that a separate column is maintained in the payroll sheet for deductibles of a
repetitive nature such as income tax, pension, repayment of loan and the like;
Check deductions other than those authorized by law (such as deduction for edir
contribution, resettlement bank loan, family allowance, and the like) to ensure that the
deduction is in accordance with an approved written application from the employee (or
other official document) and that such documentary evidence is kept in the personal file
of the employee;
Ascertain that collections from deductibles have been paid to the correct beneficiary
account in full and in a timely manner.
3.4.2.5 Payment of salary
 Ascertain that documentary evidence relating to matters such as salary scale changes,
the employment of new staff, promotion, resignation, penalty or court order has been
sent to payroll section before the payroll for the month is prepared;
 Ensure that contracts and properly signed attendance sheets support the payroll sheet
for daily laborers;
 See that documentary evidence of entitlement for the payment of allowances is kept
in the personal files of those employees and officials who are eligible for such
payment;
 Check that necessary caution has been exercised to prevent an employee from being
involved in the whole process of payroll preparation, from its initiation to the
delivery of the payroll sheet for salary payment to be effected;
 Ascertain that the accuracy of details shown in the payroll sheet such as names, gross
salary, working hours, over time and the computation of deductibles has been
verified by an official with no involvement in payroll sheet preparation;
 Ascertain that the payroll sheets have been signed by the payroll clerk, the staff
member responsible for checking and finally by the designated official who
authorizes the payment;
 Verify that the salary payment for each month has been compared with the payment
for the previous month and that the causes of any differences are identified and
reconciled;
 Check that every employee on the payroll signs on the payroll sheet to acknowledge
the receipt of the net pay;
 Check that no employee is allowed to take the salary of another employee without a
written delegation.
3.4.2.6 Unclaimed salary
Verify unclaimed salaries against summation of net pays unclaimed on payroll sheets;
Ascertain that unclaimed salaries are deposited in to the bank within predefined period
10
 of time.
3.4.2.7 Accounting records
 Test postings of payrolls to subsidiary and general ledgers;
 Compare actual expenditure against the budget.

11