AUDITING

CHAPTER 14
Control & Substantive
Tests in Personnel &
Payroll
By
David N. Ricchiute
TOPICS
Nature personnel, payroll functions
Controls over personnel, payroll
activities
Auditors consideration of controls
Substantive tests of payroll accounts
Earnings manipulation in payroll,
postretirement benefits

2 GBW 8th ed., Ch. 14

NATURE OF
PERSONNEL, PAYROLL
CYCLE
Resources (services) acquired in
exchange for obligations to pay
Obligations to employees are paid

3 GBW 8th ed., Ch. 14

PERSONNEL, PAYROLL
DOCUMENTS
Personnel records
Time record
Payroll register
Employee
earnings record

4 GBW 8th ed., Ch. 14

PERSONNEL RECORDS
Salary or wage rates
Payroll deductions
Employee signatures
Job classification
Performance evaluation

5 GBW 8th ed., Ch. 14

INTERNAL CONTROL
OBJECTIVES
Authorization
Execution
Recording
Access to assets
Segregation of duties

6 GBW 8th ed., Ch. 14

AUTHORIZATION:
Objective, Errors, Procedure
Objective Error Procedure
Employees Excessive Clear hiring
hired training, policies,
according to relocation costs; procedures;
criteria equal opportunity updated records
Compensati Excessive labor Updated listings
on costs; violation pay rates,
deductions union contracts; deductions;
according to inaccurate review, approval
authorizatio accruals
n
Adjustments Increased pay, Clear adjustment
authorized
7 overstated labor
GBW 8th ed., Ch. 14 policies,
EXECUTION:
Objective, Errors, Procedure
Objective Error
ProcedureMisappropriated
Payroll, Personnel,
personnel cash from payroll
procedures paychecks for procedures
authorized terminated, fictitious manual
employees Periodically
verify employee
assignments
All payroll Misappropriated Prenumber,
disbursemen cash, overstated control time
ts for labor costs records,
recognized
8 GBW 8th ed., Ch. 14 paychecks,
liability adjustment
RECORDING:
Objective, Errors, Procedure
Objective Error Procedure
Amounts due Payroll costs Document
employees at inaccurate; account
proper misstated distribution
amounts, expenses; procedures;
time periods, details do reconcile ledgers,
classification not agree journals; physical
barriers unused
documents,
forms
9 GBW 8th ed., Ch. 14
ACCESS:
Objective, Errors, Procedure
Objective Error
Procedure
Access to Records, Prenumber, contro
personnel, forms, forms, documents
payroll documents Segregate
records, misused; authorizing,
forms, unauthorize executing,
documents d labor costs recording;
restricted to maintain listings
authorized authorized
personnel signatories
10 GBW 8th ed., Ch. 14
CONSIDERING
INTERNAL CONTROL:
Obtain understanding
Payroll
Preliminary review

Document system
Perform transaction walk-
through
Determine whether controls
are potentially reliable in
assessing control risk below
maximum
Test controls

11 GBW 8th ed., Ch. 14

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

12 GBW 8th ed., Ch. 14

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

13 GBW 8th ed., Ch. 14

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

14 GBW 8th ed., Ch. 14

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

15 GBW 8th ed., Ch. 14

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

16 GBW 8th ed., Ch. 14

MANIPULATED
EARNINGS:
Capitalized Costs
CEO, CFO, others at Safety-
capitalized payroll costs
Kleen
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

17 GBW 8th ed., Ch. 14

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

18 GBW 8th ed., Ch. 14

AUDIT JUDGMENT

Required for
Postretirement benefits other
than pensions
Health care obligations

19 GBW 8th ed., Ch. 14