AUDITING CHAPTER 14

1. AUDITING CHAPTER 14 Control & Substantive Tests in Personnel & Payroll By David N. Ricchiute

2. TOPICS • Nature personnel, payroll functions • Controls over personnel, payroll activities • Auditor’s consideration of controls • Substantive tests of payroll accounts • Earnings manipulation in payroll, postretirement benefits GBW 8th ed., Ch. 14

3. NATURE OF PERSONNEL, PAYROLL CYCLE • Resources (services) acquired in exchange for obligations to pay • Obligations to employees are paid GBW 8th ed., Ch. 14

4. PERSONNEL, PAYROLL DOCUMENTS • Personnel records • Time record • Payroll register • Employee earnings record GBW 8th ed., Ch. 14

5. PERSONNEL RECORDS • Salary or wage rates • Payroll deductions • Employee signatures • Job classification • Performance evaluation GBW 8th ed., Ch. 14

6. INTERNAL CONTROL OBJECTIVES • Authorization • Execution • Recording • Access to assets • Segregation of duties GBW 8th ed., Ch. 14

7. AUTHORIZATION:Objective, Errors, Procedure Objective Error Procedure GBW 8th ed., Ch. 14

8. EXECUTION: Objective, Errors, Procedure Objective Error Procedure GBW 8th ed., Ch. 14

9. RECORDING:Objective, Errors, Procedure Objective Error Procedure GBW 8th ed., Ch. 14

10. ACCESS:Objective, Errors, Procedure Objective Error Procedure GBW 8th ed., Ch. 14

11. CONSIDERING INTERNAL CONTROL: Payroll • Obtain understanding • Preliminary review • Document system • Perform transaction walk-through • Determine whether controls are potentially reliable in assessing control risk below maximum • Test controls GBW 8th ed., Ch. 14

12. 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 GBW 8th ed., Ch. 14

13. 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 GBW 8th ed., Ch. 14

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 GBW 8th ed., Ch. 14

15. 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 GBW 8th ed., Ch. 14

16. 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 GBW 8th ed., Ch. 14

17. MANIPULATED EARNINGS:Capitalized Costs at Safety-Kleen CEO, CFO, others capitalized payroll costs 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 GBW 8th ed., Ch. 14

18. 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 GBW 8th ed., Ch. 14

19. AUDIT JUDGMENT • Required for • Postretirement benefits other than pensions • Health care obligations GBW 8th ed., Ch. 14