18 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit of the Payroll and Personnel Cycle Chapter 18

18 - 1©2006 Prentice Hall Business Publishing, ©2006 Prentice Hall Business Publishing, Auditing 11/e,Auditing 11/e, Arens/Beasley/Elder Arens/Beasley/Elder

Audit of the PayrollAudit of the Payrolland Personnel Cycleand Personnel Cycle

Chapter 18Chapter 18


Learning Objective 1Learning Objective 1

Identify the accounts andIdentify the accounts and

transactions in the payrolltransactions in the payroll

and personnel cycle.and personnel cycle.


The overall objective in the audit of the payrollThe overall objective in the audit of the payrolland personnel cycle is to evaluate whether theand personnel cycle is to evaluate whether theaccount balances affected by the cycle areaccount balances affected by the cycle arefairly stated in accordance with generallyfairly stated in accordance with generallyaccepted accounting principles.accepted accounting principles.

Accounts in the Payroll and Accounts in the Payroll and Personnel CyclePersonnel Cycle



Accrued Wages, Salaries,Accrued Wages, Salaries,Bonuses, and CommissionsBonuses, and Commissions

PaymentPayment BeginningBeginningbalancebalance

Earned wages,Earned wages,salaries, etc.salaries, etc.

Ending balanceEnding balance

DirectDirectLaborLabor

Cash in BankCash in Bank

Payment forPayment forsalariessalaries

Payment forPayment forpayroll taxespayroll taxes

Withheld Income TaxesWithheld Income Taxesand Other Deductionsand Other Deductions


PayrollPayrollwithholdingwithholding




Cash in BankCash in Bank

Payment forPayment forsalariessalaries

Payment forPayment forpayroll taxespayroll taxes

Withheld Income TaxesWithheld Income Taxesand Other Deductionsand Other Deductions


PayrollPayrollwithholdingwithholding


Accrued PayrollAccrued PayrollTax ExpenseTax Expense


PayrollPayrolltax expensetax expense


Payroll Tax ExpensePayroll Tax Expense



In most systems the accrued wages andIn most systems the accrued wages andsalaries account is used only at thesalaries account is used only at theend of an accounting period.end of an accounting period.



Describe the business functionsDescribe the business functions

and the related documents andand the related documents and

records in the payroll andrecords in the payroll and

personnel cycle.personnel cycle.


Business Functions in the Cycle Business Functions in the Cycle and Related Documents and and Related Documents and RecordsRecords

The payroll and personnel cycle begins withThe payroll and personnel cycle begins withthe hiring of personnel and ends with paymentthe hiring of personnel and ends with paymentto the employees for the services performedto the employees for the services performedand to the government and other institutionsand to the government and other institutionsfor the withheld and accrued payroll taxesfor the withheld and accrued payroll taxesand benefits.and benefits.


Personnel and EmploymentPersonnel and Employment

Personnel recordsPersonnel records

Deduction authorization formDeduction authorization form

Rate authorization formRate authorization form


Timekeeping and Payroll Timekeeping and Payroll PreparationPreparation

Time CardTime Card

Job Time TicketJob Time Ticket

Payroll Transaction FilePayroll Transaction File

Payroll JournalPayroll Journal

Timekeeping andTimekeeping andPayroll PreparationPayroll Preparation


Payroll Master FilePayroll Master File

A payroll master file is used forA payroll master file is used forrecording each payroll transactionrecording each payroll transactionfor each employee and maintaining totalfor each employee and maintaining totalemployee wages paid for the year to date.employee wages paid for the year to date.


Payment of PayrollPayment of Payroll

Payroll checkPayroll check

Payroll bank account reconciliationPayroll bank account reconciliation


Preparation of Payroll Tax Returns Preparation of Payroll Tax Returns and Payment of Taxesand Payment of Taxes

W-2 FormW-2 Form

Payroll tax returnsPayroll tax returns



Understand internal control andUnderstand internal control and

design and perform tests ofdesign and perform tests of

controls and substantive testscontrols and substantive tests

of transactions for the payrollof transactions for the payroll



Methodology for Designing Methodology for Designing Controls and Substantive TestsControls and Substantive TestsUnderstand internalUnderstand internalcontrol – payrollcontrol – payrolland personnel.and personnel.

AuditAuditproceduresprocedures

SampleSamplesizesize

ItemsItemsto selectto select

TimingTiming

Assess plannedAssess plannedcontrol risk – payrollcontrol risk – payrolland personnel.and personnel.

Determine extent of testing controls.Determine extent of testing controls.

Design tests of controls andDesign tests of controls andsubstantive tests ofsubstantive tests oftransactions for payroll andtransactions for payroll andpersonnel to meet transaction-personnel to meet transaction-related audit objectives.related audit objectives.


Understand Internal Control –Understand Internal Control –Payroll and Personnel CyclePayroll and Personnel Cycle

• Adequate separation of dutiesAdequate separation of duties• Proper authorizationProper authorization• Adequate documents and recordsAdequate documents and records• Physical control over assets and recordsPhysical control over assets and records• Independent checks on performanceIndependent checks on performance


Payroll Tax Forms and PaymentsPayroll Tax Forms and Payments

Payment of the payroll taxes withheld andPayment of the payroll taxes withheld andother withholdings on a timely basisother withholdings on a timely basis

Preparation of payroll tax formsPreparation of payroll tax forms


Inventory and FraudulentInventory and FraudulentPayroll ConsiderationsPayroll Considerations

Relationship between payrollRelationship between payrolland inventory valuationand inventory valuation

Tests for nonexistent payrollTests for nonexistent payroll


Methodology for Designing Tests Methodology for Designing Tests of Balances for Payroll Liabilitiesof Balances for Payroll LiabilitiesPhase IPhase I

Identify client business risks affecting payrollIdentify client business risks affecting payrollliability accounts.liability accounts.

Set tolerable misstatement and assess inherentSet tolerable misstatement and assess inherentrisk for payroll liability accounts.risk for payroll liability accounts.

Assess control risk for the payroll and personnelAssess control risk for the payroll and personnelcycle.cycle.


Methodology for Designing Tests Methodology for Designing Tests of Balances for Payroll Liabilitiesof Balances for Payroll Liabilities

Design and perform tests of controls andDesign and perform tests of controls andsubstantive tests of transactions for thesubstantive tests of transactions for thepayroll and personnel cycle.payroll and personnel cycle.

Phase IIPhase II


Methodology for Designing Tests Methodology for Designing Tests of Balances for Payroll Liabilitiesof Balances for Payroll Liabilities

Design and perform analytical procedures for theDesign and perform analytical procedures for thepayroll and personnel cycle.payroll and personnel cycle.

Phase IIIPhase III

TimingTimingItems toItems toselectselect

SampleSamplesizesize

AuditAuditproceduresprocedures

Design tests of details of payroll accounts balancesDesign tests of details of payroll accounts balancesto satisfy balance-related audit objectives.to satisfy balance-related audit objectives.



Design and perform analyticalDesign and perform analytical

procedures for the payrollprocedures for the payroll



Analytical Procedures for the Analytical Procedures for the Payroll and Personnel CyclePayroll and Personnel Cycle

Compare direct labor as aCompare direct labor as apercentage of sales withpercentage of sales withprevious years.previous years.

Misstatement of directMisstatement of directlabor and inventory.labor and inventory.

Analytical procedureAnalytical procedure

Compare payroll expenseCompare payroll expenseaccount balances withaccount balances withprevious years.previous years.

Misstatement of payrollMisstatement of payrollexpense accounts.expense accounts.

Possible misstatementPossible misstatement


Analytical Procedures for the Analytical Procedures for the Payroll and Personnel CyclePayroll and Personnel Cycle

Analytical procedureAnalytical procedure

Compare commission expenseCompare commission expenseas a percentage of sales withas a percentage of sales withprevious years.previous years.

Misstatement ofMisstatement ofcommission expensecommission expenseand commission liability.and commission liability.

Compare payroll tax expenseCompare payroll tax expenseas a percentage of salaries andas a percentage of salaries andwages with previous years.wages with previous years.

Misstatement of payrollMisstatement of payrolltax expense and payrolltax expense and payrolltax liability.tax liability.

Possible misstatementPossible misstatement

Compare accrued payroll taxCompare accrued payroll taxaccounts with previous years.accounts with previous years.

Misstatement of accruedMisstatement of accruedpayroll taxes and expense.payroll taxes and expense.



Design and perform tests ofDesign and perform tests of

details of balances for accountsdetails of balances for accounts

in the payroll and personnel cycle.in the payroll and personnel cycle.


Two Major Balance-relatedTwo Major Balance-relatedAudit ObjectivesAudit Objectives

Accruals in the trial balanceAccruals in the trial balanceare stated at the correctare stated at the correctamounts (accuracy).amounts (accuracy).

Transactions in the payroll andTransactions in the payroll andpersonnel cycle are recordedpersonnel cycle are recordedin the proper period (cutoff).in the proper period (cutoff).


Tests of Details of BalancesTests of Details of Balancesfor Liability Accountsfor Liability Accounts

Amounts withheld from employees’ payAmounts withheld from employees’ pay Accrued salaries and wagesAccrued salaries and wages Accrued commissionsAccrued commissions Accrued bonusesAccrued bonuses Accrued vacation pay, sick pay,Accrued vacation pay, sick pay, or other benefitsor other benefits Accrued payroll taxesAccrued payroll taxes


Tests of Details of BalancesTests of Details of Balancesfor Expense Accountsfor Expense Accounts

Officers’ compensationOfficers’ compensation CommissionsCommissions Payroll tax expensePayroll tax expense Total payrollTotal payroll Contract laborContract labor


Types of Audit Tests for the Types of Audit Tests for the Payroll and Personnel CyclePayroll and Personnel Cycle

TOCTOC + + STOTSTOT + + APAP + + TDBTDB= Sufficient competent evidence per GAAS= Sufficient competent evidence per GAAS

Cash inCash inBankBank

PayrollPayrollLiabilitiesLiabilities

Direct Labor andDirect Labor andPayroll ExpensesPayroll Expenses

PaymentsPayments ExpensesExpenses

Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP

EndingEndingbalancebalance

EndingEndingbalancebalance

Audited by Audited by APAP and and TDBTDB

Audited byAudited byTOCTOC, , STOTSTOT, and , and APAP


End of Chapter 18End of Chapter 18