Cristopherson A.

Perez Understanding of Payroll Scheme

ACT 141 Identifying Test of Controls

TESTING THE RELEVANT CONTROLS FOR PAYROLL CYCLE

Auditor’s Documentation of Testing the Design and Implementation (D&I) and/or Operating
Effectiveness of Payroll Controls

Significant accounts affected: Payroll expense, Accrued payroll liabilities, Cash

Assertions addressed: The assertions to be addressed are cutoff, completeness, and occurrence.

Activity#1: "For those paid on an hourly basis, many companies use a time card which is used to
record the hours worked. The time card also includes the total hours worked for a pay period."
Identification of Risk of Material Misstatement (ROMM or “What Could Go Wrong?”):
Some employees may manipulate their time-ins and time-outs, resulting to number of hours
worked being misstated and consequently, payroll amounts being inaccurately computed.

Control Activity that addresses ROMM: (The control that addresses ROMM is the control to
be relied upon by the auditor)
“Payroll processing can be made more efficient by collecting employee time and attendance data
electronically instead of on paper documents. Those data are then automatically fed to the payroll
processing system. Also, electronic time clocks can transmit time and attendance data directly to
the payroll processing system.”

Classification of Risk: Lower than normal risk

Planned control reliance strategy: Relying on controls

Controls Testing Procedures:

Design and Implementation Testing:
1. Perform walkthrough procedure based on the understanding of the significant flow of
transactions by performing the following steps:
a. Observe the process of the electronic system from capture of employee information to
payroll processing.
b. Inquire to management about the design of the the electronic system (e.g. purpose of
establishing the system, personnel involved in the system, materiality for investigation, etc.)
2. Determine if the identified controls was sufficiently drawn/put up and properly performed.
3. Evaluate the results and conclude.

Operating Effectiveness:
1. Conduct a walkthrough to test the control's operating effectiveness by performing the following:
a. Reperform how an employee inputs an information into the system and trace the whole
process. Note any significant deficiencies in the system.
b. Observe how employees or personnel perform the processes of the system. Consider the
competence of personnel.
c. In case paper trails are generated, match supporting documents from sample transactions
in terms of time and signatories.
2. Determine if identified controls are operating effectively.
3. Evaluate the results and conclude.

Activity#2: Once payslips have been prepared, the payroll register is sent to the accounts payable
department for review and approval. A disbursement voucher is then prepared to authorize the
transfer of funds from the company’s general checking account to its payroll bank account. The
disbursement voucher and payroll register are then sent to the cashier.

Identification of Risk of Material Misstatement (ROMM or “What Could Go Wrong?”):

ROMM_1: Unauthorized disbursement vouchers may have been prepared.
ROMM_2: Disbursement vouchers may not match with the payroll register.
ROMM_3: Disbursement vouchers, payroll register, and checks may not match properly.

Control Activity that addresses ROMM: (The control that addresses ROMM is the control to
be relied upon by the auditor)
The cashier reviews the payroll register and disbursement voucher and then prepares and signs a
check transferring funds to the company’s payroll bank account. The cashier also reviews, signs,
and distributes the employee paychecks.

Classification of Risk: Lower than normal risk

Planned control reliance strategy: Relying on controls

Controls Testing Procedures:

Design and Implementation Testing:
1. Perform walkthrough procedure based on the understanding of the significant flow of
transactions by performing the following steps:
a. Obtain sample documents of the latest payroll transaction.
b. Observe personnel do the control.
2. Determine if the identified controls was sufficiently drawn/put up and properly performed.
3. Evaluate the results and conclude.

Operating Effectiveness:
1. Conduct a walkthrough to test the control's operating effectiveness by performing the following:
a. Inspect sample supporting documents for the whole year under audit. Perform a three-
way matching of disbursement voucher, payroll register, and check/payroll slips.
2. Determine if identified controls are operating effectively.
3. Evaluate the results and conclude.

Activity#3: "The next step is actual disbursement of paychecks to employees. Most employees
are paid by either cheque [...]"
Identification of Risk of Material Misstatement (ROMM or “What Could Go Wrong?”):
ROMM_1: Checks may not be directly handed to employees, resulting to ghost ones as
may be created by the payroll cashier.
ROMM_2: Checks may be stolen if not received by employees and are placed in
unsecured locations
Control Activity that addresses ROMM: (The control that addresses ROMM is the control to
be relied upon by the auditor)
“Direct deposit is one way to improve the efficiency and reduce the costs of payroll processing.
Direct deposit provides savings to employers by eliminating the cost of purchasing, processing,
and distributing paper checks, not to mention reducing bank fees and postage.”

Classification of Risk: Lower than normal risk

Planned control reliance strategy: Relying on controls

Controls Testing Procedures:

Design and Implementation Testing:
1. Conduct a walkthrough of the company’s significant flow of transactions by performing:
a. Obtain the list of employee’s names and their corresponding bank account numbers
b. Inspect the accounting records for recent bank transfers to employee bank accounts.
2. Determine if the identified controls was sufficiently drawn/put up and properly performed.
3. Evaluate the results and conclude.

Operating Effectiveness:
1. Conduct a walkthrough to test the control's operating effectiveness by performing the following:
a. Observe personnel perform the authorization of bank transfers and their subsequent
review. Consider their competence.
b. Obtain sample disbursement vouchers for direct deposits and trace them to the updated
payroll master file. Check for the possibility of ghost employees or terminated employees, still
getting paid.
2. Determine if identified controls are operating effectively.
3. Evaluate the results and conclude.

References:

Auditing Payroll: The Why and How Guide. (n.d.). Retrieved February 6, 2018 from http://cpa-
scribo.com/auditing-payroll/

Le, Kim. (2016). #24 | Part 8 – Controls Testing, Design Effectiveness and Operating
Effectiveness in Demystifying SOX 404 – Auditing Standard 5. Retrieved February 6, 2018 from
https://www.a2q2.com/blog/sox/part-8-controls-testing-design-effectiveness-and-operating-
effectiveness-demystifying-sox-404-auditing-standard-5/