Audit of the Payroll

and Personnel Cycle

Chapter 18

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 1

 Learning Objective 1

Identify the accounts and

transactions in the payroll
and personnel cycle.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 2

 Accounts in the Payroll and
Personnel Cycle
The overall objective in the audit of the payroll
and personnel cycle is to evaluate whether the
account balances affected by the cycle are
fairly stated in accordance with generally
accepted accounting principles.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 3

 Accounts in the Payroll and
Personnel Cycle
Accrued Wages, Salaries, Direct
Bonuses, and Commissions Labor
Payment Beginning
Cash in Bank balance
Payment for Earned wages,
salaries salaries, etc.
Payment for Ending balance
payroll taxes
Withheld Income Taxes
and Other Deductions
Payment Beginning
balance
Payroll
withholding
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder
Ending balance 18 - 4
 Accounts in the Payroll and
Personnel Cycle
Withheld Income Taxes
and Other Deductions
Payment Beginning
Cash in Bank balance
Payment for Payroll
salaries withholding
Payment for Ending balance
payroll taxes
Accrued Payroll
Payroll Tax Expense Tax Expense
Payment Beginning
balance
Payroll
tax expense
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder
Ending balance 18 - 5
 Accounts in the Payroll and
Personnel Cycle
In most systems the accrued wages and
salaries account is used only at the
end of an accounting period.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 6

 Learning Objective 2

Describe the business functions

and the related documents and
records in the payroll and
personnel cycle.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 7

 Business Functions in the
Cycle and Related Documents
and Records
The payroll and personnel cycle….

Begins Hiring of personnel

Ends Payments

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 8

 Personnel and Employment
 Personnel records

 Deduction authorization form

 Rate authorization form

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 9

 Timekeeping and Payroll
Preparation
Time Card
Job Time Ticket
Payroll Transaction File
Payroll Journal

Timekeeping and
Payroll Preparation

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 10

 Payroll Master File

A payroll master file is used for

recording each payroll transaction
for each employee and maintaining total
employee wages paid for the year to date.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 11

 Payment of Payroll
 Payroll check

 Payroll bank account reconciliation

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 12

 Preparation of Payroll Tax Returns
and Payment of Taxes
 W-2 Form

 Payroll tax returns

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 13

 Learning Objective 3

Understand internal control and

design and perform tests of
controls and substantive tests
of transactions for the payroll
and personnel cycle.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 14

 Methodology for Designing Controls
and Substantive Tests
Understand internal control – payroll and personnel

Assess planned control risk – payroll and personnel

Determine extent of testing controls

Design tests of controls and Audit procedures

substantive tests of transactions Sample size
for payroll and personnel to meet Items to select
transaction-related audit objectives Timing
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 15
 Understand Internal Control –
Payroll and Personnel Cycle
 Adequate separation of duties
 Proper authorization
 Adequate documents and records
 Physical control over assets and records
 Independent checks on performance

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 16

 Payroll Tax Forms and
Payments
 Preparation of payroll tax forms

 Timely payment of the payroll taxes

withheld and other withholdings

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 17

 Inventory and Fraudulent
Payroll Considerations
 Relationship between payroll
and inventory valuation

 Tests for nonexistent employees

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 18

 Methodology for Designing Tests
of Balances for Payroll Liabilities
Identify client business
risks affecting Phase I
payroll liability accounts

Set tolerable misstatement

and assess inherent risk Phase I
for payroll liability accounts

Assess control risk for the

Phase I
payroll and personnel cycle
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 19
 Methodology for Designing Tests
of Balances for Payroll Liabilities
Design and perform
tests of controls and
substantive tests
Phase II
of transactions
for the payroll and
personnel cycle

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 20

 Methodology for Designing Tests
of Balances for Payroll Liabilities
Design and perform
analytical procedures
Phase III
for the payroll and
personnel cycle
Design tests of Audit procedures
details of payroll
accounts balances Sample size
Phase III
to satisfy Items to select
balance-related
audit objectives Timing
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 21
 Learning Objective 4

Design and perform analytical

procedures for the payroll
and personnel cycle.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 22

 Analytical Procedures for the
Payroll and Personnel Cycle
Analytical procedure Possible misstatement

Compare payroll expense Misstatement of payroll

account balances with expense accounts
previous years

Compare direct labor as a Misstatement of direct

percentage of sales with labor and inventory
previous years

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 23

 Analytical Procedures for the
Payroll and Personnel Cycle
Analytical procedure Possible misstatement

Compare commission expense Misstatement of

as a percentage of sales with commission expense
previous years and commission liability

Compare payroll tax expense Misstatement of payroll

as a percentage of salaries and tax expense and payroll
wages with previous years tax liability

Compare accrued payroll tax Misstatement of accrued

accounts with previous years payroll taxes and expense

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 24

 Learning Objective 5

Design and perform tests of

details of balances for accounts
in the payroll and personnel cycle.

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 25

 Two Major Balance-related
Audit Objectives
1. Accruals in the trial balance
are stated at the correct
amounts (accuracy).

2. Transactions in the payroll and

personnel cycle are recorded
in the proper period (cutoff).

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 26

 Tests of Details of Balances
for Liability Accounts
 Amounts withheld from employees’ pay
 Accrued salaries and wages

 Accrued commissions
 Accrued bonuses
 Accrued vacation pay, sick pay, or other benefits
 Accrued payroll taxes

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 27

 Tests of Details of Balances
for Expense Accounts
 Officers’ compensation
 Commissions

 Payroll tax expense

 Total payroll
 Contract labor

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 28

 Presentation and Disclosure
Objectives
 Required disclosures are not extensive

 Some complex transactions require

footnote disclosure

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 29

 Types of Audit Tests for the
Payroll and Personnel Cycle
Cash in Payroll Direct Labor and
Bank Liabilities Payroll Expenses
Payments Expenses
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP

Ending Ending
balance balance
Audited by AP and TDB

TOC + STOT + AP + TDB

= Sufficient appropriate evidence per GAAS
©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 30
 End of Chapter 18

©2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 18 - 31