AUDITING

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

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 training, Clear hiring policies,
hired relocation costs; procedures;
according to equal opportunity updated records
criteria
Compensation Excessive labor Updated listings pay
deductions costs; violation union rates, deductions;
according to contracts; inaccurate review, approval
authorization accruals
Adjustments Increased pay, Clear adjustment
authorized overstated labor policies, procedures
costs
7 GBW 8th ed., Ch. 14
EXECUTION:
Objective, Errors, Procedure
Objective Error Procedure
Payroll, Misappropriated cash Personnel, payroll
personnel from paychecks for procedures manual
procedures terminated, fictitious Periodically verify
authorized employees employee
assignments
All payroll Misappropriated cash, Prenumber, control
disbursements overstated labor costs time records,
for recognized paychecks,
liability adjustment forms;
dual signatures
8 GBW 8th ed., Ch. 14
RECORDING:
Objective, Errors, Procedure
Objective Error Procedure
Amounts due Payroll costs Document account
employees at inaccurate; distribution
proper misstated procedures;
amounts, time expenses; reconcile ledgers,
periods, details do not journals; physical
classification agree barriers unused
documents, forms

9 GBW 8th ed., Ch. 14

ACCESS:
Objective, Errors, Procedure
Objective Error Procedure
Access to Records, Prenumber, control
personnel, forms, forms, documents;
payroll documents Segregate
records, misused; authorizing,
forms, unauthorized executing, recording
documents labor costs maintain listings
restricted to authorized
authorized signatories
personnel
10 GBW 8th ed., Ch. 14
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

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 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

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