Chapter 14 Personnel and Payroll

Major topics discussed in this chapter

• The nature of the personnel management and
payroll functions within the expenditure
/disbursement cycle.
• Controls over personnel and payroll.
• The auditor’s consideration of controls over
personnel and payroll.
• Substantive tests applicable to payroll accounts.
• Earnings manipulation in accounting for payroll
costs and post- retirement health care benefits.
 Outline
• The expenditure/disbursement cycle
– Personnel & payroll
• Personnel
• Payroll preparation & distribution
– Internal control objectives and potential errors or
fraud
• Transaction authorization
• Execution
• Recording
• Access to assets
• Segregation of duties
• Independent verification
 Outline
• Considering internal control
– Obtaining an understanding
• Preliminary review
• System documentation
• Transaction walkthrough
• Identification of control procedures
– Tests of controls: Personnel & Payroll
• Personnel & payroll
• Distribution of employee paychecks
• Assess control risk
• Analytical procedures: payroll and accruals
 Internal Control Objectives and
Potential Errors or Fraud
• The following focuses on internal control over
– transaction authorization
– Execution
– Recording
– access to assets for personnel and payroll.
– Segregation of duties
– Independent verification
• The discussion identifies
– control objectives
– examples of errors or frauds that may arise if objectives are not
achieved
– examples of control procedures designed to prevent or detect
errors or frauds.
 Transaction Authorization
OBJECTIVES FRAUDS OR ERRORS PREVENTIVE CONTROLS
IF OBJECTIVE NOT OR DETECTIVE
MET CONTROLS
Hiring: Unqualified •Establish clear
Employees employees may be statements of hiring
should be hired, potentially policies and procedures.
hired resulting in excessive •Maintain updated
according to training costs, personnel records for all
criteria unnecessary employees.
authorized by relocation costs, or •Verify employment
management. penalties for violating applications.
equal opportunity
laws.
 Transaction Authorization
OBJECTIVES FRAUDS OR ERRORS PREVENTIVE CONTROLS
IF OBJECTIVE NOT OR DETECTIVE
MET CONTROLS
Deductions: •Employees may be paid •Maintain updated listings of
Compensation unauthorized amounts, authorized pay rates and
and payroll potentially resulting in deductions.
deductions excessive labor costs or •Establish procedures for
should be made violation of union reviewing and approving pay
in accordance contracts. rates and deductions.
with •Accruals for pensions,
management’s vacations, or bonuses may
authorization. be calculated from
inaccurate information
potentially resulting in
misstated accruals.
 Transaction Authorization
OBJECTIVES FRAUDS OR ERRORS PREVENTIVE CONTROLS
IF OBJECTIVE NOT OR DETECTIVE
MET CONTROLS
Adjustments to Unauthorized Establish clear statements of
payroll or adjustments may be adjustment policies and
personnel processed to increase an procedures.
records should employee’s pay,
be made in potentially
accordance with misappropriating cash
management’s and overstating labor
authorization. costs.
 Transaction Authorization
OBJECTIVES FRAUDS OR ERRORS PREVENTIVE CONTROLS
IF OBJECTIVE NOT OR DETECTIVE
MET CONTROLS
Valid employees: A form of payroll fraud The personnel action form helps
Ensure that only involves submitting time payroll keep the employee
the time cards of cards for employees who no records current.
current and valid longer work for the firm.
employees are
processed.
 Execution
OBJECTIVES FRAUDS OR ERRORS PREVENTIVE CONTROLS
IF OBJECTIVE NOT OR DETECTIVE
MET CONTROLS
Payroll and Employees could process •Establish personnel and
personnel paychecks for terminated payroll procedures manuals.
procedures or fictitious employees, •Periodically verify employee
should be potentially resulting in reassignments and personnel
established in misappropriated cash. action reports.
accordance with
management’s
authorization.
 Execution
OBJECTIVES FRAUDS OR ERRORS PREVENTIVE CONTROLS
IF OBJECTIVE NOT OR DETECTIVE
MET CONTROLS
All payroll cash Cash may be disbursed for •Prenumber and control time
disbursements services not performed, records, paychecks, and
should be based potentially resulting in adjustment forms.
upon a misappropriated cash and •Require manual dual
recognized overstated labor costs. signatories for all pay over a
liability. prespecified peso amount.
 Recording
OBJECTIVES FRAUDS OR ERRORS IF PREVENTIVE
OBJECTIVE NOT MET CONTROLS OR
DETECTIVE CONTROLS
Payroll: •Payroll costs, labor costs, •Establish and document
Amounts due to and related liabilities (e.g., account distribution
employees withholding tax) may be procedures.
should be inaccurate, potentially •Reconcile appropriate
recorded at the resulting in misstated ledgers and journals.
proper expense and liabilities. •Establish physical barriers
amounts, be •Summaries of detail records over unused documents
recorded in the (e.g., payroll register and and forms.
proper period, summary of labor costs) may
and be properly not agree, potentially
classified. resulting in miscalculated
labor costs.
 Access to Assets
OBJECTIVES FRAUDS OR ERRORS IF
OBJECTIVE NOT MET
Access to •Records, forms, or
personnel and documents may be misused
payroll records by unauthorized personnel,
and to forms potentially resulting in
and documents misapplied cash or
should be unauthorized labor costs.
restricted to •A dishonest individual can
personnel misrepresent the number of
authorized by hours worked on the time cards signatories.
and thus embezzle cash.
management.
PREVENTIVE
CONTROLS OR
DETECTIVE CONTROLS
•Prenumber and control
forms and documents.
•Segregate responsibilities
for authorizing, executing,
and recording payroll and
personnel transactions.
•Maintain listings and
samples of authorized
 Segregation of Duties
• The time-keeping function and the personnel
function should be separated.
• The personnel function provides payroll with pay
rate information for authorized hourly
employees.
– Typically, an organization will offer a range of valid pay
rates based on experience, job classification, seniority,
and merit.
– If the production (time-keeping) department provided
this information, an employee might submit a higher
rate and perpetrate a fraud.
 Segregation of Duties
• The time-keeping function and the personnel
function should be separated.
• Payroll function - Segregating key aspects of
the payroll transaction between AP and cash
disbursement functions.
– AP reviews the work done by payroll (payroll
register) and approves payment.
– Cash disbursements then writes the check to
cover the total payroll.
 Independent Verification
1. Verification of time: Before sending time cards to payroll,
the supervisor must verify their accuracy and sign them.
2. Paymaster: The use of an independent paymaster to
distribute checks (rather than the normal supervisor)
helps verify the existence of the employees. The
supervisor may be party to a payroll fraud by pretending
to distribute paychecks to nonexistent employees.
3. Accounts payable: The AP clerk verifies the accuracy of
the payroll register before creating a disbursement
voucher that transfers funds to the imprest account.
4. General ledger: The general ledger department provides
verification of the overall process by reconciling the labor
distribution summary and the payroll disbursement
voucher.
 Personnel
OBJECTIVES FRAUDS OR ERRORS IF PREVENTIVE CONTROLS OR
OBJECTIVE NOT MET DETECTIVE CONTROLS

Hiring/termination, •Misunderstanding of •Hiring criteria based on policy and

determination of instructions. approval.
compensation package, •Misappropriation of •Compensation rates and payroll
deductions should be approved in
changes in salary rates, cash by making
writing.
and payroll deductions unauthorized changes •Selected payroll amounts should be
should be authorized in to payroll data. compared with predetermined
writing. •Erroneous payroll control totals to ensure that
deductions. authorized payroll data are accurately
processed.
•Adequate written personnel
procedures manual.
 Payroll Processing
OBJECTIVES
•All services performed by
employees should be
reported.
•All amounts due to
employees should be
recognized as liabilities and
accurately recorded in the
books.
•Amounts due to employees
should be based on actual
hours worked and should be
accurately and promptly
reported, computed,
summarized, and recorded.
FRAUDS OR PREVENTIVE CONTROLS OR
ERRORS IF DETECTIVE CONTROLS
OBJECTIVE NOT
MET
•Misappropriation •Use of time records, output
of payroll cash. records, or other means to
monitor time and attendance.
•Review and approval by
responsible supervisors of time or
output records, including overtime
for fixed salary employees.
•Comparison of totals per time or
output records with payroll
register totals, labor cost allocation
reports, and supporting
documentation of hours worked.
 Payroll Processing
OBJECTIVES FRAUDS OR PREVENTIVE CONTROLS OR DETECTIVE
ERRORS IF CONTROLS
OBJECTIVE NOT
MET
•There should be periodic •For salaried employees, comparison of
verification of the payroll register totals with predetermined
validity, completeness, control totals.
and accuracy of recorded •Reconciliation of payroll register totals to
balances of accounts totals posted to the GL accounts
related to payroll. •Use of prenumber journal vouchers and
•There should be periodic accounting for its completeness.
evaluation of recorded •Checking the accuracy of payroll
balances of payroll- calculations (gross pay, deductions, and
related accruals. net pay) by persons other than the
payroll prepares.
•Review and approval of the payroll by a
designated official not involved in payroll
preparation activities.
 Payroll Processing
OBJECTIVES FRAUDS OR ERRORS IF PREVENTIVE CONTROLS OR
OBJECTIVE NOT MET DETECTIVE CONTROLS

•Checking the propriety oof labor

cost distribution.
•Periodic comparison of recorded
balances of payroll-related
accounts with budgeted amounts.
•Periodic reconciliation of control
account balances with year-to-date
earnings records.
•Periodic review of the method
used to determine accruals (e.g.,
pension and retirement benefits).
Comparison of recorded amounts
with budget and prior period.
•Adequate written procedures for
payroll processing activities.
 Payroll Disbursement Distribution
OBJECTIVES FRAUDS OR ERRORS IF PREVENTIVE CONTROLS OR
OBJECTIVE NOT MET DETECTIVE CONTROLS

•All payroll •Misappropriation of •Preparation of payroll checks

disbursements should be payroll cash by making based on approved payroll
properly authorized, unauthorized payroll summary or register.
should be based on disbursement. •Examining supporting
recognized liabilities, documentation before signing
should be accurately payroll checks. Check signers
prepared, and should be should be other than those who
accurately and promptly prepare or approve payroll.
recorded in the book. •Cancellation of supporting
•Custody of payroll cash documentation to prevent re-use.
should be limited to •Performing bank reconciliation
authorized personnel. procedures.
 Payroll Disbursement Distribution
OBJECTIVES FRAUDS OR ERRORS IF PREVENTIVE CONTROLS OR
OBJECTIVE NOT MET DETECTIVE CONTROLS

•All payroll •Misappropriation of •Limiting access to check-signing

disbursements should be payroll cash by making equipment and signature plates to
properly authorized, unauthorized payroll authorized personnel.
should be based on disbursement. •Distribution of pay envelopes
recognized liabilities, should be assigned to a paymaster
should be accurately who is not involved in payroll
prepared, and should be preparation.
accurately and promptly •Control and prompt recording of
recorded in the book. unclaimed salaries and wages by
•Custody of payroll cash persons other than the payroll
should be limited to preparer.
authorized personnel. •Adequate written procedures for
the payroll distribution.