Miss Argumentative Essay

General ledger accounts that are likely to be affected by the payroll and personnel cycle in most audits include the following: CashDirect labor Inventory, Salary expense, Construction in progress, Commission expense, Wages,  payable Payroll, tax expense, Payroll taxes. In companies where payroll is a significant portion of inventory, as in manufacturing and construction companies, the improper account classification of payroll can significantly affect asset valuation for accounts such as work in process, finished goods, and construction in process.

For example, if the salaries of administrative personnel are incorrectly charged to indirect manufacturing overhead, the overhead charged to inventory on the balance sheet can be overstated. Similarly, if the indirect labor cost of individual employees is charged to specific jobs or processes, the valuation of inventory is affected if labor is improperly classified. When some jobs are billed on a cost plus basis, revenue and the valuation of inventory are both affected by improperly classifying labor to jobs. 18-3Five tests of controls that can be performed for the payroll and personnel cycle are:

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1. Examine time card for indication of approval to ensure that payroll payments are properly authorized. The purpose of this test is to determine that recorded payroll payments are for work actually performed by existing employees (occurrence).
2. Account for a sequence of payroll checks to ensure existing payroll payments are recorded. The purpose of this test is to determine that existing payroll transactions are recorded (completeness).
3. Examine time cards to ensure that recorded payroll payments are for work actually performed by existing employees. The purpose of this test is the same as in item 1 above. Compare postings to the chart of accounts to ensure that payroll transactions are properly classified.
4. Observe when recording takes place to ensure that payroll transactions are recorded on a timely basis.

The percentage of total audit time in the cycle devoted to performing tests of controls and substantive tests of transactions is usually far greater in the payroll and personnel cycle than for the sales and collection cycle because there is relatively little independent third party evidence, such as confirmation, to verify the related payroll accounts.

In contrast, the accounts related to the sales and collection cycle can usually be verified for the most part by confirmations from customers. In addition, in the sales and collection cycle, verification of the realizability of receivables and sales cutoff tests are important and time- consuming tasks.

The auditor should be concerned with whether the human resources department is following the proper hiring and termination procedures. An obvious reason for this would be to ensure that there are adequate safeguards against hiring and retaining incompetent and untrustworthy people.

The ramifications of hiring such people can range from simple inefficiency and waste to outright fraud or theft. More importantly, though, it is necessary for the auditor to assure himself or herself that the client is hiring and terminating according to operations standards and procedures. It is necessary to see if the internal controls are working as planned before they can be effectively evaluated. To say that the auditor doesn't care who is hired and who is fired is to suggest that he or she doesn't care if the internal controls work according to any standards.

Failure to follow proper termination procedures could lead to fraudulent payments for work not performed. To trace a random sample of prenumbered time cards to the related payroll checks in the payroll register and compare the hours worked to the hours paid is to test if those employees who worked are being paid for their time actually worked. Employees are likely to inform management if they are not paid, or underpaid. To trace a random sample of payroll checks from the payroll register and compare the hours worked to the hours paid is to test if the recorded payroll payments are for work actually performed by existing employees.

This test, in effect, attempts to discover nonexistent employees or duplicate payments, if there are any. For this reason, the second procedure is typically more important to the audit of payroll. In auditing payroll withholding and payroll tax expense, the emphasis should normally be on evaluating the adequacy of the payroll tax return preparation procedures rather than the payroll tax liability, because a major reason for misstatements in the liability account is incorrect preparation of the returns in the past.

If the preparation procedures are inadequate, and the amounts do not appear reasonable, then the auditor should expand his or her work and recompute the withholding and expense amounts to determine that the proper amount has been accrued. In addition, the auditor should consider the amount of penalties which may be assessed for inadequate withholdings and include these amounts in the accrual if they are significant.

Several analytical procedures for the payroll and personnel cycle and misstatements that might be indicated by significant fluctuations are as follows:

1. Comparison of payroll expense accounts to amounts in prior cutoff misstatements or improper amounts recorded in a years period.
2. Direct labor divided by sales compared to industry standards in cutoff misstatements or amounts charged to improper payroll prior years accounts.
3. Commission expense divided by sales compared to industry failure to record commission on sales, or recording the standards, prior years, or sales agreements. |improper commission amount.
4. Payroll tax expense divided by salaries and wages compared to failure to record payroll taxes or recording of the improper prior year balances adjusted for changes in the tax rate and not amount. including officers' salaries.
5. Comparison of accrued payroll and payroll tax accounts to prior failure to record payroll accruals or recording improper years amounts at the end of a period.
6. The percentage of labor included in work in process and finished|Use of improper labor standards, or classification | |goods inventories compared to prior years. |misstatements.
7. Analysis of direct labor variances. |Use of improper labor standards, or classification misstatements.
8. An auditor should perform audit tests primarily designed to uncover fraud in the payroll and personnel cycle when he or she has determined that internal controls are deficient (or the opportunity exists for management to override the internal controls) or when there are other reasons to suspect fraud.

Audit procedures that are primarily for the detection of fraud in the payroll and personnel cycle include:

1. Examine cancelled payroll checks for employee name, authorized signature, and proper endorsement (especially for second endorsements) to discover checks going to nonexistent employees. The endorsement should be compared to signatures on W-4 forms.
2. Trace selected transactions recorded in the payroll journal or listing to the human resources department files to determine whether the employees were actually employed during the period.
3. Select several terminated employees from payroll records to determine whether each former employee received his or her termination pay in accordance with company policy and to determine that the employee's pay was discontinued on the date of termination.
4. Examine the subsequent payroll periods of terminated employees to ascertain that the employees are no longer being paid. 5. Request a surprise payroll payoff to observe if any unclaimed checks result, which will necessitate extensive investigation.

The Payroll Master File is maintained for each employee indicating the gross pay for each payment period, deductions from the gross pay, the net pay, the check number, and the date. The purpose of this record is to provide detailed information for federal and state income tax purposes, and to serve as the final record of what each employee was actually paid.

The W-2 Form is issued to each employee at the end of each calendar year and indicates his or her gross pay, income taxes withheld, and FICA withheld for the year. In serving as a summary of the employee's earnings record, the W-2 form conveniently provides information necessary for the employee to fill out his or her income tax returns. A Payroll Tax Return is the form required by and submitted to the local, state and federal governments for the payment of withheld taxes and the employer's portion of FICA taxes and state and federal unemployment compensation taxes.

Where the primary objective is to detect fraud, the auditor will examine the following supporting documents and records:

1. Cancelled payroll checks for employee name, authorized signature and proper endorsement, watching specifically for unusual or recurring second endorsements.
2. Payroll journal or listing, tracing transactions to the personnel files to determine whether the employees were actually employed during the payroll period.
3. Payroll journal or listing and individual payroll records, selecting terminated employees to determine whether each terminated employee received his or her termination pay in accordance with company policy and whether each employee was paid in the subsequent payroll period.
4. Payroll checks, observing each employee as he or she picks up and signs for his or her check.
5. Time cards, testing them for reasonableness or observing whether they are being punched by the proper employees.

Types of authorizations in the payroll and personnel cycle are:

1. Deduction authorization, without which the wrong amount (or no deduction) may be deducted from the employee's paycheck.
2. Rate authorizations, without which the employee may be getting paid at the wrong rate.
3. Time card authorization, without which the employee may be getting paid for the wrong quantity of hours worked.
4. Payroll check authorization, without which unauthorized funds may be paid out.
5. Commission rate authorization, without which the salespeople might be improperly compensated for their sales efforts.
6. Authorization to hire a new employee, without which nonexistent or unqualified personnel may be added to the payroll.

It is common to verify total officers' compensation even when the tests of controls and substantive tests of transactions results in payroll are excellent because the salaries and bonuses of officers must be included in the SEC's 10-K Report and the federal income tax return and because management may be in a position to pay themselves more than the authorized amount, since the controls over the officers' payroll are typically weaker nd therefore easier to override than those of the normal payroll.

The usual audit procedure used to verify the officers' compensation is to obtain the authorized salary of each officer from the minutes of the board of directors and compare it to the related earnings record. An imprest payroll account is a separate payroll bank account in which a constant balance, either zero or small, is maintained. When a payroll is paid, the exact amount of the net payroll is transferred by check or electronic funds transfer from the general account to the imprest account.

The purpose and advantage of an imprest payroll account is that it limits the company's exposure to payroll fraud by limiting the amount that may be misappropriated.

Several audit procedures the auditor can use to determine whether recorded payroll transactions are recorded at the proper amounts are: 1. Recompute hours worked from time cards. 2. Compare pay rates with union contract, approval by the board of directors, or other source. 3. Recompute gross pay. 4. Check withholdings by reference to tax tables and authorization forms in personnel files. 5. Recompute net pay. 6.

Compare cancelled check with payroll journal or listing for amount. 18-16Attributes sampling can be used in the payroll and personnel cycle in performing tests of controls and substantive tests of transactions with the following objectives:

1. Time card hours agree with payroll computations.
2. Overtime hours are approved.
3. Foreman approves all time cards.
4. Hourly rates agree with personnel files and union contracts.
5. Gross pay calculation is verified.
6. Exemptions taken agree with W-4.
7. Income tax, other deductions, and net pay calculations are verified.
8. Authorizations are available for voluntary withholdings and miscellaneous deductions.
9. Paycheck endorsement is same as signature on W-4 form.

The frequency of control deviations or monetary errors must be estimated prior to performing the tests. This estimate together with the acceptable risk of assessing control risk too low (ARACR) and the tolerable exception rate will enable the auditor to determine the sample size required. Once the tests are performed on the sample, evaluation of the results will indicate whether the exception rate is lower than, equal to, or higher than that anticipated.

The auditor must then use this judgment to decide the appropriate action to take.

Brendin's approach to determining why this year's payroll tax expense was so high suffers from two serious deficiencies: First, it lacks relevance, and second, it is too narrowly focused. The approach lacks relevance in that he is testing payroll withholding which is not the same as payroll tax expense.

Some payroll taxes are related to withholding such as FICA, but income tax withheld does not give rise to an expense, and certain payroll taxes, such as unemployment compensation, are not withheld. The approach is too narrowly focused in that the analytical test results could have resulted from a misstatement of the payroll itself; Brendin does not appear to be considering this possibility.

A more suitable approach for determining whether payroll tax was properly stated in the current year would be to evaluate the reasonableness of the total payroll, reconcile the payroll to amounts shown on payroll tax reports, and check computations as shown on those reports for reasonableness.

The following audit procedures should be used to verify the payroll related accounts:

1. Accrued payroll:

a. Review the company's policy for computing the accrual and whether it is consistent with the prior year.

b. Assess whether 60 percent is a reasonable approximation of the portion of the subsequent payroll application to the current year.

c. Test the subsequent payroll for cutoff and accuracy.

d. Determine that the computation of the accrual is correct.

2. Withheld payroll taxes:

a. Compare the balance in the liability account with the payroll journal or listing.

b. Reconcile the amount to subsequent payroll tax reports and cash disbursed.

c. Review in light of the subsequent period's payroll.

3. Accrued payroll taxes:

a. Trace FICA withheld from payroll journal or listing to payroll tax reports.

b. Review amounts on payroll tax reports for reasonableness.

c. Reconcile accruals to payroll tax reports.

d. Examine subsequent cash disbursed.

The purpose of a surprise payroll payoff is to determine whether or not nonexistent personnel are included in the payroll. Procedures other than a surprise payroll payoff that can be used to discover nonexistent employees are:

1. Examine cancelled payroll checks for employee name, authorized signature, and proper endorsement that agrees with the employee's signed W-4 form.
2. Select several terminated employees from payroll records to determine whether each former employee received his or her termination pay in accordance with company policy and was not paid in subsequent payrolls.

When the payroll payoff is taking place, the client should observe these control procedures:

1. All employees must prove identity.
2. Unclaimed paychecks must be further investigated. Unclaimed paychecks might be accounted for by employees who are sick or on vacation.

After all present employees have received their checks, the remaining paychecks should be traced to the personnel files to determine if these employees were ever employed by the client. Thereafter, if practical, the remaining checks should be held until the employees can be present with proper identification to claim the check.

Some increase in payroll expense may occur, if there are disputes between Archer Uniforms and the credit card agencies over the amounts processed throughout the month. Additional time may be required to reconcile the processing of cash payments by the credit card agencies and the recording of sales in Archer Uniform’s financial statements. Accounts Payable Moderate Increase Assuming total sales significantly increase due to the new online offering, Department the volume of inventory purchases will increase.

This increase in inventory purchasing will result in an increase in vendor payments to be processed. Thus, payroll expense for the accounts payable department may increase moderately. Some efficiencies may be obtained by processing larger bulk orders in a single vendor payment. However, new products may be offered and additional vendors may be used, which in turn will increase the volume of processing required in accounts payable.

An audit program to verify sales commission expense is as follows:

1. Select a sample of office copies of sales invoices.

a. Check commissions rate to commissions rate file.

b. Check computation of sales commissions.

c. Examine invoices for internal verification by accounts receivable clerk.

d. Trace sales commission amounts to sales commission ledger.

2. Foot the sales commission ledger for one or more months, and trace the total to the general ledger.

3. Compare totals for periods in the sales commission ledger to period balances of sales commission expense.

An audit program to verify accrued sales commissions is:

1. Compare the accrual with that of the previous year. Investigate any significant change.
2. Compare the amount of commissions paid to the salesmen on the fifteenth of the month following year-end to the total accrued commissions at year-end. Obtain a reconciliation and explanation for any reconciling items.
3. Send confirmations to salesmen for the larger amounts of accrued commissions and a sample of the smaller amounts. Conventional forms and documents in a payroll system include the following:

In using the computer service center, it appears that there is no loss in documentation in substance; however, the earnings record is not printed out each pay period, thus, the current version is usually in machine readable form. This assumes that authorization forms exist although they are not discussed in the case.  The fact that the earnings record is in magnetic form is not a problem, as long as the service bureau has adequate backup and recovery controls. The above analysis reflects the fact that Leggert's internal controls in the payroll area are generally good. There is good segregation of duties between the President and Clark, assuming both are trustworthy, honest people.

Procedures, forms, records, and reports are comprehensive and well-designed. The only potential deficiency in internal control is that errors in details could be made by the service bureau and not necessarily be caught. It is difficult to imagine that these would be material.

You might wish to point out to the students the difficulty in interpreting such data as that presented on this site. Specifically, median salaries data are presented for a number of categories such as size of facility, geographic region, and location. The inquisitive student should inquire about these differences and so a liberal view may be appropriately applied when grading this component of the problem.

Note: Internet problems address current issues using Internet sources. Because Internet sites are subject to change, Internet problems and solutions are subject to change.

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