Question

For each of the preceding questions:

• Identify the assertion to which the question applies.
• Specify one test of controls an auditor could use to determine whether the control was operating effectively.
• Provide an example of an error or fraud that could occur if the control were absent or ineffective.
• dentify a substantive auditing procedure that could detect errors or frauds that could result from the absence or ineffectiveness of the control items.

1. Are names of terminated employees reported in writing to the payroll department?
2. Are authorizations for deductions signed by the employee on file?
3. Is there a timekeeping department (function) independent of the payroll department?
4. Are timekeeping and cost accounting records (such as hours, dollars) reconciled with payroll department calculations of hours and wages? For what purposes should an auditors’ understanding of the internal control components be used in planning an audit What is required for an audit team to assess control risk below the maximum level?

Answer 1

1.         a.                     Occurrence: The control provides evidence that only valid payroll transactions are being recorded in the financial statements (i.e., no fictitious employees).

            b.                     Select a sample of personnel files for new hires and terminations and trace to reports submitted to the personnel department. Trace also to first or last paycheck issued and to cumulative payroll records.

            c.                     Paychecks might be delayed and terminated workers might continue to be “paid” (with theft of check by someone else) if payroll is not promptly notified of new hires and terminations.

            d.                     Select a sample of terminated employees. Interview their supervisors or the employees themselves for information about termination date. Search next payroll register for evidence of overpayment the next pay period.

2.         a.                     Occurrence: The control provides evidence that the recorded payroll deductions are valid.

            b.                     Select a sample of payroll deductions and vouch them to signed authorizations.

            c.                     It is possible that incorrect amounts might be deducted from pay.

            d.                     Same as tests of controls: Select a sample of paychecks, and vouch the deductions to the amount  authorized according to the personnel files.

3.         a.                     Occurrence: This control provides evidence that recorded payroll transactions are valid and  properly authorized.

            b.                     Observe the timekeeping operations to determine whether they are performed separately.

            c.                     If payroll department personnel were also responsible for time records, they would have effective control over transaction authorization (i.e., hours worked approval) and could overpay themselves or friends.

            d.                     Select the paychecks issued to the people involved in combined duties. Examine them for evidence of overpayment (wage rate or overtime).

4.         a.                     Completeness: This control provides evidence that payroll and labor cost transactions are recorded in a complete manner.

            b.                     Obtain reconciliation worksheets or check off reports and see whether the reconciliation was done.

            c.                     Cost accounting records might contain more or fewer dollars than actually paid (per payroll data). Simple errors in cost analyses might occur.

            d.                     If possible, obtain a total of labor charged to cost accounting jobs or processes, and reconcile to total wages reported on Federal Form 941. For details, select a sample of labor cost analyses and reconcile them to the payroll register for the same period.

5.         In planning an audit, the auditors’ understanding of the internal control components should be used to identify the types of potential misstatements that could occur, to consider the factors affecting the risk of material misstatement, and to influence the design of substantive procedures.

An audit team obtains an understanding of the design of relevant internal control activities (policies and procedures) and whether they have been implemented. Assessing control risk below the maximum level further involves identifying specific control activities (policies and procedures) relevant to specific assertions that are likely to prevent or detect material misstatements in those assertions. It also involves performing tests of controls to evaluate the operating design and effectiveness of the client’s control activities.