Chapter 12Chapter 12

Auditing the Human Resource Management Process

McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved

Human Resources/Payroll

Major expense

Strong controls

Often outsourced

12-3

Overview of the Human Resource Management Process

The human resource process starts with the establishment of sound policies for hiring, training, evaluating, counseling, promoting, compensating,

and taking remedial actions for employees.

The main concern of the auditor involves payroll transactions once an employee has been hired.

LO# 1

12-4

Flowchart for EarthWear Clothiers

OperatingHuman

Resource

DepartmentsDepartments

PayrollInitiates

personnelchanges

Payrollmaster filechanges

Reviewsmaster file

changereport

Review

By date

Payrollmaster filechanges

Timecards

Approvedby

supervisor

Timecards

Input

Errorcorrections

From IT

To IT

LO# 1

12-5

Payroll transactions

Employee performs a job

Employee records the time

Approval by supervisor

12-6

Flowchart for EarthWear Clothiers

Payroll

DepartmentsDepartmentsITPayroll

masterfile

Errorreport

Payrollprocessing

Payrollchecks

Payrollregister

Errorcorrections

Payrollregister

Reviewby date

Payroll masterfile changes

report

Payrollreporting

Generalledger

Periodicpayrollreports

Tax reportsand forms

LO# 1

12-7

Two types of transactions are typically processed Two types of transactions are typically processed through the human resource management process:through the human resource management process:

1.1. Payments to employees for services rendered.Payments to employees for services rendered.

2.2. Accrual and payment of payroll-related liabilities Accrual and payment of payroll-related liabilities arising from employees’ services, including liabilities arising from employees’ services, including liabilities for Social Security and unemployment taxes.for Social Security and unemployment taxes.

LO# 2

Types of Transactions and Financial Statement Accounts Affected

12-8

Type of Transaction Account AffectedPayroll transactions Cash

InventoryDirect and indirect labor expense accountsVarious payroll-related liabilitiy and expense accounts

Accrued payroll liability Cashtransactions Various accruals (such as payroll taxes and pension costs)

LO# 2

Types of Transactions and Financial Statement Accounts Affected

12-9

Types of Documents and Records▪Personnel records, including wage-rate or salary authorizations.▪W-4 and other deduction authorization forms.▪Time card.▪Payroll check/direct deposit records.▪Payroll register.▪Payroll master file.▪Payroll master file changes report.▪Periodic payroll reports.▪Various tax reports and forms.

▪Personnel records, including wage-rate or salary authorizations.▪W-4 and other deduction authorization forms.▪Time card.▪Payroll check/direct deposit records.▪Payroll register.▪Payroll master file.▪Payroll master file changes report.▪Periodic payroll reports.▪Various tax reports and forms.

LO# 3

12-10

Major Functions of HR

Record production and other types of costs

Ensure that payroll costs are for legitimate activities

Accrue liabilities for salaries, wages, etc.

12-11

The Major Functions

PersonnelAuthorization of hiring, firing, wage-rate and salary adjustments, salaries, and payroll deductions.

SupervisionReview and approval of employees' attendance and time information; monitoring of employee scheduling, productivity, and payroll cost variances.

TimekeepingProcessing of employees' attendance and time information and coding of account distribution.

Payroll processing

Computation of gross pay, deductions, and net pay; recording and summarization of payments and verification of account distribution.

Disbursement Payment of employees' compensation and benefits.

General ledger Proper accumulation, classification, and summarization of payroll in the general ledger.

LO# 4

12-12

Segregation of DutiesLO# 5

Payroll Function OperatingHuman

ResourceTime-

keeping Payroll IT TreasurerInitiation of wage or salary changes XInitiation of employee hiring and firing XApproval of wage and salary changes XUpdating of personnel records XUpdating of payroll records XApproval of time cards and job classification XReview of time data and payroll distribution XPreparation of payroll X XPreparation and signing of payroll checks XDistribution of payroll checks XUndating of general ledger for payroll XComparison of payroll expense to budget XCalculation and recording of payroll taxes X

12-13

Segregation of Duties

No one person should control all phases of a transaction

12-14

Inherent Risk AssessmentIn assessing inherent risk the auditor may want to

consider the effect of economic conditions on payroll costs, the supply of skilled workers, and the frequency of employee turnover. The auditor should be familiar with any existing labor contracts and the

impact of regulation on the company.

The inherent riskassociated with non-officers

of the company isgenerally considered low.

The inherent risk associated withofficers of the company may not

be considered low because of theability to take advantage of their

high position.

LO# 6

12-15

Risk Assessment Procedures

Risk Assessment Procedures

Risk Assessment Procedures

12-16

Control Risk Assessment

Understand and document the human resource Understand and document the human resource management process based on a reliance management process based on a reliance

approach.approach.

Set and document the control risk for the Set and document the control risk for the human resource management process.human resource management process.

Plan and perform tests of controls on payroll Plan and perform tests of controls on payroll transactions.transactions.

LO# 7

12-17

Tests of Controls ( Transactions)

Tests of Controls

Risk Assessment Procedures

Test of Controls

12-18

Control Activities and Test of Controls – Payroll Transactions

Occurrence of Payroll TransactionsOccurrence of Payroll TransactionsThe auditor want assurance that payments for payroll-

related services are being made to valid employees for time actually worked. Controls must be in place to

ensure that no payments are made to fictitious employees and payments to valid employees are

stopped once the employee is terminated.

LO# 8

12-19

Control Activities, Cont’d

External payroll servicer

SAS #70 report

12-20

Control Activities and Test of Controls – Payroll Transactions

Authorization of Payroll TransactionsAuthorization of Payroll TransactionsThe client must have controls for hiring and terminating employees, setting pay rates,

making withholdings, awarding benefits, and issuing payroll checks.

LO# 8

12-21

Control Activities and Test of Controls – Payroll Transactions

Accuracy of Payroll TransactionsAccuracy of Payroll TransactionsThe auditor’s main concern is that the

employee’s gross pay and payroll deductions are determined correctly.

LO# 8

12-22

Control Activities and Test of Controls – Payroll Transactions

Classification of Payroll TransactionsClassification of Payroll Transactions

If payroll expense is charged to the wrong accounts, the financial statement may be misstated. If payroll expense is not properly classified between direct

and indirect labor, inventory and cost of goods sold may not be valued properly.

LO# 8

12-23

Relating the Assessed Level of Control Risk to Substantive ProceduresIf the results of the tests of controls for the payroll system support the planned level of control risk, the auditor conducts substantive procedures of

payroll-related accounts at the assessed level. If the tests do not support the level of control risk, the

nature and extent of substantive testing will be increased.

LO# 9

12-24

Substantive Analytical Procedures

Substantive Analytical Procedures

Tests of Controls

Risk Assessment Procedures

Substantive Analytical Procedures

12-25

Auditing Payroll-Related Accounts

Substantive Analytical ProceduresSubstantive Analytical Procedures

Payroll Expense Accounts:Compare current year with prior years' payroll expense accounts

Compare current and prior years' payroll costs as percent of sales and industry data

Compare labor utilization rates and statistics with industry data

Compare budgeted payroll expenses with actual payroll expenses

Estimate sales commissions with formula and recorded sales

Payroll-Related Accrual Accounts:Compare current and prior years' balances in payroll related accounts

Test reasonableness of accrual balance

Substantive Analytical Procedures

LO# 10

12-26

Tests of Details

Substantive Tests of Details

Substantive Analytical Procedures

Tests of Controls

Risk Assessment Procedures

Substantive Test of Details

12-27

Tests of Detail of Transactions, Account Balances, and Disclosures

Assertions about Transactions Substantive Tests of Transaction

OccurrenceTrace a sample of payroll checks to the master employee list to verify validity.

Completeness Trace a sample of time cards to the payroll register.

AuthorizationTest a sample of payroll checks for proper authorization.

AccuracyRecompute a sample of payroll checks for gross pay, deductions, and net pay.

CutoffTrace a sample of time cards before and after period end to the appropriate payroll report.

ClassificationExamine a sample of payroll checks for proper classification into expense accounts.

LO#

11 & 12

12-28

Tests of Detail of Transactions, Account Balances, and Disclosures

Assertions about Account Balances at Period End Tests of Details of Account Balances

ExistenceVouch selected amounts from account schedules for accruals to supporting documents (payroll tax returns, corporate benefit policies, etc..

Rights and obligations Review supporting documentation to determne that the entity is legally obligated to pay the liability.

Completeness Search for unrecorded liabilities.

Valuation and Allocation

Obtain an account analysis schedule for accrued payroll liabilites; foot schedules for accrued payroll liabilities. Compare amounts accrued to supporting documentation, such as payroll tax returns.

LO#

11 & 12

12-29

Tests of Detail of Transactions, Account Balances, and Disclosures Assertions about Presentation and

Disclosure Tests of Details of DisclosuresOccurrence, and rights and

obligationsInquire about accruals to ensure that they are properly disclosed.

CompletenessComplete financial reporting checklist to ensure that all financial statement disclosures related to payroll expense have been made.

Accuracy and valuation

Review benefit contracts for proper disclosure of pension and postretirement benefits. Read footnotes and other information to ensure that the information is accurate and properly presented at the appropriate amounts.

LO#

11 & 12

12-30

Payroll Expense AccountsPayroll transactions affect many expense accounts, including direct and indirect manufacturing expense, general and administrative salaries, sales salaries,

commissions, and payroll tax expenses.

If the entity’s internal control is reliable, the auditor does not need to conduct detailed tests of all these payroll

expense accounts. Additional testing is necessary only when control weaknesses exist.

If the entity’s internal control is reliable, the auditor does not need to conduct detailed tests of all these payroll

expense accounts. Additional testing is necessary only when control weaknesses exist.

LO#

11 & 12

12-31

Accrued Payroll Liabilities

The entity incurs a number of liabilities including payroll taxes withheld (federal and state income and FICA), medical and life insurance premiums, pension, and other miscellaneous deductions.

Accrued wagesAccrued wagesand salariesand salaries

Accrued wagesAccrued wagesand salariesand salaries

Accrued payrollAccrued payrolltaxestaxes

Accrued payrollAccrued payrolltaxestaxes

Accrued Accrued commissionscommissions

Accrued Accrued commissionscommissions

Accrued Accrued bonusesbonusesAccrued Accrued bonusesbonuses

Accrued benefits Accrued benefits (vacation & sick pay)(vacation & sick pay)Accrued benefits Accrued benefits

(vacation & sick pay)(vacation & sick pay)

LO#

11 & 12

12-32

Accrued Payroll Liabilities

CutoffCutoffAn examination of supporting documentation for

the accruals provides evidence on the proper period for recording the expense or liability.

LO#

11 & 12

12-33

Accrued Payroll Liabilities

Existence and ValuationExistence and ValuationTo verify the existence and valuation of an accrued payroll liability, the auditor can trace the amounts included on the account analysis working paper to

supporting documentation such as payroll tax reports.

LO#

11 & 12

D irec t m a te ria ls .................... $ 1 8 ,0 0 0 D irec t lab o r .......................... $ 2 1 ,0 0 0 M an u fac tu rin g o v e rh ead ...... $ 3 3 ,0 0 0 S e llin g ex p en ses ................... $ 1 4 ,0 0 0 A d m in is tra tiv e ex p en ses ...... $ 1 9 ,0 0 0

12-34

Accrued Payroll Liabilities

CompletenessCompletenessThe auditor must be aware of the normal payroll-

related taxes that are paid by the entity and therefore should be able to determine if accruals have been made for payroll taxes such as Social

Security taxes and unemployment insurance.

LO#

11 & 12

12-35

Accrued Payroll Liabilities

Presentation and Disclosure Completeness AssertionPresentation and Disclosure Completeness Assertion Sample Disclosure Items for the Human Resource

Management Process Pension disclosures required by FASB Nos. 87, 132R, 158

Postretirement benefit disclosures required by FASB Nos. 106, 132

Stock-based compensation disclosure required by FASB Nos. 123R, 148Deferred Compensation arrangements and Profit-sharing plans

LO#

11 & 12

12-36

Evaluating the Audit Findings – Payroll-Related Accounts

If the likely misstatement is less than the tolerable misstatement, the auditor may accept the accounts as fairly presented.

If the misstatement is greater than the tolerable misstatement, the auditor may

conclude that the accounts are not fairly presented.

LO# 13

12-37

Questions?

12-38

End of Chapter 12