Audit of the Payroll

and Personnel Cycle

Chapter 17

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 Learning Objective 1

Identify the accounts and

transactions in the payroll
and personnel cycle.

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 Accounts and Transactions in the
Payroll and Personnel Cycle

The overall objective in the audit of the payroll

and personnel cycle is to evaluate whether the
account balances affected by the cycle are
fairly stated in accordance with generally
accepted accounting principles.

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 Accounts and Transactions in the
Payroll and Personnel Cycle
Accrued Wages, Salaries,
Bonuses, and Commissions
Cash in Bank Payment Beginning Direct Labor
balance
Payment
for salaries Earned wages,
salaries, etc.
Payment for Ending balance
payroll taxes Withheld Income Taxes
and Other Deductions
Payment Beginning
balance
Payroll withholding
Ending balance
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 4
 Accounts and Transactions in the
Payroll and Personnel Cycle
Withheld Income Taxes
and Other Deductions
Cash in Bank Payment Beginning
Payment balance
for salaries
Payroll withholding
Payment for Ending balance
payroll taxes
Accrued Payroll Tax Expense
Payroll Tax Expense Payment Beginning balance
Payroll tax expense
Ending balance
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 Accounts and Transactions in the
Payroll and Personnel Cycle

Separate operating accounts for payroll also

normally include officers’ salaries and bonuses,
office salaries, sales salaries and commissions,
and indirect manufacturing labor.

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 Accounts and Transactions in the
Payroll and Personnel Cycle

These accounts have the same relationship

to accrued wages and withheld taxes and
other deductions that is shown for direct labor.

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 Learning Objective 2

Describe the business functions

and the related documents and
records in the payroll and
personnel cycle.

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 Business Functions in the Cycle and
Related Documents and Records

The payroll and personnel cycle begins with

the hiring of personnel and ends with payment
to the employees for the services performed
and to the government and other institutions
for the withheld and accrued payroll taxes
and benefits.

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 Personnel and Employment

Personnel records

Deduction authorization form

Rate authorization form

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 Timekeeping and Payroll
Preparation
Time Card
Job Time Ticket
Payroll Transaction File
Payroll Journal

Payroll Master File

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 Payment of Payroll

Payroll check

Payroll bank account reconciliation

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 Preparation of Payroll Tax
Returns and Payment of Taxes

W-2 Form
Payroll Tax Returns

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 Learning Objective 3

Understand internal control and

design and perform tests of
controls and substantive tests
of transactions for the
payroll and personnel cycle.
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 Methodology for Designing Tests of
Balances – Accounts Receivable
Understand internal control –
payroll and personnel.

Assess planned control risk –

payroll and personnel.

Evaluate cost-benefit
of testing controls.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 15
 Methodology for Designing Tests of
Balances – Accounts Receivable

Design tests of details of Audit procedures

controls and substantive tests
of transactions for payroll Sample size
and personnel to meet Items to select
transaction-related
audit objectives. Timing

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 Understand Internal Control –
Payroll and Personnel Cycle

• Adequate separation of duties

• Proper authorization
• Adequate documents and records
• Physical control over assets and records
• Independent checks on performance

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 Payroll Tax Forms
and Payments

Preparation of payroll tax forms

Payment of the payroll taxes withheld

and other withholdings on a timely basis

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 Inventory and Fraudulent
Payroll Considerations

Relationship between payroll

and inventory valuation

Tests for nonexistent payroll

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 Methodology for Designing Tests of
Balances – Accounts Receivable
Identify client business risks
affecting payroll liability accounts.

Set tolerable misstatement

and assess inherent risk
for payroll liability accounts.

Assess control risk for the

payroll and personnel cycle.
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 20
 Methodology for Designing Tests of
Balances – Accounts Receivable
Design and perform tests of
controls and substantive tests
of transactions for the
payroll and personnel cycle.

Design and perform analytical

procedures for the
payroll and personnel cycle.
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 21
 Methodology for Designing Tests of
Balances – Accounts Receivable

Design tests of details of Audit procedures

payroll accounts balances Sample size
to satisfy balance-related Items to select
audit objectives. Timing

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 Learning Objective 4

Design and perform analytical

procedures for the payroll
and personnel cycle.

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 Analytical Procedures for the
Payroll and Personnel Cycle
Analytical Procedure Possible Misstatement
Compare payroll expense Misstatement of payroll
account balance with expense accounts
previous years.
Compare direct labor as a Misstatement of direct
percentage of sales with labor and inventory
previous years.
Compare commission Misstatement of
expense as a percentage of commission expense and
sales with previous years. commission liability
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 24
 Analytical Procedures for the
Payroll and Personnel Cycle
Analytical Procedure Possible Misstatement
Compare payroll tax expense Misstatement of payroll
as a percentage of salaries and tax expense and payroll
wages with previous years. tax liability
Compare accrued payroll tax Misstatement of accrued
accounts with previous years. payroll taxes and payroll
tax expense

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 17 - 25
 Learning Objective 5

Design and perform tests

of details of balances for
accounts in the payroll
and personnel cycles.

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 Tests of Details of Balances
for Liability Accounts

Amounts withheld from employees’ pay

Accrued salaries and wages
Accrued commissions
Accrued bonuses
Accrued vacation pay, sick pay, or other benefits
Accrued payroll taxes

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 Tests of Details of Balances
for Expense Accounts

Officers’ compensation
Commissions
Payroll tax expense
Total payroll
Contract labor

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 Types of Audit Tests for the
Payroll and Personnel Cycle
Cash in Payroll Direct Labor and
Bank Liabilities Payroll Expenses
Payments Expenses
Audited by Audited by
TOC, STOT, and AP TOC, STOT, and AP
Ending Ending
balance balance
Audited by Audited by
AP and TDP AP and TDP
TOC + STOT + AP + TDP
= Sufficient competent evidence per GAAS
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 End of Chapter 17

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