Audit of the Payroll

and Personnel Cycle

Chapter 18

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 Learning Objective 1

Identify the accounts and

transactions in the payroll
and personnel cycle.

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 Accounts 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 in the Payroll and
Personnel Cycle
Accrued Wages, Salaries, Direct
Bonuses, and Commissions Labor
Payment Beginning
Cash in Bank balance
Payment for Earned wages,
salaries salaries, etc.
Payment for Ending balance
payroll taxes
Withheld Income Taxes
and Other Deductions
Payment Beginning
balance
Payroll
withholding
Ending balance
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 4
 Accounts in the Payroll and
Personnel Cycle
Withheld Income Taxes
and Other Deductions
Payment Beginning
Cash in Bank balance
Payment for Payroll
salaries withholding
Payment for Ending balance
payroll taxes
Accrued Payroll
Payroll Tax Expense Tax Expense
Payment Beginning
balance
Payroll
tax expense
Ending balance
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 Accounts in the Payroll and
Personnel Cycle

In most systems the accrued wages and

salaries account is used only at the
end of an accounting period.

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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

Timekeeping and
Payroll Preparation

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 Payroll Master File

A payroll master file is used for

recording each payroll transaction
for each employee and maintaining total
employee wages paid for the year to date.

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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
Controls and Substantive Tests
Understand internal Assess planned
control payroll control risk payroll
and personnel. and personnel.

Determine extent of testing controls.

Design tests of controls and Audit Items

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

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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 for Payroll Liabilities
Phase I

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.
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 Methodology for Designing Tests
of Balances for Payroll Liabilities
Phase II

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 for Payroll Liabilities
Phase III

Design and perform analytical procedures for the

payroll and personnel cycle.

Design tests of details of payroll accounts balances

to satisfy balance-related audit objectives.

Audit Sample Items to

Timing
procedures size select
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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 balances with
expense accounts.
previous years.

Compare direct labor as a

Misstatement of direct
percentage of sales with labor and inventory.
previous years.

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 Analytical Procedures for the
Payroll and Personnel Cycle
Analytical procedure Possible misstatement

Compare commission expense Misstatement of

as a percentage of sales with commission expense
previous years. and commission liability.

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 expense.

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 Learning Objective 5

Design and perform tests of

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

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 Two Major Balance-related
Audit Objectives

Accruals in the trial balance

are stated at the correct
amounts (accuracy).

Transactions in the payroll and

personnel cycle are recorded
in the proper period (cutoff).

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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

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 18 - 28

 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 AP and TDB

TOC + STOT + AP + TDB

= Sufficient competent evidence per GAAS
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 End of Chapter 18

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