CHAPTER 6 AUDIT OF THE CONVERSION CYCLE

NATURE OF THE CONVERSION CYCLE

We are going to discuss the conversion or The functions within the cycle as represented on
manufacturing cycles, specialized areas of the slide include the following:
manufacturing including the nature, internal
1. Preparation of the production order and
controls, tests of controls and substantive
materials requisition.
procedures over the production, inventory
warehousing, and payroll transactions. This time
A production order is an order issued
we will discuss the three mentioned areas of
within a company to produce a specific
manufacturing by topic, from the nature up to the
quantity of material within a certain time
substantive procedures.
frame. For example, a production of
100,000 plain white t-shirts in a period of
one month.

2. Stores will issue the appropriate quantity of

materials for the production and notes the
issuances on the materials requisition form.

The accomplished materials requisition

form is forwarded to cost accounting for the
updating of the cost records.
MANUFACTURING involves the conversion of raw
materials into finished goods. It includes
3. The goods are produced once the materials
production planning and control of the types and
are issued from the stores.
quantities of products to be manufactured, the
inventory levels, raw materials as well as the
4. The production report is prepared at the
finished goods to be maintained and the activities
end of the production time frame whether
pertaining to the manufacturing process.
they were able to produce the 100, 000
This cycle interfaces with both the revenue and plain white t-shirts or less than that.
expenditure cycles.
5. The finished goods together with the
production report is forwarded to the
finished goods warehouse.

The finished goods are reconciled with the

production report.
 6. The production report is forwarded to the
cost accounting for the updating of cost
records.
The finished goods ledger is updated, and
the monthly cost summary is prepared.
7. Lastly, the monthly cost summary is
submitted to the general ledger function for
the updating of the general ledger control
accounts.
3. MATERIALS REQUISITION SUMMARY is a
DOCUMENTS USED IN THE CYCLE AND THEIR
AUDIT SIGNIFICANCE
1. PRODUCTION ORDER is a prenumbered
document that is issued internally to
4. COST ACCUMULATION REPORT is a form
instruct the production function to produce
a certain number of quantities of a
particular product.
A production order may be issued pursuant
to a sales order and its issuance triggers a
number of events. It is used to record
approval for production personnel to
produce the product.
5. LABOR TICKET is a pre-numbered form on
2. MATERIALS REQUISITION is a list of raw
materials component required to produce a
product issued to the warehouse or stores.
If components in the bill of materials are in
6. LABOR TICKET SUMMARY is a form that
stock, reservations are generated for those
items. If they are not in stock, then
requisition orders may be generated.
Requisition orders may also be generated
for production that occurs externally to the
firm. Planned costs for the order are also
generated and capacity requirements are
generated for the work centers. This
document records the approval to issue
materials to production.
When a number of component materials
are required to produce a product the
quantity of materials issued will be dictated
by the BILL OF MATERIALS which is a list of
raw materials components required to
produce a product.
form used to summarize the materials
requisition by job or by process for a period
such as a day, a week or a month depending
on the volume of the transaction.
It records materials used in any given period
and is the basis for assigning costs to an
account.
that accompanies goods as they are
transferred through production.
As additional costs are incurred, the costs
are recorded on the report. This document
records cost of raw materials placed in
production.
which time worked on job is recorded. It
records the specific activity of a laborer and
is the basis for assigning costs to an
account.
summarizes the daily labor tickets by job or
by process. It is a record of labor used in
production in any given day.
 7. COMPLETED PRODUCTION REPORT is a recording and reporting of costs that go into the
report that summarizes cost for control production process.
purposes and for determining the amount
of cost to assign to goods remaining in the
production process. It provides a basis for
inventory valuation.

ACCOUNTING RECORDS
1. GENERAL JOURNAL this journal contains
the entries not entered in a special journal
such as the transfer of raw materials to
work in process.
2. SUBSIDIARY LEDGERS/SHARED CARDS
Subsidiary ledgers are maintained for raw
materials, work in progress, finished goods,
and manufacturing overhead. Each
subsidiary ledger includes a group of
detailed records. For example, a subsidiary
ledger for raw materials includes a record
for each type of material.
TESTS OF CONTROL
A sample questionnaire with the file name control
risk assessment questionnaire for production
transactions may be downloaded from my shared
google drive this will aid the auditor to help identify
and document the strengths and weaknesses of
the internal control after he has obtained an
understanding of the entity's business and internal
control.
Auditors perform one or more audit procedures to
test the assertions including the following as seen
on the slide.
EXISTENCE OR OCCURRENCE. Recorded production
transactions occurred.
COMPLETENESS. All production transactions that
occurred are recorded.
VALUATION OR ALLOCATION. Production
transactions are recorded for the proper amounts.
PRESENTATION AND DISCLOSURE. Production
transactions are recorded to result in presentation
and disclosure in accordance with PFRS/PAS.

TEST OF CONTROLS AND SUBSTANTIVE

PROCEDURES RELATED TO PRODUCTION
TRANSACTIONS
It must be noted that the specialized branch of cost
accounting plays a major role in the accurate
These and the following slides presents the control
an entity should implement to ensure the propriety
of each assertion and the tests an auditor might
perform to determine the effectiveness of the
controls on production transactions.
EXISTENCE OR OCCURRENCE Recorded production
transactions occurred.
Controls:
COMPLETENESS All production transactions that
1. A material requisition should be prepared
occurred are recorded.
by operating personnel and signed by a
warehouse custodian when goods are Controls:
transferred to production requiring
3. Production orders are pre-numbered and
materials to be completed by two persons,
accounted for to determine that all
one who releases raw materials and
productions are recorded.
another who accepts responsibility for
merchandise provides evidence that a
To test this control the auditor should
transaction exists.
OBSERVE THE PROCEDURE and ACCOUNT
FOR THE NUMERICAL SEQUENCE OF
Properly completed materials requisition
PRODUCTION ORDERS.
should be on file in accounting where an
employee accounts for their sequence.
4. Materials requisitions are pre-numbered
and accounted for by an accounting clerk.
To test this control over the assertion, the
auditor should OBSERVE SEPARATION OF
To test this control the auditor should
DUTIES and EXAMINE APPROVAL
OBSERVE THE PROCEDURE and ACCOUNT
SIGNATURES.
FOR THE NUMERICAL SEQUENCE OF
MATERIAL REQUISITIONS.
2. Labor tickets bearing a signature indicating
that work was actually performed should
5. Time charged on labor ticket is reconciled
be the basis in recording labor.
to employee timed cards.
To test this control, the auditor should
To test this control the auditor should
EXAMINE THE LABOR TICKETS.
OBSERVE IF A CLERK RECONCILES THE
TIME CHARGE ON COMPLETED LABOR
 TICKETS TO THE TOTAL HOURS FOR WHICH
PRODUCTION WORKERS ARE PAID.
recorded to result in presentation and disclosure in
the financial statement in accordance with
PAS/PFRS.
Control:
8. The chart of account should adequately
describe the accounts to be used and
account coding is independently checked.

To test this control the auditor should

EXAMINE THE CHART OF ACCOUNTS and
also he or she SHOULD EXAMINE THE
VALUATION OR ALLOCATION Production SIGNATURE OF EMPLOYEES PERFORMING
transactions are recorded on the proper amount. THE PROCEDURES MENTIONED.

Controls: The controls and tests of controls discussed are not

exhaustive but only illustrative.
6. Value for transactions are based on a bill of
materials, approved tickets and rates for
labor, and predetermined overhead rates.

To test this control the auditor should

TRACE THE AMOUNTS TO THE BILL OF
MATERIALS TIME CARDS AND OVERHEAD
RATES, assigned COSTS MAY THEN BE
TRACED TO AUTHORIZED PRICE LISTS AND
UNDERLYING SCHEDULES.

7. Overapplied or underapplied overhead is

reviewed periodically and rates are
adjusted as necessary.

To test this control the auditor should

OBSERVE THE SIGNATURE INDICATING
THAT THE OVERHEAD RATE HAS BEEN
REVIEWED.

WEAKNESS IN CONTROL AND POSSIBLE

FRAUD/ERROR
Some identified weaknesses in controls in the
production transaction may result to miss
statement in the financial statement the foregoing
tests of controls may reveal the following
weaknesses and the possible errors or fraud.
Weaknesses and possible errors:
PRESENTATION AND DISCLOSURE Transactions are
1. Persons recording inventory cost flows
maintaining inventory records determining
overhead application rates setting standard
costs or costing physical inventory are not
competent to do so.
ERRORS:
 It could lead to error in inaccurate
recording of inventory cost flows
from the materials, in the
manufacturing cost to the working
4. Lack of periodic test counts and
process and up to the finished
comparison of inventory with perpetual
goods inventory.
records.
 It could also lead to inaccurate
costing of inventory and cost of
ERROR: Undetected inventory shrinkage or
sales.
recording errors.
 Inaccurate recording of perpetual
inventory records.
5. Failure to agree subsidiary inventory and
overhead ledgers to controlling accounts
2. Inadequate documentation of inventory
on a regular basis.
movements.
ERRORS:
ERROR: Undetected errors in recording or
 Unauthorized issuances of
posting overhead accounts.
materials.
 Inaccurate inventory records. On the basis of the preliminary evaluation and the
results of compliance testing or testing of controls,
3. Lack of rigorous cost accounting system as the auditor makes a final evaluation of the controls
evidenced by: over production transactions.
a. Absence of journal entries
The auditor then determines the nature, timing
recording cost flows.
and extent of substantive tests to be done on
b. Failure to incorporate standard
account balances affected by the production cycle.
costs and variance analysis into the
accounting system.
c. Failure to maintain detailed
manufacturing overhead ledger.
d. Failure to use standards standard
journal entries in costing monthly
production.
ERRORS:

 Errors in inventory recording.

 Errors in calculating and recording SUBSTANTIVE TESTS
the cost of sales.
Auditors perform substantive tests of production
 Failure to promptly locate and
transactions by:
correct unfavorable variances in the
standard costing.
 1. Examining documents, materials
requisitions and labor tickets that support
particular transactions.
2. Accounting for the sequence of documents
to ascertain that all transactions have been
recorded.
3. Reviewing and testing computation on cost
accounting records
4. Testing allocations by tracing costs to bill
of materials, labor tickets, authorized labor
rates, and overhead rates
5. Verifying mathematical accuracy
6. Testing account coding
AUDIT PROCEDURES THAT AIM TO SUBSTANTIATE
THE TARGET ASSERTION
1. The first audit procedure is the preliminary
analytical procedure of course that may be
also applied to other objectives including
completeness, valuation and proper cutoff.
First audit procedure other than the
preliminary or analytical procedure is to
test the assertion of existence or
occurrence for selected transactions,
examine signed materials requisitions,
approved labor tickets and allocation of
overhead.
2. To test the assertion of completeness,
account for a sequence of production
reports, account for a sequence of materials
requisitions, and reconcile time cards and
labor tickets.
3. To test the assertion of valuation or
allocation, test cost records by tracing to
underlying documents.
4. To test the assertion of presentation and
disclosure, check the accuracy of account
coding by reference to the chart of
accounts.
INVENTORY WAREHOUSING
Warehousing or storage of materials or finished
goods results in a very significant current asset for
many manufacturing wholesale and retail entities.
The transactions included in the warehousing
activities are:
1. The receipt of goods by the storeroom.
2. The issuance of goods to production
It is because of the difficulties associated with
establishing the existence and valuation of
inventories that this cycle is often the most time
consuming and complex part of the audit.
The cycle is also unique because many of the tests
of the inputs to the cycle are tested as part of the
audit of other cycles.
Tests performed as part of the inventory and
warehousing cycle focus on
1. cost accounting records
2. physical inventory observation
3. tests of the pricing
4. compilation of the ending inventory
balances
Entities store supplies, replacement parts, raw To test this control over the assertion the
materials and finished goods. Although the stored auditor should OBSERVE SEPARATION OF
goods may differ the basic controls and the tests of DUTIES AND EXAMINE APPROVAL
controls than that an auditor performs are similar SIGNATURES ON MATERIALS REQUISITION.
for these different categories of goods.

TESTS OF CONTROLS – Inventory warehousing

COMPLETENESS All inventory warehousing

transactions that occurred are recorded.
Controls:
3. Receiving reports and materials requisition
are pre-numbered and accounted for by a
clerk in inventory accounting.

To test this control the auditor should

TEST OF CONTROLS OVER INVENTORY OBSERVE THE PROCEDURE AND ACCOUNT
WAREHOUSING FOR THE NUMERICAL SEQUENCE OF
RECEIVING REPORTS to determine that all
EXISTENCE OR OCCURRENCE Recorded inventory have been recorded.
warehousing transactions occurred.
Control: 4. An inventory clerk signs a copy of the
receiving report after inspecting and
1. A copy of a receiving report signed by a counting goods transferred to his or her
receiving clerk is used by inventory area.
accounting to record receipt of goods.
To test this control the auditor should
To test this control over the assertion the OBSERVE SEPARATION OF DUTIES AND
auditor should OBSERVE SEPARATION OF EXAMINE APPROVAL SIGNATURE ON
DUTIES AND EXAMINE APPROVAL MATERIALS REQUISITION.
SIGNATURES ON THE RECEIVING REPORTS.

2. A materials requisition is prepared and

signed by appropriate operating personnel.
 VALUATION OR ALLOCATION Inventory
warehousing transactions are recorded for the
proper amounts.
7. Costs assigned to work in progresses and
finished goods are set by procedures that
are reviewed and periodically evaluated.
Mathematical accuracy is tested.

To test this control the auditor should

5. Access to inventory is limited to personnel
responsible for its custody.
To test this control the auditor should
OBSERVE THE PROCEDURES BEING
PERFORMED.
inquire about and observe evidence of
standard setting, review of standards, and
the testing of standards.

PRESENTATION AND DISCLOSURE Inventory

warehousing transactions are recorded to result in
RIGHTS AND OBLIGATIONS Inventory warehousing
presentation and disclosure in accordance with
transactions are for goods that belong to the
PAS/PFRS
entity.
8. Chart of accounts adequately describes
6. Goods received on consignment are labeled
accounts to be used and account coding is
and separated from goods the entity owns.
assigned by one person and checked by
another.
To test this control the auditor should
INQUIRE ABOUT AND OBSERVE THE
To test this control the auditor should
PROCEDURE.
EXAMINE THE CHART OF ACCOUNTS ALSO
HE OR SHE SHOULD EXAMINE THE
SIGNATURE OF EMPLOYEES PERFORMING
THE PROCEDURE.

WEAKNESSES AND POSSIBLE ERRORS
Absence or inadequate controls over inventory
warehousing transactions could result into the
following misstatement and irregularities:
1. Fictitious receipts issues may be recorded.
2. Goods may be received or issued but not
recorded
3. Errors may be recorded in the quantity of
goods transferred.
3. Inventory may be misvalued.
4. Goods on consignment may be treated as
inventory
5. Receipts or issue may be charged or
credited to wrong accounts
SUBSTANTIVE TESTS OF INVENTORY WAREHOUSING
EXISTENCE OR OCCURRENCE. Recorded inventory
warehousing transactions occurred.
COMPLETENESS. All inventory warehousing
transactions that occurred are recorded.
RIGHTS AND OBLIGATIONS. Inventory warehousing
transactions are for goods that belong to the entity.
VALUATION OR ALLOCATION. Inventory warehousing
transactions are recorded for the proper amounts.
PRESENTATION AND DISCLOSURE. Inventory
warehousing transactions are recorded to result in
presentation and disclosure in accordance with
PAS/PFRS.
The following are the assertions indicated in the
inventory warehousing transactions and the
corresponding audit objectives of the auditor when
performing the specific relevant audit procedures.
Auditors perform substantive tests of inventory
warehousing transactions in the following slides.
AUDIT PROCEDURES THAT AIM TO SUBSTANTIATE THE
TARGET ASSERTIONS
The first audit procedure is the preliminary analytical
procedure that may be applied to other objectives
including completeness, valuation and proper catalog.
1. To test the assertion of EXISTENCE OR
OCCURRENCE for a selected transaction
recorded in the inventory control account
examine signed receiving report.
2. To test the assertion of COMPLETENESS,
account for a sequence of receiving reports and
requisitions and perform records to floor and
floor to records tests
3. To test the assertion of RIGHTS AND
OBLIGATIONS examine invoice for goods
received.
4. To test for the assertion of VALUATION OR
ALLOCATION trace allocated costs back to
supporting documents and verify mathematical
accuracy and trace postings.
 5. To test the assertion of PRESENTATION AND
DISCLOSURE check accuracy of accounts on
invoices by referring to the chart of accounts.
The audit procedures described in the preceding slides
are designed primarily to test the quantities of goods
recorded and the price assigned to goods in the
perpetual inventory records.
INVENTORY RECORDS usually include a description of
goods, the warehouse location and the quantity on
hand.
The auditor may select items from the inventory
records, goes to the warehouse and count the goods on
hands, and determines the accuracy of the inventory
records. The auditor may also examine the related
receiving reports and requisition.
To test the PRICES WHICH ARE ASSIGNED TO THE
INVENTORY, this should be in accordance with the
client's method, for example FIFO, weighted average or
specific identification.
To test the ACCURACY OF PRICES, an auditor may trace
amounts to:
 vendors’ invoices
 prior year’s schedules, listing the inventory
value
 standard cost sheets
 cost of production report.
Any of these documents, the auditor may use to test
accuracy or prices.
To test the assertion of rights and obligations, the
auditor should examine invoices for goods received
To test for assertion of valuation or allocation, the
auditor should trace allocated costs back to supporting
documents and verify mathematical accuracy and trace
to post things.
PAYROLL TRANSACTIONS
PAYROLL TRANSACTIONS involve the events and
activities related to executive and employee
compensation including the compensation for the
employees who worked in the production.
This class of transaction includes salaries of personnel,
wage earner, sales persons commission, bonuses to
executives (only executives), payroll taxes, pensions and
profit-sharing plan only for executives and some
managers and other employee fringe benefits.
The primary errors or irregularities that may occur are a
PADDED PAYROLL, which means that there are people
receiving amounts but they have not rendered any
service, and MISAPPROPRIATION OF UNCLAIMED
PAYCHECKS. The auditor should therefore adopt
procedures that will enable him to detect such
occurrences.
PAYROLL PROCESS
The functions involved in the payroll for transactions is
as depicted on the slide, it includes the following tasks:
1. Time cards are checked and approved by
the supervisor and then reviewed by the
time keeper. However, when electronic
time records are used the supervisor will
only approve corrections on the time cards.
The timekeeper downloads the file and
sends to the payroll department where the
net pay is computed.
2. The time card is forwarded to the payroll
department for matching with current
Documents used are the following:
listing of employees and the rates. The
payroll register is prepared in multiple
copies.
3. A copy of the payroll is sent to the treasurer
where the cheques are written for each
employee.
4. When the payroll is through ATM via the
banks and advice to debit accounts or ADA
file is prepared. The checks and/or the ADA
is signed.
5. The checks are distributed to employees by
the pay master, usually he is an employee
of the cash disbursement department, and
the ADA is forwarded to the bank which
then credits each employee account with
the corresponding net pay.
6. A payroll summary is forwarded to the
general ledger update function which
reconciles the payroll register, the checks
issued and the total of the ADA file. When
everything matches, the payroll is then
recorded in the general ledger.
7. The finished goods together with the
production report is forwarded to the
finished goods warehouse. The finished
goods are reconciled with the production
report.
8. The production report is forwarded to the
cost accounting for the updating of cost
records. The finished goods ledger is also
updated and the monthly cost summary is
prepared. The monthly cost summary is
submitted to the general ledger function
for the updating of the general ledger
control accounts.
DOCUMENTS USED IN THE PAYROLL TRANSACTIONS
1. TIME CARD - these are pre-numbered record for
each employee indicating the number of hours
worked each day during a pay period, say a
period of 15 days or a period of 30 days.
Many entities use a time clock or a bounty clock
that automatically records a starting and
stopping time onto the time cards when
inserting the cards in the time clock and
simultaneously into the database in the machine.
This record provides evidence about the validity
of the hours an employee is paid for working.
2. DEDUCTION AUTHORIZATION - this is a form
that an employee signs to authorize their
employer to withhold specific optional payments
from their paychecks. For examples are
deductions for the union dues and loans,
however, taxes, SSS/GSIS, PhilHealth and other
mandatory deductions do not need deduction
authorization. This indicates that the employee
authorized an amount to be withheld from a
paycheck for a specific purpose.
3. CERTIFICATE OF FREE TAXES WITHHELD (BIR
FORM 2037) - this is a report prepared every
year for each employee to report the gross
amount of earnings, income taxes withheld, and
social security taxes withheld. Copies are
submitted to employees for filing with their tax
returns to the Bureau of Internal Revenue and to
other government taxing authorities are
required. However, in many organizations the
filing to BIR is also done voluntarily by the
employer, this form indicates that taxes
withheld were reported to BIR
4. LABOR TICKET - it is a pre-numbered form on
which time worked on a job is recorded. It
records the specific activity of a laborer.
5. LABOR TICKET SUMMARY - is a pre-numbered
form that summarizes the daily label tickets by
job or by process. It records labor used in
production on any given day.
 6. PAYROLL TAX RETURNS (BIR FORM 1700) - this other data such as the number of hours worked
is a form that the entity files with governmental during each payroll period.
agencies reporting wages and taxes withheld.
This provides evidence that amounts withheld 3. LABOR DISTRIBUTION JOURNAL - is a report in
have been paid to the appropriate authorities, which based on an account code salaries and wages
that is the BIR. are allocated to particular accounts such as direct or
indirect labor or other functions within the entity. It
7. OTHER PERSONAL RECORDS - include the provides a basis for determining amounts allocated
following: to labor components of the manufacturing process.
 employment application - provide evidence
that employees exist
 reports on reference checks - provide
evidence that employees exist
 authorization for employment - provide
evidence that employees work for the entity
 authorization for pay or paid changes -
provide evidence that the pay rate is
approved and current
 others performance evaluation reports -
provide evidence that the employee exists
 the records of sick and vacation days -
provide existence in testing the accrued TESTS OF CONTROL
payroll
A sample questionnaire with the file name control
risk assessment questionnaire for payroll
transactions.

 Auditors use this or such questionnaire to

aid in the identification and the
documentation of the strengths and
weaknesses of the internal control after the
understanding phase.

ACCOUNTING RECORDS IN THE PAYROLL

The auditor performs one or more audit
TRANSACTION
procedures in the following slide and to test
1. PAYROLL REGISTER - this is a document which assertions including in the following table:
includes a list of each payroll check along with the
gross pay amounts withheld and the net pay of each
employee or worker. The payroll registers 1. Existence or Occurrence - recorded payroll
sometimes called a payroll journal is a book of transactions occurred.
original entry totals for each payroll are posted to 2. Completeness - all payroll transactions that
the general ledger accounts. occurred are recorded
3. Rights and Obligations- payroll
2.EMPLOYEE EARNINGS RECORD - this record transactions are for services rendered to
includes for each employee for each pay period, the
the entity.
date check, number gross amount deductions and
net pay. The record includes the gross earnings and
deductions for the year to date and may include
 4. Valuation and Allocation- payroll
transactions are recorded for the proper
amounts.
5. Presentation and Disclosure- payroll
transactions are recorded to result in
presentation and disclosure in accordance
with PAS/ PFRS.

2. One employee should review the details of

the payroll and sign the payroll checks; and
another employee should distribute the
checks. Neither employee should be in
personnel, payroll accounting or a
supervisory position in operations.

To test this control the auditor should

The following slides present:
 The controls an entity should implement to
ensure the propriety of each assertion and
 The test that an auditor might perform to
determine the effectiveness of the controls
on payroll transactions.
OBSERVE THE SEPARATION OF DUTIES and
observe also the procedures being
performed.
3. Using time cards and requiring a
supervisor's approval of total hours
entered in time cards.

To test this control, the auditor should

EXISTENCE OR OCCURRENCE. Recorded payroll OBSERVE THE PROCEDURE if it is being
transactions occurred. followed.

Control:
1. Personal department officials the addition
of an employee to the payroll or any
changes in employees’ status such as:
• promotion or termination; or
• pay rates to test this control over the
assertion

To test this control, the auditor should

OBSERVE PROCEDURES following but
followed by the personal department.
EXAMINE WRITTEN APPROVALS for
selected payrolls.
COMPLETENESS. All payroll transactions that
occurred are recorded
4. Use pre-numbered checks and accounted
for in the bank reconciliation. Require an
employee not involved in the preparation
 of payroll to reconcile the payroll bank
account.

To test this control the auditor should

observe whether RECONCILIATIONS ARE
ROUTINELY PREPARED BY A PERSON NOT
INVOLVED WITH PAYROLL ACTIVITIES.

VALUATION AND ALLOCATION. Payroll

transactions are recorded for the proper amounts
7. Payroll calculations should be verified for
accuracy. In a manual accounting system
this is done by recalculation. In a
computerized system, program controls
and checks as well as control and hash
totals ensure clerical accuracy.

RIGHTS AND OBLIGATIONS. Payroll transactions

are for services rendered to the entity.
5. Employees are required to record the time
they work using a time clock employee are
not allowed to time in for each other.
To test this control the auditor should
observe whether the procedure is being
followed. The auditor should also
EXAMINES SIGNATURES ON THE CARDS
6. Supervisors should review and approve
each employee's time card.
To test this control the auditor should
examine payroll register for signature
indicating verification.
8. Control totals of hours worked are verified
independently of payroll accounting and
compared to the hours for which payment
is recorded.
To test this control the auditor should
examine the worksheet that documents
the comparison.

To test this control the auditor should

observe the functioning of this control and
also examine the time cards for the
supervisor signature.

PRESENTATION AND DISCLOSURE. Payroll

transactions are recorded to result in precision
presentation and disclosure in accordance with PAS
and PFRS.
9. An employee should use a chart of
accounts in assigning codes for labor
charges. Another employee should check
the work of the employee who assigned
the codes and then signs or initials the
work
To test this control the auditor should
examine the payroll summary for the
signature indicating that this procedure is
being followed.
the controls are not exhaustive but only
illustrative
WEAKNESSES AND THE POSSIBLE ERRORS OR
FRAUD.
Absence of or the inadequacy of controls over
payroll transactions could lead or result into the
following errors:
1. Lack of care in calculating payroll and
failure to review and check calculations.
Incompetent personnel assigned in the
calculation of payroll withholding taxes or
reconciliation of payroll bank accounts.
ERRORS: Inaccurate calculation of gross
pay, deductions, net pay and payroll taxes.
2. Standard journal entries not drafted for
monthly payroll entries. Journal entries to
record payroll and payroll taxes are not
reviewed for correctness.
ERRORS: Inaccurate recording of payroll
and payroll taxes.
3. Inadequate separation of duties among
time keeping personnel production payroll
accounting and check distribution.
FRAUD: - PAYROLL PADDING which
happens when an entity has fictitious
people drawing paychecks.
Generally, this can only happen when a supervisor
falsely signs and approves employee work records
that supervisor is usually the one that ends up with
the extra checks and keeps them for himself.
SUBSTANTIVE TESTS OF PAYROLL TRANSATIONS
the following are the assertions indicated in the
payroll transactions and the corresponding
objectives of the auditor when performing the
specific relevant audit procedures auditors perform
substantial substantive tests of payroll as described
in the following:
1. EXISTENCE OR OCCURRENCE- Recorded payroll
transactions occurred
2. COMPLETENESS- All payroll transactions that
occurred are recorded
3. RIGHTS AND OBLIGATIONS- Payroll transactions
are for service rendered to the entity
4. VALIDATION AND ALLOCATION- Payroll
transactions are recorded for the proper amounts
5. PRESENTATION AND DISCLOSURE- Payroll case any dispute arises when cheques are
transactions are recorded to result in presentations issued auditor compares the paychecks to
and disclosure in accordance with PAS/ PFRS the payroll journal.
3. Investigate the company's process in handling of
unclaimed pay. The client's procedures for handling
unclaimed pay must be designed effectively and
followed closely to reduce the possibility of
misappropriation of funds.

 The auditor should list unclaimed wages for

the period under investigation and
determine the disposition that has been
made of the items.

AUDIT PROCEDURES that aim to substantiate the

target assertion
a. the preliminary analytical procedure that
should be performed by the auditor and this
COMPLETENESS
may be applied to other objectives including
completeness valuation and proper cutoff 1. Trace the payroll tested to summaries.
2. Trace postings to summary totals to the general
ledger and to the subsidiary letters.
EXISTENCE OR OCCURRENCE
3. Check the propriety of the accounting
1. Check the personal records to ascertain whether
distribution.
the persons paid were actually employed during
the pay period tested These procedures will satisfy the auditor that the
details of the payroll have been summarized
• this procedure will enable the auditor to
properly and thus the totals have been recorded
ascertain whether there are fictitious
properly in both the general and subsidiary ledgers
names of terminated employees still
included in the payroll sheet. Inclusion of RIGHTS and OBLIGATIONS
such names is one of the most common
 Examine the cancelled employee payroll
techniques used by employees to obtain
checks for propriety.
funds by fraudulent means.
If employees are paid in cash examine
2. Observe the actual payroll distribution
receipts signed by them to determine that
• this procedure is followed to ascertain
payments have in fact been made to proper
whether the proper employees did receive
party.
their pay as authorized.
• The auditor checks the identification of the
employees being paid compare the amount The purpose of this procedure is to enable the
paid with the payroll journal and observes auditor to ascertain whether the proper
the employee signing the receipt employees receive their pay and whether the
• this should be done in the presence of a amounts paid are in agreement with the payroll
responsible official from the company in journal.
VALUATION AND ALLOCATION

 Check the recorded pay against the original

record of hours worked or units produced.
 Compare the rates paid with authorization
forms, union contracts or other pertinent
source data.
This procedure is done to determine whether
employees are being paid at the proper and
authorized rate.

 Check the computation of payroll and

deductions from gross pay. The auditor
verifies the calculations of the pay of the
individual selected for testing.

The arithmetic accuracy of the payroll

journal. Journal is likewise tested to
ascertain whether the client's internal
control structure is functioning properly and
tend to detect any errors in footings that
could mistake payroll expense or conceal
defalcations.

PRESENTATION AND DISCLOSURE.

 Compare total of the payroll tested with

appropriate recorded disbursements from
the general bank account.