SOLUTIONS MANUAL

CHAPTER

11 Audit of Payroll

Review Questions
QUESTION 1
Key issues in auditing payroll are:
(a) That payroll expense and its related deductions are recorded and not understated, and
(b) Liabilities resulting from outstanding payroll are recorded.

Thus the main audit objectives for payroll transactions are completeness, occurrence and accuracy.

QUESTION 2
The objective of preparing a personnel authorization form is to keep employee details. Employee
details include biographical data, job classification, salary scale and authorized payroll deductions.
HR is mainly responsible for documenting employee details in the personnel authorization forms
and then keeping the data in a personnel master file. The personnel authorization forms are used to
be a source document for finance department to prepare payrolls.

QUESTION 3
It is important to have segregation of duties between a personnel who has the authority to sign the
cheques and a personnel who initiates or processes payroll transactions. Separate functions for
creating and updating personnel records for payroll payments prevent the risk of payments made
to fictitious employees (audit objectives: occurrence). If the two functions are assumed by the same
person, it is likely that there will be misappropriation of funds.

QUESTION 4
Auditors should check on subsequent payroll payments to ensure the reasonableness of the payroll
accrual recorded at the end of the current period.

QUESTION 5
Further audit procedures comprise tests of control and substantive procedures. The amount of
procedures to be performed are based on the assessed risk levels. Auditors should address significant
risks of misstatements by evaluating the design of controls and determining whether the controls are
implemented effectively. Tests of controls should be performed prior to substantive tests. However,
in the event that the controls over payroll transactions are not well implemented or are ineffective,
the substantive procedures should be done after the auditors obtain an understanding of internal
controls.
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While payroll is subjected to high levels of inherent risk associated to completeness and accuracy
assertions, most entities have a proper control system over payroll in place. The control is usually
effective and the control risk is low. Thus, for substantive procedures, auditors focus on the application
of analytical procedures to payroll expense accounts and tests of details. Auditors only focus on test
of balances and not test of transactions for payroll transactions. The tests of controls for payroll
transactions can be constituted as test of transactions.

Case 11: Questions

“During the year, salaries and wages included a significant bonus paid to each director. A separate
disclosure of the bonus is required by legislation.”

Auditor in planning the audit strategy should plan to perform test of details of balances for bonuses
paid to directors. The auditors should inspect documents such as the minutes of the meeting to
approve the remuneration for directors and executive officers. This is to ensure there is no overpayment
of bonuses. In addition, auditors should verify disclosure and presentation of directors’ bonuses to
ensure a proper classification and accurate amount of bonuses are made and presented.