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CHAPTER 12
AUDITING THE HUMAN RESOURCE
MANAGEMENT PROCESS
12-1 Most entities either computerize their payroll systems or use an outside service
bureau because of the large volume and routine nature of payroll transactions.
12-2 There are two major types of transactions that are processed through the human
resource management process: (1) payments to employees for services rendered
and (2) accrual and payment of payroll-related liabilities arising from employees'
services.
The financial statements accounts that are generally affected by the two types of
payroll-related transactions are:
Payroll transaction:
• Cash
• Inventory
• Direct and indirect labor expense
• Various payroll-related liability and expense accounts
12-3 The payroll register, which is also referred to as the payroll journal, is a summary
of all payroll checks issued to employees. The payroll master file is the computer
file that maintains all the entity's records related to payroll, including information
on each employee such as name, Social Security number, pay rate, and authorized
deductions. The payroll master file changes report contains a record of the
changes made to the payroll master file.
12-4 The following duties are performed in the human resources, timekeeping, and
payroll-processing functions:
12-1
12-5 The following table contains the key segregation of duties in the human resource
management process and possible errors and fraud that can occur if such
segregation of duties is not present.
Segregation of Duties Possible Errors or Fraud as a
Result of Conflicts in Duties
The supervision function should be Unauthorized payments to existing
segregated from the personnel records and employees or payments to fictitious
payroll-processing functions. employees.
The disbursement function should be Unauthorized payroll checks may be
segregated from the personnel records, issued.
supervision, and payroll-processing
functions.
The payroll-processing function should be Concealment of a defalcation that
segregated from the general ledger would normally be detected by
function. independent review of accounting
entries made to the general ledger.
12-6 Two control environment factors that have a pervasive effect on the human
resource management process must be considered. First, the entity's
organizational structure, its personnel practices, and its methods used to assign
authority and responsibility must be examined. Second, the entity should have
sound policies for hiring, training, promoting, and compensating employees.
These policies should include specific authority and responsibility for hiring and
firing of employees, for setting wage rates and making salary changes, and for
establishing benefits.
12-7 The key authorization points within the human resource management process
include authorization procedures for hiring and terminating employees, setting
pay rates, making withholdings, awarding benefits, and issuing payroll checks.
12-8 Control activities must exist for the classification assertion to ensure that the
appropriate payroll accounts are charged. If payroll is not properly classified
between direct and indirect labor, inventory and cost of goods sold may not be
properly valued.
12-9 Except for executive and share-based compensation, there are generally few
inherent risk factors that affect the human resource management process and its
related accounts. Some factors the auditor might consider include the effect of
economic conditions on payroll costs, the supply of skilled workers, the frequency
of employee turnover, the presence of labor contracts, and legislation such as the
Occupational Safety and Health Act.
Because officers may have motive and opportunity to take advantage of their
high-positions in the form of excessive compensation, inherent risk is frequently
not set at low. Key risk factors to consider are the level of performance-based
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Chapter 12 - Auditing the Human Resource Management Process
12-10 Two audit procedures that can be performed using CAATs are: (1) testing the
computer logic used to calculate payroll amounts and (2) recomputing the
calculation of gross pay, deductions, and net pay.
12-11 Substantive analytical procedures that can be used to test payroll accounts and
payroll-related accrual accounts are:
12-12 For the accrued payroll tax account, the auditor obtains a detailed account
analysis schedule. The credits to the account represent the recognition of payroll
tax expense at the end of each pay period. These amounts can be traced to the
various payroll tax returns or other documentation filed by the entity and should
agree to the amount of payroll tax expense included in the income statement. The
debits to the account represent payments made to the relevant government
agencies. These payments can be verified by tracing the amounts to the cash
disbursements journal.
12-13 Disclosure items for the human resource management process and related
accounts include:
• Pension benefits
• Postretirement benefits
• Share-based compensation
• Profit-sharing plans
• Deferred-compensation arrangements
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Chapter 12 - Auditing the Human Resource Management Process
12-14 b 12-19 c
12-15 c 12-20 b
12-16 a 12-21 c
12-17 b 12-22 b
12-18 c 12-23 c
Solutions to Problems
12-24 To best prevent errors and fraud, one person should be assigned to each of the
following functions: human resources, supervision, timekeeping, payroll
processing, disbursement, and the general ledger. However, fewer could be hired,
as long as certain segregations are in place. The supervision function should be
separated from the human resources and payroll-processing functions; the
disbursement function should be separate from human resources, supervision, and
payroll-processing; and the payroll-processing function should be separate from
the general ledger function. These separations would help prevent fictitious
employees from appearing on the payroll, unauthorized payments from being
made, and alteration of the accounting records from happening.
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Chapter 12 - Auditing the Human Resource Management Process
12-26 McCarthy should consider performing the following procedures in the audit of
Kent Company's payroll transactions:
12-5
Chapter 12 - Auditing the Human Resource Management Process
12-27 a. In order to verify the information in the input form, James should:
• Compare the names, Social Security numbers, and withholding data on the
input form with W-4 forms.
• Compare names with employment authorizations.
• Compare pay rates with wage authorizations and union contracts.
• Compare numbers of hours worked (regular and overtime) with approved
time sheets or other supportive records; recompute regular and overtime
hours.
• Inspect employee authorization forms for "special deductions."
12-28 a. The following edit checks might be used to detect errors during the typing of
answers to the input cues:
• Password: Ensures that the operator is authorized to access computer
programs and files.
• Numeric check: Ensures that numbers are entered into and accepted by the
system where only numbers are required to be entered (e.g., numbers 0-9 in
Social Security number).
• Alphabetic check: Ensures that letters are entered into and accepted by the
system where only letters are required to be entered (e.g., letters A-Z in
employee name).
• Special-character check: Ensures that only specific special characters are
entered into and accepted by the system where only those special characters
are required to be entered (e.g., hyphens between numbers in Social Security
number).
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Chapter 12 - Auditing the Human Resource Management Process
• Sign check: Ensures that positive or negative signs are entered into and
accepted by the system where only such signs are required to be entered or
that the absence of a positive or negative sign appears where such an absence
is required (e.g., hours worked).
• Arithmetic check: Ensures the validity of the result of a mathematical
computation (e.g., total employees for period equal number of employee
numbers in system).
• Validity check: Ensures that only authorized data codes will be entered into
and accepted by the system where only such authorized data codes are
required (e.g., authorized employee account numbers).
• Limit (reasonableness) check: Ensures that only data within predetermined
limits will be entered into and accepted by the system (e.g., rate per hour
cannot be lower than the minimum set by law or higher than the maximum
set by management).
• Self-checking digit: Ensures that only specific code numbers prepared by
using a specific arithmetic operation will be entered into and accepted by the
system (e.g., employee numbers generated by the modulus 11 method with
prime-number weighting).
• Size check: Ensures that only data using fixed or defined field lengths will be
entered into and accepted by the system (e.g., number of dependents requires
exactly two digits).
• Missing-data check: Ensures that no blanks will be entered into and accepted
into the system when data should be present (e.g., an "S" or "M" is entered in
response to "single or married?").
• Overflow check: Ensures that no digits are dropped if a number becomes too
large for a variable during processing (e.g., hourly rates "on size errors" are
detected).
• Control-total check: Ensures that no unauthorized changes are made to
specified data or data fields and all data have been entered.
• Logic check: Ensures that spurious data are rejected (e.g., no negative regular
hours).
b. The assurances provided by each validation check are provided within "a."
above.
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Chapter 12 - Auditing the Human Resource Management Process
12-29
a. A rough estimate of the average employee’s salary can be computed by
dividing the estimated employee compensation expense by the estimated
total number of employees. The salaries of the executive officers can be
found on a number of websites (e.g., www.ecomponline.com,
www.aflcio.org/corporatewatch/paywatch/) and are usually found in the
company’s proxy statement or annual report. The salary for one officer
divided by the average salary equals the proportion of executive salary to
average employee salary.
J. Day, President and CEO of KMART CORP earned about $2.9 million in
salary and bonus in 2004. If the average employee salary is $40,000, the ratio
is 72.5 to 1.
It is argued that this proportion is high because of the value of the executive’s
strategic influence on the company. Whether or not this is true depends
entirely on the circumstances of the company. Recently there has been
increased public outrage at the large disparity between top executive salary
and that of the average employee.
12-8
Auditing and Assurance Services A Systematic Approach Messier 8th Edition Solutions Manual
The biggest disadvantage is the potential greed associated with high levels of
stock-option compensation. When the executive stands to gain tens or
hundreds of millions of dollars by achieving earnings targets, the executive’s
self interests provides incentives for earnings management or fraud in order
to meet or beat earnings forecasts.
There are also a number of regional sites that contain information on the retail
industry. For example, the North Carolina Retail Merchants Association’s site
reported that North Carolina retail stores pay over $15 billion in wages and
salaries annually.
12-9