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Payroll Processing and Fixed

Asset Procedures

DFD of Payroll Procedures

Manual Payroll System


Personnel dept. uses personnel
action forms to:
activate new employees
change the pay rate of employees
change marital status and/or number
of dependents
terminate employees

Manual Payroll System


Production employees fill out two forms:
job tickets - account for the time spent by
the worker on each production job
time cards - used to capture the total time
worked each pay period for payroll
calculations
must be signed by a supervisor

Manual Payroll System


Cost Accounting dept:
uses the job tickets to allocate labor
costs to WIP accounts
summarizes these charges in a labor
distribution summary which is
forwarded to G/L dept.

Manual Payroll System


Payroll dept receives personnel action
forms and time cards.
Uses them to:
prepare the payroll register
enter the information into the employee payroll
records
prepare paychecks
send paychecks to Cash Disbursements and a
copy of the payroll register to Accounts Payable

Manual Payroll System


Accounts Payable dept:
prepares a cash disbursements
voucher for the total amount of the
payroll
sends copies to the Cash
Disbursements and G/L depts.

Manual Payroll System


Cash Disbursements dept:
reviews and signs the paychecks and
forwards them to a paymaster for
distribution to the employees
writes a check for the payroll and
deposits it into the payroll imprest
account

Manual Payroll System


G/L dept. makes the following journal entries:
From the Labor Distribution Summary
WIP (Direct Labor)
DR
Factory Overhead (Indirect Labor)
DR
Wages Payable
From the Distribution Voucher
Wages Payable
DR
Cash
Fed. Inc. Tax Withholding Payable
State Inc. Tax Withholding Payable
FICA Withholding Payable
Other Withholding Payables

CR

CR
CR
CR
CR
CR

Manual Payroll System


G/L dept. makes a journal entry to transfer
the cash from the operating bank account
to the payroll imprest account:
Cash - Payroll Imprest Account
Cash - Operating Account

DR
CR

Payroll Procedures Flowchart

Payroll Controls
Transaction authorization - the
personnel action form helps prevent:
terminated employees from receiving
checks
wage rates from being improperly
changed for current employees

Payroll Controls
Segregation of Duties timekeeping and personnel
functions should be separated
Supervision - need to monitor
employees to ensure they are not
clocking in for one another

Payroll Controls
Accounting Records - audit trail
includes:
time cards
job tickets
disbursement vouchers
labor distribution summary
payroll register
subsidiary ledger accounts
general ledger accounts

Payroll Controls
Access Controls - need to prevent
employees from having improper access
to:
accounting records, such as time cards
which can be altered
unsigned checks

Payroll Controls
Independent Verification:
verification of time cards
distribution of paychecks to authorized
employees
verification of accuracy of payroll
register by A/P dept.
G/L dept. reconciles the labor
distribution summary and the payroll
disbursement voucher

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PERSONNEL, PAYROLL
DOCUMENTS

Personnel records
Time record
Payroll register
Employee earnings
record

PERSONNEL RECORDS

Salary or wage rates


Payroll deductions
Employee signatures
Job classification
Performance evaluation

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INTERNAL CONTROL
OBJECTIVES

Authorization
Execution
Recording
Access to assets
Segregation of duties

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AUTHORIZATION:
Objective, Errors, Procedure
Objective

Error

Employees
hired
according to
criteria

Excessive
training,
relocation costs;
equal opportunity

Clear hiring
policies,
procedures;
updated records

Compensati
on
deductions
according to
authorizatio
n

Excessive labor
costs; violation
union contracts;
inaccurate
accruals

Updated listings
pay rates,
deductions;
review, approval

Adjustments Increased pay,


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authorized
overstated labor
costs

Procedure

Clear adjustment
policies,
procedures

EXECUTION:
Objective, Errors, Procedure

Objective
Payroll,
personnel
procedures
authorized

Error

Misappropriated
cash from
paychecks for
terminated, fictitious
employees

All payroll
Misappropriated
disbursemen cash, overstated
ts for
labor costs
recognized
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liability

Procedure

Personnel,
payroll
procedures
manual
Periodically
verify employee
assignments
Prenumber,
control time
records,
paychecks,
adjustment

RECORDING:
Objective, Errors, Procedure
Objective
Amounts due
employees at
proper
amounts,
time periods,
classification

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Error

Procedure

Payroll costs
inaccurate;
misstated
expenses;
details do
not agree

Document
account
distribution
procedures;
reconcile ledgers,
journals; physical
barriers unused
documents,
forms

ACCESS:
Objective,
Errors,
Procedure
Objective
Error
Procedure
Access to
personnel,
payroll
records,
forms,
documents
restricted to
authorized
personnel
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Records,
forms,
documents
misused;
unauthorize
d labor costs

Prenumber, contro
forms, documents
Segregate
authorizing,
executing,
recording;
maintain listings
authorized
signatories

CONSIDERING INTERNAL
CONTROL: Payroll
Obtain understanding
Preliminary review
Document system
Perform transaction walkthrough
Determine whether controls are
potentially reliable in assessing
control risk below maximum
Test controls
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TESTS OF CONTROLS:
Personnel & Payroll
Obtain payroll register
Verify mathematical accuracy

Obtain payroll summary, labor distribution


Verify accuracy of summaries; compare totals to
payroll register
Trace totals to GL & cost accounting records

Select random sample employees & obtain


personnel file
Examination for completeness, authorization
Compare pay rates, deductions
Trace from register to employee records
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TESTS OF CONTROLS:

Distribution
Paychecks
Obtain sample canceled payroll checks
Trace details to payroll register
Compare endorsements to signatures in
file

Personally distribute checks to properly


identified employees

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GBW 8th ed., Ch. 14

ASSESS CONTROL RISK


Review system documentation
Review results of controls tests
Determine whether existing controls are
Effective
Can be relied upon to
Assess control risk below maximum
Assess detection risk above minimum
Restrict substantive tests of payroll
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GBW 8th ed., Ch. 14

SUBSTANTIVE TESTS:

Payroll
Obligations, Valuation
Determine by analytical procedures,
reasonableness

Obligations, Valuation, Completeness


Determine reasonableness of accruals

Presentation & Disclosure


Review to determine classification, adequate
disclosures

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GBW 8th ed., Ch. 14

ANALYTICAL PROCEDURES:
Payroll & Accruals
Compare ratios
Total payroll expenses & accrued
expense with prior years; & adjusted
for pay rate changes
Direct labor to budgets, sales, prior
years
Commissioned sales payroll: sales X
average commission rates
Payroll tax expense to payroll with
prior years
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MANIPULATED EARNINGS:
Capitalized Costs at Safety-Kleen
CEO, CFO, others capitalized payroll costs
to unrealized contingent-contract claims
to understate period expenses
Board investigation reduced income for
1997 1999 by $534 million
SEC filed suit alleging management
falsely represented financial statements
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POST RETIREMENT BENEFITS:


Health Care
Benefits based on estimates
Off-balance sheet financing
Pay-as-you-go system

Management incentives to minimize for


little earnings effect
Auditor incentives to ensure fair
presentation
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AUDIT JUDGMENT
Required for
Postretirement benefits other
than pensions
Health care obligations

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The Fixed Asset System (FAS)


Fixed Assets - property, plant, and
equipment used in the operation of a
business

Life of a Fixed Asset


1. Acquisition
of asset.
Asset
cost $

Dec
lin

2. Depreciation.
3. Subsequent
expenditures.

e in

ass

ets
s

er v
ice

Cost

4. Disposal
of asset.

pot
e

ntia
l
Salvage
value

Time (useful life)

DFD of Fixed Asset System

ComputerBased
FAS
Flowchart

Objectives of FAS
Acquire fixed assets in accordance with
management approval and procedures
Maintain adequate accounting records of asset
acquisition, cost, description, and location
Maintain depreciation records for depreciable
assets in accordance with acceptable method
Provide management with information to help it
plan future fixed asset investments
Properly record the retirement and disposal of
fixed assets

Asset Acquisition
Begins when a dept. manager determines
that an old fixed asset needs to be replaced
or that a new fixed asset is warranted
A purchase requisition is filled out.
May require an authorizing signature for items
over a pre-specified limit

FAS dept. performs record-keeping


functions.

Asset Maintenance
Involves adjusting FAS subsidiary account
balances as assets depreciate
Depreciation calculations are internal
transactions that the FAS system bases
upon a depreciation schedule.
Physical improvements must also be
recorded to increase the subsidiary account
balance and depreciation schedule.

Asset Disposal
At the end of an assets useful life (or
earlier disposition), the asset must be
removed from the records and
depreciation schedule
Disposals require disposal request
forms and disposal reports as source
documents.

Computer-Based Fixed Asset


SystemAcquisition
Receipt of assets are digitally
recorded in the system, along with
information such as its useful life,
depreciation methods, etc.
Ledgers are automatically updated

Computer-Based Fixed Asset


SystemMaintenance
Computerized FAS automatically:
calculate current periods depreciation
update accumulated depreciation and bookvalue fields in the subsidiary records
post total depreciation to the affected general
ledger accounts
record depreciation transactions by adding
records to the journal voucher file

Computer-Based Fixed Asset


SystemDisposal
Computerized FAS automatically:
post adjusting entries to the fixed asset
control account in the general ledger
record losses or gains associated with the
disposal transaction
prepare journal voucher records

FAS Controls
Authorization - should be formal and
explicit because of high cost of FAS:
acquisitions
changes in depreciation methods

Supervision - threat of misappropriation


requires constant management oversight:
theft - secure physical locations of assets
misuse - monitor on-the-job activities

FAS Controls
Independent Verification - internal
auditors should periodically verify FAS
records:
the reasonableness of factors used in decisions
(useful life, discounts, budgeting model)
location, condition, and fair value of the fixed
asset records in the subsidiary ledger
the programming logic for automatic calculations
(depreciation)