Payroll

Review: Control Activities

1. Prenumbering of documents
2. Authorization of transactions
3. Independent checks to maintain asset accountability
4. Documentation
5. Timely and appropriate performance reviews
6. Information processing controls
7. Physical controls for safeguarding assets
8. Segregation of duties
Objectives of Control over the Payroll Cycle
 Pay the right people
 At the right rate
 For valid work done
 And deal correctly with taxes and other deductions
Importance of Consideration of
Payroll Cycle in Audits
 Material amounts
 Affects inventory cost
 Fraud, e.g.:
o Falsification of work hours
o Creation of fictitious employees
o Terminated employees continue to be paid
Overview of the
Payroll Cycle:

Timekeeping Personnel

Payroll
Documents:
1. Employment records and employee masterfile
2. Time cards
3. Job time tickets
4. Payroll register
5. Paychecks
Major Controls
Segregation of Duties:
1. Authorization to employ and pay
 Human Resource hire new employees (based on requisitions from
user departments)
 Human Resource maintain personnel records – hire date,
department, salary, position
 Human Resource to promptly send termination notices to payroll
Segregation of Duties:
2. Supervision
 All base pay data (hours, absences, time-off, etc.) should be
approved by an employee’s immediate supervisor.
Segregation of Duties:
3. Timekeeping and Cost Accounting
 Data on which pay is based (hours worked or jobs completed)
should be accumulated independent of other function
 If paid hourly
o use of time clocks or other similar tools
o Department supervisor should compare job time tickets
with employee clock cards signed by employees
 For salaries employees
o Use of time sheets also requiring supervisor approval
Segregation of Duties:
4. Payroll Check Preparation
 Payroll department computes salary, creates Payroll Register,
prepares unsigned checks for signature by Treasurer/CFO
 Payroll should not have authority to initiate changes in
hours/rates nor the ability to sign checks
Segregation of Duties:
5. Check Distribution
 Direct deposit to bank account
 If manually distributed – by a paymaster with no other payroll function
 Employees should show identification before receiving paychecks
 Unclaimed payroll: investigated by an independent party and
o If in cash – deposited in a separate bank account
o If check – locked in a safe
 Internal audit to regularly compare personnel files with payroll files
Imprest Payroll Account
 A bank account to which the exact amount of payroll for the pay
period is transferred from the employer’s general cash account.
 Limits exposure to payroll fraud
 Allows delegation of payroll check signing duties
 Separates routine payroll disbursements from other disbursements
 Simplifies bank reconciliation
Service Organizations
 Considered part of an entity’s information system when those
services affect the initiation, execution, processing, or reporting of
the entity’s transactions.
 In that case, controls put in place by the service organization are
considered part of the user organization’s information system.
Internal Control
Evaluation
Internal Control Evaluation
 Which is most critical: Occurrence or Completeness?
Internal Control Evaluation
1. Observe segregation of duties
2. Compare personnel records for each department with actual time
cards and employees working in each department
3. Observe payroll distribution on an unannounced basis
4. Observe use of time clocks and investigate time cards not used
5. Test transfers and underlying employee authorizations if direct
deposit is used
Internal Control Evaluation
6. Test the general and application controls to ensure that payroll
transactions are valid, properly authorized, and completely and
accurately recorded.
e.g. compare hours worked to predetermined minimums and
maximums (range test) or to prior periods (reasonableness)
Importance of Consideration of
Payroll Cycle in Audits
 Material amounts
 Affects inventory cost
 Fraud, e.g.:
o Falsification of work hours
o Creation of fictitious employees
o Terminated employees continue to be paid
When Internal Controls Over Payroll is
Inadequate:
Fictitious employees
1. Compare names/endorsements/signatures on cancelled cheques
vs time cards
2. Scan for unusual 2nd endorsements
3. Payroll register/journal  HR records
When Internal Controls Over Payroll is
Inadequate:
Terminated employees continue to be paid
1. Check list of terminated EEs in HR records vs severance pay
(not regular pay)
2. Check subsequent period if still being paid
3. Payroll register vs hours (time summaries, time cards)
When Internal Controls Over Payroll is
Inadequate:
Falsification of work hours
1. Reconcile total hours paid in payroll records vs independent
records of hours worked (e.g. production control)