CHAPTER 11

AUDIT OF PAYROLL
 INTRODUCTION
• Payroll audit is an analysis of the company's payroll process to ensure
accuracy. Payroll audits examine things like active business income,
payroll, wages, and etc. You need to run a Payroll audit at least once a
year to make sure your process is up to date and compliant.

Payroll also relates to the acquisition of labour services and payment to

employees
 AUDIT OBJECTIVES
 To obtain sufficient audit evidence for transaction and balance.

KEY ISSUES IN AUDIT PAYROLL

• That payroll expenses and its related deductions are recorded and not understated
• Liabilities resulting from outstanding payroll are recorded
 Balance objectives
 Existence
 Rights and obligation
• Occurrence
 Completeness
• Completeness
 Valuation and
• Accuracy allocation
• Cut-off  Occurrence
• Classification  Rights and obligation
 Completeness
 Classification and
Transaction Objectives understandability
 Accuracy
 Valuation
 NATURE OF PAYROLL TRANSACTION
• Payroll transaction include salaries, wages, commissions, bonuses and other
employee benefits, such as paid leave and sick leave
• Other deductions recorded for payroll is statutory deductions or voluntary
deductions
• The related account to payroll are;
a) Payroll
b) Payments
c) Accrued payroll
d) Deduction accounts such as employees provident fund [EPF] and taxes.
• The human resources department [HR] is responsible for maintenance employee
record whereas;
• The payroll department is responsible calculating and making payment to employees
• The methods to determine the amount of salary or wages for employees ;

Hourly rate A daily rate A monthly rate

 ACCOUNTING SYSTEM
AND CONTROL ACTIVITIES
 Preparing
attendance
&
Hiring timekeeping Recording
Employees data payroll

Authorizing Preparin Pay-outs

payroll g the
changes payroll
 HIRING EMPLOYEES
Human Resources (HR) Payroll Department

• Documenting employee • Receive a copy of personnel

details in personnel authorization form
authorization forms • Processing payments to
• Keeping the data in a employees.
personnel master file

Separate functions to prevent the risk of payments to fake employees

Audit objectives:
• Occurrence
• Rights
• Obligations
 AUTHORIZING PAYROLL CHANGES
• Changes on job specification and salary scale (e.g: revised or termination)
• Has the same process as updating data for hiring a personnel

Human Resources (HR) Payroll Department

• Authorized changes • Processing payments to
• Forward to payroll department employees.

Control over changes of employees data is to ensure accuracy of the payroll

Audit objectives:
• Accuracy
• Rights
• Obligations
PREPARING ATTENDANCE AND TIMEKEEPING DATA

Practice a computerized systems Each employee will have their own

for maintaining attendance and security identification card for
timekeeping recording entries into the office

Attendance and total hours for each employees are properly recorded and kept

Audit objectives:
• Occurrence
• Rights
• Obligations
 PREPARING THE PAYROLL
• Payroll system is used to calculate the payroll of an entity.

• Salary scales will be manually updated in the payroll system ;

• Or automatically updates using an integrated system with some application controls by HR.

• Payroll department prepares payroll register

• Independent check will be performed to ensure reasonableness of the amounts based on the hours
worked.
 RECORDING THE PAYROLL
• Control for recording payroll should be established to ensure all transactions are recorded (audit
objective : completeness) ;

• And no unrecorded payroll liabilities (audit objectives : occurrence).

• The amount of payroll need to be recorded accurately

(audit objective : accuracy) in the proper period (audit objective : cut-off).

• Steps that involve in recording payroll :

• Amount calculated by payroll system are entered in the payroll journal. Payroll register will
support document for the payroll journals.

• Related deductions are also journalized in the accounts based on the payroll register.
• Pay slips are issued to accompany the payroll cheques or electronic direct bank
transfers. Employee can refer to the pay slips for the amount and the calculation of
net salary.

• Any differences can be reconciled with the payroll department.

• Payroll date are periodically checked against personnel records to ensure the data is
updated.
 PAYMENT TRANSACTIONS
• Payments are updated in the payrolls records.

• There are some controls over payroll system which should be established by an
entity :

a) Segregation of duties between personnel who has the authority to sign the
cheques and the personnel who initiates or process payroll transactions.

b) The cheque signer should ensure the payroll amount is correctly stated and the
details of employee are matched with payroll register.
c) Indication of payments should be made to the payroll list once the payment is
made to avoid resubmission of duplicate payments.

d) Custody and mailing cheques should be responsibility of the cheque signers

to prevent theft or alterations.

e) Putting in place an imprest bank account that is specific for payroll that
ensure the amount to be paid for the month is available in the account to prevent
overpayments to employees.
DEVELOPING AUDIT
PLAN
• Developing audit plan for payroll transaction involves performing risk
assessment procedures by obtaining an understanding of the entity and
its internal control over payroll transaction

Risk assessment procedure

Obtaining an
Understanding the understanding of Assessing risk Designing
entity to identify internal controls of material further audit
inherent risk over payroll misstatement procedures
transaction
 OBTAINING AN UNDERSTANDING OF INTERNAL
CONTROLS OVER PAYROLL TRANSACTIONS

• Can better understand control over payroll by preparing:

- written description or flowchart
- completing internal control questionnaire on payroll transaction
• Determine if the internal controls over payroll are implemented appropriately and
effectively. Example : segregation of function between HR and payroll disbursement
• May observe, inquire and inspect documents such as payroll register, to determine
whether payroll and authorized deductions are appropriately recorded
 ASSESSING RISK OF MATERIAL MISSTATEMENT

• Auditor may determine whether the payroll is susceptible to risk of

misstatements due to the complexity of payroll calculations.
• More concerned with overstatement of payroll payments because this
affects the welfare of employees
 DESIGNING FURTHER AUDIT PROCEDURES
• Further audit report comprise test of control and substantive procedures.
• Amount of procedures to be performed are based on assessed risk level.
• Address significant risk of misstatement by evaluating the design control and determining whether
the controls are implemented effectively
• Need not to rely on evidence obtained from prior period or analytical procedures to address risk of
misstatements in payroll records

Test of
controls
Further Audit
Procedures
Substantive
procedures
PERFORMING FURTHER
AUDIT PROCEDURES
 TESTS OF CONTROLS
• Tests of controls are design to obtain sufficient evidence to determine whether controls over
payroll are functioning effectively.

Assessment of tests of controls

• Test of design effectiveness

• Test of operating effectiveness

• Tests of controls is performed controls specifically to prevent or detect overstatement in

situation such as ;
a) Termination of employee
b) Distribution of payroll cheques
a) Test of design effectiveness
Auditors use understanding of the information
systems and internal controls specific to the client
• to determine the effectiveness of controls
over payroll.
Auditors need to understand the functions within
the payroll transactions
• To determine the necessary controls and
potential misstatements.
Once auditors have identifies the presence or
absence of necessary controls, they will make
preliminary assessment of control risks.
b) Test of operating effectiveness
Auditors should perform tests to check the operating
effectiveness of controls.
The payroll is prone to overstatements in :
• Payments to fictitious employees
( audit objective : occurrence )
• Payments for overstated hours
( audit objective : occurrence )
• Payments for overstated rates
( audit objective : accuracy )
*Can refer page 189 for control risk assessments (function, potential
misstatements, control procedures)
 SUBSTANTIVE PROCEDURES
• Auditors focus on the application of analytical procedures to payroll expense accounts and
tests of details.

Designing/types of Substantive Procedures

a) Analytical procedures
b) Test of details of transactions
c) Test of details of balances
a) Analytical procedures
Analytical procedures are planned to confirm expectations and are to performed in three stages :
• To review the understanding of the entity and the likelihood of changes to payroll amounts
• To determine any fluctuations in payroll amounts between this year and the previous year.
• To determine the ratio for average wages per employee – some changes may be due to a rise in wage rates for the
current year.

Analytical procedures for payroll is important to achieve the desired level of risk detection in payroll amounts.
b) Test of details of transaction
• Tests of transaction are used to corroborate test of balances.
• Normally performed in the audit interim and in the form of dual-purpose tests.
• Auditors only focus on test of balances and not test of transaction for payroll transactions

c) Test of details of balances

• Obtain evidence about accrued payroll balances.
• Includes two tests:
 Recalculating payroll liabilities
- auditors must recalculate the accrued payroll and check all authorized deductions.
- Required to check on the consistency of payroll calculations and payroll accrual.
- Check on subsequent payroll payment to ensure the reasonableness of the payroll accrual recorded at the end of the current
period.
 Verifying directors’ and executive officers’ remuneration
- Auditors should inspect documents such as the minutes of the meeting to approve the remuneration.
- This is to ensure there is no overpayment of bonuses.
THANK YOU