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Chapter Twelve
Auditing the Human Resource
Management Process

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Overview of the Human Resource

Management Process
The human resource process starts with the
establishment of sound policies for hiring, training,
evaluating, counseling, promoting, compensating
and taking remedial actions for employees.

The main concern of the auditor involves payroll

transactions once an employee has been hired.

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Flowchart for EarthWear Clothiers

Departments
Human
Operating Resource Payroll
Initiates Payroll 
personnel master file Payroll
changes changes master file Time
changes cards
Time Reviews
cards master file
change To IT
Input
report
Approved
by
supervisor Review Error From IT
corrections
By date

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Flowchart for EarthWear Clothiers

Departments
Payroll IT
Payroll
master
Error file
corrections
Payroll Payroll
processing reporting
General
Error Payroll ledger
report cheques
Periodic
Payroll Payroll payroll
register register reports

Payroll master
Review Tax reports
file changes
by date and forms
report
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Financial Statement Accounts Affected

Type of Transaction Account Affected

Payroll transactions Cash.
Inventory.
Direct and indirect labor expense accounts.
Various payroll-related liabilitiy and expense accounts.
Accrued payroll liability Cash.
transactions Various accruals (such as payroll taxes and pension costs).

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Types of Documents and Records

Personnel records, including wage-rate or salary authorizations.
Deduction authorization forms.
Time card.
Direct deposit records/payroll cheques.
Payroll register.
Payroll master file.
Payroll master file changes report.
Periodic payroll reports.
Various tax reports and forms.

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The Major Functions

Authorization of hiring, firing, wage-rate and salary
Personnel
adjustments, salaries and payroll deductions.
Review and approval of employees' attendance and
Supervision time information; monitoring of employee scheduling,
productivity and payroll cost variances.
Processing of employees' attendance and time
Timekeeping
information and coding of account distribution.
Computation of gross pay, deductions and net pay;
Payroll
recording and summarization of payments and
processing
verification of account distribution.
Disbursement Payment of employees' compensation and benefits.
Proper accumulation, classification and
General ledger
summarization of payroll in the general ledger.

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Segregation of Duties

Department
Human Time-
Payroll Function Operating Resource keeping Payroll IT Treasurer
Initiation of wage or salary changes X
Initiation of employee hiring and firing X
Approval of wage and salary changes X
Updating of personnel records X
Updating of payroll records X
Approval of time cards and job classification X
Review of time data and payroll distribution X
Preparation of payroll X X
Preparation direct deposits/payroll cheques X
Direct deposit transfers/distrubution of payroll cheques X
Undating of general ledger for payroll X
Comparison of payroll expense to budget X
Calculation and recording of payroll taxes X
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Inherent Risk Assessment

In assessing inherent risk the auditor may want to

consider the effect of economic conditions on
payroll costs, the supply of skilled workers and the
frequency of employee turnover. The auditor should
be familiar with any existing labour contracts and
the impact of regulation on the company.
The inherent risk The inherent risk associated with
associated with non-officers officers of the company may not
of the company is be considered low because of the
generally considered low. ability to take advantage of their
high position.

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Control Risk Assessment

Understanding and documenting the human

resource management process based on a
reliance approach.

Planning and performing tests of controls on

payroll transactions.

Setting and documenting the control risk for the

human resource management process.

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Control Activities and Test of Controls –

Payroll Transactions
Occurrence of Payroll Transactions
The auditor want assurance that payments for payroll-
related services are being made to valid employees
for time actually worked. Controls must be in place to
ensure that no payments are made to fictitious
employees and payments to valid employees are
stopped once the employee is terminated.

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Control Activities and Test of Controls –

Payroll Transactions
Authorization of Payroll Transactions
The client must have controls for hiring and
terminating employees, setting pay rates,
making withholdings, awarding benefits and
issuing payroll cheques.

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Auditing Payroll-Related Accounts

Substantive Analytical Procedures
Substantive Analytical Procedures
Payroll Expense Accounts:
Compare current year with prior year payroll expense accounts
Compare current and prior year payroll costs as percent of sales and industry data
Compare labour utilization rates and statistics with industry data
Compare budgeted payroll expenses with actual payroll expenses
Estimate sales commissions with formula and recorded sales
Payroll-Related Accrual Accounts:
Compare current and prior years' balances in payroll related accounts
Test reasonableness of accrual balance

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Control Activities and Test of Controls –

Payroll Transactions
Accuracy of Payroll Transactions
The auditor’s main concern is that the
employee’s gross pay and payroll deductions
may be incorrectly computed.

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Control Activities and Test of Controls –

Payroll Transactions
Classification of Payroll Transactions

If payroll expense is charged to the wrong accounts,

the financial statement may be misstated. If payroll
expense is not properly classified between direct
and indirect labour, inventory and cost of goods sold
may not be valued properly.

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Relating the Assessed Level of Control

Risk to Substantive Procedures

If the results of the tests of controls for the payroll

system support the planned level of control risk,
the auditor conducts substantive procedures of
payroll-related accounts at the assessed level. If
the tests do not support the level of control risk, the
nature and extent of substantive testing will be
increased.

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Tests of Detail of Transactions, Account

Balances and Disclosures
Vouch a sample of direct deposits or payroll cheques
Occurrence
to the master employee list to verify validity.
Completeness Trace a sample of time cards to the payroll register.
Test a sample of direct deposits or payroll cheques for
Authorization
proper authorization.
Recompute a sample of direct deposits or payroll
Accuracy
cheques for gross pay, deductions and net pay.
Trace a sample of time cards before and after period
Cutoff
end to the appropriate payroll report.
Examine a sample of direct deposits or payroll cheques for
Classification
proper classification into expense accounts.

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Tests of Detail of Transactions, Account

Balances and Disclosures
Assertions about Account
Balances at Period End Tests of Details of Account Balances
Vouch selected amounts from account schedules for
Existence accruals to supporting documents (payroll tax returns,
corporate benefit policies, etc.).
Review supporting documentation to determine that
Rights and obligations
the entity is legally obligated to pay the liability.
Completeness Search for unrecorded liabilities.
Obtain an account analysis schedule for accrued
payroll liabilites; foot schedules for accrued payroll
Valuation and Allocation
liabilities. Compare amounts accrued to supporting
documentation, such as payroll tax returns.

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Tests of Detail of Transactions, Account

Balances and Disclosures
Assertions about
Presentation and
Disclosure Tests of Details of Disclosures
Occurrence, and rights and Inquire about accruals to ensure that they are properly
obligations disclosed.
Complete financial reporting checklist to ensure that
Completeness all financial statement disclosures related to payroll
expense have been made.
Review benefit contracts for proper disclosure of
pension and postretirement benefits. Read notes and
Accuracy and valuation other information to ensure that the information is
accurate and properly presented at the appropriate
amounts.

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Payroll Expense Accounts

Payroll transactions affect many expense accounts,
including direct and indirect manufacturing expense,
general and administrative salaries, sales salaries,
commissions and payroll tax expenses.
If the entity’s internal control is reliable, the auditor does
not need to conduct detailed tests of all these payroll
expense accounts. Additional testing is necessary only
when control weaknesses exist.

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Accrued Payroll Liabilities

The entity incurs a number of liabilities including

payroll taxes withheld, medical and life insurance
premiums, pension and other miscellaneous
deductions.
Accrued wages Accrued benefits
and salaries (vacation & sick pay)

Accrued payroll
taxes

Accrued Accrued
commissions bonuses
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Accrued Payroll Liabilities

Cutoff
An examination of supporting documentation for
the accruals provides evidence on the proper
period for recording the expense or liability.

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Accrued Payroll Liabilities

Existence and Valuation
To verify the existence and valuation of an accrued
payroll liability, the auditor can trace the amounts
included on the account analysis working paper to
supporting documentation such as payroll tax
reports.

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Accrued Payroll Liabilities

Completeness
The auditor must be aware of the normal payroll-
related taxes that are paid by the entity and
therefore should be able to determine if accruals
have been made for payroll taxes such as social
security taxes and unemployment insurance.

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Accrued Payroll Liabilities

Presentation and Disclosure Completeness Assertion

Sample Disclosure Items for the Human Resource

Management Process
Pension disclosures
Postretirement benefit disclosures
Profit-sharing plans
Deferred compensation arrangements

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Evaluating the Audit Findings –

Payroll-Related Accounts
If the aggregated amount of misstatement is less
than the tolerable misstatement, the auditor may
accept the accounts as fairly presented. If the
misstatement is greater than the tolerable
misstatement, the auditor may conclude that the
accounts are not fairly presented.

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End of Chapter 12

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