Review Questions Solutions
Chapter 13, Auditing Human Resources Processes: Personnel
and Payroll in Service Industries
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A1 Give examples of industries for which a service is the primary productive output.
Health care; education; banking and related financial services businesses such as investment, brokerage and insurance firms; personal services; professional services such as lawyers and accountants
A2 What activities make up personnel functions? Payroll functions?
Personnel: hiring; maintaining and terminating (or separating from) employees; maintaining personnel records; performing administrative responsibilities for benefit plans
Payroll: calculating, processing, paying employees for the work performed; calculating, processing and paying other entities for related costs; posting employee compensation and other related expenses and liabilities
A3 For what reasons do businesses withhold funds from their employees’ pay?
An employer acts as “quasi” collection agency for taxing authorities by withholding money from payroll payments and remitting it to the government on each employee’s behalf; employers also withhold and submit remittances for items such as health insurance, savings, etc.
A4 For sales and billing purposes of a company in the service industry, why is proper human resources accounting important?
For internal management and billing in services industries, human resources costs are often considered a part of work-in-process or unbilled labor until the task or job is completed and the client is billed.
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B1 Why do public accounting firms require their employees and partners to submit time sheets?
To permit tracking time spent on each client; facilitate engagement management and the client billing process; and tracking sick leave and vacation time.
B2 What functions does a human resources or personnel department perform when a new employee is hired?
1. Collect information regarding tax status and the employee’s decisions regarding participation in various benefit plans like savings and health care.
2. Prepare the employee’s personnel file that includes information about taxes and benefits, and holds documents from the application and hiring process such as any verification obtained about educational degrees received, state licenses held or recommendation letters.
3. Assign the employee an identification number (or similar identifying/security mechanism)
4. Authorize that the identification number, the employee’s rank or staff classification, department and salary and deduction information be in put into the IT system.
B3 When does an employer have to submit payroll tax payments?
When the total amount reaches certain levels (or when a specific period of time passes, whichever occurs first) it triggers the need to make payments to the government taxing authorities
B4 What functions does an engagement management program perform? What information does it use and from what source is the information captured?
The engagement management system tracks items like:
Hours worked on the engagement by each employee
The billable dollars correlated with hours worked based on billing rate-per-hour
Out-of-pocket expenses incurred by employees
Dollars calculated based on time worked that have not yet been billed
Dollar amounts billed to and receivable from the client
Dollar amounts collected
The engagement management system uses details of time utilization of employees and partners, and billing and collection information. The sources are time sheets and the billing and collection records.
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C1 What are management’s objectives related to payroll?
1. Paying employees accurately
2. Paying other entities for payroll-related liabilities as required.
3. Satisfying reporting obligations imposed by government
4. Accounting for the various transactions properly in the accounting records and financial statements
C2 For what functions should a human resources cycle have controls?
Hiring, documenting workers’ activity, processing payroll and disbursing cash. Records that track when employees quit or are fired. Records that track disbursing amounts withheld and due.
C3 What types of period-end adjustments are made to payroll and related amounts?
Accruing payroll and labor expense and recording the liability for any unpaid amounts including
Liabilities to taxing authorities, health care and other benefits providers
Vacation and sick leave benefits for compensation expense and related liabilities
C4 When does payroll become part of inventory as a product cost?
This occurs when the payroll costs relate to the specific employees working in the manufacturing process. These may be direct labor or overhead.
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D1 What information needs to be authorized or documented when a new person is hired?
Authorization to hire the employee, pay rate or salary at which the employee is hired
Deductions to be withheld from the employee’s pay
If the payroll payment is to be made by EFT, information and authorization to pay by “direct deposit”
D2 What information is contained in the payroll master file? How and by whom is it updated when information changes?
For each employee:
Personal information
Current payroll transactions and year-to-date information
Changes, such as from receiving a raise, changing deductions or EFT information, or separating from the company
The update is carried out by the human resources department, or by other based on the authorization of the human resources department.
D3 How does an imprest payroll account work? What are the advantages of using an imprest account for payroll?
The net amount of each payout is deposited in the payroll checking account before the payout is made. After all the payments have been completed, the balance in the payroll checking account should be zero, unless the company maintains some minimum balance in the bank account.
The advantages of using an impress account for payroll are efficiency and control. Because the only transactions that go through the account are payroll disbursements and the deposits to cover the payroll, reconciling the bank statement to the payroll records is much easier and more efficient. Using an imprest system makes it easier to identify outstanding, uncashed checks, invalid receiving accounts for direct deposit payments, and any suspicious transactions
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E1 What segregation of duties is necessary and appropriate for payroll?
Master file changes for hiring, terminating and changing employee pay rates are authorized by appropriate human resources personnel, rather than line personnel or those actively involved in processing payroll.
Approval for time worked comes from the line department before payroll personnel process disbursements.
Transactions processes to initiate payment to employees start at the line department level and progress through the accounting department to the cashier or treasury department.
E2 Who should perform employee check-in and check-out functions, and why?
The individual employee should check in or out so that the employee must actually be present at the workplace for pay to be earned and payment authorized.
E3 What types of authorization and verification should occur before an employee is paid?
1. Confirmation of time worked
2. Approval of a payroll before funds are disbursed
3. Payroll information such as an identification number for the employees to be paid matches information on the payroll master file
4. Rates at which employees are paid are the authorized rates
5. Withholdings are authorized and at the proper amounts
E4 How does employee monitoring of personal records provide an additional control for payroll?
Any errors that inappropriately reduce gross or net pay or increase withholdings are likely to be caught by the affected employee.
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F1 What payroll services are typically included in those outsourced to an outside service provider?
1. Updating the payroll master file.
2. Keeping track of current and year-to-date information by employee as well as for the company as a whole.
3. Creating documents and forms required for tax purposes such as W-2 forms and quarterly payroll tax returns.
4. Submitting information for general ledger entries back to the organization.
5. Performing the tracking and calculations required for applying payroll costs to inventory.
6. Providing custom management reports on payroll expenses.
7. Managing documents related to unemployment compensation.
F2 What functions does the user company need to perform when payroll processing is outsourced?
1. Determine and communicate who payroll is to be calculated.
2. Provide any company-specific information about amounts to be withheld, such as for benefits and other items, and communicate each employee’s personal and specific information upon which payroll calculations and records are based.
3. Maintain employee documents and authorize any changes to the payroll master file records.
4. When compensation is based on variable inputs such as hours worked or commissions, the line departments must still provide and approve the information that serves as inputs for each pay period.
5. Establish and implement various controls for the information that goes to and is received from the outside service provider, as well as for the cash disbursements.
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G1 What information must the user organization submit to the service provider? By what means can the information be input and submitted?
1. Company name and probably a company code.
2. Frequency of payment to employees.
3. Whether and which employees – sometimes based on department or rank – are paid based on salary, commission, and hours worked.
4. Policies for meal allowances and their computation.
5. The basis for applying payroll costs to inventory.
6. Personal information for each employee – name, identification number, department (or other sub-organization level) code, pay rate, number of exemptions for tax withholding and deduction information, bank account to which each employee’s payments are to be directed.
7. Any current changes to the master file for new hires and separations, and updates to information on existing employees.
8. Current hours worked or other information about each employee’s earnings for the current period.
Information can usually be submitted electronically, orally by telephone, or in written form by fax, mail or courier.
G2 What is payroll master file maintenance?
Modifying the master file for the addition of new employee information and changes, including termination of employment.
G3 What outputs are produced by the service provider related to paying employees?
Outputs related to employees are checks (or transfer of funds orders) and earnings statements with current and year-to-date totals.
Outputs for accounting and management include:
1. Reports with accounting and management purposes such as updated payroll master file, payroll register, deduction exception report.
2. Control reports such as a detailed listing of all master file changes processed and a count or distribution of the number of employee payments that fell within various dollar amount categories.
G4 What controls should a user organization have in place for the information and activities related to an outside service provider for payroll?
1. Employee-related controls for interface with the provider
2. Input and submission
3. Processing-error corrections
4. Output monitoring
5. Company specific controls over hiring process, cash activities, such as moving funds into a payroll bank account from which payments are disbursed and reconciling the payroll bank account
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H1 Under what conditions does a company’s auditor (the user auditor) have to consider the ICFR at the service organization?
If the activity outsourced is determined to be a significant process, then the auditor must consider the controls for the process as they affect the significant accounts involved and the assertions for those accounts.
H2 What is a SAS 70 report? What is its purpose? Who has access to it?
A SAS 70 report is a report on the auditing of transaction processing controls at a service organization. Its purpose is to provide the user organization and its auditor with information on controls, which although performed in the service organization, affect the user’s ICFR. The report is a limited use report, intended for the user organization and its auditor.
H3 What is the difference between a Type 1 and Type II report? What conditions might cause the auditor to decide that more evidence is needed beyond a Type II report?
A Type I report is a report relating only to whether the controls are appropriately described, in place and effectively designed to meet the described control objectives. A Type II report is a report of tests of operating effectiveness of the controls. An auditor might want more evidence than a Type II report when:
-the time period covered by the tests of controls was not long enough
-too much time has elapsed between the date of the testing and the period covered by the financial statement audit, or management’s report date on ICFR
-the scope of the examination, applications covered and controls tested is insufficient
-the results of the controls tests indicate problems
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I1 What evidence about the human resources cycle can be obtained through substantive analytical procedures?
[Early indications during planning of areas that may require more audit effort; this is planning, not substantive analytical procedures]
Evidence about the reasonableness of both payroll-related expenses and liability account balances.
Current-year balances can be compared to prior years, budget and benchmarks
Estimates can be made of account balances
Evidence about compensation expense by considering other account balances and their relationship to payroll
Accounts addressed through analytical procedures: wages, commissions, bonuses, officers’ compensation, payroll tax expense
I2 What liability accounts are related to payroll?
1. Compensation that has been earned by employees but not yet paid
2. Amounts withheld from employee payments but not yet disbursed
3. Accrued payroll taxes
4. Accrued vacation and sick pay
I3 What tests of details can be applied to individual amounts and account balances?
Examining underlying documents related to specific transactions or account balances:
1. Examine payroll tax returns and reconcile to aggregate payroll documents and to W2s
2. Agree officers salaries and bonuses to amounts authorized in Board of Directors minutes
3. Select large commission payments and agree to supporting documents
Test payroll-related liability accounts through document examination and recalculation:
1. Examine client documents supporting year-end adjusting entries (for accruals that are estimated) and reperform client calculations
2. Examine client document for accrued payroll taxes
Analyze calculation method for reasonableness and consistency with prior year
Trace information used as input to supporting documents
Reperform calculation
Agree calculation result to GL balance
Reconcile account balance to subsequent payroll tax return and cash disbursement
3. Examine client documentation for calculation of withholdings from employee payments
(same as for 2.)
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