Module Payroll Cycle - Lecture notes 1 PDF

Preview

Summary

Notes on the payroll cycle...

Description

UNIVERSITY OF JOHANNESBURG DEPARTMENT OF ACCOUNTANCY AUDITING 300/BCTA 2018

MODULE: Payroll Cycle

1. CHAPTER 4: PAYROLL CYCLE 1.1

INTRODUCTION OF THE TOPIC

You have recently qualified as a Chartered Accountant, and unlike most of your peers have decided to start your own company selling photocopiers. You realise that you require the help of a personal assistant and a couple of sales clerks. Where do you begin? You would start by advertising the positions, and where suitable candidates respond to the advert, you would request them to fill out an application form. After identifying potential candidates, an interview will be conducted and if successful an employment contract, stipulating the terms and conditions of employment, will be signed. An employee file containing, the employee’s ID document, employee number, the employment contract, authorisation to deduct UIF, Pension Fund Contributions, etc will also be created. The employee will resume work, and on a weekly basis account for the hours worked by completing a timesheet. At the end of each week or month this information would be collated and captured onto the system, resulting in a payslip being generated for the employee, detailing the gross salary/wages, deductions and net pay. This would also enable payment to be made to the employee for services rendered. This in a nutshell explains the payroll cycle. As you go through the module, remember this simple example and make applicable what you learn to it, for e.g. what controls would you put in place to ensure that you on a monthly basis account completely for all employee related cost? This cycle controls what is to most businesses, a major expense. Inherently this cycle is a high risk cycle from an audit perspective due to the fact that cash is involved. Although many businesses are trying to move away from using cash to pay wages by making payments directly into bank accounts, extensive use of cash is still made as many wage earners prefer cash and may not operate bank accounts. Wages and salaries are also usually internally generated, and unlike purchases and payments supported by external documentation, for e.g. a supplier’s invoice, it is therefore reasonably easy to create fraudulent outflows if controls are not sound, for e.g. by creating fictitious hours worked or fictitious employees In this module we will endeavor to explore the intricacies of this cycle and also find out how this will affect the audit procedures to be performed in order to attain sufficient and appropriate audit evidence to reduce audit risk to an acceptably low level.

1.2

CHARACTERISTICS AND ACTIVITIES IN THE CYCLE

The payroll cycle consists of five functions which we will explore throughout this module. These functions are:  The human resources function  The timekeeping function  The payroll preparation function  The payment preparation and payout function  The deductions: payments and recording function As elucidated in earlier modules, it is important to understand that the auditor does not provide an opinion over individual cycles audited, but over the financial statements as a whole. The accounts therefore typically affected by this cycle are the following: 1) Within the statement of comprehensive income  Gross salaries  Wages  Commissions  Bonuses  Manufacturing wages  Directors’ emoluments  Employer contributions 2) Within the statement of financial position  Employees for remuneration accrued  Accounts payable (Payroll deductions)  Accounts payable (Employer contributions)  Various bank accounts Now knowing which accounts are affected, let’s start discovering the functions mentioned earlier on an individual basis starting with the human resource function. It is important to explore the documentation relevant within each function, remember it is literally impossible to audit anything if you are not certain about what documents to scrutinize. We will then move on by looking at the risks that exist within each function, as well as the controls that should be in place to ensure that risk is reduced. It is important to note that the system description that is about to be provided is for a company with the necessary staff capacity to ensure the necessary levels of segregation of duties between each function.

1.3

HUMAN RESOURCES

Description of the function The objective of this function is to ensure that all matters relating to the personnel department are properly maintained. This department deals with all aspects of the human assets of the company and therefore should be skilled in things such as recruiting, counseling, negotiating and labour law. They will be responsible for keeping all employee records (i.e. employee permanent file), focus on the hiring and dismissal of staff, and ensuring that pay rates and changes thereto are implemented promptly. It is important that accurate and complete records for all valid employees are maintained by this department, this facilitates the provision of information necessary to produce valid clock cards or timesheets. Documentation used   

Employee’s file Payroll amendment forms Updated list of employee details

Risks in this function 1. Unsatisfactory or unnecessary employees may be recruited or retained 2. Dismissals of employees that may not have been followed the correct procedures 3. There may be staff that are not necessarily needed, but are kept because of the human resources department not identifying this 4. Employee details could be fraudulently amended to include non-existent employees, or to change the rates of pay applicable to an employee. The controls that should be implemented within this function to reduce risks to an acceptable level should include: 1. Interviews should be conducted with all applicants; the head of department in which the applicant is going to work should also be present. 2. All appointments and dismissals/resignations should be authorised and approved by a senior official on supportive documentation. 3. Changes to pay rates, promotions to higher employment grades and any other changes in service conditions should be decided upon by the human resource department after consultation with all interested parties, e.g. unions, and consideration of relevant laws and regulations, e.g. minimum wage regulations. 4. All changes should be documented and authorized by the authorizing body (e.g. wage committee) 5. All these amendments should be recorded on sequentially numbered payroll amendment forms and supported by further documentation. These should also be authorised and signed by senior management 6. All documents above should be maintained in each employee file. This will include documents such as application forms, personal details of each employee, letter of appointment, IRP2, authorisation in respect of deductions, employment contracts and payroll amendment forms.

1.4

TIMEKEEPING

Description of the function This function is necessary to keep an accurate and complete record of valid hours worked for which the company must remunerate employees, i.e. the company needs to ensure that all employees are paid exactly for the hours that they worked. This relates mainly to wage earners, as salary earners usually get paid at the end of the month, and it is usually a fixed amount. Wage earners on the other hand, get paid weekly, and their remuneration will vary depending on the hours that they have worked during that specific week. Keeping a record of a wage earner’s hours can be achieved by requiring the employee to pass a clock card or swipe through a time clocking device which will automatically record the time of either entry or exit. On a weekly basis, daily hours clocked will be calculated and totalled before being sent to the next function – the payroll preparation function. Documentation used   

Blank clock cards Hours recorded on clock Batch control sheet and batch register

Risks in this function 1. Fellow employees can clock in for an absent employee, therefore resulting in recording of invalid hours 2. Clock cards could be made out and clocked for ghost employees, thereby facilitating the payment of wages to ghost employees 3. Errors could be made by payroll department, in calculating and collating information on the clock card for recording, e.g. hours worked and rates used etc.

The controls that should be implemented within this function to reduce risks to an acceptable level should include: 1. Clock cards should: a. be numerically accounted for; b. be issued by the personnel department and prepared from personnel records/master file c. be kept at clock machine, under supervision, not with the employees). 2. Entry and exit points to the work area should: a. be limited to one b. protected by a “turnstyle” type mechanism c. supervised during clocking periods 3. Clock procedures: a. clocking machine should be situated at the entrance to ensure that personnel may not leave premises without clocking in/out; b. supervision over clock (prevent employees to clock in for absentees). 4. The foreman should: a. keep a record of personnel present and time worked b. sign clock card as evidence of approval of hours worked by the employee the foreman’s clock card should be approved by a senior official (eg. factory manager). Overtime should: c. be authorised according to the company policy by the factory manager or foreman The foreman’s overtime is authorised by the factory manager.

1.5

PAYROLL PREPARATION

Description of the function The aim of this function is to calculate gross wages, deductions from employees which must be paid over to the relevant authorities, and net wages. As mentioned earlier during our discussion of the timekeeping function, at the end of each week, the details on the clock cards need to be calculated and collated, so that the payroll can be drawn up. This involves calculation of all the hours worked, and must be split between overtime and normal hours, as the rates per hour for these two categories are different. Total hours worked by an employee, multiplied by the corresponding rate per hour as per the employee’s permanent file, would equal to the amount that the employee is to be paid for the week. Very important to remember that in this function appropriate deductions, for e.g. PAYE, must also be extracted from authorised, up to date tables, or in the case of other deductions, for e.g. Pension Fund, must be deducted in terms of the authorisation form completed by the employee. This information is then recorded on the payroll also referred to as the wages journal. Documentation used    

Clock cards Updated list of employees Payroll (wage journal) Week to week reconciliation

Risks in this function 1. Errors may be made due to incorrect calculations and casting 2. The company may use incorrect or unauthorized pay rates, hours or deduction tables during recording 3. Fictitious employees may be included fraudulently

The controls that should be implemented within this function to reduce risks to an acceptable level should include: 1. The hours recorded on the payroll should be obtained directly from the clock card or computer-transaction file 2. The wage rates, deductions should be obtained from personnel records or master files; 3. The calculations and castings should be reviewed by an independent person (e.g. one wage clerk checks another clerks work/edit checks); 4. Before payments can be authorised, the senior personnel, should inspect the payroll and the week to week reconciliations performed. 5. All personnel should sign payroll as proof of functions performed. 1.6

PAYMENT PREPARATION AND PAYOUT

Description of the function The objective of the function is to ensure that employees are paid out the amount of wages for which they have worked. As wages are paid out weekly, it is done mostly by cash, for which an employee must sign after the collection thereof. Employees will also receive a pay slip, indicating how much they have earned, and the amount of money that should be included in their pay packets. The pay packets should be distributed at the respective paypoints of the employees; they should count their cash immediately upon collection, and compare it to the pay slips. Any discrepancies should be queried immediately. Where an employee is absent during the pay out of wages, the wages remaining are known as “unclaimed wages”. Unclaimed wages must also be recorded. Documentation used     

Authorised payroll Payroll signed by employees Payslips Paypackets Unclaimed wages register

Risks of this function 1. Since the payment function is done by working mostly with cash, there is a risk that errors could occur as well as theft, when cash is actually being paid to employees, or when the pay packets are being made up. 2. There is also a risk that there could be misappropriation of the unclaimed wage packets.

The controls that should be implemented within this function to reduce risks to an acceptable level should include: 1. The wage cheque should be signed by two signatories, one of whom must be senior management: a. The wages cheque together with the current and previous payroll and supporting documentation in respect of appointments, dismissals and increases should be presented to the cheque signatories for authorisation. b. A senior employee should compare the payroll to the wages cheque c. The current payroll should be compared with the previous payroll and check the validity of all changes to supportive documentation d. The payroll and documentation should be signed/stamped to cancel after approval. 2. Wages cheque should be cashed at bank a. by two or more persons; b. not at regular times/routes; It is preferable to make use of security company to do wage payouts. 3. The make-up of wage packets should: a. be done by two wage department members and physical security over all aspects of cash handling should be extremely tight. b. preferably be done by an independent persons not involved with the preparation of the pay-roll; c. the wage details should appear on the wage-packet (gross wage, deductions); d. the money in the wage-packet should be independently reviewed. 4. The payout a. should be done by personnel not involved with make-up of wages; b. The foreman must identify all employees, however the payout must not done by himself c. the employees should sign payroll as proof of receipt; d. the foreman should signs payroll after payout as proof of supervision and identification of employees.

5. Unclaimed wages a. at the end of the payout, the paymaster and the foreman who conducted the payout should agree all unclaimed pay packets to the payroll (i.e unsigned entries). Once all employees who have not claimed the pay

packets have been identified, details of unclaimed wages should be entered in an unclaimed wage register. The payroll should be signed as evidence of performing the control procedure. b. unclaimed wages and payroll should be retained by the paymaster who should lock them away c. regular independent reconciliations of unclaimed wages on hand and the register should be performed and the register should be reviewed for unusual occurrences. d. unclaimed wages remaining unclaimed after two weeks should be banked and a copy of the deposit slip attached to the register. 1.7

DEDUCTIONS: PAYMENTS AND RECORDING

Description of this function It is the responsibility of the company to hold back certain portions of the wages earned, due to statutory requirements, such as PAYE. The portion held by the company, does not belong to the company, and the company has a responsibility, not only to pay the correct amount over the relevant authorities, but also to do so within the correct period. The objective of this function is to ensure that the amounts owed to the relevant authorities are correct, paid over within the required period, and are supported by the relevant supporting documentation or return. Documentation used    

General ledger Payroll (wage journal) Cash payments journal Return form

Risks in this function 1. Should the correct amount not be paid over to the different authorities, there could be significant losses due to penalties, e.g. incorrect payment of tax to SARS 2. If payments to the different authorities are late, there could also be significant losses due to penalties. 3. Non-payment to authorities may result in criminal/civil charges as this is theft. 4. Losses could be incurred as a result of undetected overpayments.

The controls that should be implemented within this function to reduce risks to an acceptable level should include: 1. A strict monthly schedule should be developed for: a. Posting the entries to raise the liabilities for the deductions, b. Making the necessary payments on a timeous basis, and c. Supervisory checks on the above activities 2. The payroll and return forms should be presented as supporting evidence to the signatories before the deductions cheques are signed 3. The financial accountant should perform independent monthly reviews of the general ledger accounts for deductions to confirm that they are being promptly cleared 1.8

AUDITING PAYROLL

Having taken time to understand the activities in the cycle, the auditor has to obtain an understanding of certain controls which, if operating effectively, can assist the auditor in ensuring that the balances in the financial statements are fairly stated. If internal controls are properly designed, implemented correctly and operate effectively throughout the period under review, the auditor is able to assess managements assertions. Let us now refresh the assertions relevant to each financial statement caption. NB: You must refer to ISA 315 for the explanation of each audit assertion. It is of utmost importance that you understand the meaning of each assertion to be able to apply the audit assertions in a practical scenario and question. These assertions will be applicable in all the business cycles that will be covered in the first semester. We have already explored the risks within the cycle. This indicates “what could go wrong” within the cycle should controls not be designed properly and not operate effectively. It is important to remember that the auditor follows a risk based approach, and equally important to note the applicable direction of testing.

Risk/Test Direction:

DIRECTION OF TESTING Credits (Liabilities/Income/Reserves) Debits (Assets/Expenses) Overstatement Understatement Accounting Records (G/L) to Source documentation Source documentation Accounting Records (G/L)

to

Having refreshed your memory of assertions and direction of testing, we are now ready to take a look at how the auditor will go about decreasing his/her audit risk. Relying on controls can be beneficial to the auditor as it will result in a more efficient and sometimes cost effective audit. Therefore what objectives will management try to achieve through the implementation of control in this cycle?

1.9

CONTROL OBJECTIVES

For classes of transactions  All valid payroll transactions are recorded and nothing is left out (Completeness)  Personnel and wage rate changes, as well as total weekly payroll amounts have been properly authorised (Authorisation)  All recorded wages are valid and supported by proper documentation (Validity)  Payroll transaction are shown at the correct amounts (Accuracy)  All purchase transactions are correctly recorded (Recording) For account balances      

Payroll liabilities represent all amounts owed at balance sheet date (Completeness) Payroll liabilities represent amounts properly owed to employees and payroll deductions accounts payable at balance sheet date (Existence) Recognition and measurement of employee benefits in accordance with IFRS (Measurement) Fair Value measurements of post-retirement benefits for employees recognized in accordance with IFRS (Valuation) Payroll liabilities re...