This document discusses the audit of a company's payroll cycle. It provides an overview of payroll and personnel functions, key internal controls related to payroll, and substantive audit procedures to test the payroll account. The internal controls discussed are adequate separation of duties, proper authorization of payroll activities, adequate documentation of transactions, physical control over assets and records, independent checks of payroll processing, proper preparation of tax forms, and timely payment of withheld taxes.

1. TOPIC 10: AUDIT OF PAYROLL
CYCLE
References: Chapter 20
AUD390 2014
AUDITING AND ASSURANCE
SERVICES
IN MALAYSIA

2. LEARNING OUTCOMES
AUD390 2014
 OVERVIEW OF THE ACCOUNTS & CLASSES OF
TRANSACTIONS
 BUSINESS FUNCTIONS & DOCUMENTS
 FINANCIAL REPORT ASSERTIONS
 MAJOR INTERNAL CONTROL & RELATED AUDIT
PROCEDURES
 SUBSTANTIVE TESTS FOR PAYROLL ACCOUNT

3. OVERVIEW OF PAYROLL &
PERSONNEL CYCLE
AUD390 2014
 Objective to audit:
› To evaluate whether the account affected by the
cycle are fairly presented in accordance with
generally accepted accounting principles
 Differences between this cycle and the other cycles:
› There is only 1 class of transactions for payroll
› Transactions are far more significant than related
balance sheet accounts
› Internal control over payroll are effective for almost
all companies

4. AUD390 2014
CLASSES OF
TRANSACTIONS
ACCOUNTS BUSINESS
FUNCTIONS
DOCUMENTS &
RECORDS
Payroll Payroll cash
All payroll expense
accounts
All payroll
withholding
accounts
All payroll accrual
accounts
1. Personnel &
employment
2. Timekeeping &
payroll
preparation
3. Payment of
payroll
4. Preparation of
payroll tax
returns &
payment of
Personnel records
Deduction
authorization form
Rate authorization
form
Time card
Job time card
Payroll transaction
listing
Payroll journal or
listing
Payroll master file
Payroll cheque
Payroll bank
account
reconciliation
W-2 form
Payroll tax return

5. KEY CONTROL ACTIVITIES
AUD390 2014
1. Adequate separation of duties
2. Proper authorization
3. Adequate documents & records
4. Physical control over assets and records
5. Independent check on performance
6. Preparation of Payroll Tax Forms
7. Payment of the Payroll Taxes Withheld and Other
Withholdings on a timely basis

6. 1. Adequate Separation Of Duties
AUD390 2014
 Purpose:
 To prevent overpayments and payments to
nonexistent employees
 Therefore, Human Resource Department should be
independent of the payroll function
 E.g.
 Payroll processing (include authorizing for addition
and termination of employees, changes in pay
rates & deductions) should be separate from the
custody of signed payroll cheque

7. 2. Proper Authorization
AUD390 2014
 Purpose:
 To ensure that the payroll payment are for
authorized purposes
 For example:
 The hours worked by each employee, especially
overtime, should be authorized by the employee’s
supervisor.
 Evidence of approval maybe noted on all time cards.

8. 3. Adequate Documents & Records
AUD390 2014
 Purpose:
 To ensure adequate number of documents & records
represent the transactions
 For example: The existence of time card or punch card to
verify the attendance of employee to work

9. 4. Physical Control Over
Assets & Records
AUD390 2014
 Purpose:
 To ensure payroll cheques are being used for
authorized transactions only
 E.g.
 Access to unsigned cheques should be restricted
 Cheque should be signed by an independent
person
 Payroll cheque should be distributed by someone
independent of the payroll and timekeeping
functions
 Any unclaimed cheques should be returned for
redeposit
 Access to the cheque signed-machine should be

10. 5. Independent Check On Performance
AUD390 2014
 Purpose: To ensure payroll transaction are monitored
accordingly by responsible person
 For example: Payroll computations should be
independently verified, including comparison of batch
totals to summary report

11. 6. Preparation Of Payroll Tax Forms
AUD390 2014
 Purpose:
To prevent a potential liability for unpaid taxes, penalty
and interest if the client fails to prepare the tax forms
properly
 For example: Perform detailed reconciliation of the
information on the tax forms and the payroll records
 Indication of potential misstatements:
The payment of penalties and interest in the past for
improper payments
New personnel in the department responsible for the
preparation of returns
Lack of internal verification of the information
The existence of serious cash flow problems for the
client

12. 7. Payment Of The Payroll Taxes Withheld &
Other Withholdings On A Timely Basis
AUD390 2014
 Purpose:
 To ensure the payment of the payroll taxes withheld &
other withholdings on a timely basis
 For example: Determine the client’s requirements for
submitting the payments by referring to sources such as
laws, union contracts & agreements with employees