Question

Problem-based Scenario –

Your client, Sonny Days Limited (Sonny Days) is a company involved in the manufacture and development of play equipment for parks, schools and other bodies such as local authorities, councils and community groups. Sonny Days was set up in Ireland five years ago with support from government grants for employment costs and capital equipment costs. The company’s employee numbers continue to expand from a starting base of 15 employees.

As external auditors to Sonny Days, your firm’s audit approach has been to carry out an interim audit approximately ten months into the company’s financial year; followed by the final audit, which generally commences six weeks after the year-end. As a newly appointed Audit Senior you have been given managerial responsibility for this assignment and are currently reviewing the audit papers which were prepared during the interim audit visit to Sonny Days.

You met with the Audit Manager for the interim audit and he has indicated to you that from his interim audit work on the payroll processing and accounting system, the system does not employ the full extent of controls, which are evident in other companies of similar size and complexity. He has copied for you comprehensive system notes which he prepared during the interim audit.

These notes are reproduced below:

“Sonny Days operates a number of payrolls, the largest of which is the “manufacturing” payroll which deals with approximately 40 employees. Manufacturing employees are paid a standard weekly wage for a 35-hour working week. However, overtime is worked by most employees and can significantly boost weekly earnings.

All manufacturing employees are required to account for their time on a daily basis. This process involves employees logging time spent on particular activities into keypads located throughout the factory. Production Supervisors provide hard copy information to

the Human Resources Department for those employees on leave and this is used to compare employees logged in against total manufacturing staff numbers. Any discrepancies should be followed up. However, this hasn’t been done for several months due to a backlog of work in the Human Resources Department in addition to Production Supervisors not providing the hard copy reports in a timely manner.

In addition, all employees complete time-sheets each week recording their standard and over-time hours. These are then forwarded to the Human Resources Department where they are manually entered into the payroll processing system. If a time-sheet is not received, the standard hours for the week are automatically generated by the system.

The payroll is then run and the payslips and automatically generated cheques are produced. These are given to the Production Supervisors who hold them for collection by the individual employees. The payroll system is integrated with the nominal ledger and it generates a payroll expense split into production and non production accounts in addition to a charge in the wages liability account and the creation of liabilities for net pay, statutory and voluntary deductions. The balance on the payroll liability account is expensed quarterly. There are no hard copy reports produced by the system.

The payroll programme uses both input hours and information sourced from the employees’ master file. The master file is updated regularly for new employees, changes to tax free allowances, new rates of pay, changes in voluntary deductions, etc. Changes are accumulated each week and processed by payroll department staff. Changes are stamped within the system and flagged with the Human Resources Department User I.D. and password which are common to all payroll staff. Changes are investigated if there are employee queries.

A separate payroll bank account is maintained and is funded by weekly transfers equal to total gross pay. All payroll related payments are made from this account.

Any balances outstanding on the various deduction accounts are written off as part of the process for preparing annual accounts each year. Any balance on the wages bank account is transferred back to the main bank account”.

Required:

(c) ISA 500 Audit Evidence requires auditors to obtain sufficient and appropriate audit evidence. Appropriateness is a measure of the quality of audit evidence; that is, its relevance and its reliability. Identify and explain FOUR factors which influence the reliability of audit evidence.

Answer 1

"Audit evidence" is all the information gathered and used by auditor to reach at the conclusion on which audit opinion is based. It includes the information contained in the accounting records underlying the financial statements and other informations.

Auditor is required to obtain sufficient and appropriate audit evidence i.e they should be relevant and reliable.

The reliability of audit evidence is influenced by its source and by its nature and is dependent on the individual circumstances under which it is obtained.

In the given case scenario, In Sonny Days Limited there is computerised system for all payroll activities where employees record logging time spent on particular activities into keypads located throughout the factory and the hardcopy of employees on leave is provided by Production manager to HR Deptt for record maintenance and smooth working of payroll system. However it is also provided in Audit Managers notes that HR Deptt. has not done any review regarding the accurateness of the time sheet, and comparision of  employees logged in against total manufacturing staff numbers for some months. This is an alarming area of susception of any kind of misappropriation and misreporting so this required a collection of relevant audit evidence and also keep in mind the reliabilty of audit evidence.

The reliability of evidence refers to the degree to which evidence is considered believable or trustworthy. Reliability of Audit Evidence is affected by various factors, some of them are:

1) Source: Source is evaluated based on its provider's independence, objectivity, internal control's strength. The audit evidence obtained from independent sources outside the entity are more reliable and audit evidence directly obtained by auditor is more reliable that audit evidence obtained indirectly.

2) Verifiability: Evidence so obtained should be cross verified from the different sources. As in given situation auditor should verify the occurrence and accuracy of payroll transaction that they are given to actual employees not to terminated employees and the payment is actually made to them not only a book transaction.

3) Timeliness: The collection of evidence should be done in proper time, any delay can lead to sabotage information.

4) Effectiveness of internal Control: The evidence are more reliable if there are effective internal control within the entity. All the documents are kept under proper security and preference should be given to original documents in place of photocopies that can be altered. The system should be properly protected so that it can't be accessed by any unauthorised user.