Question

Diamond Construction is an owner-managed entity with contracting revenues of $20 million in 2020. As construction is a labour-intensive industry, one of Diamond’s largest expense accounts is labour and wages. You are a first-year auditor at Klein and Partners. You have been given the following information regarding the entity’s payroll process for hourly employees at Diamond Construction:

1. The owner-manager is the only person who can authorize the hiring of a new employee.
2. When a new employee is hired, the payroll clerk prepares a new employee package that includes:
(a) safety orientation
(b) tax forms
(c) benefits plan enrolment
3. Only the payroll manager has the ability to update the employee master list. This can only be done once the tax forms, a void cheque with direct deposit information, and the owner’s approval have been received. All forms need to be returned before the payroll manager will update the payroll master list and add any new employees.
4. Hourly employees are paid biweekly.
5. Hours worked are tracked on time cards. Supervisors fill in the time cards for each individual day, noting the hours worked.
6. At the end of the pay period, time cards are provided to the payroll clerk, who compiles the total hours worked and codes the hours to the appropriate job number. Once compiled, the payroll clerk enters the hours worked per person in the payroll system.
7. The accounting system prepares the direct deposit information based on the rates of pay maintained in the payroll master list (listing of all authorized staff and approved wage rates). It also calculates the withholding taxes.
8. This is transferred to the bank and a record of the transmission is printed and attached to the front of the payroll run.
9. The payroll module is integrated with the general ledger. The payroll clerk prepares and posts the journal entry to the payroll expense accounts.
10. Remittance advices are given to the supervisors for distribution.
11. If an employee is terminated, Diamond just stops paying them as they no longer have time cards submitted.
12. When an employee has been promoted or their job classification has changed, the supervisor will verbally communicate this to the payroll manager, who will then update the payroll master file. Therefore, source documentation in employee files will only relate to an employee’s original job classification. The rationale for this was that most job classification changes would only result in an additional dollar or two per hour paid to the employee.

Which of the following are control strengths with the payroll process?

The payroll manager has the ability to update the employee master list once the completed paperwork is received.

Supervisors fill in the time cards for each individual day, noting the hours worked and initialling each of the time cards.

The payroll clerk, who compiles the total hours worked and codes the hours to the appropriate job number, enters the hours worked per person in the payroll system.

All employees are on direct deposit.

The accounting system calculates the wages, withdrawing taxes.

The payroll module is integrated with the general ledger.

If an employee is terminated, Diamond just stops paying them as they no longer have time cards submitted.

When an employee has been promoted or their job classification has changed, the supervisor will verbally communicate this to the payroll manager, who will then update the payroll master file.

  

  

Which of the following tests of controls should be performed for Diamond Construction?

Compare monthly figures to expectations.

Take a sample of employees and compare to the employee files to ensure they exist.

Select a sample of time cards and review for the supervisor’s initials.

Examine termination notices in payroll department.

Take a sample of payroll journal entries and ensure they are posted and posted correctly.

Witness distribution of payroll remittance advices.

Examine evidence of the preparation and use of batch totals.

Test the system using a sample of hours and ensure it is calculating all items correctly.

Answer 1

Strengths

1.

No changes are made to the employee master list without the tax forms and the owner authorization - this ensures only approved employees prevents fictitious employees from being added to the payroll master list.

Test:

Take a sample of employees and go back to the employee files to ensure they exist.

2.

Only owner manager can authorize hiring of new employees — only authorized additions are made to the payroll.

Test:

Take a sample of new employees and review hiring forms for evidence of approval.

3.

Supervisors fill in the time cards for each individual day noting the hours worked and initials each of the time cards. This ensures employees are only paid for actual hours worked.

Test:

Select a sample of time cards and review for the supervisor’s initials.

4.

The payroll module is integrated with the general ledger and prepares and posts the journal entry to the payroll expense accounts. This ensures the payroll expense is recorded in the general ledger and recorded at the right amounts and in the correct general ledger accounts.

Test:

Take a sample of payroll journal entries and ensure it is posted and posted correctly.

5.

All employees are on direct deposit and remittance advices are given to supervisors for distribution, therefore there is no risk cheques will be distributed to unauthorized people.

Test:

Witness distribution of payroll remittance advice.

6.

Accounting system calculates the wages, withdrawing taxes. This prevents calculation errors with respect to wages as well as tax deductions. This ensures the payroll expense is correctly calculated.

Test:

To test the control: Test the system using a sample of hours and ensure it is calculating all items correctly.