Question

Internal controls

1. Any changes to employee master file information since the last payroll period are evaluated to ensure that they have been properly authorized by the appropriate personnel.

2. The output is reviewed for reasonableness prior to distribution to users.

Consider the four methods of testing the operating effectiveness of controls (inquiry, observation, document examination, and re-performance). For each of the preceding controls, provide an example of how Mark's audit team might choose to test the operating effectiveness of the control using the four methods of test of controls (e.g., how would the audit team use inquiry, observation, document examination, and re-performance to test control #1, the generation and review of the system log?). [Note: Not all types of tests of controls will be appropriate for testing all the controls.]

Answer 1

Internal control is a process designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

· Effectiveness and efficiency of operations

· Reliability of financial reporting

· Compliance with applicable laws and regulations

Internal control process:

Internal control consists of five interrelated components as follows:

· Control (or Operating) environment

· Risk assessment

· Control activities

· Information and communication

· Monitoring

Risk Identification. A risk is anything that could jeopardize the achievement of an objective. For each of the department's objectives, risks should be identified. Here we can explain the risk identification process in following steps:

· What could go wrong?

· How could we fail?

· What must go right for us to succeed?

· Where are we vulnerable?

· What assets do we need to protect?

· Do we have liquid assets or assets with alternative uses?

· How could someone steal from the department?

· How could someone disrupt our operations?

· How do we know whether we are achieving our objectives?

· On what information do we most rely?

· On what do we spend the most money?

· How do we bill and collect our revenue?

· What decisions require the most judgment?

· What activities are most complex?

· What activities are regulated?

· What is our greatest legal exposure?

Now in this case there are some changes in employee master file information since last payroll period:

Verify Active Employees

For each person that received a paycheck during the quarter, verify that the person was employed during the time period for which the check was issued. Pay particular attention to recent changes in job status. Although it is more difficult to commit payroll fraud on a smaller business, one method of financial theft is by cutting checks to terminated employees and then altering the checks for cashing or colluding with the terminated employee to cash the checks and provide a kick back

Verify Employment Records

Payroll centers around each employee's master file and the organization's record of a worker's assigned pay rate. Factors that are taken into account include employee number, benefit eligibility, employment status, and year-to-date earnings. Payroll audits compare file contents against issued pay, track changes and change authorizations, and review security measures such as access. A master file audit also confirms that only active, eligible employees are being paid, and reviews the timeliness of employee separation transactions.

Verify whether they were matched and employees will have a unique code number or identity number for the sake of attendance so verify the employees in payroll with their physical presence and need to concentrate more on the additional employees in the payroll.

If any one is not present mention it in the note so that you can review it later.

If it is found almost half of the employees were not present at the time of verification inquire whether they were present or not and mention it in the note. This is about inquiry and observation

Regarding the documents examination:

Compare the payroll reports with the general ledgers. Compare the totals, such as gross payroll expense, taxes withheld and net check amount, to the general ledger to ensure each payroll processing is correctly recorded on the general ledger. If you have multiple salaries and wages accounts, such as manager payroll, administrative payroll and sales payroll, ensure that each category of payroll reflects the correct expense for the employees in those specified positions.

Regarding test controls:

Bank reconciliation review: Review the bank reconciliation for the payroll account to ensure that all checks cleared for the issued amount and make a note of any stale-dated payroll checks to research. Make sure you receive the hard copy of all payroll checks from your bank, even if you have to pay an additional fee for the service. Review each payroll check to ensure the check does not appear altered in any way.