Question

AP9.3 Anna has the task of designing the audit program for the payroll area. There have been no recent changes to the payroll system or to its interface with the general ledger. Among other tests, Anna is considering using the following substantive analytical procedures to gather evidence:

1. Compare payroll tax expenses (such as state and federal unemployment taxes) to the annual payroll multiplied by the statutory tax rates.

2. Compare the relationship between direct labor costs and number of employees with prior periods.

Required

Evaluate the persuasiveness of the evidence obtained from each substantive analytical procedure.

Answer 1

Substantive procedures are to ascertain the reliability and genuineness of the transactions. So we must take more care in designing these procedures.

1)Compare payroll tax expenses (such as state and federal unemployment taxes) to the annual payroll multiplied by the statutory tax rates.

This is a very good procedure. It is really efficient and effective way to check the payroll. Because we are checking the salary details with another database which is maintained by an independent third party. As this independent third party being the government itself, this procedure incerases the reliability of the audit evidence obtained through this procedure. If any mismatch found in this verification, it gives an indication of misstatement either by manipulation of the wage register or by evation of payroll taxes. While performing this procedure, the auditor should consider the rate difference in respect of the income slab change.

2. Compare the relationship between direct labor costs and number of employees with prior periods.

Eventhough it is a good audit procedure, we can not place much realiance on the audit evidence obtained from this analytical substantive procedure. Because the relationship between the number of employees and employee cost may not be in same trend for all the periods. This is caused by various reasons. The company may change the production pattern or employed highly paid skilled employees instead of low salaried unskilled labour. For example a company employed 5 highly skilled labour in substitution of the 10 unskilled labour for the same total cost. In this case, the total cost is same but the ratio between total cost and number of employees is different. Hence this is not an effective procedure to obtain reliable audit evidence in this situation.