Auditing and Investigations

AC404

Payroll and Personnel Cycle

 Outline

• 1. Introduction
• 2. Assertions
• 3. Further audit procedures
 1. Introduction
• The risk of material misstatement in the
salaries and wages accounts would not
normally be regarded as high even if they
make up a significant portion of the company’s
expenses.
• The reasons for this are:
– Management is usually strongly control conscious with regard to the
payment of salaries and wages as it is a cycle which can result in fraud
if controls are not implemented.
– The account headings do not offer huge opportunities for the directors
to manipulate the financial statements if they are inclined to do so.
– There are parties external to the entity, which are directly “interested”
in the cycle, e.g.
• ZIMRA
• the company’s medical aid,
• trade unions, etc, for example, trying to include fictitious employees can get
complicated.
• Government departments such as the Department of Labour may also conduct
external audits of the company’s employment practices.
– Current payroll software processes are accurate and contain
programme controls which make it difficult to include fictitious workers
or change salaries or wage rates without leaving a trail, e.g. mandatory
fields and logging of amendments.
There are however
– plenty of wage frauds,
– management is not always honest,
– companies don’t necessarily use good software
and
– there are plenty of illegal labour practices being
undertaken.
• In terms of ISA 315 (Revised), the auditor is
required to:
– identify and assess the risk of material
misstatement in the financial statements.
• It is this process which will determine the:
– nature,
– timing and
– extent of the further audit procedures which will
be carried out on the audit.
• There are a number of circumstances which
could give rise to material misstatement
relating to salaries and wages which the
auditor may need to address:
– The inclusion of fictitious employees on the
payroll.
– Illegal employment practices.
– Disclosure of director’s and prescribed officer’s
remuneration.
– Employment benefits.
The inclusion of fictitious employees on the payroll.
– Although the inclusion of fictitious employees is far more likely to be a fraud
perpetrated by employees to enrich themselves and not an attempt by
management to manipulate the profits of the company to reduce tax, the
auditor will still need to respond if he thinks the risk is present.

– Auditors, uncovering “ghost/dummy” workers (including teachers) in

provincial and government departments, so the threat of this practice is real.

– On the audit of smaller companies, there is always the possibility of

owners/directors/ managers deliberately adding a family member/ friend to
the company payroll even though the individual does not actually work for
the company.

– Afictitious employee does not have to be an imaginary person –a fictitious

employee in the context of a company may be a genuine person who is paid
by the company but who does not work for the company.
Illegal employment practices.
• These include employing illegal aliens, people without work
permits, or paying wages below the minimum wage rates.
• Whilst wages (and salaries) paid in these circumstances may
not directly result in the misstatement of the financial
statements, there are severe penalties and fines arising from
these illegal activities.
• To achieve fair presentation these should be disclosed but it
is hardly likely that the directors will make these disclosures!
• Whilst illegal employee practices can be an emotive and
ethical issue, the fact remains that they are illegal and the
company could face prosecution, penalties and fines.
• The problem is compounded by the fact that management
are unlikely to include these individuals on the formal
payroll and wages paid to them may be concealed.
Disclosure of director’s and prescribed officer’s remuneration.
• Extensive disclosures about the remuneration of directors and
prescribed officers in all its forms, must be made in the financial
statements of all companies which, have their financial statements
audited.
• Directors, particularly of private companies, may be hesitant/unwilling
to comply with these requirements which may result in disclosure
which is incomplete or inaccurate.
• An added complication is that the definition of a prescribed officer is
open to interpretation as to which employees are or are not
prescribed officers, which may also result in incomplete disclosure in
terms of the section.
• The risk of material misstatement in disclosure may be increased if the
directors engage in tax evasion schemes to reduce their personal tax
burdens.
• For example, the company provides vehicles for the director’s personal
use, pays all vehicle expenses, but the company does not declare the
fringe benefit and does not deduct PAYE.
Employment benefits.
• In terms of various accounting standards there are
extensive disclosures which must be made in
respect of employee benefits which apply to both
salary earners and wage earners.
• These are classified as either short-term benefits,
long-term benefits, post-employment benefits and
termination benefits, and can be in themselves
very complex to account for.
• The audit of amounts and disclosures relating to
these benefits, is beyond the scope of this text and
will not be addressed other than in a general way.
 2. Assertions
• 2.1 Transactions
– Occurrence,
– Completeness,
– Accuracy, cut-off and classification,

• 2.2 Presentation and disclosure

– Completeness,
– Classification,
– Accuracy and valuation,
2.1 Transactions
• Occurrence, i.e. The totals (account balances) recorded
for salaries and wages include only amounts paid to
genuine (non-fictitious) employees in respect of genuine
(non-fictitious) hours worked.

• Completeness, i.e. All salaries and wages paid or

payable for the period, have been included in the
account balance.

• Accuracy, cut-off and classification, i.e. Amounts paid

for salaries and wages and other related data have been
recorded appropriately, the payments have been
recorded in the correct accounting period, and the
amounts have been recorded in the proper accounts.
• 2.2 Presentation and disclosure
• The risk of material misstatement in the disclosure of
director’s and prescribed officer’s emoluments may be
reasonably high.
• The auditor is most likely to be concerned about the
following assertions :
– Completeness, e.g. Have all disclosures about all directors
(executive and non-executive) and all prescribed officers,
been included.
– Classification e.g. Does the disclosure classify the type of
remuneration as required, e.g. Salary, contribution to
pensions, compensation for loss of office.
– Accuracy and valuation, e.g. Are the details of the
disclosure and related amounts accurate and fair.
 3. Further audit procedures
• 3.1 Analytical procedures
• 3.2 Procedures to confirm that employees on
the payroll are not fictitious
• 3.1 Analytical procedures
– Where the risk of material misstatement is assessed as low, the auditor may simply
decide to conduct analytical procedures and follow up on any fluctuations revealed by
the analysis.
– Analytical procedures will include
• comparisons
– salaries : month to month by division, department or section
– wages : period to period by cost centre, etc.
– salaries and wages to the prior year corresponding period
– deductions paid over to third parties, month to month.
• ratio and trend analysis, e.g.
– salaries as a percentage of total expenses
– wages as a percentage of production costs
– wages in relation to production (output).
– investigation of fluctuations and follow up of any explanations given by the client.
• if a month to month reconciliation for salaries and a period to period
reconciliation for wages are produced, they will prove a valuable source of
evidence for the auditor as they should corroborate the fluctuations identified
by the analytical procedures.
3.2 Procedures to confirm that employees on the payroll are not
fictitious
– The auditor’s intention will be to obtain evidence that salaries/wages are
paid to genuine living people who work for the company. To do this, the
basic approach will be to extract a sample of employees from the payroll
selected, and
– Inspect the documentation in the employee’s personnel file, e.g. signed
employment contract, identity details (identity numbers can be verified on
the national identity number database), tax registration forms, etc. and
agree it to the payroll.
– Perform a positive (physical) identification of the employee where possible;
this would involve visiting the employee at his place of work during working
hours and inspecting his personal identity document or staff identity tag.
– Enquire of senior personnel to confirm (in writing) that specified individuals
are employed in their section or division.
– Inspect returns to outside entities for the inclusion of employees selected
in the sample, e.g. PAYE reconciliations submitted to ZIMRA, or medical aid
contribution returns.
• Use audit software to scan the employee masterfile
for “error conditions” which may indicate fictitious
employees, e.g.
– duplicated or missing identity numbers
– duplicated or missing tax reference numbers
– duplicated bank accounts
– duplicated staff employee numbers.
• By discussion with the staff in the personnel section
and examination of the employment and
dismissal/resignation documentation, confirm that
employees are put onto or removed from the
masterfile on the correct date (if an employee leaves,
but is left on the payroll, he is in effect a fictitious
employee).
Practice Questions
See LMS
THE END