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CHAPTER 8
Employee costs
lntroduction
Examination context
Topic List
1 Calculating wages and salaries
2 Recording of wages and salaries and deductions
3 Payment of wages and salaries
4 Deficiencies
Summary and Self-test
Answers to lnteractive questions
Answers to Self{est
127
lntroduction
Learning objectives Tick
o ldentify risks in a payroll system
. ldentify relevant controls to mitigate risk
. ldentify tests of those controls n
o Recognise weaknesses in a payroll system n
Specific syllabus references for this chapter are: 2f , g, h, 3f
Syllabus links
You will have learnt about double entries relating to wages and salaries in Accounting
Examination context
As payroll is an important practical area, your assessment might well include scenario internal controls
questions in this area. The sample paper contained a number of questions focused on payroll controls.
ln the assessment, candidates may be required to:
. Show how specific internal controls in a payroll system mitigate risk and state their limitations
. ldentify internal controls for an organisation in a given scenario
. ldentify internal control strengths and weaknesses in a given scenario
. Determine the extent to which tests of controls should be used in a set of circumstances
128 Assurance
1 Calculating wages and salaries
r-dt Section overview
r=rEry .r A;;"",;*
rcffi| "
ru, nn emproyees too much
tey controiis auihorisation (of time records or of changes to the payroll for exampte).
1.1 Risks and control objectives
When calculating wages and salaries, a company might recognise the following risks:
r The company may pay employees too much money
o The company may pay employees who have not been at work
. The company may pay employees who have left
The controls put into place will be designed to mitigate these risks. Hence the objectives of the controls will be
to prevent these risks from occurring. Here are the control objectives which might arise from the risks noted
above:
. Employees are only paid for work that they have done
o Gross pay has been calculated correctly and authorised
. Net pay has been calculated correctly
1.2 Controls
o
The following controls may be put into place to mitigate the risks noted above. H
o Staffing and segregation of duties A
?
. Maintenance of personnel records and regular checking of wages and salaries to details in personnel T
records
E
o Authorisation R
Engagement and discharge of employees
Changes in pay rates
- Overtime I
- Non-statutory deductions (for example pension contributions)
Advances of pay
. Recording of changes in personnel and pay rates
o Recording of hours worked by timesheets, clocking in and out arrangements
. Review of hours worked
. Recording of advances of pay
. Holiday pay arrangements
. Answering queries
o Review of wages against budget
Employee costs 129
Worked example: Calculating wages
W The workforce at CleanCo Limited has negotiated a pay rise through discussions between the union and
management. ln relation to this pay rise, management will want to ensure that they have the following controls
in place to ensure that employees are not paid too much or too little for their work:
o lncreases should be authorised on an individual basis by Adrian Lewis, the personnel manager, who is in
charge of payroll
. Details of the pay rise should be entered into each employee's personnel file
o As the computer system calculates pay automatically, the new details must be entered into the master file
by Adrian Lewis using the private password which allows him to make such changes.
1.3 Tests of controls
. Check that the wages and salary summary is approved for payment.
. Confirm that procedures are operating for authorising changes in rates of pay, overtime, and holiday
pay.
. Obtain evidence that staff only start being paid when they join the company, and are removed from
the payrollwhen they leave the company.
. Check that the engagement of new employees and discharges have been confirmed in writing.
. Check calculations of wages and salaries are being checked.
o For wages, check calculation of gross pay with:
- Authorised rates of pay
- Production records. See that production bonuses have been authorised and properly calculated
Clock cards, time sheets or other evidence of hours worked. Verify that overtime has been
authorised
. For salaries, verify that gross salaries and bonuses are in accordance with personnel records,
contracts of employment etc and that increases in pay have been properly authorised.
Worked example: Tests of controls over calculating pay
ru The auditors at CleanCo want to check that controls over the negotiated pay rise operated properly. They have
a copy of the minutes of the meeting where the pay rise was agreed, the pay rise being a 3.25% increase
across the board. This minute of agreement indicates that the pay rise was authorised by the directors.
The auditors select a sample of employees and request their personnel files. They recalculate the pay rise as
compared to the previous pay rate (which they agree to the previous payroll).
They then review the standing data in the payroll system for each employee sampled to ensure that the
computer system contains the correct pay rate. They check that each employee was paid the correct wage in
the month following the pay rise.
Lastly, (with permission) the auditors attempt to change the standing data in the computer system to ensure
that unauthorised amendments cannot be made.
lnteractive question 1: Calculating pay [Difficutty levet: Exam standard]
m The following system of time records exists at Shepherd Limited. Staff members are required to fill in a manual
timesheet as they arrive, stating the time of arrival and as they leave, stating the time of departure. Staff
members are then paid an hourly rate on the basis of this record.
E Assurance
Which two of the following outcomes could arise from this system?
Employees may be paid at an inappropriate rate
Employees may be paid for work they have not done
Employees are paid for the hours they have worked
Employee deductions may be inappropriate
See Answer at the end of this chapter
2 Recording of wages and salaries and deductions
a
a
2.1 Risks and control objectives
When considering recording wages and salaries, the company might recognise the following risks:
o The various elements of pay might not be recorded correctly in the payroll
. Amounts paid to employees might not be reflected in the cash books
. Pay might not be recorded correctly in the general ledger
o
ln addition, the company has a duty to pay over to Commissioner of Taxes the correct amounts in respect of H
tax and national insurance. lf these are calculated wrongly, the company might face a large tax bill in the future A
of arrears and penalties. The company also has a duty to pay other deductions on behalf of employees, for P
example, pension deductions. Again, errors might mean future liabilities. T
These lead to the following control objectives: E
R
. Gross and net pay and deductions are accurately recorded on the payroll
. Wages and salaries paid are recorded correctly in the bank and cash records
. Wages and salaries are correctly recorded in the general ledger
. I
All deductions have been calculated correctly and are authorised
. The correct amounts are paid to Commissioner of Taxes
2.2 Gontrols
of payroll should be delegated to a suitable person, and adequate staff
Responsibility for the preparation
appointed to assist him. The extent to which the staff responsible for preparing wages and salaries may
perform other duties should be clearly defined. ln this connection full advantage should be taken where
possible of the division of duties, and checks available where automatic wage accounting systems are in use.
ln addition there should be:
. Bases for compilation of payroll (for example, clockcards, overtime records, agreed hours)
. Arrangements for the preparation, checking (reconciling to payroll information) and approval of payroll
. Procedures for dealing with non-routine matters
. Maintenance of separate employees' personnel records
. One for one checking of payroll details back to independently maintained personnel records
r Reconciliation of total pay and deductions between one pay day and the next
. Comparison of actual pay totals with budget estimates or standard costs and the investigation of
differences between them
. Agreement of gross earnings and total tax deducted with taxation returns
Employee costs 1 31
Worked example: Preparation of payroll
W The system of control over payroll production at Maybury plc operates as follows
Anne, the payroll clerk, uses a well-known computerised payroll system. She enters the number of hours
worked by each employee in the week per their clock cards. The computer then produces the payroll based on
the standing data concerning pay rates and deductions. Anne prints off the payroll for the week, checks that the
brought foruyard figures for tax and national insurance agree to the previous payroll and sends it to Sandra, who
checks the payroll and authorises it.
Sandra also checks that the brought forward figures agree to the previous payroll and indicates that she has
checked by initialling the appropriate column in the payroll. She compares a sample of net pays to the previous
payroll and investigates any significant differences. She authorises it by signing it. She prepares the journals
that will be posted to the cash books and general ledgers and passes these and the payroll to the finance
department, so that the journals may be posted and the cheques prepared.
2.3 Tests of controls
A key control assurance providers will be concerned with will be the reconciliation of wages and salaries. For
wages, there should have been reconciliations with:
o The previous week's payroll
e Clock cards/time sheets/job cards
o Costing analyses, production budgets
The total of salaries should be reconciled with the previous week/month or the standard payroll.
ln addition, assurance providers should confirm that important calculations have been checked by the clients
and re-perform those calculations.
These include checking for wages for a number of weeks:
. Additions of payroll
. Totals of payroll detail selected to summary of payroll
. Additions and cross-casts of summary
o Postings of summary to general ledger (including control accounts)
. Net cash column to cash book
For salaries they include checking for a number of weeks/months:
r Additions of payroll
o Totals of salaries details to summary
. Additions and cross-casts of summary
o Postings of summary to genera! ledger (including control accounts)
o Total of net pay column to cash book
Assurance providers should check the calculations of taxation and non-statutory deductions. For PAYE
and Nl they should carry out the following tests:
. Scrutinise the control accounts maintained to see appropriate deductions have been made
. Check that the payments to Commissioner of Taxes are correct
They should check other deductions to appropriate records. For voluntary deductions, they should see the
authority completed by the relevant employees.
Worked example: Test of controls over recording pay
ru An audit assistant on the audit of l\4aybury plc has been asked to test controls over the payroll. She has been
given the following audit plan.
o Sample four separate weeks of payroll.
E Assurance
Ensure that Sandra's signature appears, authorising payroll.
Check for Sandra's initials showing the brought fonvard figures have been checked.
Recheck the brought forward figures from the previous payroll.
a Cast a sample of lines in the payroll to ensure it is arithmetically accurate.
a Check the calculations of statutory deductions.
a Obtain journal sheet for posting to ledger and cash book and confirm the postings are correct.
a Trace postings to ledgers to ensure processed correctly.
a Check a sample of hours worked to original clock cards.
lnteractive question 2: Recording pay [Difficulty level: Exam standard]
ffi Personnel and wages records at Simonston Brothers Limited are maintained by Sam, the wages clerk, on a
personal computer. Sam calculates the hours worked by each employee on a weekly basis, based on that
employee's clock cards and enters them on the computer. The payroll program, using data from personnel
records in respect of wage rates and deductions, produces the weekly payroll and a payslip for each employee.
Sam prepares a cheque requisition for the total net pay for the week, which is sent to the company accountant
together with a copy of the payroll. The accountant draws up the cheque, made payable to cash, and has it
countersigned by a director. The wages clerk takes the cheque to the bank and uses the cash to prepare the
wage packets.
Which two of the following are deficiencies which exist in the wages system at Simonston Brothers Limited? o
Sam records the salaries and organises the pay packets H
A
There is no authorisation of the payroll
P
The wages cheque is countersigned by a director T
The payroll and the time recording system are separate E
R
See Answer at the end of this chapter
3 Payment of wages and salaries
3.1 Risks and control objectives
The key risks here are that people who are not employees are paid and those that are employees are not paid
Therefore the overriding control objective is that the correct employees are paid.
Employee costs 133
3.2 Controls
Payment of cash . Segregation of duties
wages (this is
increasingly rare) - Preparing the payroll net pay summary
Filling of pay packets
Distribution of wages
o Authorisation of wage cheque cashed
o Custody of cash
- When the wages cheque is cashed
- Security of pay packets
- Security of transit
Security and prompt banking of unclaimed wages
r Verification of identity
. Recording of distributions
Payment of salaries . Preparation and authorisation of cheques and bank transfer lists
. Comparison of cheques and bank transfer llst with payroll
. Maintenance and reconciliation of wages and salaries control account
Worked example: Payment of wages
:b At Pynewood Limited, the bookkeeper calculates the wages, counts out the cash and puts it into envelopes for
the staff. This system displays the following deficiency:
. There is no segregation of duties between preparing the payroll and making up the pay packets, so that
the bookkeeper could easily perpetrate a fraud of paying staff extra or paying non existent staff and
keeping the proceeds.
3.3 Tests of controls
lf wages are paid in cash
r Arrange to attend the pay-out of wages to confirm that the official procedures are being followed.
o Before the wages are paid compare payroll with wage packets to ensure all employees have a wage
packet.
. Examine receipts given by employees; check unclaimed wages are recorded in unclaimed wages book.
. Check that no employee receives more than one wage packet.
r Check entries in the unclaimed wages book with the entries on the payroll.
o Check that unclaimed wages are banked regularly.
. Check that unclaimed wages books show reasons why wages are unclaimed.
. Check pattern of unclaimed wages in unclaimed wages book; variations may indicate failure to record.
o For salaries, check that comparisons are being made between each month's payroll net pay summary and
examine paid cheques or a certified copy of the bank list for employees paid by cheque or bank
transfer.
Worked example: Tests of control over payment of wages
ffi At HyperCo plc, all employees are salaried and are paid by direct transfer to their bank each month. The
auditors will test that controls operate properly over this direct transfer by requesting a certified copy of the
bank list for the payroll to see how the sum leaving the company's bank account is broken down and checking
the individual amounts paid back to the payroll.
134 Assurance
ru
L^o
lnteractive question 3: Payment of wages
pay packet which is collected by the leaver or an accomplice?
[Difficutty tevel: Exam standard]
Which two of the following control activities will reduce the risk of employees who have left being made up a
Check that each employee only collects one pay packet
Supervision of payout by member of staff who knows all the employees personally
Authorisation of payroll
Comparison of payroll with wage packets to ensure that they match
See Answer at the end of this chapter
4 Deficiencies
Section
W
lnteractive question 4: Deficiencies of a payroll system
m [Difficulty level: Exam standard]
The following describes the payroll system in operation at Whistling Co. For each process indicate whether the
process indicates a strength or a deficlency of the system. c
H
(1) Employees each have an electronic card to swipe in order to A
enter and leave the factory premises. This 'swipe' system Strength Deficiency ?
automatically updates time records in the payroll system. T
(2) There is no personnel department. Employees are engaged E
Strength Deficiency
by department heads with the verbal consent of a director. R
(3) On leaving, employees are required to return their swipe
cards. I strensth n Deficiency
a
(4) The payroll has a variance function which reports items within
the payroll falling outside the expected conventions which
must be resolved by an authorised member of staff before the
payroll can be finalised. The ability to resolve this report is
tr Strength tr Deficiency
controlled by a secret password.
See Answer at the end of this chapter
Employee costs 135
Summary and Self-test
Summary
Controls in the employee costs system are focused on the
following key points of the cycle
Recording wages
Setting wages and deductions Payment
Risk Risl<s: Risks:
Employees are paid for - lncorrect recording of Employees are not paid
work not done wages and cash paid - Non-employees are paid
lncorrect deductions
leading to future
liabilities
Self-test
Answer the following questions.
1 List six procedures assurance providers should carry out if wages are paid in cash.
(1)
(2)
(3)
(4)
(5)
(6)
2 What are the most important authorisation controls over amounts to be paid to employees?
3 How should assurance providers confirm that wages have been paid at the correct rate to individual
employees?
Now, go back to the Learning Objectives in the lntroduction. lf you are satisfied you have achieved these
objectives, please tick them off.
136 Assurance
Answers to lnteractive questions
Answer to lnteractive question 1
Shepherd has a simple control over how much work is being done by its employees. Therefore, employees
should be being paid for the hours they have worked.
However, it is a very simple control, which relies on the integrity of the employees in recording the correct times
they arrived and left the premises. There does not appear to be a supervisory control ensuring that employees
are writing the correct times. Nor is there any provision for times when the employees are not working, for
example, lunch hour or slack periods. Therefore it is possible that despite the presence of this control,
employees may be paid for work they have not done.
Answer to lnteractive question 2
Sam records the salaries and organises the pay packets, there is no authorisation of the payroll
Answer to lnteractive question 3
Check that each employee only collects one pay packet. Authorisation of payroll
Comparison of the payroll with the pay packets will only be effective if the payroll has been properly updated for
the leaver. Supervision by a member of staff who knows all the staff will be necessary if the employees are not o
required to show identification to pick up wages, but will not necessarily stop a leaver picking up a wage packet H
if the supervisor does not know the staff member has left.
A
P
Answer to lnteractive question 4 T
E
(1) Strength. The fact that employees cannot access the factory to work without updating the time records
R
automatically is a strength in the system.
(2) Deficiency. lt appears that the recruitment process is casual and there is not necessarily any written
documentation resulting from the appointment of an employee. This could lead to errors in pay rates and I
payroll production that could be eliminated if written notice of an employee's start was given to the payroll
department.
(3) Strength. The fact that employees are required to return their cards when they leave means that they are
effectively excluded from the time recording system and in practice cannot continue to be paid after they
have left.
(4) Strength. The fact that the payroll has parameters beyond which it seeks authorisation means that
mistakes should be corrected before the payroll is finalised. ln addition, there are application controls over
correction of the payroll, strengthening this control.
Employee costs 137
Answers to Self-test
1 Any from:
o Arrange to attend the pay-out of wages to confirm that the official procedures are being followed
. Before the wages are paid compare payroll with wage packets to ensure all employees have a
wage packet
o Examine receipts given by employees; check unclaimed wages are recorded in unclaimed wages
book
. Check that no employee receives more than one wage packet
o Check entries in the unclaimed wages book with the entries on the payroll
r Check that unclaimed wages are banked regularly
. Check that unclaimed wages book shows reasons why wages are unclaimed
. Check pattern of unclaimed wages in unclaimed wages book; variations may indicate failure to
record
. Verify a sample of holiday pay payments with the underlying records and check the calculation
of the amounts paid
2 The most important authorisation controls over wages and salaries are controls over:
. Engagement and discharge of employees
. Changes in pay rates
. Overtime
r Non-statutorydeductions
. Advances of pay
3 Assurance providers should confirm that wages have been paid at the correct rate by checking calculation
of gross pay to:
r Authorised rates of pay
r Production records
. Clock cards, time sheets or other evidence of time worked
138 Assurance