Payroll Internal ControlThe payroll office is the ultimate gatekeeper regarding payroll internal controls and, correspondingly, has the greatest fraud opportunity. A properly completed and approved time card can be altered by the payroll clerk and processed for higher hours. The clerk can simply discard the time card stating 40 hours and pay a friend for 60 hours instead.

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In addition, salary change forms could be processed at a higher rate than approved.

How good is your understanding about internal control for personnel and payroll ? Take this test!

 

Internal Control Test-1. An auditor vouched data for a sample of employees in a payroll register to approved clock card data to provide assurance that:

a. Payments to employees are computed at authorized rates.
b. Employees work the number of hours for which they are paid.
c. Segregation of duties exist between the preparation and distribution of the payroll.
d. Controls relating to unclaimed payroll checks are operating effectively.

Answer: (b)

The requirement is to identify a purpose of vouching data for a sample of employees in a payroll register to approved clock card data. Answer (b) is correct because the clock card data provides the auditor with evidence on whether employees worked the number of hours for which the payroll register indicates they were paid. Answer (a) is incorrect because clock card data often does not include authorized pay rates. Answer (c) is incorrect because the procedure does not directly address the segregation of duties since no information is provided concerning the distribution of the payroll. Answer (d) is incorrect because unclaimed payroll checks are not being analyzed.

 

Internal Control Test-2. Which of the following is a control that most likely could help prevent employee payroll fraud?

a. The personnel department promptly sends employee termination notices to the payroll supervisor.
b. Employees who distribute payroll checks forward unclaimed payroll checks to the absent employees’ supervisors.
c. Salary rates resulting from new hires are approved by the payroll supervisor.
d. Total hours used for determination of gross pay are calculated by the payroll supervisor.

Answer: (a)

The requirement is to identify the control that most likely could help prevent employee payroll fraud. Answer (a) is correct because prompt notification of the payroll supervisor concerning terminations will lead to timely removal of terminated employees from the payroll. Accordingly, no payroll checks will be prepared for such terminated employees. Answer (b) is incorrect because unclaimed payroll checks should not be returned to the supervisors who might inappropriately cash them. Answer (c) is incorrect because since the payroll department is involved in recordkeeping, it should not approve salary rates. Answer (d) is incorrect because calculation of total hours by the payroll supervisor is unlikely to prevent employee payroll fraud.

 

Internal Control Test-3. In determining the effectiveness of an entity’s controls relating to the existence or occurrence assertion for payroll transactions, an auditor most likely would inquire about and:

a. Observe the segregation of duties concerning personnel responsibilities and payroll disbursement.
b. Inspect evidence of accounting for prenumbered payroll checks.
c. Recompute the payroll deductions for employee fringe benefits.
d. Verify the preparation of the monthly payroll account bank reconciliation.

Answer: (a)

The requirement is to determine the best procedure for determining the effectiveness of an entity’s controls relating to the existence or occurrence assertion for payroll transactions. Answer (a) is correct because proper segregation of duties between personnel and payroll disbursement eliminates many frauds in which “phantom” employees are being paid. Answer (b) is incorrect because accounting for the prenumbered payroll checks addresses completeness more directly than it does existence or occurrence. Answer (c) is incorrect because recomputing payroll deductions for employee fringe benefits without additional analysis, provides only a very limited test of existence or occurrence. Answer (d) is incorrect because verifying the preparation of the monthly payroll account bank reconciliation is unlikely to provide evidence on the existence or occurrence assertion, although some possibility does exist if signatures on checks are analyzed in detail.

 

Internal Control Test-4. An auditor most likely would assess control risk at the maximum if the payroll department supervisor is responsible for:

a. Examining authorization forms for new employees.
b. Comparing payroll registers with original batch transmittal data.
c. Authorizing payroll rate changes for all employees.
d. Hiring all subordinate payroll department employees.

Answer: (c)

The requirement is to identify the situation in which it is most likely that an auditor would assess control risk for payroll at the maximum. Answer (c) is correct because the payroll department, which is essentially a recordkeeping function, should not also authorize payroll rate changes. Under strong internal control recordkeeping, authorization, and custody over assets should be segregated. Answer (a) is incorrect because examining authorization forms for new employees is consistent with the payroll department’s recordkeeping function. Answer (b) is incorrect because comparing payroll registers with original batch transmittal data is a control relating to recordkeeping. Answer (d) is incorrect because while the actual hiring of employees is normally done in the personnel department, allowing the payroll department supervisor to hire subordinates, with proper approval, is not as inconsistent with payroll’s recordkeeping function as is authorizing rate changes for all employees.

 

Internal Control Test-5. Which of the following controls most likely would prevent direct labor hours from being charged to manufacturing overhead?

a. Periodic independent counts of work in process for comparison to recorded amounts.
b. Comparison of daily journal entries with approved production orders.
c. Use of time tickets to record actual labor worked on production orders.
d. Reconciliation of work-in-process inventory with periodic cost budgets.

Answer: (c)

The requirement is to identify the control most likely to prevent direct labor hours from being charged to manufacturing overhead. Answer (c) is correct because time tickets may be coded as to whether direct labor on various projects was involved. Accordingly, using time tickets will help identify direct labor costs. Answer (a) is incorrect because while periodic counts of work in process may provide a control over physical units of production, the counts will not in general provide assurance that direct labor hours are properly charged to the product rather than to manufacturing overhead. Answer (b) is incorrect because comparing daily journal entries with production orders will not in general identify costs that have been omitted from direct labor due to the level of aggregation of the entries. Answer (d) is incorrect because the reconciliation of work in process inventory with budgets will provide only very limited detection ability relating to the charging of direct labor to manufacturing overhead.

 

Internal Control Test-6. Proper internal control over the cash payroll function would mandate which of the following?

a. The payroll clerk should fill the envelopes with cash and a computation of the net wages.
b. Unclaimed pay envelopes should be retained by the paymaster.
c. Each employee should be asked to sign a receipt.
d. A separate checking account for payroll be maintained.

Answer: (c)

Answer (c) is correct. If payment of wages were to be in cash, each employee receiving payment should be required to sign a receipt for the amount of pay received. Thus, there would be control over the total amount disbursed as well as amounts disbursed to each individual employee. Answer (a) is incorrect because if a signed receipt is not received from each employee paid, there would be no proof of payment. Even though the pay envelopes include both cash and a computation of net wages, the employees should have the opportunity to count the cash received before signing a payroll receipt. Answer (b) is incorrect because unclaimed pay envelopes should not be retained by the paymaster, but rather deposited in a bank account by the cashier. Answer (d) is incorrect because the wage payment will be made in cash and not by check. Accordingly, a receipt must be obtained for each cash payment.

 

Internal Control Test-7. The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the:

a. Authorization of transactions from the custody of related assets.
b. Operational responsibility from the recordkeeping responsibility.
c. Human resources function from the controllership function.
d. Administrative controls from the internal accounting controls.

Answer: (a)

The requirement is to identify the purpose of segregating the duties of hiring personnel and of distributing payroll checks. Answer (a) is correct because the hiring of personnel is an authorization function while the distribution of checks is a custody function. Thus, in order to properly segregate authorization from custody, these duties should not be performed by the same individual. The combination of these two functions in the same position would create the possibility of the addition of a fictitious employee to the payroll and subsequent misappropriation of paychecks. Answer (b) is incorrect because the functions involved are not primarily operational or recordkeeping. Answer (c) is incorrect because the treasury function, and not the controllership function, will normally be responsible for distributing payroll checks. Answer (d) is incorrect because segregation of duties does not directly address administrative controls vs. internal accounting controls.

 

Internal Control Test-8. To minimize the opportunities for fraud, unclaimed cash payroll should be:

a. Deposited in a safe-deposit box.
b. Held by the payroll custodian.
c. Deposited in a special bank account.
d. Held by the controller.

Answer: (c)

The requirement is to determine the best method to minimize the opportunities for fraud for unclaimed cash in a cash payroll system. Answer (c) is correct. For a cash payroll the best control is to get the unclaimed cash out of the firm’s physical control and into the bank. Answer (a) is incorrect because maintaining the accountability for cash which is in a safedeposit box is difficult. Answers (b) and (d) are incorrect because the cash need not be kept by the firm.

 

Internal Control Test-9. The auditor may observe the distribution of paychecks to ascertain whether

a. Pay rate authorization is properly separated from the operating function.
b. Deductions from gross pay are calculated correctly and are properly authorized.
c. Employees of record actually exist and are employed by the client.
d. Paychecks agree with the payroll register and the time cards.

Answer: (c)

The requirement is to identify a reason why an auditor may observe the distribution of paychecks. Answer (c) is correct because an employee’s presence to collect the paycheck provides evidence that the employee actually exists and is currently employed by the client. Answer (a) is incorrect because the distributions of payroll checks would not reveal whether payrate authorization is properly separated from the operating function. Answer (b) is incorrect because the paycheck distribution does not provide information on whether deductions from gross pay have been calculated properly. Answer (d) is incorrect because observation of the paycheck distribution process does not of itself provide assurance that the paychecks agree with the related payroll register and time cards.

 

Internal Control Test-10. Which of the following departments most likely would approve changes in pay rates and deductions from employee salaries?

a. Personnel.
b. Treasurer.
c. Controller.
d. Payroll.

Answer: (a)

The requirement is to determine the department most likely to approve change in pay rates and deductions from employee salaries. Answer (a) is correct because the personnel department, which has the primary objective of planning, controlling and coordinating employees, will determine that proposed salary increases (often recommended by supervisors of employees) are consistent with the company’s salary guidelines and will approve changes in deductions. Answers (b) and (c) are incorrect because the treasurer and controller will in general initiate the pay rate change process for only those employees within their departments and will not generally approve changes for employees outside their departments. Answer (d) is incorrect because the payroll function is a recordkeeping function which will modify employee pay rates based on approved changes from personnel. Payroll should not have authority regarding pay rates and deductions.