Audit Program 1

Week Five Team Assignment

Audit Program II

Rachel Ramos, Renee Williams, Dale Cornn,

Branden Klink, & Gloria Ochoa

Accounting 492

Robert Hinske

August 14, 2006

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Week Five Team Homework

Audit Memo

Kudler Fine Foods

Planning Memorandum
Year Ended December 31, 2003

To: Robert Hinske, Engagement Partner

From: Gloria Ochoa, Rachel Ramos, Dale Cornn, Renee Williams and Branden Klink
The purpose of this review is to design the attached internal control questionnaire and audit
program for the current year’s audit of the financial statements, with respect to the company’s
payroll.

Internal Control Questionnaire

The purpose of the internal control questionnaire is to help assess the level of control
surrounding the payroll process. There are not any specific weaknesses that we have
documented at this time; however the questionnaire will help reveal weaknesses that are not
always available to the naked eye.

Audit Program

The audit program has been designed to test the controls over the payroll function and to provide
substantive tests of the account balances. During this audit we will use statistical sampling for
testing of controls, substantive tests of account balances and the application of analytical
procedures, all of which are addressed in the audit program.

Objectives

We have completed the audit of the payroll cycle for Kudler Fine Foods on behalf of their audit
committee and the Board of Directors. Our payroll cycle audit included three main objectives:
(1) to determine that payroll disbursements were made for work authorized and performed; (2)
to verify that payroll, including withholdings and deductions, is computed using rates and other
factors in accordance with federal salary schedules and applicable laws; and (3) to ensure that
payroll expense and related liabilities are recorded correctly as to amount, period and adequate
disclosure. The period of our test data was from December 31, 2005 through June 30, 2006. Our
payroll cycle audit did not constitute a certified audit of any financial statements prepared by
Kudler Fine Foods. Therefore, no opinion was given on any financial statements.

Tests of controls

Testing for control is an important tool in an audit. In the onset of an audit, it is important to
assess the risks of internal control within the company. We need to inquire what internal
controls the company has and inquire as to whether or not those internal control techniques are
being followed as prescribed by management. With this in mind, we decided to make inquires
on the following areas. The first area for review is the company’s policies and procedures. This
will show what approval processes are in place within the payroll department, if payroll
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personnel are knowledgeable, and if the segregation of duties is specified. Another area of
testing is reviewing who is authorized to have access to the computer system and their levels of
authorization. A third area of review is payroll documents. As an audit team we must be able to
trace these source documents starting at time sheets to payroll accounting procedures, to payroll
distribution, to cash disbursements, and then back to the original time sheet. In going through
these procedures, we are able to make an initial risk assessment, develop strategies, and proceed
further into our actual audit testing.

Substantive tests of transactions

Substantive test of transactions are required in order to verify processed payments. The audit
team will confirm that transactions made in payroll processing follow the guidelines of the
company. The audit team will investigate the employee time cards for accuracy, validity and for
proper authorization for duties and hours worked. The time cards will also be used to determine
whether payroll disbursements have been properly calculated, including calculation and payment
of payroll taxes and deductions. These deductions are significant to both the employer and
employee, so these numbers will be verified by sampling pay vouchers using the statistical
sampling method as outlined in our sampling outline. This will allow the audit team to determine
the allowable risk of the sample failing to detect a material misstatement and the tolerable
misstatement. Electronic funds transfers (EFT) will be validated to ensure that vendors,
customers, and banks involved in this process have sufficient controls built into their portion of
the process. This would include comparison of the payments made from the vendor, banks, etc.
with information in the EFT journal.

Analytical procedures

In conducting our audit of risk assessment we chose to investigate the training of the
accounting/payroll staff. The client must prove they operate in accordance with all the reporting
agencies and requirements, so proper training is a must. There has to be correct comprehensive
accounting methods used since the employer and employees are counting on the payroll function
to properly account for and pay all of their payroll deductions and taxes. In addition to the
abilities of the accounting staff, each employee should be authorized to conduct all of their
duties. We will test the payroll with some analytical procedures that we believe will bring to
light any weaknesses in their payroll accounting. By conducting both investigations we are
looking to see if the accounting/payroll staff of the company is both knowledgeable and certified
to conduct their normal workings with the company.

Substantive tests of account balances

In choosing steps to perform substantive tests of account balances, the auditor must consider
what substantive tests will produce the most accurate results for dollar errors that could affect the
accuracy of the account balances. Although the payroll process for Kudler is seemingly secure,
we prefer to rely heavily on substantive tests of detail in which we will select a sample of items
from the major payroll related accounts and find hard evidence in support of these items being
recorded properly. This process will allow for a higher level of assurance that account balances
and underlying classes of transactions do not contain any material misstatements. For Kudler,
the audit team has specific areas of concern, which include whether or not salaries, wages and
withholdings are properly recorded and supported in the payroll system and whether or not the
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ending balance reported for Accrued Payroll and Benefits is fairly stated. We will be following
the full paper trail in order to validate each item sampled, which will entail going back to original
pay vouchers and journal entries to get the full picture for each item.

Sampling detail sheet

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Internal Control Questionnaire

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Question Yes/No Comments

Control Environment

1. Is a special payroll bank account used?

2. Is the payroll bank account reconciled by someone who does not

prepare, sign or deliver paychecks?

3. Are there adequate segregation of duties in approving time

records, overtime and vacations?

4. Are payroll department personnel rotated in their duties?

5. Are payroll department personnel required to take vacations?

6. Are payroll department personnel bonded?

7. Is there a timekeeping department (function) independent of the

payroll department?

8. Are authorizations for deductions that have been signed by the

employees on file (FICA withholding, medical withholding,

federal and state income tax withholding, health insurance

premium deductions, medical and childcare flexible spending

deductions, and 401(K) deductions, etc.)?

9. Is access of personnel files restricted to specific employees?

10. Are changes made to payroll related information verified by

authorized personnel?

Risk Assessment
1. What training is provided to accounting to accounting staff to

ensure that they have an understanding of the payroll process?

2. What training is provided to accounting staff to insure that they

have an understanding of the accounting for payroll?

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Question Yes/No Comments

Control Activities

1. Are timesheets being verified by management?

2. Are personnel comparing time records to payroll?

3. Are payroll rates (salary, federal tax rates, state tax rates,

FICA rates, etc) being processed accordingly in the system?

4. Do payroll personnel approve bank wire transfers for

payment of federal taxes, state taxes, FICA rates, etc?

5. Are employees required to sign for receipt of non EFT

payroll checks?

6. Is there a back-up for payroll personnel?

7. Have procedures been established to record the usage of

employees benefit time?

8. Are attendance records reviewed by management, so that

excessive absences are reviewed?

Information Systems and Communications

1. Who has passwords to access the payroll processing system?

2. Is there an audit trail function within the payroll processing

system? Is it kept turned on?

3. Do training policies communicate roles and responsibilities to

the appropriate accounting employees in regards to payroll

processing?
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Question Yes/No Comments
4. Does the payroll system interface with any system other than

the financial system? If yes, is that interface manual or

electronic?

5. Is there a system of verification of allocation of expenses that

relates to payroll?

6. Is there a list of authorized personnel who can call in to Intuit

to process payroll and make payroll changes (salaries,

deductions, etc.)?

7. Is there a back-up for all employee files?

Monitoring

1. If there are discrepancies, are the issues handled and resolved

by competent employees?

2. Are payrolls audited periodically by internal auditors?

3. Is the accuracy, as it relates to the payroll company’s

processing, verified upon receipt of the actual payroll?

4. Are quarterly tax reports reviewed for accuracy against the

accounting system data?

5. Are the bank statements reconciled against payroll

documentation from Intuit?

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Audit Program
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Audit Performed Work Paper Date

Objectives Audit Procedures for Consideration By Index Completed
A. To determine that payroll disbursements

were for work authored and performed.

B. To verify that payroll, including

withholdings and deductions, is computed using

rates and other factors in accordance with

Federal salary schedules and applicable laws.

C. To ensure that payroll expense and related

liabilities are recorded correctly as to amount,

period and disclosures are adequate.

Test of Controls

1. Review policies and procedures for payroll

data entry for completeness and usefulness.

2. Inquire of personnel about procedures.

3. Determine which employees are responsible

for input of data, and ensure adequate

segregation of duties.

4. Obtain and review signed confidentiality

statements for all employees who are involved in

a payroll process to ensure that an

understanding of confidentiality exists.

5. Verify that only authorized access to system

software programs and data are granted.

5(A). Access to personnel files is restricted.

5(B). Access to payroll files is restricted.
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Audit Performed Work Paper Date
Objectives Audit Procedures for Consideration By Index Completed

5(C). Access to QuickBooks program is

restricted.

6. Review employee changes to ensure changes

were accurate and made in a timely manner and

approved by supervisors.

7. Obtain and verify all reports are utilized to

help monitor payroll transactions (budget to

actual, error/audit reports).

8. Review payroll registers and summaries to

ensure supervisors have reviewed and approved

prior to pay distribution.

9. Examine cancelled payroll vouchers for

completeness and validity; compare to the

payroll register.

10. Trace vouchers and labor distributions

(coding) to GL and: (a) from/to payroll

subsidiary records, and (b) from/to personnel

records.

11. Verify for authorization for payroll amounts

and for the physical distribution of signed

checks.

12. Verify the consistency and integration of the

payroll procedures with cash audit and accounts

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Audit Performed Work Paper Date
Objectives Audit Procedures for Consideration By Index Completed

payable audit.

SUBSTANTIVE TEST OF TRANSACTIONS

1. Verify time cards for legitimate work hours.

2. Verify check payments made to each

employee.

3. Verify deduction amounts subtracted from

each employee’s check.

3(A). FICA.

3(B). State tax.

3(C). Health insurance.

3(D). Life insurance.

3(E). Pension.

3(F). Allotments (charity, etc).

4. Verify electronics funds transfers (EFT) are

processed accordingly.

4(A). From the company’s regular check

account to the dedicated payroll checking

account.

4(B). The employee’s financial institutions via

an ACH file.

4(C). Administrating the flexible spending and

401(K) accounts.

4(D). The federal and state taxing authorities.

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Audit Performed Work Paper Date
Objectives Audit Procedures for Consideration By Index Completed

4(E). Pay voucher printing software

application.

5. Verify ETF transfers were journalized.

ANALYTICAL PROCEDURES

1. Compare the number of employees that work

from each day to the master file of employees to

make sure there are no differences.

2. Perform Analytical procedures to the

relationship of employee’s wages to the hours

that was worked. Investigate if there are less

hours actually worked.

3. Compare employee’s benefits, taxes, etc as a

percentage of sales and wages compared to last

years and this year.

4. Compare direct labor as a percentage of sales

with last year and this year.

5. Compare payroll expense as percentage of

sale with last year and this year.

SUBSTANTIVE TESTS OF ACCOUNT

BALANCES
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Audit Performed Work Paper Date
Objectives Audit Procedures for Consideration By Index Completed
1. Verify that annual salaries and rates are

adequately supported and recorded in the payroll

system.

2. Verify withholdings are adequately

documented, properly authorized and accurately

recorded.
3. Review supporting information to determine

whether the ending balance reported for Accrued

Payroll and Benefits are fairly stated.

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Sampling Detail Sheet
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Sampling Detail Sheet

Define
The objectives: The objectives
1. Determine that payroll disbursements
are made for authorized work (sample
of pay vouchers and time records will be
examined)
2. Verify time records for legitimate
work hours (items in the sample will be
verified)
3. Verify that payroll disbursements
were made to actual employees (pay
voucher information in sample will be
verified)
4. Determine that payroll deductions
were withheld from employee checks
(for each pay voucher in the sample)
a. Deductions to be verified:
(1) Federal withholding
(2) FICA
(3) State tax
(4) Health insurance
(5) Life insurance
(6) Pension
(7) Allotments (charity, etc.)
(8) Childcare flexible spending
deductions
5. Verify EFT transfers processed
according to company procedure/policy
a. Determine if items in sample were
journalized
according to company procedure

The population: The population

1. The period of time to be covered for
pay vouchers, time records, and EFT
transfer statements in the sample will
be 12-31-2005 through 12-31-2006
2. Ensure completeness:
a. Account for the numerical
sequence of pay
vouchers by reviewing pay voucher
logs
b. Review each time record in the
sample to ensure
proper supervisory authorization
c. Compare EFT transfer to copies of
wire transfer
sheets in general accounting
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Sampling units: The sampling unit
a. pay vouchers
b. time records
c. EFT bank transfer statement
d. Personnel records, including wage
rates or salary
authorizations.
e. W-4 and other deduction
authorization forms.
f. Payroll register.
g. Payroll master file.
h. Payroll master file changes report.
i. Periodic payroll reports
j. Various tax reports and forms.

75% of planning materiality: Tolerable misstatement (Related to

$725,650 x 75% x .01 = $12,698 materiality – should not exceed auditor’s
preliminary judgment of materiality)
Determine the Sampling Approach
Statistical Statistical or Non
Determine the Selection Method
Random-number
th
Systematic, every 30 item Systematic (every nth item)
Other
Determine the sample size
Based on the results of the ICQ, Preliminary assessment of control risk
observations, preliminary tests and
consideration of the fraud control risk
factors, controls appear to be effective
and the preliminary assessment of
control risk will be low.
With control risk low and inherent risk at Consider the acceptable level of risk
moderate the risk of material
misstatement is low-moderate. If the
risk of material misstatement is low-
moderate and the acceptable level of
audit risk is low, then detection risk will
be high.
See above Consider the tolerable misstatement
The expected misstatement is based Consider the expected amount of
upon prior year audits, results of other misstatement
substantive tests, audit judgment and
knowledge of changes in accounting
and personnel. We do not have
information on any of these items on
the Kudler Fine Foods internet site.
The population size is calculated based Consider the population size
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on 127 employees that get paid 2 times
every month for the time period being
audited. This comes out to be 3,048,
which is why we will sample every 30th
item, for an approximate population size
of 102 items.
Perform the sampling plan

Evaluate the sample results

Reach an overall conclusion
Document the Sampling Procedure