CHAPTER

AUDIT OF THE EXPENDITURE CYCLE:

5 TESTS OF CONTROLS AND SUBSTANTIVE
TESTS OF TRANSACTIONS - II

5-1. The following duties must be separated in the preparation of payroll: hiring,
reporting and approval of time, paycheck preparation, check signing, and
paycheck distribution.

5-2. Payroll checks should be prenumbered and accounted for in a bank reconciliation.

5-3. Auditors substantive tests of payroll balances are primarily analytical procedures.
Procedure Possible Error
Scan the payroll register, general Fictitious employees may be paid, or
ledger, and payroll earnings records for significant overpayments may be made
entries that appear unusual, such as to genuine employees.
very large paychecks or employees not
assigned to departments.
Compare average pay per employee for Payroll expense may be overstated or
the current year to average pay for prior understated.
year (taking into consideration pay
raises).
Compare direct labor as a percentage of Payroll expense may be overstated or
cost of sales with the previous years understated.
percentage.
Compare the ratio of commission Commission expense may be
expense to sales with previous years overstated or understated.
percentage.
Compare payroll tax expense as a Payroll tax expense may be overstated
percentage of cost of goods sold with or understated.
percentage of previous years.

5-4. a. A production order provides a record of authorization to production

personnel to produce products.
b. A bill of materials is a list that indicates components to be used in producing
a product.
c. A materials requisition is a recorded authorization to issue materials to
production.
d. A cost accumulation report is a record prepared by operating personnel of
costs incurred as goods are transferred through production.
5-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition

e. A materials requisition summary is a record of materials used for a period,

such as a day.
f. A labor ticket is a record of the time a production employee works on a job.
g. A labor ticket summary provides a record of labor used in production for a
period, such as a day.
h. A completed production report provides a basis for inventory valuation.

5-5. Auditors perform three procedures that provide evidence that all production
transactions that occur are recorded. First, auditors observe that prenumbered
production orders are accounted for to determine that all materials issued are
recorded. An auditor might also account for a sequence of production orders.

A second procedure is to observe that the client accounts for prenumbered

materials requisitions to reduce inventory and to assign costs to production. An
auditor might also account for a sequence of materials requisitions.

Finally, an auditor might observe that a clerk reconciles completed and charged
time tickets with the total hours for which production workers are paid.

5-6. 1) c 2) b

5-7. 1) d 2) d 3) b 4) b

5-8. 1) d 2) c

5-9. 1) a 2) a

5-10. 1) d 3) d 5) c
2) b 4) d 6) c

5-11. 1. a. Existence or occurrence

b. Payroll may include fictitious or former employees.
c. Examine approval signatures.
d. For selected entries, examine signed authorizations for hiring and
compare signature on paid check to signature on job application.

2. a. Rights and obligations

b. Employees may be paid for more hours than they work.
c. Examine signature on cards.
d. Reconcile time charged to jobs to total hours worked.

3. a. Rights and obligations

b. Employees may be paid for more hours than they work.
c. Examine signature on cards.
d. Reconcile time charged on cards to total charged to jobs.
 Audit of the Expenditure Cycle: Tests of Controls and Substantive Tests of Transactions II 5-3
4. a. Existence or occurrence
b. Payroll may include fictitious or former employees.
c. Observe separation of duties.
d. For selected entries, examine signed authorizations for hiring, pay rates,
and deductions, and compare signature on paid check to signature on
application, or distribute paychecks in a surprise payoff.

5. a. Completeness
b. Paychecks may be issued but not recorded.
c. Observe whether paychecks are prenumbered and determine whether a
bank reconciliation is prepared by a person independent of the payroll
function.
d. Test or prepare a bank reconciliation.

6. a. Completeness
b. Paychecks may be issued but not recorded.
c. Observe whether a bank reconciliation is prepared by a person
independent of the payroll function.
d. Test or prepare a bank reconciliation.

5-12. Match objectives and procedures:

1. d
2. c
3. a

5-13. 1. a. Production planning should sign a production order authorizing

personnel to undertake work.
b. Examine signature on production orders.
c. Rights and obligations.

2. a. Materials requisitions should be prenumbered and accounted for by a

clerk in accounting.
b. Observe procedure and account for a sequence of materials requisitions.
c. Completeness

3. a. Chart of accounts should adequately describe accounts to be used, and

account coding should be assigned by one person and checked by
another.
b. Examine chart of accounts and signature of employee performing check
on the account coding.
c. Presentation and disclosure

4. a. Chart of accounts should adequately describe accounts to be used, and

account coding should be assigned by one person and checked by
another.
5-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition

b. Examine chart of accounts and signature of employee performing check

on the account coding.
c. Presentation and disclosure.

5. a. Production orders should be prenumbered and accounted for to determine

that all production is recorded.
b. Observe procedure and account for a numerical sequence of production
orders.
c. Completeness

6. a. Time charged on job tickets should be reconciled to time-clock cards

from which employees are paid.
b. Observe procedure.
c. Completeness

5-14. 1. a. An inventory storage clerk should sign a copy of the prenumbered

receiving report after counting goods transferred to the storage area.
b. Observe procedure and examine signature on receiving reports.
c. Rights and obligations

2. a. Receiving reports and requisitions should be prenumbered and accounted

for by a clerk in accounting.
b. Observe procedure and account for a numerical sequence of receiving
reports to determine that they all have been recorded.
c. Completeness

3. a. Provision for inventory obsolescence should be reviewed by officials and

adjusted as necessary.
b. Inquire about review for obsolescence.
c. Valuation

4. a. Access to inventory storage should be limited to personnel responsible

for its custody.
b. Observe procedures.
c. Completeness of inventory or completeness of issuances

5. a. A production employee should sign a copy of the purchase requisition

after counting goods transferred to production.
b. Observe procedure and examine signature on requisition.
c. Rights and obligations