CHAPTER 13

MULTIPLE CHOICE

c 1. An auditor will ordinarily determine whether payroll checks are properly endorsed during the
testing of
a. Time cards.
b. The voucher system.
c. Cash in bank.
d. Accrued payroll. (AICPA ADAPTED)

a 2. Which of the following control procedures could best prevent direct labor from being charged to
manufacturing overhead?
a. Comparison of daily journal entries with factory labor summary.
b. Examination of routing tickets from finished goods on delivery.
c. Reconciliation of work-in-process inventory with cost records.
d. Recomputation of direct labor based on inspection of time cards. (AICPA ADAPTED)

b 3. For appropriate segregation of duties, journalizing and posting summary payroll transactions
should be assigned to
a. The treasurer's department.
b. General accounting.
c. Payroll accounting.
d. The timekeeping department. (AICPA ADAPTED)

d 4. The proper use of prenumbered termination notice forms by the payroll department should
provide assurance that all
a. Uncashed payroll checks were issued to employees who have not been terminated.
b. Personnel files are kept up to date.
c. Employees who have not been terminated receive their payroll checks.
d. Terminated employees are removed from the payroll. (AICPA ADAPTED)

c 5. Hitech, Inc., has changed from a conventional to a computerized payroll clock card system.
Factory employees now record time in and out with magnetic cards, and the computer system
automatically updates all payroll records. Because of this change,
a. The auditor must audit through the computer.
b. Internal control has improved.
c. Part of the audit trail has been lost.
d. The potential for payroll-related fraud has been diminished. (AICPA ADAPTED)

a 6. In the weekly computer run to prepare payroll checks, a check was printed for an employee who
had been terminated the previous week. Which of the following control procedures, if properly
utilized, would have been most effective in preventing the error or assuring prompt detection?
a. A control total for hours worked, prepared from time cards collected by the timekeeping
department.
b. Requiring the treasurer's office to account for the numbers of the prenumbered checks issued to
the computer department for the processing of the payroll.
c. Use of a check digit for employee numbers.
d. Use of a header label for the payroll input sheet. (AICPA ADAPTED)

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c 7. 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. (AICPA ADAPTED)

d 8. A large retail enterprise has established a policy that requires that the paymaster deliver all
unclaimed payroll checks to the internal auditing department at the end of each payroll
distribution day. This policy was most likely adopted in order to
a. Assure that employees who were absent on a payroll distribution day are not paid for that day.
b. Prevent the paymaster from cashing checks that are unclaimed for several weeks.
c. Prevent a bona fide employee's check from being claimed by another employee.
d. Detect any fictitious employee who may have been placed on the payroll.
(AICPA ADAPTED)

a 9. In the audit of the following types of profit-oriented enterprises, which one would the auditor be
most likely to place special emphasis on testing the internal controls over proper classification of
payroll transactions?
a. A manufacturing organization.
b. A retailing organization.
c. A wholesaling organization.
d. A service organization. (AICPA ADAPTED)

d 10. A common audit procedure in the audit of payroll transactions involves tracing selected items
from the payroll journal to employee time cards that have been approved by supervisory
personnel. This procedure is designed to provide evidence in support of the audit proposition that
a. Only bona fide employees worked, and their pay was properly computed.
b. Jobs on which employees worked were charged with the appropriate labor cost.
c. Internal controls relating to payroll disbursements are operating effectively.
d. All employees worked the number of hours for which their pay was computed.
(AICPA ADAPTED)

a 11. Which of the following procedures is most effective in providing reasonable assurance that
payroll checks are distributed only to bona fide employees?
a. An employee independent of payroll preparation compares endorsements on canceled payroll
checks with employee signatures in personnel records.
b. All changes in pay rates and deductions are reviewed and approved by a responsible official
independent of payroll preparation and distribution.
c. All unclaimed paychecks are returned to an employee independent of payroll preparation and
distribution.
d. All personnel and payroll records and documents are prenumbered and physically protected from
unauthorized access.

d 12. Personnel department responsibilities should be separated from payroll preparation to

a. Separate the custody of assets from the recording function.
b. Establish clear lines of authority and accountability.
c. Separate the authorization of transactions from the recording function.
d. Separate the authorization of transactions from the execution of transactions.

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d 13. For internal control purposes, which of the following individuals should preferably be responsible
for the distribution of payroll checks?
a. Bookkeeper.
b. Payroll clerk.
c. Cashier.
d. Receptionist. (AICPA ADAPTED)

b 14. A factory foreman discharged an hourly worker but did not notify the payroll department. The
foreman then forged the worker's signature on time cards, and, when giving out the checks,
diverted the payroll checks drawn for the discharged worker to his own use. The most effective
procedure for preventing this activity is to
a. Require written authorization for all employees added to or removed from the payroll.
b. Have a "paymaster" who has no other payroll responsibility distribute the payroll checks.
c. Have someone other than persons who prepare or distribute payroll obtain custody of unclaimed
checks.
d. From time to time, rotate persons distributing the payroll. (AICPA ADAPTED)

a 15. Which of the following is not a common activity within personnel and payroll?
a. Initiate terminations.
b. Prepare and update personnel records.
c. Prepare and record payroll.
d. Distribute paychecks to employees.

b 16. Which of the following control procedures is inappropriate to prevent errors or irregularities
resulting form hiring unqualified employees?
a. Establish clear statements of hiring policies and procedures.
b. Maintain updated listings of authorized pay rates and deductions.
c. Maintain updated personnel records for all employees.
d. Verify employment applications.

a 17. What control objective is served by management's establishing and documenting account
distribution procedures?
a. Amounts due to employees should be recorded at the proper amounts, be recorded in the proper
period, and be properly classified.
b. All payroll cash disbursements should be based upon a recognized liability.
c. Payroll and personnel procedures should be established in accordance with management's
authorization.
d. Employees should be hired according to criteria authorized by management.

b 18. Which of the following control procedures is most likely to prevent errors or irregularities related
to access to assets?
a. Reconcile appropriate ledgers and journals.
b. Prenumber and control forms and documents.
c. Establish personnel and payroll procedures manuals.
d. Verify employment applications.

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b 19. Of the financial statement accounts listed below, which is not likely affected by the accuracy of
payroll and account distribution?
a. Cost of sales.
b. Accrued taxes.
c. Cash.
d. Finished goods inventory.

b 20. In auditing postretirement healthcare benefits, auditors face what's called the attribution period,
which is the period from the date the employee:
a. Was hired to the date the employee terminated employment.
b. Was hired to the date the employee is eligible to receive benefits.
c. Was terminated to the date the employee is eligible to receive benefits.
d. Was terminated to the date the employee receives benefits.

d 21. Effective controls over payroll would include which of the following controls?
a. Total time recorded on time cards should be reconciled with job reports by employees responsible
for those specific jobs.
b. Payroll department employees should be supervised by the management of the personnel
department.
c. Payroll department employees should be responsible for maintaining employee personnel records.
d. Total time spent on jobs should be compared with total time indicated on time records.
(AICPA ADAPTED)

b 22. One of the auditor's objectives in observing the actual distribution of payroll checks is to
determine that every name on the payroll is that of a bona fide employee. The payroll
observation is an auditing procedure that is generally performed for which of the following
reasons?
a. The professional standards that are generally accepted require the auditor to perform the payroll
observation.
b. The various phases of payroll work are not sufficiently segregated to afford effective control.
c. The independent auditor uses personal judgment and decides to observe the payroll distribution
on a particular audit.
d. The standards that are generally accepted by the profession are interpreted to mean that payroll
observation is expected on an audit unless circumstances dictate otherwise.
(AICPA ADAPTED)

SHORT ANSWER

1. Name the two major business functions encompassed by personnel and payroll.

Answer:
 Resources (services) are acquired from employees in exchange for obligations to pay.
 Obligations to employees are paid.

2. What safeguards should management utilize to safeguard payroll from fraud?

Answer:
Student answers will vary but will generally concern the safeguarding of personnel records and
payroll records and forms. For example, to minimize the likelihood of fraud, personnel records

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 should not be accessible to employees who are responsible for preparing, approving, or
distributing payroll.

3. To safeguard payroll, what procedures should be followed when employees are terminated?

Answer:
When employees are terminated, the personnel department should determine the nature and terms
of any related termination settlement, such as lump sum cash payments and accrued vacation pay.
The payroll department should be advised immediately of the termination settlement and notified
that further compensation has ceased.

4. As internal evidence prepared by the client is the only pervasive audit evidence available for
testing payroll what must the auditor rely on to substantiate payroll?

Answer:
Auditors rely predominately on tests of controls rather than substantive procedures when auditing
payroll. If the tests of controls indicate that control procedures can be relied on in assessing
control risk below the maximum, substantive testing focuses on analytical procedures such as
ratio analysis.

5. Narrate the tests of controls in the distribution of paychecks.

Answer:
The auditor would obtain a sample of canceled payroll checks and then trace details of sample
checks (payee name, date, amount, and check number) to entries in the payroll register. The
auditor would then compare endorsements on checks with signatures in employee personnel
records. The auditor would also take control of payroll checks just prior to distribution by
department supervisors, and personally distribute checks to properly identified employees.

PROBLEMS

1. Substantive tests of payroll focus primarily or exclusively on analytical procedures. Describe five
of the analytical procedures that may be used in the audit of payroll.

Answer:
Students may answer in a variety of ways including the following procedures:

 Compare both direct labor and payroll to budgets and to prior years.
 Compare the ratios of payroll to total expenses and payroll to sales with prior years.
 Compare the ratios of direct labor to cost of sales and direct labor to sales with prior
years.
 Compare commissioned sales payroll to sales times average commission rates.
 Compare payroll to prior-year payroll adjusted for pay rate changes and the number
of employees.
 Compare the ratio of payroll tax expense to payroll with prior years.
 Compare accrued payroll and accrued payroll tax expense with prior years.

2. Complete the following tables based upon the expenditure/disbursement cycle of personnel and
payroll.

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 Related Business Common Common Common
Function Activities Entries Forms

Answer:

Related Business Common Common Common

Function Activities Entries Forms

Resources (services) Prepare and update

Personnel records
are acquired from personnel records Payments to
employees in employees (cash
Prepare and record
exchange for disbursements) Time records
payroll
obligations to pay
Obligations to Account distribution Payroll register
Distribute paychecks
employees are paid Accrued payroll Employee earnings
to employees
records

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