- 35 Marks
AA – L2 – Q30 – Internal Control Systems
Question
Apex Engineering
Your firm is the external auditor of Apex Engineering, a listed company, which has revenue of $75 million. The head office site includes the manufacturing unit, the accounting functions, and main administration. There are a number of sales offices in different parts of the country. Apex Engineering does not have an internal audit function.
At the interim audit, you have been assigned to the audit of the wages system. This will involve obtaining an understanding of the wages system, testing the controls, and performing substantive procedures in order to verify wages transactions.
The wages records are maintained on a computer, and all the wages information is processed at the head office. Some of the employees in the manufacturing unit are paid in cash, and all other employees have their wages paid directly into their bank account.
Manufacturing employees are paid their wages a week in arrears. All other employees are paid at the end of each week or month.
There is a personnel department which is independent of the wages department. The personnel department maintains records of the employees, including their starting date, grade, current wage rate, and leaving date (if appropriate).
Previous years’ audits have revealed frauds by wages department staff which have been facilitated by deficiencies in controls in the wages system. These frauds have included:
- paying employees after appointment but before they commenced work;
- paying employees after they have left; and
- paying fictitious employees.
A check of current controls in the wages system has revealed that the company has failed to instigate controls to prevent these types of fraud recurring. So the audit programme requires extensive substantive procedures to be carried out to ensure that recorded wages transactions have not been misstated by similar frauds taking place in the current year.
The existence of employees at the head office site can be verified by physical inspection. From a cost-effectiveness point of view, only a small sample of sales offices will be visited. The audit manager has asked you to consider the audit procedures you would carry out to obtain sufficient appropriate evidence of the existence of employees at sales offices not visited by the audit staff.
The audit manager has explained that ‘unclaimed wages’ (in part (c) below) arise when manufacturing employees are not present to collect their wages (when they are paid out in part (b)). The unclaimed wage packets are given to the cashier who records their details in the unclaimed wages book and is responsible for their custody. Any employee who has not received his/her wage packet at the pay-out can obtain it from the cashier. You have ascertained that there is no system of checking the operation of the unclaimed wages system by a person independent of the cashier and the wages department.
Required: - (a) Describe the normal controls you would expect to see in a wages system and explain their purpose.
- (b) Describe how you would verify that employees are not paid before they commenced work for the company.
- (c) Describe the audit procedures you would carry out in connection with attending a pay-out of wages in cash to manufacturing employees.
- (d) Describe the substantive procedures on transactions you would carry out on the unclaimed wages system.
- (e) Describe the evidence you would obtain to verify the existence of employees whose wages are paid directly into their bank account, including those at sales offices.
Answer
(a)
| Control | Purpose |
|---|---|
| Payroll data is approved by a senior official. | To prevent any unauthorised inaccurate deductions being made. |
| Payroll transactions should be recalculated. | The correct amount is paid over to employees or the relevant authorities. |
| Official notification of starters and leavers i.e. tax documentation. | To prevent employees being paid after they have left or before they have started. |
| All hours worked are authorised. | To prevent the company paying for work not done. |
| All employees to collect their wages in person. | To prevent loss/theft. |
(b) Verifying that employees are not paid prior to commencing work
(i) Two payrolls should be selected from different periods in the year.
(ii) Employees not listed on the second payroll should have left during the year, and employees not listed on the first payroll should have started during the period.
(iii) This can then be verified by examining the permanent payroll information where there should be a copy of each employee’s contract of employment.
(iv) Also, Apex Tax Authority official forms should confirm departure and start dates. The main reason for carrying out this exercise is to ensure that all employees are bona fide, i.e., payments are being made to authorised employees
(c) Attendance at the wages pay-out
(i) Before attendance, I will review the payroll to ensure that a pay packet exists for all employees.
(ii) Each employee should sign for the pay package when they collect it. As they sign, the auditor should verify the signature to the contract of employment.
(iii) It should be ensured that no one employee collects more than one pay packet.
(iv) All unclaimed wages should be listed; the payroll date, name, and amount noted.
(v) The unclaimed wages should then be stored in the safe until collected.
(d) Procedures re unclaimed wages
(i) All unclaimed wages should be recorded in an unclaimed wages book, and it should be checked that a wage packet physically exists for each entry in the book.
(ii) If someone has collected wages on behalf of somebody else, then it should be ensured that a letter of authorisation exists allowing the pay packet to be collected.
(iii) After a certain period, say a month, all unclaimed wages should be returned to the bank, so the details for each pay package should be agreed from the unclaimed wages book to the banking slip.
(iv) Any significant delay in banking unclaimed wages should be noted and investigated.
(e) Verification of direct bank payments
(i) Carry out a physical verification of employees to ensure that they actually exist.
(ii) Check employee details to the personal records from payroll information.
(iii) The finance directors could be asked to sign a copy of the payroll to verify that all the employees are bona fide.
(iv) Employees’ existence can be verified by confirmation of signatures on expense claims.
(v) Also, annual Apex Tax Authority returns can be reviewed.
- Tags: Fraud Prevention, Internal controls, Payroll Controls, Wages System
- Level: Level 2
- Topic: Internal Control Systems
- Uploader: Samuel Duah