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in Microsoft®
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Prepared by
Brad MacDonald
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© 2003 McGraw-Hill
Ryerson Limited
Chapte
r
11
Production and Payroll Cycle
Copyright © 2003 McGraw-Hill Ryerson Limited
2
Learning Objective 1
Describe the production cycle, including
typical source documents and controls.
Chapter 11
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Production Cycle:
Typical Activities
The production cycle includes transactions
that flow through the following business
activities:
– production planning, inventory planning and
management
– producing goods and services
– cost accounting and cost of goods sold
administration
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Start Here
Determine cost of
goods sold
Cost
accounting
Production
planning
Production
Cycle
Inventory
planning
Produce
goods and
services
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Production Cycle:
Typical Activities
– Authorization - Production authorization based on
sales forecasts interacts with production orders, bills
of materials, materials requisitions.
– Custody - Physical custody of materials, equipment
and labour, and cost accounting requisitions.
– Recordkeeping (cost accounting) - Determination
of cost-per-unit, standard costs, and variances.
– Periodic Reconciliation - Reconciliation of
physical assets and liabilities to amounts recorded in
the company accounts.
Chapter 11
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Audit Evidence in Management
Reports and Files
Production accounting systems produce timely
reports to supervise and control production. These
can be used as supporting evidence for assertions:
– Sales Forecast - Provides the basis for management
planning.
– Production Plans and Reports -Plan for the amount
and timing of production, based on sales forecast.
– Amortization Schedule - Detailed schedule of
depreciation on fixed assets, prepared by cost
accounting.
Chapter 11
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Learning Objective 2
Give examples of detail test of controls
procedures for auditing the controls over
conversion of materials and labour in a
production process.
Chapter 11
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Control Risk Assessment
Control risk assessment governs the nature,
timing, and extent of substantive audit
procedures that will be applied in the audit of
the account balances in the production cycle.
– Accounts include
• inventories (raw materials, work in process,
finished goods)
• cost of goods sold
• amortization (expense and accumulated)
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Control Risk Assessment
General Control Considerations
– Proper segregation of responsibilities for
authorization, custody, recording and
reconciliation
• Custody of inventories in hands of persons
who do not authorize or account for
production
• Cost accounting performed by persons
who do not authorize production or have
custody of production assets
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Control Risk Assessment
General Control Considerations
– Controls should produce evidence to allow for
for detail control checking procedures.
– Complex computer systems may be used to
manage production and materials flow.
– Information about the production cycle control
structure often is gathered initially by
completing an internal control questionnaire.
(ICQ). An ICQ for general controls is in
Appendix 11A-1.
Chapter 11
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Detail Test Controls Audit
Procedures
Tests of controls should address all of the
control objectives.
– Tests include identification of population and
expression of the action to be taken.
• Note dual direction of testing for
completeness and validity requires
selection of sample from appropriate
population.
– See Exhibit 11-3.
Chapter 11
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Control Risk Assessment
The purpose of testing controls is to
determine nature, extent, and timing of
substantive procedures.
– Good controls – low control risk
• Smaller sample sizes, earlier timing for
substantive tests.
– Poor controls – high control risk
• Larger samples, more work at year end.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Learning Objective 3
Describe some common errors,
irregularities, and frauds in the accounting
for production costs and related cost of
goods sold, and design some audit and
investigation procedures for detecting them.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Substantive Procedures
Audit procedures to gather direct evidence
on account balances are called substantive
procedures.
– recalculation, observation, confirmation,
enquiry, vouching, tracing, scanning,
analytical review
– Dual purpose procedures – gain substantive
purpose evidence and control purpose
evidence with the same test.
Chapter 11
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Audit Casettes:
Substantive Audit Procedures
Specific examples of test of controls and
substantive procedures are in the form of
casettes (mini-case studies).
– Each casette has the following parts:
Paper Trail
Method
Amount
Audit Approach
Audit Objective
Control
Test of Controls
Audit of Balance
Chapter 11
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Audit Casettes:
Substantive Audit Procedures
11.1: Unbundled Before Its Time:
– Production “sold” as finished goods before actual unit
completion caused understated inventory, overstated
cost of goods sold.
11.2: When in Doubt, Defer!
– SoCom Corporation deferred costs under the
heading of work in process, military claims, and R&D
test equipment, thus overstating asses, understating
cost of goods sold, and overstating income.
Disclosure of the auditor’s fees was manipulated and
understated.
Chapter 11
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Learning Objective 4
Describe the payroll cycle, including typical
source documents and controls.
Chapter 11
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Part II: Payroll Cycle:
Typical Activities
Personnel management and the payroll
accounting cycle include transactions that affect
the wage and salary accounts and a number of
related accounts:
– Personnel and Labour Relations: Hiring and firing.
– Supervision: Approval of work time.
– Timekeeping and cost accounting: Payroll
preparation and cost accounting.
– Payroll Accounting: Cheque preparation and related
payroll reports.
– Payroll Distribution: Actual custody and distribution to
employees.
Chapter 11
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Start Here
Cash disbursement
Payroll
distribution
Payroll
accounting
Chapter 11
Personnel
hiring / firing
Payroll
Cycle
Compensation
determination
Supervision,
attendance,
and work
Copyright © 2003 McGraw-Hill Ryerson Limited
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Part II: Payroll Cycle:
Typical Activities
– Authorization: Personnel department,
supervision, timekeeping, and cost accounting .
– Custody - Possession of payroll cheques, payroll
distribution, supervision, and timekeeping
documents.
– Recordkeeping - Payroll accounting prepares
checks and related tax reports.
– Periodic Reconciliation - Payroll records and
reports should be reconciled.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Audit Evidence in Management
Reports and Files
Payroll systems produce numerous reports
that can be used as supporting evidence for
assertions.
– Personnel Files - Detailed individual
employees files (existence).
– Timekeeping Records - Detailed records of
hourly workers’ time.
– Payroll Register - A special journal
containing detailed pay information.
Chapter 11
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Audit Evidence in Management
Reports and Files
– Labour Cost Analysis - Labour cost
information used for purposes such as
reconciliation and distribution of labour rates.
– Government and Tax Reports
• year-to-date earnings records
• employee T-4 reports
Chapter 11
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Learning Objective 5
Give examples of detail test of controls
procedures for auditing the controls over
payroll.
Chapter 11
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Control Risk Assessment
The major risks in the payroll cycle are
– paying fictitious employees
– overpaying for time or production
– incorrect accounting for costs and expenses.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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General Control Considerations
Proper segregation of responsibilities - for
authorization, custody, recording, and
reconciliation of payroll functions.
• Custody of payroll distribution by persons
who do not authorize employees’ pay or
prepare payroll cheques.
• Recordkeeping is performed by payroll and
cost accounting personnel who do not
make authorizations or distribute pay.
Chapter 11
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Computer-based Payroll
Computer-based Payroll
– Various records and approval
signatures may not exist. They
may all embedded in computerized
payroll systems.
Internal Control Questionnaire
– Information about payroll is often gathered
initially by ICQ.
Chapter 11
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Detailed Test of Controls
Tests of controls should address all of the
control objectives.
– Cut-off is important to revenue cycle.
– Tests include identification of population and
expression of the action to be taken.
• Note dual direction of testing for
completeness and validity requires
selection of sample from appropriate
population.
– See Exhibit 11-8.
Chapter 11
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Computerized Payroll
Processing
Payroll processing and payroll register
preparation are usually the first computer
applications a business implements.
– Many off-the-shelf computer programs are
available.
– The files the auditor should expect to find
include:
• reference files
• dynamic files
Chapter 11
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Control Risk Assessment
The purpose of testing controls is to
determine nature, extent, and timing of
substantive procedures.
– Good controls – low control risk:
• Smaller sample sizes, earlier timing for
substantive tests.
– Poor controls – high control risk:
• Larger samples, more work at year end.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Learning Objective 6
Describe some common errors,
irregularities, and frauds in payroll, and
design some audit and investigative
procedures for detecting them.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Substantive Procedures
Audit procedures to gather direct evidence
on account balances are called substantive
procedures.
– recalculation, observation, confirmation,
enquiry, vouching, tracing, scanning,
analytical review
– dual purpose procedures – gain substantive
purpose and control purpose evidence with
the same test.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Audit Casettes: Substantive
Procedures
11.3 Time Card Forgeries:
– False claims for work time caused the
overpayment of wages.
11.4 The Well Padded Payroll:
– Embezzlement with fictitious people on the
payroll.
Chapter 11
Copyright © 2003 McGraw-Hill Ryerson Limited
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Just-In-Time Manufacturing
(Appendix 11B)
Underlying the JIT system is a continuous
improvement philosophy of eliminating all nonvalue-added activities (waste) such as material
movement, storage, rework, and waiting time.
– In a typical JIT system all types of inventories, raw
materials, work-in-process, and finished goods are
minimized.
– The ultimate measure of success with JIT occurs
when manufacturing cycle efficiency ratio equals one.
Chapter 11
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The 10 JIT Principles
• Strive for linear
production.
• Make it right the first
time. (Rejects and
scrap are waste.)
• Eliminate waste in
rework.
• Dedicate work cells to
product families.
• Form partnership with
vendors.
Chapter 11
• Reduce manufacturing
lead time.
• Cut inventories to
minimum.
• Synchronize production
processes.
• User demand flows to
control the shop.
• Reduce lot sizes and
setup time.
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