Auditing Payroll Expenses – Risks – Assertions, and Procedures

Overview

There are numerous different expenses that are incurred by the company over the course of the year. It is important to ensure that all these expenses are properly accounted for in order to arrive at the correct figure for the profit for the particular year. Even during the year-end audit, it is important for auditors to ensure that they are able to conduct a proper audit for all the expenses involved, so that there is reasonable evidence gathered based on which they are able to comment on the overall accuracy with which the financial statements have been prepared.

Payroll Expenses are considered to be one of the most significant operating expenses on the financial statements of any organization. Since they comprise a major operating expense, they need to be audited properly.

Payroll comprises mainly comprise of expenses that are paid in order to settle the dues of the human capital of the organization. In this regard, it must be taken into consideration that payroll in itself comprises numerous different human payroll expenses and salaries.

Therefore, auditing payroll expenses tends to be an increasingly important factor from the perspective of accountants, since it directly tends to impact the overall profitability of the company.

Risk Associated with Auditing Payroll Expenses

Payroll expenses tend to be one of the major expenses incurred by a company. Therefore, there are a number of variables that need to be considered when auditing payroll expenses. The overall element of risk involved with payroll expenses is considerably high, and hence, needs to be investigated in a rigorous manner.

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Classifying the overall risks involved with auditing payroll expenses, it can be seen that these risks are mainly twofold: Risks of Material Misstatement, and Detection Risk. Subsequent explanation for these risks is given below:

  • Risk of Material Misstatement: As far as the Risk of Material Misstatement is concerned, it involves the risk of the payroll associated figures being materially misstated. It is mainly triggered by a lesser level of internal control within the organization, which mainly results in payroll amounts being disbursed abruptly. Generally speaking, this particular risk is higher in organizations, primarily because of the relative ability with which these numbers can be tweaked in order to reflect the existing position of the company.
  • Detection Risk: Detection Risk refers to the inability of the auditors to point out the relevant inconsistencies in the financial statement when in reality, they have been materially misstated. In other words, this particular risk mainly implies that the audit procedures and processes are subsequently unable to detect any inconsistency or material misstatement in the payroll figures that have been disclosed in the financial statements. Typically, this risk is also high in organizations.

Therefore, it can be seen that payroll expenses are usually high-risk, because it is an internal matter of the organization, and therefore, this particular expense can be inflated in order to suit the preference of the organization that is being audited.

Audit Assertions when Auditing Payroll Expenses

Since payroll audit tends to be a high-risk element within organizations, it is important to consider the fact that it needs to factor in a couple of various audit assertions in order to gather reasonable evidence that the amount for payroll expenses has not been materially misstated. These assertions are given below:

Subsequent explanation of these audit assertions are provided below:

  • Existence: The audit assertion of existence states that the payroll expenses that have been declared by the organizations should actually have been paid (or incurred) by the organization in the current year. They should not be figures that are made out of thin air in order to accommodate these expenses for the relevant year.
  • Occurrence: The audit assertion of occurrence implies that organizations should only record payroll expenses that have actually been occurred. They should not report expenses that would have occurred if they had undergone a certain project. Only concrete and verifiable human resource amounts should be recorded in the financial statements.
  • Cut-Off: This particular audit assertion states that only those payroll expenses should be recorded in the financial year that is specifically relevant to the year for which the financial statements are being prepared for.
  • Presentation and Disclosure: Since payroll expenses are expansive in nature, the disclosure to the payroll expenses should include descriptions for all the payroll expenses, including basic salaries, bonuses, and other relevant disbursements that have been made by the organization in line with payroll expenses.  
  • Accuracy: All payroll expenses should be calculated properly in order to ensure that the final figure of payroll expense is not materially misstated.
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Audit Procedures associated with Auditing Payroll Expenses

Given the fact that there are numerous different assertions that need to be accounted for by organizations, it is important to realize the fact that audit procedures should be designed in order to rigorously test these assertions against the disclosures made by the organization. Therefore, audit procedures can be broadly clubbed into two broader categories:

  • Analytical Procedures: Analytical Procedures mainly involve tests of details, including tests of details to assess the level of internal control within the company. A higher internal control would imply that the audit assertions mentioned in the earlier part of the article are fully applied. Internal Control is a measure of the extent to which the organization has checks and balances in place in order to mitigate the risk associated with fraud, or cash embezzlement within the organization. The efficacy of internal control is mainly gauged by checking the authorization protocols, as well as the structure of the Human Resource Department, and the extent to which it functions in an independent manner.

However, observations and analytical procedures are not solely sufficient in order to comment on the reasonableness of the disclosed payroll expenses. Organizations still need to ensure that they inculcate substantive audit testing against all the assertions to gather further concrete evidence.

  • Substantive Audit Procedures: Substantive Audit Procedures are created in order to test the assertions using tests that are specifically designed to address the particular assertions. They are summarized in the following table:
Audit AssertionSubstantive Testing
Existence In order to test the assertion of occurrence, the following substantive tests are carried out: Checking for payroll slips, and bank accounts in order to reconcile the payout made to employees. A random sampling of monthly paychecks, further verified by bank accounts. Questionnaires and Interviews with the staff, at random, to ensure that they have received the particular amount.
OccurrenceThis is mainly checked by the auditor calculating the payroll expense, as per his knowledge, and then comparing it with the disclosed figure. In the case where there is a material discrepancy, further investigation needs to be carried out to determine the reason for the differential.
Cut-OffThis assertion is mainly tested by checking if the previous year’s payroll records were settled, and the current outstanding dues. Additionally, the amount paid in payroll is used in order to gauge the payroll expense for the year.
Presentation and DisclosureSince payroll constitutes various different expenses, it is important to ensure that all the relevant disclosures have been made in the financial statements that might help the end-user of the financial statement in the decision-making process.  
AccuracyThis is tested by rechecking and recalculating the figures that were disclosed by the organization as payroll expenses. The auditor needs to design a procedure to ensure that there have been no mathematical or totaling-related errors involved in calculating the total figure for payroll for the subsequent year.
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