How to Audit Payroll Expense?

Auditing payroll is the process that auditors use to test the true and fair view
of the payroll balance on the income statement.

Payroll expense presented on the income statement, it represents the cost

that the company spends on the employee.

It is the compensation that a company spends on employees in exchange for

their employment over a period of time.

Payroll is one of the significant expenses that company spends to

support its operation. It is a compulsory expense that company can not avoid
unless they outsource everything. Most of the company hire employees to
work in various departments. They need staff to work in the production,
marketing, accounting, and other departments.

When the company expands its operation, it will increase the payroll as well.
The big business operation will require more people both front and back
office.

Most of the time, the auditor will scope the payroll expense as it is a large
portion of the operating expenses. However, it is most likely considered a
low risk due to its straightforward nature.

Risk Associated with Payroll Expense

Payroll is the major expense for most of the company, so the risk is high if
anything wrong happens to the balance. It will have a significant impact on
the whole financial statement.

The risk associated with auditing payroll expenses happens when the auditor
cannot detect or prevent risk. It is the result of inherent risk, control risk, and
detection risk.
  Inherent risk: It is the risk that attaches to the account balance
based on the nature of the account, and business complexity. It
is the auditor’s judgment over the account base on various
factors. Auditor has nothing to do with the inherent risk.
 Control Risk: The risk that company internal control fails to
detect and prevent material misstatement from happening. It
depends on the control design by client management and
implementation. An auditor can only validate the effectiveness of
internal control.
 Detection Risk: It is the risk that auditors fail to detect material
misstatement in the payroll expense. An auditor can reduce the
risk by increasing the testing sample.
Auditor can only have an impact on the detection risk. They can increase the
testing and sample to reduce the risk. It is necessary to increase the testing
to reduce the detection risk when the account is high risk and the control is
high.

It is not necessary to increase the testing while the account is not risky and
the client has proper control. An auditor can reduce the testing to save time
and effectiveness.

Audit Assertion for Payroll Expense

Audit assertion is the characteristic of an account that the auditor needs to
test to ensure the amount record is correct. The audit assertion is separate
between income statement items and balance sheet items.

Payroll expense is the income statement account, so the auditor has to test
the following assertions:
  Cut-Off: Payroll expense is the income statement line item, so it
must comply with accrued accounting method. The company
must record the expense which really happens during the
accounting period. The expense has to record on income
statement even the company has not yet made payment.
 Occurrence: The transaction record represent the business
activity. The payroll expense shows the record of transactions
that really happens during the year. It will be a fraud if the
company records an expense that is not occurring.
 Accuracy: The payroll expense record must be the same as the
amount spent on the employees. The amount recorded and the
amount spent must be the same.
 Completeness: All the expenses that happen in the period must
be fully recorded. Not a single transaction is left behind.
 Classification: The business expense is supposed to be present
in the correct classification. The payroll is the main operating
expense that has to be present on its own line. It will be a
problem if company shows it in the other expense.

Substantive Analytical Procedure for Payroll

Expense
The analytical procedure is the process the auditor use high-level analysis to
perform an overall assessment to ensure the balance of payroll expense.
Each balance always has a connection between other accounts due to double
entry. Moreover, the account also has a connection with non-financial data.
The payroll expense will increase when the company increases production as
they require to hire more people.

Auditor performs an analytical procedure for payroll expenses by comparing

the balance from one month to another. The payroll that company spends
on employees is supposed to be consistent unless there are changes in total
number of employees.
The employee will receive the same salary for the year unless there is an
increment or new promotion. The increment rate will depend on the
management approval and it is also within the expectation as well.

Besides that, the auditor can measure the payroll cost by comparing it with
the operational size. It also aligns with the monthly revenue as well. The
payroll should remain the same if the operation size remains the same.

Auditor can access the payroll cost for a month and multiple with 12 months
to get the total amount of payroll per year. This amount should be
comparable with the payroll cost on the income statement. There may be
variance that raises from the annual increment, bonus, or new employees.

The auditors must investigate the payroll cost that has significant variance
compared to their independent expectations. The investigation will lead to
the conclusion in the payroll expense account.

The analytical procedure will provide auditors with the reasonableness of the
amount recorded on the income statement.

Test of Detail for Payroll Expense

Test of detail is the audit procedure that auditors use to verify the detailed
transactions record of the client’s financial statement.

As the name suggests, auditors use various testing procedures to test the
financial assertion that is compatible with the account.

When auditor uses a test of detail to verify the payroll cost, they will check
the below assertion.

The analytical procedure will provide auditors with the reasonableness of the
amount recorded on the income statement.
Test of Detail for Payroll Expense
Test of detail is the audit procedure that auditors use to verify the detailed
transactions record of the client’s financial statement.

As the name suggests, auditors use various testing procedures to test the
financial assertion that is compatible with the account.

Regarding the nature of payroll expense, company expects to pay for the
employee who performs work during the month and year. We can review
employment contracts to ensure there are really doing the work. We also can
spot check the employee headcount in any particular period and compare it
to the payroll listing, it should be reasonable to prior months’ listing. Auditor
can also use professional judgment to compare the operation size to the
staff’s headcount.

 Accuracy: the transaction record on the financial statement have

to be accurate. The amount record is the same as the supporting
document, real business transaction, and so on.
Auditor has to compare the transaction to the original supporting document.
To ensure the accuracy of payroll, we have to compare the payroll listing to
the amount on the trial balance.

The payroll list consists of payments to each staff and it contains all
components such as basic salary, performance bonus, overtime, and so on.
The auditor must go deep by checking each component.

The basic salary can be checked again in the employment contract or

increment letter. The bonus must be included in the annual approved listing.
The overtime can be found in the employee timesheet and so on.

 Completeness: The auditor can test if the recorded balance is

completed or not. Auditor can request the payroll listing during
the year and reconcile it with the balance on income statement.
 It will help to ensure completeness and the reliability of the
listing.
 Classification: is the presentation of account on both income
statement and balance sheet. The payroll expense has to be
reported in the correct account under operating expense in the
income statement. Some payroll expenses may be recorded as
the cost of goods sold depending on the nature of the business,
it has to be consistent.
Audit Procedures For Fixed Assets: Assertion,
Risks And More
Audit, Audit Procedures
Overview:
Tailoring the correct audit procedures to the testing of fixed assets is not only
helps auditors to minimize the detection risks but also helps the auditor to
work more efficiently. That means the auditor could spend less time and effort
on reviewing the fixed assets but still get the required result.

The auditor could tailor the right auditor procedure only if the controls related
to fixed assets are obtained and the risks are properly assessed.

Now, before we go into the detail on audit procedures of fixed assets, it is

good to start with the overview of fixed assets including the relevance
standard with deal with, the control, audit assertion, and the risks that might
be happened to fixed assets.

Fixed assets are the long-term assets that are recorded in the balance sheet
and show balance at the end of the reporting date. Fixed assets are non-
current assets that have a useful life for more than one year.

Fixed assets are not recognized as expenses in the income statement at the
time of purchasing but it is recognized as expenses when the entity uses them.
The company uses the systematic method to depreciate fixed assets and the
depreciation expenses are recognized during the useful life of assets.

Fixed assets are normally large if we compare them to other assets like current
assets. And they are generally considered as sensitive areas from the audit
perspective.

The auditor in charge of these areas should be the one that has the experience
and knowledge enough otherwise the detection or audit risks might be
increasing.
Understanding Control:
Auditors should obtain the key control on how the entity manages and control
its fixed assets. The better auditors understand internal control over fixed
assets, the better the auditor tailors the procedures and implement the
procedures.

There are many key areas that they should consider reviewing. Those include
CAPEX budget preparation and authorization.

The procurement procedures from suppliers’ finding process into receiving

assets as well as making payments. These controls are critical for auditors. If
the controls here are not strong, then the quality of financial reporting related
to fixed assets is also questionable.

The auditor should also obtain an understanding of how the management

controls the physical assets. For example, if physical control is strong enough
to ensure that our assets are safe? How often does the management perform
the physical count and reconcile all of the assets?

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One auditor obtains and updates their understanding of the key internal
control, then they should validate the control by testing the key process and
control that matter to financial statements. The procedure should be tailored
after validation of the control.

Now let talk about the assertions that auditors used to audit fixed assets,

Assertions:
Fixed assets are the accounting balance that reports and present in the
balance sheet and the assertion used to prepare and report these items are
not much different from other balance sheet items. The audit procedures
should sufficient enough to address all of these assertions.
  Existence: There are the risks that fixed assets that report in the
balance sheet might not exist. To ensure this, the auditor should
consider performing the physical observation as well as joining the
physical observation.
 Completeness: this assertion concern the completeness of fixed
assets that record in the balance sheet, as well as fixed assets listing. If
the fixed assets are not completely records, understatement is likely
to happen.
 Valuation assertion concern the net present value of the reported
fixed assets. These including the cost that the entity include or
exclude from the cost of capitalization as well as recoverability of
fixed assets compared to its net book value. There are the risks of
overstatement of fixed assets for certain assets that significantly
affected by technology.
 Cuff off is the income statement assertion, but it is like the balance
sheet assertion. For example, if the fixed assets that purchase before
and after the reporting date are not correctly cut off then the fixed
asset amount that reports in financial statements also not correct.
 Classification: This assertion concerning the classification between
fixed assets and current assets as well as the items among the fixed
assets. For example, repair and maintenance might be included in the
capital expenditure.
 Disclosure: This assertion concern the disclosure of important
information that matters to the users of financial statements. Those
include the accounting policy, significant purchase, as well as
disposal.

Common Risks Related To Fixed Assets:

The audit risks related to fixed assets are vary based on the nature of fixed
assets, control that entity has, and auditor limitation. The following are the
risks that normally attach to an audit of fixed assets:

 Incorrect Depreciation rate and calculation: Depreciation rate is

normally decided by management. In some cases, management
might intend to manipulate the depreciation rate to get the
 depreciation expenses based on what they want. The auditor needs to
ensure that the assessment of the depreciation rate is performed. The
rate should be based on the expected useful life, as well as the
capacity of assets.
 The reported fixed assets are not existing: The assets that report in
the financial statements are normally material compare to other
assets and the existence of those assets is normally the concern of
auditors. To address this, the audit might need to check between
book value in the financial statements to fixed assets listing. And then
check the listing to the fixed assets count sheet.
 Overstatement of fixed assets: It is important to assess the
recoverable amount of fixed assets. For example, the business units of
the entity have their revenues down over that last twelve months. This
indicates that book values of fixed assets that use in these business
units are lower than the reported amount.
Audit Procedures:
 Reconcile the book value of assets to GL and TB: Auditors should have
entity’s financial statements, general ledger as well as Trial Balance for
the period that they are auditing as well as relevance period. Before
working on TB and GL of fixed assets, it is important for the auditor to
check whether the GL and TB are linked to fixed assets book value,
depreciation, as well as accumulate depreciation, which is tight to
financial statements.
 Reconcile book value of assets to fixed assets register or mater file to
ensure that the register that uses for the physical count is completed
and accurate.
 Review the depreciation schedule: Accountant use depreciation
schedule to calculate and control the depreciation expenses as well as
accumulated depreciation. Auditor review the reasonableness of
depreciation rate, useful life, depreciation calculation, as well as
accumulate depreciation calculation.
 Review the working paper of reconciling fixed asset per listing to
actual count to ensure that the result after count reflects fixed assets
in the financial statements.
 Review repair and maintenance costs whether it is currently correctly
classified. Repair and maintenance is the cost that spends for bringing
assets to current and earlier condition. If the cost that spends on
assets is to extend the capacity of assets, then those costs should not
be included in the repair and maintenance. Those costs should be
capitalized.
 Review the acquisition of fixed assets and related capitalization cost
whether all necessary costs that should be capitalized as per IAS 16
had been included in the capitalization costs.
 Disposing of fixed assets during the years are also important for
certain cases. For example, based on the pre-analytical review,
auditors found that there are material amounts of fixed assets that
were disposed of. If this is the case, the auditor should review not
only the procedures of disposal, accounting recognition but also the
main reason for disposal which might affect the others recoverable of
fixed assets.
 Maintaining a fixed asset register and/or master file is only important
for the accuracy, completeness, and existence of fixed assets. The
auditor should consider reviewing the reliability of fixed assets listing
as well as mater file.
 Review fixed assets impairment assessment: Based on IAS 36
Impairment, the entity needs to assess the impairment every year. The
auditor should consider reviewing the procedures and processes that
managers use to assess the impairments.
 De-recognition of fixed assets is agreed to the de recognition
procedure and policy. Make sure that assets that had been disposed
of and written off are removed from the list and financial statements.