LESSON THREE

THE HUMAN RESOURCES MANAGEMENT/PAYROLL CYCLE

INTRODUCTION
• Questions to be addressed in this chapter include:
– What are the basic business activities and data processing operations that are
performed in the human resources management (HRM)/payroll cycle?
– What decisions need to be made in this cycle, and what information is needed to
make these decisions?
– What are the major threats and the controls that can mitigate those threats?
• The HRM/payroll cycle is a recurring set of business activities and related data
processing operations associated with effectively managing the employee workforce.
• The most important tasks performed in the HRM/payroll cycle are recruiting and hiring
new employees; training; job assignment; compensation (payroll); performance
evaluation; and discharge of employees (voluntarily or involuntarily). Additionally,
payroll costs are allocated to products and departments for use in product pricing and mix
decisions. The payroll system handles compensation, while the other duties are the
purview of HR management.
• This chapter focuses primarily on the payroll system, which is one of the largest and most
important components of the AIS. This system must be designed to meet management’s
needs and government regulations. Incomplete or erroneous payroll records can impair
decision making and result in fines or imprisonment.
• There are five major sources of input to the payroll system. The HRM department
provides information about hiring’s, terminations, and pay-rate changes. Employees
provide changes in discretionary deductions (e.g., optional life insurance). Various
departments provide data about the actual hours worked by employees. Government
agencies provide tax rates and regulatory instructions. Insurance companies and other
organizations provide instructions for calculating and remitting various withholdings.
• Principal outputs of the payroll system are checks. Employees receive individual pay
checks. A payroll check is sent to the bank to transfer funds from the company’s regular
account to its payroll account. Checks are also issued to government agencies, insurance
companies, etc., to remit employee and employer taxes, insurance premiums, union dues,
etc. The payroll system also produces a variety of reports.
• Employees are an organization’s most valuable assets. However, the traditional AIS has
not measured or reported on the status of a company’s human resources. Some
companies are now creating positions for a director of intellectual assets. Because
employees are so valuable, turnover is expensive, and employee morale is important.
• To effectively track intellectual capital and human resources, the AIS must do more than
just record time and attendance and prepare pay checks. Payroll should be integrated
with HRM so management can access data about employee-related costs and employee
skills and knowledge.
PAYROLL CYCLE ACTIVITIES
• The payroll application is processed in batch mode because pay checks are issued
periodically, and most employees are paid at the same time.
• There are seven basic activities in the payroll process.
• Activity 1: Update payroll master file—The HRM department provides information on
new hires, terminations, changes in pay rates, and changes in discretionary withholdings.
Appropriate edit checks, such as validity checks on employee number and reasonableness
tests are applied to all change transactions. Changes must be entered in a timely manner
and reflected in the next pay period. Records of terminated employees should not be
deleted immediately as some year-end reports (e.g., W-2s) require data on compensation
for all employees during the year.
• Activity 2: Update tax rates and deductions—The payroll department receives
notification of changes in tax rates and other payroll deductions from government
agencies, insurers, unions, etc. These changes occur periodically.
• Activity 3: Validate time and attendance data--Information on time and attendance
comes in various forms depending on the employee’s pay scheme. Some employees are
paid on an hourly basis. Many companies use a time card to record their arrival and
departure time. Some use electronic time clocks, where employees swipe their badge
through a reader when they come and go. Manufacturing companies may use job time
tickets to record not only time present but also time dedicated to each job.
• Some employees earn a fixed salary, e.g., managers and professional staff. These
employees usually don’t record their time, but supervisors informally monitor their
presence. Professionals in accounting, law, and consulting firms must track their time on
various assignments to accurately bill clients.
• Sales staff are often paid on a straight commission or base salary plus commission, n.
Some may also receive bonuses for surpassing sales targets. Requires careful recording
of their sales. Increasingly, labourers may be paid partly on productivity. Some
management and employees may receive stock to motivate them to cut costs and improve
service.
• The payroll system needs to link to the revenue cycle and other cycles to calculate these
payments. It’s also important to design bonus schemes with realistic, attainable goals
that can be measured, are congruent with corporate objectives, are monitored by
management for continued appropriateness, and are legal.
• Recent corporate scandals have led to scrutiny and criticism of executive compensation
plans. Compensation boards are being created to design compensation plans, rather than
having executives create their own. Accountants can help by advising on financial and
tax effects of proposals; identifying appropriate metrics to measure performance;
enabling compliance with legal and regulatory requirements; and suggesting appropriate
public disclosures.
• IT can help by collecting time and attendance data electronically, e.g., badge readers,
electronic time clocks, data entered on terminals, touch-tone telephone logs, and using
edit checks to verify accuracy and reasonableness when the data are entered.
• Activity 4: Prepare payroll--The employee’s department provides data about hours
worked. A supervisor confirms the data. Pay rate information is obtained from the
payroll master file. The payroll transaction file is sorted by employee number (same
sequence as master file). For each transaction, the payroll master file is read for pay
rates, etc., and gross pay is calculated. Payroll deductions are summed and subtracted
from gross pay to obtain net pay. Year-to-date totals for gross pay, deductions, and net
pay are calculated, and the master file is updated.
• Pay checks are printed for employees, often accompanied by an earnings statement,
which lists pay detail, current and year-to-date. A payroll register is produced, which
lists each employee’s gross pay, deductions, and net pay in a multi-column format. The
payroll register is used to authorize the transfer of funds to the company’s payroll bank
account.
• As payroll transactions are processed, labour costs are accumulated by general ledger
accounts based on codes on the job time tickets. The totals for each account are used as
the basis for a summary journal entry to be posted to the general ledger. Other payroll
reports and government reports are produced.
• Activity 5: Disburse payroll-- Most employees are paid either by check or direct deposit.
Cash payments may still be made, but this approach does not provide good
documentation. When pay checks have been prepared, the payroll register is sent to
accounts payable for review and approval. A disbursement voucher is prepared to
authorize transfer of funds from checking to the payroll bank account. For control
purposes, checks should not be drawn on the company’s regular bank account.
• The approved disbursement voucher and payroll register are sent to the cashier, who
reviews the documents; prepares and signs the payroll check to transfer the funds;
reviews, signs, and distributes employee pay checks; re-deposits unclaimed checks in the
company’s bank account; sends a list of these pay checks to internal audit for
investigation; returns the payroll register to the payroll department, where it is filed with
time cards and job time tickets; and sends the disbursement voucher to the accounting
clerk to update the general ledger.
• Direct deposit can improve efficiency and reduce costs of payroll processing.
• Activity 6: Calculate employer-paid benefits and taxes--The employer pays some payroll
taxes and employee benefits directly. The employer withholds federal and state taxes
from employee pay check, along with Medicare tax, and the employee’s share of Social
Security. The employer may also withhold voluntary deductions such as union dues,
United Way contributions, credit union savings, retirement contributions, etc. In
addition, the employer pays federal and state unemployment taxes; a matching amount of
 Social Security; and the employer share of health, disability, life insurance premiums,
and pension contributions.
• Some companies offer flexible benefit plans, sometimes called cafeteria-style benefit
plans, that offer a menu of options. Providing employees access to payroll/HRM
information through a company intranet can help reduce costs.
• Activity 7: Disburse payroll taxes and miscellaneous deductions-- The company must
periodically prepare checks or EFT to pay tax and other liabilities.
OUTSOURCING OPTIONS
• Many entities outsource payroll and HRM to payroll service bureaus that maintain the
payroll master file and perform payroll processing activities or to professional employer
organizations (PEOs) that perform the services of the payroll service bureau and also
administer and design employee benefit plans. Outsourcing is especially attractive to
small and mid-size businesses but must be monitored carefully.

CONTROL OBJECTIVES, THREATS, AND PROCEDURES

• In the HRM/payroll cycle (or any cycle), a well-designed AIS should provide adequate
controls to ensure that the following objectives are met:
• (1) all transactions are properly authorized;
• (2) all recorded transactions are valid;
• (3) all valid and authorized transactions are recorded;
• (4) all transactions are recorded accurately;
• (5) assets are safeguarded from loss or theft;
• (6) business activities are performed efficiently and effectively;
• (7) the company is in compliance with all applicable laws and regulations
•
THREATS IN EMPLOYMENT PRACTICES
• Main objective: Effectively hire, retain, and dismiss employees.
• Threat No. 1—Hiring Unqualified Employees
– Controls: Specify job skills required; make candidates accountable for inaccurate
information; perform background checks; verify skills and references.
• Threat No. 2—Violation of Employment Law
– Controls: Document all employment actions; train employees to keep them
abreast of legal requirements.
THREATS IN PAYROLL PROCESS
• Main objective: Efficiently and effectively compensate employees for services provided.
• Threat No. 3—Unauthorized Changes to the Payroll Master File
– Controls: Proper segregation of duties; independent review of changes to the file;
logical and physical access restrictions.
• Threat No. 4—Inaccurate Time Data
 – Controls: Automated recording of time; input edit routines; segregation of duties;
reconciliation of time clock data to job time tickets by an independent party; and
supervisory approval of time sheets.
• Threat No. 5—Inaccurate Processing of Payroll
– Controls: Batch totals, cross-footing of payroll register; use of payroll clearing
account; review of worker classification.
• Threat No. 6—Theft or Fraudulent Distribution of Pay cheques
– Controls: Sequentially number checks; restrict access to checks and check-
signing devices; sign checks only with proper documentation; use an imprest
payroll account; independent reconciliation of the payroll account; segregation of
duties; surprise observations of check distribution; re-deposit of unclaimed
checks.
GENERAL THREATS
• Threat No. 7—Loss, Alteration, or Unauthorized Disclosure of Data
– Controls: Offsite backups of files; external and internal file labels; logical and
physical access controls; modification of default ERP settings; encryption; VPNs;
message acknowledgment techniques.
• Threat No. 8—Poor Performance
– Controls: Performance reports.
KEY DECISIONS AND INFORMATION NEEDS
• The payroll system should be integrated with cost data and HR information so
management can make decisions with respect to the following types of issues: (1) future
work force staffing needs; (2) employee performance; (3) employee morale; and (4)
payroll processing efficiency and effectiveness.
SUMMARY OF MATERIAL COVERED
• Basic business activities and data processing operations that are performed in the
HRM/payroll cycle, including recruiting, hiring, training, assigning, compensating,
evaluating, and discharging employees.
• Key procedures in payroll processing.
• How IT can improve the efficiency and effectiveness of these processes
• Decisions that need to be made in the HRM/payroll cycle and what information is
required to make these decisions.
• Major threats that present themselves in the HRM/payroll cycle and the controls that can
be instigated to mitigate those threats

PRODUCTION CYCLE
It is a recurring set of a business activities and related data processing operations associated with
the manufacturing of the products.
The activities are grouped into four
1. Product design
 -The objectives of this activity is to design the product that meets the customers requirement
in terms of quality, durability and functionality while minimizing the product costs.

How can accountants be involved in the product design

-By showing how various design trade offs affect production costs and there by the profitability.
-By ensuring that AIS is designed to collect and provide information about the machine set up
and materials handling cost associated with alternative product design.
-By providing data about repair and warranty costs associated with existing products.
2. Planning and Scheduling
Objectives make the production planning efficient enough to meet the existing orders and
anticipate short-term demand without creating excess finished goods and inventory .The methods
used are;
a) Manufacturing resource Planning MRP-II
b) JIT production systems
NB MRP-II is an extension of material / resource planning that seeks to match existing
production capacity and raw material mix with forecasted sales demand.
JIT aims at minimising inventory materials or wip and finished goods.
How can accountants be involved in planning and scheduling:
-By ensuring that accountants collect and reports the cost in a manner consistent with the
production planning techniques used by the company – by helping to choose whether it is MRP
II or JIT is more appropriate to the company.
Documentation in planning scheduling
I) Master production schedule – is specifies how much of each product is to be
produced during the planning period and when that production should occur.
II) Material requisition - it authorises removal of materials from the store room to the
factory.
III) Subsequent transfer of material which is documented by the movement tickets.

3 Actual manufacturing of the product

-The manner in which this activity is accomplished varies greatly across companies .Many
companies use computer integrated manufacturing which entails the use of various forms of
IT in the production process such as robots and computer controlled machinery to reduce
production costs.
-Every firm needs to collect the data about the following matters of its production operation..
I) The raw materials used in production of products
ii) The labour hour spent in production operation.
iii) Machine operation performed.
iv) Manufacturing overhead cost incurred in the processes.
 4. Cost accounting
-The main objective of such a system involve:
i) To provide information for planning, controlling and evaluating of production operation.
ii) To provide accurate cost data about the products for use in pricing and product mix
decision.
iii) To collect and process the information used to calculate the inventory and costs of goods
sold values.
Control objectives of production cycle
-A well designed accounting information system is to provide adequate controls to ensure the
following objectives are met.
1) All production fixed asset acquisition are properly authorised.
2) The work in progress, inventory and fixed assets are safeguarded from misuse.
3) All valid and authorised production transactions are recorded accurately.
4) Production activities are performed efficiently and effectively.
Threats to production cycle
1) Unauthorised transactions related to the production.
2) The destruction of inventories and fixed assets.
3) Inefficiencies and quality control problems in production.
Control procedures / remedy
1) Accurate sales forecasts and inventory level.
2) Authorization of production of goods.
3) Review and approval of capital assets expenditure.
4) Documentation of all internal movements of inventory.
5) Proper segregation of duties amongst the personnel.
6) Regular performance reports produced for analysis.
7) Quality control measurement done on regular basis.

1. General Ledger and Reporting System cycle

General ledger and reporting activities
-Updating the journal / ledger.
-Posting the adjusting entries in the ledgers.
-Preparing financial statements
-Production of managerial reports.
a) Updating the journal/ ledgers
-Updating consist of posting the journal entities that originated from account subs-systems or the
treasurer.
b) Posting the various adjusting entities to the ledgers .
-The adjustment entries originates from the controller’s office after the initial trial balance has
been prepared.
The 5 groups of adjusting entities will involve:
1) Accruals (wages payable)
2) Prepayments (deferrals) rent, interest, insurance.
3) Estimation (depreciation, provision) doubtful debts.
4) Revaluation (change in inventory valuation) depreciation rates / policy).
5) Correction made in the ledgers.

c) Preparation of Financial Statement-include income statement and statement of financial

position.

d) Production of various managerial reports

-The reports prepared involve the general ledger control account and budgets.
-Examples of control reports will involve list of journal entries or vouchers by numerical
sequence, list of general ledger account balances.
-Examples of budgets prepared include operating and capital expenditure budget.
NB Budgets are performance reports that should be developed of the basis of responsibility
accounting which involves reporting financial results on the basis of managerial responsibilities
within an organization.
Control objectives of general ledgers
1) Updates to the journal / ledger are properly authorised.
2) Recorded general transactions are valid genuine recorded.
3) Valid and authorised general ledger transactions are recorded accurately.
4) General ledger data are safeguarded from theft / destruction.
5) General ledger system activities are performed efficiently.
Threats to the General ledger
a) Errors in updating of the general ledger – Errors made in updating of the general
ledger can lead to poor decision making based on erroneous information in financial
performance reports.

The control procedures to be used will include:

i) Input edit and controls.
ii) Reconciliation and control reports prepared regularly.
iii) Maintenance of adequate audit trial.

b) Unauthorised access to the general ledger - It can result into confidential data leakage
to the competitors, or corruption of the data in general ledger. It can also provide a
means of hiding the theft of assets.
The controls include:
i) Use of passwords / secret codes by employees.
ii) Read only access to the general ledger.
iii) Systems checks of authorization codes for each journal / voucher record before
posting.

c) Loss /destruction of the general ledger – Adequate backups and disaster recovery
procedures must be in place to protect the general ledger backup control will include:
i) The use of internal / external file labels.
ii) Performance of regular backup of the general ledger details.