ACC300: Auditing - Adel Manufacturing Company - Assessment Answer

Auditing Assignment

Case Scenario

The Adel Manufacturing Company employs about sixty production workers and has the following payroll procedures.

The factory foreman interviews applicants alone and on the basis of the interview either hires or rejects the applicants. When the applicant is hired he/she prepares an income tax instalment declaration form and gives it to the foreman. The foreman manually writes the hourly rate of pay for the new employee in the corner of the form and then gives the form to a payroll clerk as notice that the worker has been employed. The foreman verbally advises the payroll department of pay rate adjustments.

A supply of blank timesheets is kept in a box near the entrance to the factory. Each worker takes a timesheet on Monday morning, fills in their name and notes in pencil on the timesheet his/her daily arrival and departure times. At the end of the week, the workers drop the timesheets in a box near

the door to the factory.

A payroll clerk takes the completed timesheets from the box on Monday morning. Two payroll clerks divide the cards alphabetically between them with one taking the A to L section of the payroll and the taking the M to Z section of the payroll. Each clerk is fully responsible for her section

of the payroll .She computes the gross pay, deductions, and net pay, posts the details to the employee’s earnings records and prepares and numbers the payroll cheques. Employees are automatically removed from the payroll when they fail to turn in a timesheet.

The payroll cheques are manually signed by the chief accountant and given to the foreman. The foreman distributes the cheques to the workers in the factory and arranges for the delivery of the cheques to the workers who are absent. The chief accountant, who also prepares the various monthly payroll tax reports, reconciles the payroll bank account.

Assignment Task

(a) Identify the internal control weaknesses in the Adel Company’s procedures.

(b)Identify a test of control for each of the errors identified in part (a)

There are some glaring weaknesses in the internal control mechanism in place at Adel Company’s procedures. The paper identifies weakness in two business functions – recruitment and payroll management.

Recruiting – the weakness starts at the recruitment levels where the factory foreman is the only person authorized to conduct interviews and appoint an employee for the factory. While it can be assumed that the foreman is a worthy and learned man with an acute sense of judgment, having single person deciding on recruitments leaves scope for personal bias to creep in. this can lead to underperforming factory workers which can impact the overall production capability of the company.

Lack of recruitment policy – the foreman manually inputs the hourly rate of pay for a new employee. Thus can leave scope for bias and falsification and seemingly the company does not have well structured HR policy for recruitment where one does not have to write the hourly pay but putting a simple code is enough for the HR and the payroll to understand the hourly pay.

The payroll activities seem to lack automation and checks and balances. Some of the identified weaknesses are:

Entering Payroll Time Data – as stated in the case, the factory workers enter their times of entry and departure from work manually on paper forms for an entire week. They then leave the sheets of paper in a box at the gates of the factory at the end of the week. They also enter the timings by hand with a pencil. The problem first is using paper sheets to record time. It leaves chances of spoilage. Secondly, the manual entry leaves scope for false data entry and there is no second check to ensure that the workers put in the correct time and not overstate their work hours. This leaves scope for false earnings and can lead to financial losses to the company (Smallbusiness.chron.com, 2016).

Division of Payroll Processing – while the division of payroll between two employees for processing of payrolls is apt, what seems ot be lacking is a system of cross checking of the manual calculations that these two payroll employees do. There is no one to check whether the calculations that they have made are correct or not. This system of functioning also leaves scope for dishonest employees to set up false employee and make alterations in the record time worked or overtime hours causing financial loss to the company.

Lack of a Payroll Preview – the system of internal controls also lack any form of checking before the final pay cheque is written. The employees are solely responsible to ensure that the pay calculations are correct and the correct amounts are put on the pay cheques (Internal controls for small business, 2008).

Lack of Data security – there is no mention of what the company does to secure the personal data about the employees related to their work and employment. The company does not seem to have any form of data security measures in pace – whether it is security for the information on paper, or the data that is stored in the computers of the company. This can lead to identity theft and can leave an affected employee in financial problems.

b) Identify a test of control for each of the errors identified in part (a)

Several test of control deficiencies for each of the errors can be identified. They are as follows:

Recruiting – the test of control for recruitment can be had by the proper evaluation of the employees at the factory by the checking of the minimum qualifications possessed by each employee recruited by the foreman. The test can also be done by checking the individual productivity of the employees against the expected output from the employees.

Lack of recruitment policy – this has an easy test where the existing policies of the company can be reviewed to identify whether the company has a policy where in manual insertion of hourly pay is not required. If it is found that the recruitment policy does have such a system and it is not being followed, adequate measures can be taken if there are no identifiable policies for the same, the company should put together a policy that automatically decides the hourly pay once the grade of employment for a new employee is settled.

Entering Payroll Time Data – it is desired that entering payroll data should be automated and while letting the employees input their ‘in’ and ‘out’ times themselves there should be someone to cross check their verifications. The test to check for this weakness is to math optimum output for a period of work of the company with the number of employees at work and the number of work hours reported during that time period. It can also be tested by matching the cash outflow for payroll expenses with the actual number of work hours anticipated (Smallbusiness.chron.com, 2016).

Division of Payroll Processing – a simple way to test this weakness is to entrust someone to make regular checks of the final calculations made by each of the two payroll employees randomly. Human error while computing the payrolls for salary can be easily identified by a repeating this process.

Lack of a Payroll Preview – there is no system to check that whether the number of hours that an employee claims he/she has put in matches the ground reality. The test can include the foreman who can be consulted about the validity of work hour claims. Regular overseeing by a senior accountant over the payroll outcomes can help identify and reduce this deficiency (Audit of Payroll and other Expenditure using Data Analytic Procedures, 2016).

Lack of Data security – a close examination of the existence of the relevant paper sheets and all data containing paperwork will be the test for this weakness. However an automated system with all computer inputs can be tests by sunning hacking tests on the system to ensure that the security system is apt to protect personal data of the employees.