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    Internal controls over payroll including audit procedures

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    As part of the audit of Manor Company, you are assigned to review and test the payroll transactions of the Galena plant. Your tests show that all numerical items were accurate. The proper hourly rates were used, and the wages and deductions were calculated correctly. The payroll register was properly footed, totaled, and posted.

    Various plant personnel were interviewed to ascertain the payroll procedures being used in the department. You determine that:

    1. The payroll clerk receives the time cards from the various department supervisors at the end of each pay period, checks the employee's hourly rate against information provided by the personel department, and records the regular and overtime hours for each employee.

    2. The payroll clerk sends the time cards to the plant's data processing department for compilation and processing.

    3. The data processing department returns the time cards with the printed checks and payroll register to the payroll clerk on completion of the processing.

    4. The payroll clerk verifies the hourly rate and hours worked for each employee by comparing the detail in the payroll register to the time cards.

    5. If errors are found, the payroll clerk voids the computer-generated check, prepares another check for the correct amount, and adjusts the payroll register accordingly.

    6. The payroll clerk obtains the plant signature plate from the accounting department and signs the payroll checks.

    7. An employee of the personnel department picks up the checks and holds them until they are delivered to the department supervisors for distribution to the employees.


    a) Identify the shortcomings in the payroll procedures used in the payroll department of the Galena plant and suggest corrective actions.

    b) Identify the weaknesses, if any, that you believe are material and the reasons why.

    ICMA (adapted).

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    Solution Preview

    General comments about internal controls over payroll processing:

    The key issue in payroll is to have at least two people involved in the production, payment and distribution of payroll. The two people should not be in the same department; in fact, they should be physically separated and not within the same line of authority.

    Fraud in payroll processing is simply too easy and often difficult to detect. Independent auditors can breeze right by fraud without noticing. Even with two people involved, collusion can overcome the safeguards provided with decent internal controls. Therefore it is advisable for certain functions to be reviewed and approved by additional people not directly involved in the processing function. As redundant as some processes might seem, payroll is a good system to be somewhat overprotected from fraud.

    There are four main types of payroll fraud:

    1. A ghost employee is a fake person who is added to the payroll for the benefit of the person committing the fraud. The checks written to the 'ghost' are cashed or direct deposited for the singular benefit of ...

    Solution Summary

    The solution explains payroll internal control deficiencies in general and then how the most common payroll fraud is perpetrated. For the specific issues in the problem, a solution is presented to minimize the possible internal control issues related to each part of the procedure.