Payroll Processing and Fixed Asset Procedures:The Conceptual Payroll System

The Conceptual Payroll System

Payroll processing is actually a special-case purchases system in which the organization purchases labor rather than raw materials or finished goods for resale. The nature of payroll processing, however, creates the need for specialized procedures, for the following reasons:

1. A firm can design general purchasing and disbursement procedures that apply to all vendors and inventory items. Payroll procedures, however, differ greatly among classes of employees. For example, different procedures are needed for hourly employees, salaried employees, piece workers, and com- missioned employees. Also, payroll processing requires special accounting procedures for employee deductions and withholdings for taxes that do not apply to trade accounts.

2. General expenditure activities constitute a relatively steady stream of purchasing and disbursing transactions. Business organizations thus design purchasing systems to deal with their normal level of activity. Payroll activities, on the other hand, are discrete events in which disbursements to employees occur weekly, biweekly, or monthly. The task of periodically preparing large numbers of payroll checks in addition to the normal trade account checks can overload the general purchasing and cash disbursements system.

3. Writing checks to employees requires special controls. Combining payroll and trade transactions can encourage payroll fraud.

Although specific payroll procedures vary among firms, Figure 6-1 presents a data flow diagram depicting the general tasks of the payroll system in a manufacturing firm. The key points of the process are described in the following paragraphs.

Personnel Department

The personnel department prepares and submits personnel action forms to the prepare payroll function. These documents identify employees authorized to receive a paycheck and are used to reflect changes in hourly pay rates, payroll deductions, and job classification. Figure 6-2 shows a personnel action form used to advise payroll of an increase in an employee’s salary.

Production Department

Production employees prepare two types of time records: job tickets and time cards. Job tickets capture the time that individual workers spend on each production job. Cost accounting uses these documents to allocate direct labor charges to work-in-process (WIP) accounts. Time cards capture the time the employee is at work. These are sent to the prepare payroll function for calculating the amount of the employee’s paycheck. Figure 6-3 illustrates a job ticket, and Figure 6-4 illustrates a time card.

Each day at the beginning of the shift, employees place their time cards in a special clock that records the time. Typically, they clock out for lunch and at the end of the shift. This time card is the formal record of daily attendance. At the end of the week, the supervisor reviews, signs, and sends the time cards to the payroll department.

Update WIP Account

After cost accounting allocates labor costs to the WIP accounts, the charges are summarized in a labor distribution summary and forwarded to the general ledger function.

Prepare Payroll

The payroll department receives pay rate and withholding data from the personnel department and hours- worked data from the production department. A clerk in payroll then performs the following tasks.

1. Prepares the payroll register (Figure 6-5) showing gross pay, deductions, overtime pay, and net pay.

2. Enters the this information into the employee payroll records (Figure 6-6).

3.Prepares employee paychecks (Figure 6-7).

4. Sends the paychecks to the distribute paycheck function.

5. Files the time cards, personnel action form, and copy of the payroll register (not shown).

Distribute Paycheck

A form of payroll fraud involves submitting time cards for nonexistent employees. To prevent this, many companies use a paymaster to distribute the paychecks to employees. This individual is independent of the payroll process—not involved in payroll authorization or preparation tasks. If a valid employee does not claim a paycheck, the paymaster returns the check to payroll. The reason the check went unclaimed can then be investigated.

Prepare Accounts Payable

The accounts payable (AP) clerk reviews the payroll register for correctness and prepares copies of a cash disbursement voucher for the amount of the payroll. The clerk records the voucher in the voucher register and submits the voucher packet (voucher and payroll register) to cash disbursements. A copy of the disbursement voucher is sent to the general ledger function.

Prepare Cash Disbursement

Upon receipt of the voucher packet, the cash disbursements function prepares a single check for the entire amount of the payroll and deposits it in the payroll imprest account. The employee paychecks are drawn on this account, which is used only for payroll. Funds must be transferred from the general cash account to this imprest account before the paychecks can be cashed. The clerk sends a copy of the check along with the disbursement voucher and the payroll register to the AP department, where they are filed (not shown). Finally, a journal voucher is prepared and sent to the general ledger function.

Update General Ledger

The general ledger function receives the labor distribution summary from cost accounting, the disbursement voucher from AP, and the journal voucher from cash disbursements. With this information, the general ledger clerk makes the following accounting entries:

The debits and credits from these entries must equal. If they do not, there is an error in the calculation of either labor distribution charges or payroll. When the equality has been verified, the clerk files the voucher and labor distribution summary.

PAYROLL CONTROLS

Transaction Authorization

A form of payroll fraud involves submitting time cards for employees who no longer work for the firm. To prevent this, the personnel action form helps payroll keep the employee records current. This document describes additions, deletions, and other changes to the employee file and acts as an important authorization control to ensure that only the time cards of current and valid employees are processed.

Segregation of Duties

The time-keeping function and the personnel function should be separated. The personnel function pro- vides payroll with pay rate information for authorized hourly employees. Typically, an organization will offer a range of valid pay rates based on experience, job classification, seniority, and merit. If the production (time-keeping) department provided this information, an employee might submit a higher rate and perpetrate a fraud.

For purposes of operational efficiency, the payroll function performs several tasks. Some of these are in contradiction with basic internal control objectives. For example, the payroll function has both asset custody (employee paychecks) and record-keeping responsibility (employee payroll records). This is the equivalent in the general purchases system of assigning AP and cash disbursement responsibility to the same person.1 Segregating key aspects of the payroll transaction between AP and cash disbursement functions returns control to the process. AP reviews the work done by payroll (payroll register) and approves payment. Cash disbursements then writes the check to cover the total payroll. None of the employee paychecks is a negotiable instrument until the payroll check is deposited into the imprest account.

Supervision

Sometimes employees will clock in for another worker who is late or absent. Supervisors should observe the time-keeping process and reconcile the time cards with actual attendance.

Accounting Records

The audit trail for payroll includes the following documents:

1. Time cards, job tickets, and disbursement vouchers.

2. Journal information, which comes from the labor distribution summary and the payroll register.

3. Subsidiary ledger accounts, which contain the employee records and various expense accounts.

4. The general ledger accounts: payroll control, cash, and the payroll clearing (imprest) account.

Access Controls

The assets associated with the payroll system are labor and cash. Both can be misappropriated through improper access to accounting records. A dishonest individual can misrepresent the number of hours worked on the time cards and thus embezzle cash. Similarly, control over access to all journals, ledgers, and source documents in the payroll system is important, as it is in all expenditure cycle systems.

Independent Verification

The following are examples of independent verification controls in the payroll system:

1. Verification of time. Before sending time cards to payroll, the supervisor must verify their accuracy and sign them.

2. Paymaster. The use of an independent paymaster to distribute checks (rather than the normal supervi- sor) helps verify the existence of the employees. The supervisor may be party to a payroll fraud by pretending to distribute paychecks to nonexistent employees.

3. Accounts payable. The AP clerk verifies the accuracy of the payroll register before creating a disbursement voucher that transfers funds to the imprest account.

4. General ledger. The general ledger department provides verification of the overall process by reconciling the labor distribution summary and the payroll disbursement voucher.