Chapter 16 Payroll, Loss Contingencies, and Subsequent Events Part A: Payroll (pp. 625-629) I. Transactions concerned with: a. Personnel transactions – hiring, transfers, termination of employees b. Paying employees II. Controls a. Separation of duties: 1) Employment 2) Timekeeping 3) Payroll preparation 4) Distribution of checks or funds b. Formal hiring policies c. Detailed personnel records d. Use of time clocks e. Determine adequacy of internal control over payroll transactions III. Objectives - Determine: a. Proper authorization of new employees b. No fictitious employees included in payroll c. All terminated employees removed from payroll d. Employees paid authorized amounts e. All transactions recorded correctly f. Detailed recorded maintained g. Government regulations complied with IV. Procedures 1. Study and evaluate internal controls 2. Test payroll transactions a. Trace names and wage or salary rates to records in personnel department b. Trace time shown on payable timecards c. Verify payroll deductions to legal requirements and employee requests d. Tests extensions and footings of payroll e. Compare totals of payroll to totals of payroll checks f. Examine paid checks for endorsements and compare with payroll g. Review treatment of unclaimed checks 3. Review authorization for all payrolls 4. Review control procedures for payment of cash and/or distribution of checks 5. On a surprise basis observe a payroll distribution 6. Observe payroll procedures such as use of time clocks 7. Conduct analytical review 8. Recalculate accrued payroll 9. Recalculate payroll taxes and other withholdings 10. Test subsequent payment of accrued payroll and payroll taxes and other withholdings 11. Review officers’ salaries and trace to authorizations 12. Perform audit procedures on piece-rate or commissions, if appropriate 13. Determine financial statement presentation Part B: Loss contingency arising from litigations claims and assessments. (pp. 630-634) I. Major audit Problems a. Determine the existence of a loss contingency. b. Determine period in which underlying cause occurred. c. Appraise probability of unfavorable outcome. d. Estimate reasonableness of amount or range of loss. e. Accrue vs. Disclosure. II. Procedures a. Read minutes of meetings of stockholders, directors, and committees. b. Read contracts, loan agreements, leases, and other documents. c. Read correspondence with taxing and other governmental agencies. d. Read correspondence with insurance and bonding companies. e. Read confirmation replies for information concerning guarantees. f. Discuss with management, and accounting for litigation, claims, and assessments. g. Obtain from management or inside general counsel a description and evaluation of litigation, claims, and assessments. h. Obtain written assurance from management that the financial statements include all accruals and disclosures required by statement on Financial Accounting Standards No. 5. i. Examine documents in the client’s possession concerning litigation, claims, and assessments, including correspondence from lawyers. j. Obtain an analysis of professional fee expenses and review supporting invoices for indications of contingencies. k. Request the client’s management to prepare for transmittal a letter of inquiry to those lawyers consulted by the client concerning litigation, claims, and assessments. l. Compare the lawyer’s response to the items in the letter of inquiry to the description and evaluation of litigation, claims, and assessments obtained from management. m. Determine that the financial statements include proper accruals and disclosures of the contingencies. Part C: Subsequent Events or Post Balance Sheet Events (pp. 634-637) I. Definition – Events or transactions which occur subsequent to the balance sheet date but before financial statements are issued, which have a material effect on the financial statements and thus require adjustments to or disclosure in the financial statements. II. Two General Types of Subsequent Events A. Type I – Subsequent events which pertain to conditions which exist as of the balance sheet date and affect the estimates used in preparing the financial statements. These events require adjustments to the financial statements. See examples on page 635. B. Type II – Subsequent events which relate to conditions arising after the balance sheet date. These require disclosure in the financial statements. Examples include sale of bonds or capital stock, purchase of a business, settlement of litigation when the event giving rise to the claim took place subsequent to the balance sheet date. Also, see examples on page 635. III. Audit Procedures (Subsequent to the balance sheet date). A. Compare the latest available interim statements with the financial statements being audited. B. Inquire whether any contingent liabilities or commitments existed at the balance sheet date or the date of inquiry. C. Read or inquire about the minutes of meetings of stockholders or the board of directors. D. Inquire of the client’s legal counsel concerning litigation, claims and assessments. E. Obtain a management representation letter, dated as of the date of the audit report, as to whether any subsequent events would require adjustment or disclosure.
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