Good afternoon again, guys.

So we're going to discuss Expenditure Cycle Part Two, Chapter

Five Part Two, which is the payroll processing. And payroll is the second part of our discussion
of the expenditure cycle for this day.
Now, payroll processing is a special case purchasing system in which the organization purchases
not materials, not inventories, but labor, you know—rather than on the usual inventory.
The nature of payroll processing is very special. But nothing should have been special. Why do
we say that this is special? Because of the following three reasons. So we'll discuss the three
reasons why the payroll subsystem is a special subsystem different from the inventory
purchasing system alone.
The first reason why this is special is that:
Number one – the procedures in the payroll differ greatly among classes of employees, and
procedures for employee deductions and taxes are different now.
So in an organization, there are levels of position. You can be a staff, then you can be a
supervisor, and then you can be a manager. Now the processing procedure for the payroll for
each of these classes of employees are different.
And in our previous organization, the point person for the staff, the point person for the
supervisor, and the point person for managers in the HR (Human Resources) department are
different.
And also, usually the department head, the Human Resources department—that handles the
payroll for top management. Yeah. So procedure, and also the varying benefits. And therefore,
varying computation net deduction still.
And so there has to be a different employee that will handle different classes of payroll in the
organization.
Now the second reason is that:
Number two – the general expenditure activities constitute a relatively steady stream. I mean the
inventory purchasing system—it has a steady stream of purchasing and disbursement
transactions.
So day in and day out, there are inventory and cash disbursement transactions. And business
organizations design purchasing systems to deal with their normal level of activity. So the
normal level of activity for inventory purchasing is catered to every day.
Payroll activities, on the other hand, is not regular. It's not daily. They are sometimes weekly—
for wages. For example, if you are a worker in a construction, for example, you could be
receiving your wages weekly.
Then we also have a bi-weekly salary. Bi-weekly—quincena, Tagalog. And then we also have
the monthly, 'samawik.'
So these are events—discrete events—in which disbursement to employees occur not on a daily
basis but regularly on a less frequent basis.
And the task of periodically preparing large numbers of payroll checks or payroll accounts—
depending on the number of employees. If you have, let's say, 500 employees, then that would be
a very large number of payroll transactions.
And in addition, these employees—they could be writing into the check-writing system if the
salaries of the employees are still in the form of checks.
But the most popular form of salary now is in the form of credit to accounts, and the employees
can withdraw their salaries through their automated ATM cards—you know, automated teller
machine cards or ATM cards.
The most popular way of crediting payroll nowadays. So the days are gone when cash is being—
when cash are distributed among employees.
But for those who are receiving wages, probably the most convenient for them is still cash. Hirap
nga naman ang daily workers natin. Daily wages natin.
So the task of periodically preparing this volume of transactions or volume of payroll
transactions, in addition to the normal inventory purchasing transactions, can overload—if you
combine them in one system—then the payroll procedures can overload the purchasing and cost
disbursement system.
Number three reason why it is a special system is that:
If you combine the payroll checks with trade transactions, then you might be encouraging payroll
fraud.
Because writing checks to employees requires special controls. And if you put them in the
normal check-writing for suppliers, then it could invite some employees to commit fraud.
Now—and that’s it. Remember that the number three risk is a very inviting—inviting
consideration for people in the organization who want to defraud their company via the payroll.
So here we have the overview of the inputs of the payroll process.
Now, the periodic process that the payroll transactions—the payroll process—a periodic process
that it entails—makes it a system that is best suited for batch processing, not real-time
processing.
Because it is done only—let’s say, if it is quincena, then you do it only twice a month. Then if
your salary is monthly, then you do it only once a month.
So therefore, it does not warrant a real-time process. So it is more conducive to a batch
processing process.
So we have the inputs here on the left:
We have the employee action form or otherwise known as the personnel action document. This
one is—that this document contains any action or personnel action.
Like when you hire someone, or when you terminate someone, or when you promote someone,
or change the salaries of your personnel—then they all have to be—these actions must be
supported by an employee action form or a personnel action document.
Another input to the payroll process is the job tickets, and this is peculiar to manufacturing firms.
So the workers working at the manufacturing plant facilities—they have the job tickets that are
submitted to payroll for processing of their salaries.
Then we have the time cards, which are normally inputs coming from the employees—
employees in the organization that have daily time records.
Or sometimes they use biometric machines or equipment to capture their time-in, they track their
time-out during the day—you know—and during the pay period.
So these are the inputs here, and the data processing department will have a way of capturing
these inputs.
And then the outputs on the right will be the output of the IT processes.
We have the checks—this is what the physical output—or the bank file. The bank file contains
the amount of salary that is credited to the employee’s account.
And if the file is sent to the bank, then the account of the employee will be credited the
corresponding salary.
And then the employee will be able to withdraw the salary using the ATM card.
And then the output of the process also includes a record-keeping, which includes the historical
salaries of the employee.
So that’s part of the record that a company has to keep for reference later on—for use later.
Then we have the output to the general ledger. And of course, this is to update the accounts that
are affected by the payroll transaction for the financial statements preparation.
So those are the inputs and the outputs of the payroll process.
And again, to repeat it, the payroll process is best bettered by the batch processing method.
So let's go to the conceptual system—what needs to be done in the payroll process.
There are five tasks that need to be done in the payroll process.
And the primary inputs to these processes, or primary inputs to this payroll process, comes from
the personnel department and the production department—if the firm or the organization is a
manufacturing organization.
So may role diyan ang production department. And of course, the personnel department prepares
and submits personnel action forms.
You know, it means now the personnel department captures or sends the information for payroll
via the personnel action form, or personnel action document, or employee action form—
whatever the term the organization might use or not.
So there are varying terms that the remaining organization choose to describe this document, but
their purpose is to document and keep a record of what the personnel or the human resources
department has done to a certain employee.
And then the personnel department also prepares the payroll register—again, or the payroll
summaries.
These documents—the personnel action form and the payroll register—identify employees
which are authorized to receive a paycheck or payroll, and are used to reflect the changes in
hourly pay rates if there are any changes to that.
Or if there are also any changes to the deductions. For example, if there are loans that the
employee has taken out, and the employee has signed a salary deduction form.
And also changes like job classification. If there are certain changes to the classification—for
example, if there is a lateral movement from one department to another, if there is a promotion
from one position to a higher position.
So these are changes in job classifications.
The production department, on the other hand, is the other most significant input to the payroll
process.
They prepare—this department prepares—two types of time records. One is the job ticket, and
the other is the time cards.
Now the job tickets capture the time that individual workers in the manufacturing facility spend
on each production job.
Cost accounting uses these documents. That’s that special branch of accounting, yeah, and
usually special software for accounting for the cost in production.
And also, cost accounting uses these documents to allocate direct labor charges to the work-in-
process account.
And the time cards are used to capture the time that the employee is at work.
So the job tickets and the time cards—in that sense, these two data—these two documents are
sent to the payroll function for calculation of the amount of the employee’s paycheck.
So those are the two inputs, so that the payroll function can calculate accurately the amount of
the salary that employees will get.
Now, each day at the beginning of the shift in a manufacturing firm, the employees place their
time cards in a special clock that records the time.
So another example of this is what is usually known as the Bundy clock, wherein you insert the
card and then the clock will punch the time on the card.
And they do that when they come in, and then when they take their lunch, and then when they
come in the afternoon, and when the workers also go home.
And that's the last time that they will insert the card in the time clock for the day.
Then that will constitute a formal record of their daily attendance.
And at the end of the week, the supervisor should review and then sign the daily time record and
send the time cards to the payroll department.
So in weekly wages, their daily time records will be reviewed also weekly by the supervisor.
And such information will be used in the update of the work-in-process accounts.
And the peculiarity of the cost accounting subject explains much of what happens in the labor—
in the labor factor—
in the labor factor, no, not in manufacturing cost.
So let's go to the prepare payroll now.
In the conceptual system, the prepare payroll—the first task is the first task.
And in this task, the payroll department receives the pay rate and withholding tax data from the
personnel department, and the hours worked data from the production department.
So your input now is the personnel action form, which contains the pay rate.
And then also the other input is the—
the input is the time records from the production department.
And that will input—
and that will constitute the hours worked that will be computed against the hourly rate of the
employees, you know, so that they will come up with an accurate payroll at the end of the period.
The clerk in the payroll department then will perform the following tasks:
First, that clerk will prepare the payroll showing the gross pay, or the basic pay, and then the
deductions to the gross pay, the overtime pay if any, and the net pay.
The second task is that the clerk will enter the information into the employee payroll records.
And the third task under the prepare payroll is to prepare the employee paychecks.
Fourth task is to send the paychecks to the distribute check function, which will be the second
task later.
Yeah, a little bit later we will be discussing this after the tasks of the clerk.
The fifth task of the prepare payroll clerk is to file the time cards, personnel action form, and
copy of the payroll register.
So that’s it. The clerk has to file these three documents after he is done with them.
So let's go to the distribute paycheck now.
And this function receives the input—the checks now—from, coming from the payroll function.
So the distribute paycheck is that function in the organization that sends the paycheck to the
employees, if the form of payment for salary is via the form of check.
But since the most popular form of payroll now is to credit to their ATM accounts or the bank
accounts—that’s the most popular form now—then the distribute paycheck will, if it is done, will
not include the paychecks anymore.
Only—they will distribute now the payslips.
So the payslip will be the only document that will be given to the employee if the employee's
salary is credited to the bank account of the employees and withdrawn via the ATM machine.
Now, a form of payroll fraud involves submitting time cards for non-existent employees.
The perpetrator or the initiator of this fraud then collects the paycheck and cashes it.
And to prevent this, many companies hire or use a payroll master—or an insured paymaster.
And payroll master is the long term, but they call it a paymaster.
They allow the paymaster to distribute paychecks to employees.
The paymaster is independent—should be independent—of the payroll process.
That means he is not involved in the payroll authorization or preparation of the payroll register.
If a valid employee does not claim a paycheck from the paymaster, then the paymaster returns
the check to payroll.
And the reason the check went unclaimed can then be investigated, if some checks are not
claimed.
So that will prevent any employee from stealing cash from the organization, because now the
employee has to get the check from the paymaster.
But the paymaster will only give the check to all valid employees.
So if the paycheck is to an employee that is not a valid employee, then the paymaster will be able
to validate that when someone claims for the check.
So let's say Juan comes—Juan Dela Cruz comes—to claim the payroll that was prepared in the
name of Pedro Penduko.
So the paymaster will, of course, validate the identity of Juan Dela Cruz.
Now, if he is not the actual recipient of the check, the payroll payroll master or the
paymaster will not give him the check.
So therefore, if Juan Dela Cruz is a fraudster, then Juan Dela Cruz cannot—will not be able to
encash the check that was written fraudulently.
The paymaster then, after that of course, in the organization will have to recognize the
liability for salaries that are payable to the employees.
And that is the function of the Accounts Payable Clerk.
After reviewing the payroll register for correctness and preparing copies of the cash
disbursement voucher for the amount of the payroll—or for the amount of the payroll—the
cash disbursement voucher is equal to not the gross pay of the employee but the net pay of the
employee.
So, young total cash disbursement voucher for payroll should equal the total net pay of all
the employees.
The checks are then checked—
The list of the checks, the check register, will then be validated also by the Accounts Payable
Clerk, and then records the voucher in the voucher register and submits the voucher packet.
Again, the voucher packet, we have already discussed this in the purchasing subsystem.
It is a compilation of the documents that are required before a cash disbursement can be
made.
And this voucher packet is submitted to the “Prepare Cash Disbursement” function, which
is the fourth task in the conceptual system.
And then, a copy of the disbursement voucher is sent to the “Update the General Ledger”
function, which is the fifth task in the conceptual system.
But let’s go first to the “Prepare Cash Disbursement”, and that is after the preparation of the
check voucher.
Upon receipt of the voucher packet, the Cash Disbursement function prepares a single check
—a single check, long one check, for the entire amount of the payroll and deposits that amount
—the check—into the payroll imprest account.
Payroll imprest account—and again, so the payroll imprest account is a specific, unique, and
dedicated—yeah, specific, dedicated account for payroll and not for anything else.
So the employee paychecks are drawn against this account.
Funds must be transferred from the general cash account of the organization to the imprest
account before any of the paychecks can be cashed.
So it means, as an employee, the employee will encash the check against this payroll imprest
account.
Now, if that account has no amount, if it has no balance, for any reason—for any reason
whatsoever, congratulations—then the employee will not be able to encash the check.
And even if the salary is to the ATM card, then the employee will not be able to withdraw any
amount from the account.
So therefore, the employee has to be sure that the payroll imprest account has already been
credited before they can withdraw.
And the Human Resources Department or the Cash Disbursement Department, they have to
collaborate, coordinate very closely, so that they can credit the account before any of the
employees can try to withdraw from the bank.
They have to credit the payroll imprest account first before they can distribute any of the
paychecks or any of the payslips.
Because once the employee has received the payslip, then automatically they will assume that
they can already withdraw amounts from their salaries.
Then, the Prepared Cash Disbursement Clerk then sends a copy of the check, along with the
disbursement voucher of the payroll register—with the payroll register and a copy of the
check and the voucher and the payroll register—to the Accounts Payable Department.
So, a bundle of documents: the copy of the check, the disbursement voucher, and the payroll
register.
After they have already examined these documents, then the Accounts Payable function will
file these documents.
Finally, the Cash Disbursement Clerk will prepare a journal voucher, and that will be sent
to the Update General Ledger function for the updating of the general ledger account.
So let’s go to the last task now:
We have the Post to the General Ledger—the Update of the General Ledger.
The Update General Ledger function has received the Labor Distribution Summary from the
Cost Accounting function.
It has also received the Disbursement Voucher with the Journal Voucher from the Accounts
Payable, and also the Journal Voucher from the Cash Disbursement function.
So, tatlo 'yan—three originating departments/documents that are needed to update the
general ledger.
Again, to repeat it:
We have:
1. Labor Distribution Summary from the Production Department
2. Journal Voucher from the Accounts Payable Department, which is the disbursement from the
voucher packet
3. Journal Voucher from the Cash Disbursement, which is evidence of the cash being credited to
the Payroll Imprest Account
So that three has to be present before—it has to be received by the General Ledger function
before they can update the general ledger account.
And of course, we know the journal voucher—journal entries there—and we’ll have to look at
—we’ll have to go back to the basic accounting to review, if you have forgotten, the journal
entries to the general ledger account related to the payroll function.
Now, the physical payroll is similar—that’s similar to the paragon conceptual system.
The conceptual system has:
 Prepay payroll
 Distribute paycheck
 Prepare AP
 Prepare cash disbursement
 Update the GL
So lima 'yan—one, two, three, four, five.
All of these—because they are the conceptual tasks—they have to be present also in the
physical system.
That is really the case for the basic technology parallelism.
On the slide, you can see that such functions are also present:
 We have the payroll, preparing the paycheck here
 We also have the payroll register here, that goes to the Accounts Payable
 The main function of Accounts Payable is to distribute—or prepare—Accounts Payable
 Then, the Accounts Payable Department will document that by preparing a voucher
The Paymaster will distribute the paycheck here.
The Paymaster distributes the paycheck.
So, ‘yun ‘yung task niya—distribute the paycheck.
Then you have to prepare AP, and then prepare the cash disbursement, and update the
general ledger.
They are all here:
 Cash Disbursement will prepare the cash here
 So here, prepare the check here and sign, and send to the bank for crediting to the Payroll
Imprest Account
And of course, the function of the General Ledger is to record all these transactions from the
three sources:
1. The Labor Distribution
2. The Voucher from Accounts Payable
3. The Journal Voucher from the Cash Disbursement
...payroll process is integrated into the human resources management system, and in that
case, then the human resources management system also captures information about the
employees. So, about the employee—we have the employee records, which contains the data
coming from the personal action form or the personal action document or the employee
action form.
Then we also have outputs of this system—the labor usage file and also the time and
attendance file, which are inputs to the work in process accounts. That is also part of the data
that goes into the general ledger, and also the time and attendance file actual that goes into the
payroll processing, so it—in a payroll subsystem and human resources management system.
And as we have said, this payroll processing usually is integrated into the HR management
system (HRMS).
The data processing here that happens at the end of the work period—the following tasks are
performed in batch processes:
1. Labor costs are distributed to the various work in process—this one here, this bit here—and
they are posted to the work in process accounts.
2. The online labor distribution summary file is created. Copies of the file are accessible from
terminals in the cost accounting and general ledger departments.
3. The payroll is calculated by the system, and an online payroll register is created from the time
and attendance. Then, the payroll register is also electronic, and they can view this—they are
accessible from the system.
The payroll register file is accessible also from the AP and cash disbursement departments, so
they will not refer to physical documents anymore. They can just refer to the electronic data that
is in the payroll processing system.
4. The employee records file is updated—this is what we see here. The paychecks are prepared,
signed, and distributed to the employees.
Again, we can see that here—you can see that here—the signing of the... okay...
So the cash disbursement function should be responsible for generating the check, and then
the check will go to the employee, yeah. So the check goes to the employee, to the paymaster,
and then the funds sufficient to cover the full amount of the net take-home of the employees
are transferred to the payroll imprest account.
So it should be the cash disbursement function to update the bank with the file for the payroll
imprest account.
Then, the digital journal vouchers are entered into the journal voucher file, and then the
system automatically updates the general ledger from the journal voucher. And so the journal
voucher file here, you can see here, are electronic.
So the journal voucher from the payroll processing generates data for the voucher file (JV:
journal voucher), and then this becomes the basis for updating the general ledger. All those
are done automatically by the system.

We go now to the risks and control of the payroll process.

Now we have three risks here:
1. Inaccurate recording of payroll transaction in accounts
2. Misappropriation of cash through payroll fraud
3. Unauthorized access to payroll records and confidential employee data
And what are the controls that we can put so that these risks are controlled, mitigated, or
eliminated?

For the first risk: Inaccurately recording payroll transaction in accounts

Some possible errors in this kind of risk are the following:
 The time and attendance data are incorrectly calculated
 Wages payable go unrecorded or are recorded in the wrong period—so major delays or
recording it in the wrong period
 Employee earnings and cash payments are inaccurately posted to employee records or are
posted to the wrong employee—that’s a very unfortunate risk, if the wrong employee receives
the wrong salary
 The payroll register, accounts payable, and cash disbursement amounts are incorrectly posted
to their respective GL accounts

Now let’s go look into the controls that would prevent or eliminate these from happening.
First, we have the physical control, and then on the right side, we have the IT controls.

In terms of physical controls:

We have accounting records, which—this control has the objective of maintaining an audit
trail. The trail should be adequate for tracing a transaction from its source document to the
financial statements.
The audit trail for payroll includes the following documents:
1. Time cards
2. Disbursement vouchers—they're part of the audit trail
3. Journal information—which comes from the labor distribution summary and the payroll
register itself
4. The subsidiary ledger account—which contains accounts for the employee records, work in
process, and various expense accounts
5. And of course, the general ledger account—an indispensable part of the audit trail. This
contains:
 o The payroll control account
o The cash control account
o The payroll clearing or imprest account
Those are the three accounts affected by the payroll process, and the audit trail should be able
to record anything that occurs affecting these accounts.

Let’s look at another control here.

We have to remember that the auditor’s concern regarding payroll—this is the auditor’s
concern, okay, and not the accountant’s concern.
The auditor’s concern regarding payroll processing is that salary obligations are accurately
and completely recorded and matched to the appropriate period.
Those are the concerns of the auditor, which of course should be done appropriately by the
accountant.

Second control against inaccurately recording payroll transaction in

accounts:
Independent verification
The following are examples of independent verifications happening in the processes that we
have described:
1. Independent time and attendance verification—before submitting time cards to the payroll, the
supervisor must verify their accuracy and sign them. So the supervisor signature should not be
missing from any of the daily time cards or daily time records of the employees.
2. Accounts payable—the accounts payable clerk verifies the accuracy of the payroll register.
That’s why they receive a copy of the payroll register from the payroll function—so that they
can verify the accuracy before creating a disbursement voucher or transferring the funds to the
imprest account. They should be satisfied about the accuracy of the payroll register before
transferring any amount.
3. General ledger function—this function provides verification of the overall process, yeah. Palagi
siyang overall process, by reconciling the labor distribution summary and the payroll
disbursement voucher.
That’s specific to the payroll process.
Of course, there should be other documents that it verifies when they come from other systems.
For example, we have in the purchasing inventory purchasing system. They also have to look
at the receiving report to verify independently that the transaction really happened and was
recorded in the correct amount before they can be recorded into the general ledger master
file or the account.
Then let’s look at the IT control command—IT controls.
We have the data input edits. Again, we have already discussed that during the discussion of the
purchasing system, and we always assume that the transaction data are dirty and contain various
errors.
So in the case of payroll processing, what’s to be construed as dirty are the time and
attendance and employee action data. They could be dirty—they may contain transposed
digits, invalid employee numbers, invalid pay rates, and other clerical errors.
If they are not detected and the payroll process is executed with such errors, then these errors
will corrupt the master files of the system.
Input controls verify the integrity of transaction data being entered into the application.
Erroneous payroll data can cause:
 corruption in the work in process accounts
 corruption in the employee records
 corruption in the employee payroll register
Data entry errors made by clerks during the encoding are particularly problematic in mobile
and/or distributed workforce environments, in which the employees are directly entering time
and attendance data into the system.
So major problem iyan when the employees are directly entering time and attendance into the
system.
Edits include:
 checks for missing data
 numeric/alphanumeric data tests
 tests for invalid data values
 check digits on employee account numbers
All of this we have discussed during the inventory purchasing system. This will reduce the risk
of data entry errors by clerks and remotely located employees.
Then we have the following processing controls that should be built into the application logic
in conjunction with the data input edits.
So in conjunction with that, we also must have error messages.
Any mismatch when posting time card or personal action data to employee record should
produce an error message to the computer operator.
If there are no error messages, then the errors will never be corrected. So there should be a
mechanism for informing the computer operator that data coming into the system is dirty.
Then we have file backup. Of course, we know the value of file backup, and that reduces the
risk of data loss.
Then we have automated posting to accounts.
In this control, the record-keeping function, which in basic technology systems relies heavily
on human involvement, is automated in advanced technology systems.
So the general update function, to reduce the errors of using or posting constructions into
incorrect accounts and with incorrect amounts—to reduce that, then we should use automated
posting.
As we have discussed a little while earlier, the voucher file is an electronic file and makes an
update to the general ledger—and that is an example of automatically posting to the general
ledger accounts.

Now the second risk is misappropriation of cash through payroll fraud.

And it comes in two forms:
1. Payment to a non-existent (phantom) employee
2. Overpayment to an existing employee
Let’s look at the controls that can mitigate these two forms of fraud in payroll.

First form of fraud:

This involves someone inside the organization—might be a supervisor or a manager—
creating a phantom employee.
Because only the supervisor and managers have access to create employees, they are usually the
perpetrators of this fraud.
So they create a phantom employee, submit time cards for the employee, and ultimately receive
the paycheck.
The phantom employee may be a complete fabrication, or alternatively, may be a former
employee who has left the organization but remains on the employee file.
So pwedeng ang phantom employee ay:
 a complete fictional character, or
 an employee who was employed before by the organization but already left, and they failed to
remove the employee from the employee master file.

Second type: Overpayment of an employee

This type of fraud involves overpayment to a valid employee.
How do they do this?
They inflate the hours worked on time cards.
So let’s say they have 40 hours worked—then they put it as 50.
This is particularly a problem where:
 employees self-report
 or where supervisor control is inadequate
This fraud is usually perpetrated under conditions where:
 the employee prepares or self-reports their hours worked
 the supervisor does not check the DTR (daily time record) very closely
 there is no time recording technology

To mitigate this type of fraud, we have the following physical and IT controls:
1. Transaction Authorization
The personal action form helps payroll keep current the employee record.
So, if someone has left the organization, then there should be an employee action form that has
to be filled up by the authorized employee, and this becomes the basis for updating the
employee master file.
The employee action form describes:
 addition
 deletion
 other changes to the employee file
As already discussed, this is an important authorization control.
So, only authorize payroll to current and valid employees, such that only the time cards of
current and valid employees are processed.

2. Segregation of Duties
Now the following segregation of duties can reduce the risk of various payroll fraud:
 Timekeeping function vs. personnel function should be separated.
The personnel function provides the payroll function with pay rate information for
authorized hourly employees.
Typically, an organization will offer a range of valid pay rates based on:
o experience
o job classification
o seniority
o merit
If the production department were to provide this information, an employee may be
able to submit a higher rate and perpetrate fraud.
So this kind of situation might be prevented when timekeeping and personnel
functions are separated.

Let’s put that—personnel and then accounts payable.

For purposes of operating efficiency, the payroll function performs certain tasks that
contradict basic internal control objectives.
Specifically, the payroll function has both:
 asset custody—they have in possession the paychecks of the employees
 and record-keeping responsibility—the employee payroll records
These are the specific authorizations of the payroll function.
Now, this creates the opportunity for individuals to:
 set up a false wages payable liability to themselves or a conspirator
 approve payment
 and then write the check
To prevent this, control is returned to the system by assigning accounts payable the
responsibility of reviewing the work done by the payroll and approving payment. So,
accounts payable must be separate also from the payroll function so that will not allow anyone
from—from setting up a liability that is payable to himself.
Yeah. Again, we have the use of the independent pay master to distribute checks rather
than the employee supervisor, so that the pay master will be very strict in giving all the
checks to those employees who are—who are in the current and valid list name channel.
Now the second, the third control: physical control is supervision. Now sometimes the
employees clock in for another worker—yeah—who is late or absent, especially when the
daily time record is only in the form of a—or in the form of writing, you know. So that
London time in time out—yeah.
For biometrics, this is hard to perpetrate because you need the physical employee to log in by
himself—yeah.
Now, supervisor should observe the time keeping process and reconcile the time cards with
actual attendance. So the supervisor should, from time to time, look at how the employees
are logging into the Alibaba—on my logbook if there's a logbook. The supervisor should look
into how the employees are writing into the logbook. And so that’s one good control.
And then look at the—at the end of the payroll period, the supervisor should also look at the
daily time record and compare that with the days that the employee is absent, you know.
I'm going to observe an absence of—let's say—July 6, volatility. Then later finally employee
time record, yeah—then log out. So that should be a flag for the supervisor now that there is a
fraud here on July 6—but young daily time record.
Then we have the access control.
How does access control prevent misappropriation of cash? So the assets associated with
the payroll system are labor and cash. Both can be misappropriated through improper
access to accounting records.
As we have discussed in our previous discussion of the inventory purchasing system, a
dishonest individual can misrepresent the number of hours worked on the time cards and
thus embezzle cash.
Similarly, maintaining controls over access to all journals, ledgers, and employee data—and
this data should be accessed only by authorized personnel.
And any source document in the payroll system—source document—should be also kept
secure in a location, and they are very important, as it is in all transaction processing
systems.
So access to such records—the journals, ledgers, employee data, and even the source
document—should be limited to those who are only authorized to access them.
Now, look at the ID control summon.
We have the input controls in a mobile and distributed workforce that is prevalent now—
audition arena—because of the pandemic.
This environment is something in which the employee self-reports and directly enters time
and attendance into the system. The organization is at risk from payroll fraud.
Input controls to reduce these risks include:
1. Limit test to detect excessive hours reported per period.
2. Biometric scanners, swipe cards, and PINs will reduce the risk of payroll fraud by ensuring that
individuals clocking into the system are valid employees.
3. Automated tests to validate employee time cards against a valid and up-to-date employee file.
4. Paycheck direct deposit options for employees.
So these are input controls that can be built into the IDE environment.
Now let’s look at the last risk of the payroll process, and this is the unauthorized access to
payroll records and confidential employee data.
We have—we listed only IT controls here.
1. Passwords. Of course, passwords should be implemented on department computers
to reduce the risk of unauthorized access to payroll files.
The system logic should require and prompt users to change passwords regularly,
periodically—as was already mentioned also in our previous discussion of inventory
systems, inventory purchasing systems.
 And only strong passwords consisting of a combination of characters, numbers, and
special characters should be accepted—yeah.
2. Then we have the multi-level security.
This is a control in which security is achieved by means of segregation of duties in an
integrated data processing environment where multiple users simultaneously access
a common central application—yeah.
So this technique—HR, AP, and cash disbursement, cost accounting, and general
ledger personnel are limited in their access based on the privileges assigned to them.
So this is a role-based access control wherein many personnel from different
departments can only access the information that is relevant to their function.
So that’s one of the ID controls.
And that’s the end of the risks and controls in the payroll system.
And then let’s discuss also outsourcing of the payroll function, which is a common practice
nowadays. My—even my sister-in-law is involved in the preparation of payroll of employees
in the United States and even other countries, and also in—they prepare the payroll here in
the Philippines and submit the payroll register to their clients—union and sister-in-law ko.
So many organizations outsource their payroll function by transferring all payroll
processing tasks to a third-party provider, usually a cheaper third party which has
employees that can be paid on—by a cheaper currency, like for example pesos if you compare
it against dollars.
The service provider collects time and personal action data—yeah—so you can young third-
party service provider, and then also calculates the payroll, withholds the taxes, deposits
funds to the employee accounts, and provides the W-2 forms at the year end—or the
withholding tax form and W-2—yeah.
So these are usually the tasks that a third-party provider performs.
Now, alternately, distributed workforce employees may submit their time and attendance
data directly to the service provider by laptop computers or even by smartphones.
Employees may also access their accounts online and make changes to withholding, medical
savings accounts, and retirement plans.
To accomplish this function, the service provider needs access to sensitive internal
information. So that was one of the downsides of outsourcing: you always reduce your
security in terms of accessibility of information to third parties.
So such sensitive internal information is required by the third-party service provider, and
this includes:
 Social Security numbers,
 Even the employee bank account,
And these third-party providers will have access to those information.
And then these third-party service providers may also require the client VM to set up a
bank account and allow the payroll company to access it.
So the funds deposited in the bank account cover the total payroll, fund transfers to state
and other tax authorities, and the service provider’s fees.
So doniyan young third-party payroll outsourcing companies—a bank account.
The advantages of outsourcing the payroll function is, of course, the primary one is cost
saving, and it’s accomplished by avoiding an in-house payroll department—wherein you will
pay the employees there for the responsibility or for the job—for the task of maintaining the
payroll and preparing the payroll.
There are risks to the outsourcing, as already mentioned, and one of them is the less security of
your information.
Another is when the service provider could also fail to perform, especially when the service
provider is in financial trouble. It could not be—it could not render the service anymore at that
level that was agreed upon on account in the contract.
And then the service provider might also have a flawed internal control that could allow
material errors or fraud to be perpetrated or to be committed by the service provider
employees.
So those are some of the—some of the risks.
One other risk is that when—at the outset—the service fee is very minimal, off the offset. But
later you become dependent on the service provider.
Now the service provider has the client by the neck, and therefore, when the client is very
dependent on the service provider, then the service provider could demand higher fees that
could be—that might not be cost beneficial to the client anymore.
Now—so those are some of the outsourcing advantages and risks.
And that ends our discussion of the payroll process, and the end of Chapter 5, Part 2, and
also the end of the Expenditure Cycle.
Our next discussion will be the Revenue Cycle—the discussion of the subsystems: Sales
Order Processing and Cash Disbursement.