CHAPTER 10 SUMMARY

 Introduction to Payroll and Fixed Asset Processes. The chapter addresses the acquisition and
maintenance of valuable resources used in a business, namely, human resources and capital
resources. Specifically, the processes involve: (1) paying wages and salaries to employees (payroll),
and (2) accounting for property, plant and equipment (fixed assets). Payroll processes include the
policies and procedures that employees follow in acquiring and maintaining human resources,
capturing and maintaining employee data, paying employees for time worked, and recording the
related cash and payroll-related liabilities and expenses. Fixed asset processes include the policies
and procedures related to purchasing property, capturing and maintaining relevant data about the
assets, paying for the assets, and recording the related assets, depreciation, and other expenses,
gains or losses. These processes are triggered by events that tend to occur irregularly, such as the
hiring or firing of an employee and the purchase or disposal of a machine. This means that they
have features of both routine and non-routine processes.

 Payroll Processes. The payroll process is initiated when employees are hired by the company. The
hiring of employees is typically considered a non-routine process. Accordingly, members of
management are required to specifically approve all employees hired by the company. The Human
Resources department is responsible for maintaining records for each job and each employee within
the organization, as well as tracking job vacancies and supporting the company’s recruitment efforts.
Personal information must also be maintained, such as the employee’s address, social security
number, employment history, etc. One unique feature of the information contained in an individual
personnel file is that it is accessed frequently, but changed relatively infrequently.

Once an employee’s personnel file is complete and the term of employment has begun, routine
activities take place regarding payroll processing. A time sheet is the record of hours worked for an
employee for a specific payroll period. At the end of each pay period, employees submit completed
time sheets to their departmental supervisors for approval. Once time sheets have been approved,
they are forwarded to the payroll department, where the computation is performed to determine
the amount of net pay to be included on each paycheck. A payroll register is a complete listing of
salary or wage detail for all employees for a given time period. A payroll voucher authorizes the
transfer of cash from the company’s main operating account into the payroll cash account. Before
signed paychecks can be given to employees, the company must be sure that it has sufficient cash on
hand to cover the total amount of the payroll. A payroll disbursements journal is prepared to
provide a listing of all paychecks written, in check number sequence, with the total supporting the
amount of payroll funds transferred to the payroll bank account. Another responsibility of the payroll
department is the preparation of payroll deposits and the related tax forms.

 Controls and Risks of Payroll Processes.

o Authorization of Transactions. Departmental supervisors must be certain that all time sheets
represent actual time worked by currently active employees. Employee personnel files should
contain evidence of proper authorization for various payroll amounts. Included in the files
should be approval for pay rate adjustments, hiring, promotion, and termination (authorized by
management) as well as approval for all deductions (designated by individual employees).
Designated members of management should be given authority for the approval of the
paychecks, noted by their signatures on the face of the check.

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 o Segregation of Duties. Payroll functions such as authorizing, timekeeping, record keeping, and
custody of the paychecks should all be separated. Authorizing new employee hiring and
maintaining personnel files in HR, should be separate from the payroll time reporting and
record keeping functions, performed primarily by the payroll, cash disbursements, and
general ledger departments. In addition, employees in each of these departments
should not have check-signing authority and should not have access to the signed
checks or cash account. If a paymaster is used to distribute paychecks to employees,
he or she should not be responsible for any of the related payroll accounting functions
and should not have custody of cash.
o Adequate Records and Documents. Personnel files and the payroll register are the fundamental
records in the payroll process. There are numerous forms and reports that must be filed at
designated times throughout the year with various taxing authorities and other organizations to
summarize and remit amounts withheld from employees’ paychecks. The practice of issuing
paychecks on pre-numbered checks from a separate bank account is another control that helps
to create clear records of the payroll transactions.
o Security of Assets and Documents. Access to personnel files and payroll records should be
limited to designated persons. Electronic controls and physical controls should be in place to
ensure the confidentiality of payroll information. Access to payroll cash should be limited to the
authorized paycheck signers. Blank payroll checks should be physically protected. Unclaimed
paychecks should not be maintained by the human resources or payroll functions.
o Independent Checks and Reconciliations. The number of hours reported on time sheets should
be reconciled to the payroll register, and time sheets may be reconciled with production reports.
The payroll register should be reconciled to the general ledger on a regular basis. Someone
separate from the payroll processing functions should reconcile the bank statement for the
payroll cash account on a monthly basis.
o Cost/Benefit Considerations. The more employees a company has and the more frequently it
pays its employees, the more important it becomes to implement strong internal controls
surrounding these processes. Conditions that may warrant the need for especially strong
controls include the existence of irregular pay schedules, complex withholding arrangements,
frequent changes in pay rates, or a decentralized payroll function.

 IT Systems of Payroll Processes. Even the smallest companies may find it worthwhile to enhance
their payroll processing with computerized systems. Routine payroll processing occurs at specified
time intervals – on weekly, bi-weekly, or monthly pay dates. Because of this infrequency, and the
sequential nature of the payroll process, many companies find that batch processing is well-suited
for payroll activities. The timekeeper can accumulate all time sheets and enter them in the
computer system in batches. An alternative to manual batch accumulations is the use of electronic
timekeeping devices, such as time clocks or badge readers. These systems accumulate data
throughout the time period and automatically calculate batch totals. The data batches are then used
to prepare paychecks and the payroll register. With integrated systems, real-time personnel data is
available, and the general ledger and production system can be automatically updated at the end of
the payroll period. The Internet can be used for employees to send relevant information to their
supervisors for timely updating of time and attendance records. In some cases, employees may even
make changes to their payroll deductions via the Internet or intranets, and their pay stubs can be
sent to them via e-mail. The World Wide Web also provides many resources for employees in the
human resources and payroll departments, such as access to current legislative changes that may
affect payroll deductions. Another popular use of the Internet involves the outsourcing of payroll

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 services. Many companies use independent, Internet-based service providers to handle their payroll
processing. IT systems also allow electronic transfer of paychecks, and companies can use electronic
transfers to make payments of tax deposits and other payroll withholdings.

 Fixed Asset Processes. A fixed assets pool can include vehicles, office equipment and computers,
machinery and production equipment, furniture, and real estate (such as land and buildings). For
many companies, the investment in fixed assets is often the largest asset reported on the balance
sheet. Companies continually add to or replace items in their fixed assets pool as the old items
become used, worn, or outdated. Due to this frequency of change, it is important that clear
accounting records exist so that the status of fixed assets accounts can be determined at any point
during their useful life.
o Fixed Assets Acquisition. Acquisitions of fixed assets are carried out in much the same way as
inventory purchases described in Chapter 9. Two notable differences here are the placement of
the acquired assets in the user department (rather than a warehouse), and the inclusion of a
fixed assets department (instead of the inventory control department). Fixed assets acquisitions
are generally initiated when a user department identifies a need for a new asset, either to
replace an existing asset or to enhance its current pool. Large fixed asset acquisitions would be
regarded as non-routine transactions that require specific authorization. Some companies
require that large cash outlays for fixed assets be included in the capital budget. In addition, the
company may require that an investment analysis or feasibility study be conducted in order to
assess the merit of the purchase request in terms of the relative costs and benefits. Upon
receipt, new fixed assets are inspected by the receiving department. A receiving report is
prepared and the items are sent to the user department for installation and use. Accounts
payable and cash disbursement activities are also initiated at this time, in the same manner as
for the expenditure process. In addition, a fixed asset subsidiary ledger will be prepared so that
a detailed listing of the company’s fixed assets is available.
o Fixed Assets Continuance. The fixed assets continuance phase refers to the processes of
maintaining accurate and up-to-date records regarding all fixed assets throughout their useful
lives. New costs should be capitalized whenever the expenditure causes the fixed asset to
become enhanced, either in terms of increased efficiency or an extended useful life. Fixed asset
accounting depends on the use of estimates for useful life and estimated salvage value. The use
of estimates also means that recorded amounts may need to be changed as time passes and
new information is discovered that renders the original estimates misleading. The fixed assets
subsidiary ledger may need to be adjusted from time-to-time as the company makes changes in
the estimates that feed its depreciation calculations. A depreciation schedule is the record
detailing the amounts and timing of depreciation for all fixed asset categories except land.
o Fixed Assets Disposal. When an asset becomes old, outdated, inefficient or damaged, the
company should dispose of it and adjust its records accordingly. Disposing of an asset may
include selling or exchanging it, discarding it (throwing it away), or donating it to another party
who may be able to use it. There are four basic steps in accounting for the disposal: (1) date of
disposal is noted and depreciation computations are updated through this date; (2) disposed
assets are removed from the fixed asset subsidiary ledger; (3) depreciation accounts related to
disposed assets are removed from depreciation schedule and fixed asset subsidiary ledger; and
(4) gains or losses are computed.

 Controls and Risks of Fixed Asset Processes.

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 o Authorization of Transactions. Designated members of management should be assigned
responsibility for authorizing the purchase of new fixed assets, as well as the disposal or transfer
of existing fixed assets. In the case of high-dollar items, there should be a strict approval process
requiring the authorization of top management or the initiation of the capital budgeting
procedures. These strict procedures for purchasing fixed assets should include at least three
formal steps: (1) investment analysis; (2) comparison to the capital budget; (3) review of the
proposal and specific approval by the appropriate level of management.
o Segregation of Duties. Custody of fixed assets needs to be separate from the related record
keeping. Adequate segregation of duties reduces the risk of undetected errors or fraud by
requiring separate employees to handle the different transactions that occur in each phase of
the asset’s life. Ideally, those with custody of fixed assets should not perform any duties in the
purchasing, receiving, or fixed asset accounting departments. In addition, key IT functions such
as programming, operations, data input, and security should be segregated from each other and
from the related accounting duties.
o Adequate Records and Documents. Fixed asset subsidiary ledgers control the physical custody,
cost, and accumulated depreciation of fixed assets. Like the expenditures process for inventory
purchases, fixed asset purchases should be supported by a purchase requisition, PO, receiving
report and vendor invoice. Fixed asset tags may be used to account for the numerical sequence
of items acquired. Management should prepare and follow a capital budget.
o Security of Assets and Documents. Adequate supervision is important for controlling the
security of fixed assets because fixed assets tend to be located throughout the company where
many employees could have access to them. Physical controls should also be in place to protect
fixed assets from unauthorized use, and electronic controls are needed to control access to
automated records. A company should also protect its investment in fixed assets by maintaining
adequate insurance coverage and conducting regular preventative maintenance procedures.
o Independent Checks and Reconciliations. Actual fixed asset expenditures should be compared
with the capital budget, and additional approval should be required if budgets are exceeded. In
addition, periodic counts of fixed assets should be made by someone not otherwise responsible
for fixed asset-related activities, and the physical counts should be reconciled to accounting
records. Also, performing independent verifications to match key purchasing documents and the
related accounts payable reports may uncover errors or fraud within these records.
o Cost/Benefit Considerations. Additional factors that indicate the need for strong internal
controls over fixed asset processes include large quantities of fixed assets, large quantities of
fixed asset changes (such as additions, transfers, and disposals), high likelihood of obsolescence
due to technological changes, the existence of assets under capital leasing arrangements, and
widely dispersed fixed asset locations.

 IT Systems of Fixed Asset Processes. Due to the abundance of fixed asset data, the time-consuming
and tedious requirements for tracking changes, and the intricacy of the tax laws, most companies
can justify the investment in computerized systems dedicated to fixed asset accounting. IT systems
have evolved into simple, customized applications that may be integrated with other accounting
software. These fixed assets applications automate the processes of creating and maintaining the
financial records and tax documents required for adequate fixed assets management. With
automated fixed asset management systems, information related to fixed asset acquisitions and
changes to existing assets are input into the software by an employee in the fixed asset accounting
department. This can be done in real-time or in batches, depending upon the company’s reporting
needs and the volume of transactions. For most companies, fixed asset acquisitions are considered

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 non-routine processes because they require specific authorization and are carried out infrequently.
Thus, the online approach is most reasonable.

 Ethical Issues Related to Payroll and Fixed Assets. The payroll system is the target of several types
of fraud schemes. The most common means of defrauding a company involves dishonest
employees’ falsification of time sheets in an effort to receive excess compensation. Misuse of sick
days or vacation days results in employees taking more time off work than they have earned. These
types of frauds are actually a form of theft from the company; since the employees receive unearned
compensation, they are actually stealing the company’s cash and receiving it in their paychecks. A
ghost employee is someone who receives a paycheck who does not actually work for the company.
It is often initiated by the unethical conduct of someone within the company’s payroll function.
Bogus documentation is typically created in order to circumvent the company’s internal controls and
carry out these types of fraud.

Managers may turn to unethical conduct in fixed asset accounting in order to massage its accounting
numbers. This unethical practice is commonly referred to as earnings management. Fixed assets are
one area where earnings management may be prevalent, due to the judgmental nature of the
underlying data. This could occur through extending the lives of fixed assets beyond their
reasonable usefulness so that the cost of the assets is spread over a greater length of time,
increasing the amount of estimated salvage value, or misclassifying repair and maintenance
expenses as capitalized costs.

 Corporate Governance in Payroll and Fixed Assets. Payroll funds and fixed assets do not belong to
managers of the organization. Managers are stewards, or temporary managers of those funds.
Corporate governance policies and procedures must be in place to ensure that funds are expended
only to benefit the organization and its owners; not to benefit the managers or employees
personally. In addition, corporate governance policies should prevent a manager or employee from
using fixed assets for personal use.

60. Glazer Company is a small manufacturing firm with 60 employees with seven departments.
Required: Describe any improvements you would suggest strengthening the payroll internal controls at
Glazer.

Currently, the department managers hire employees and distribute paychecks. This gives managers the
opportunity to create fictitious workers and have custody of those checks. The improvement would
include two things. Final hiring approvals should be in the HR department, not the department
managers. Paychecks should be distributed by independent paymasters, not the department managers.

Currently, the pay rate is written on the employee W-4 by the department manager. The HR department
should determine pay rates.

Timecards are now kept in a holder near the door and workers keep them all day. This gives employees
too much opportunity to misuse timecards. They can easily be stolen, altered, or use for “buddy punch”
where an employee clocks in for his buddy. Time cards should be more secure or the company should
use a more advanced solution such as automated time keeping through ID badges or biometric time
recording.

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 Currently, the timecards are removed from the holder on Friday and taken to payroll by “an employee
who is not busy”. Two improvements are needed. First, the supervisor should0. review and approve each
time card. Second, there should be a designated person charged with delivering time cards to payroll.
Rather than the manager calling the payroll department to report pay rate changes, there should be
written documentation of pay rate changes using a personnel action form. Without such documentation,
there is no audit trail of rate changes. In addition, a manager may suggest rate changes, but final
approval should occur in the HR department.

The company should use an imprest payroll account for paychecks rather than the regular checking
account. There is no mention of the cash disbursements department approving a check from the regular
account to be deposited in the payroll account. This should occur if a separate payroll account exists.

63. The Crishner Company has the following processes related to fixed assets. Required:
Describe any improvements you would suggest strengthening the fixed asset internal controls
at Crishner.

There should be a more formal approval process that would include identification of costs and benefits, a
discounted cash flow analysis, a specific authorization from a high-level manager. There should be
established expectations of return on investment that assets must be expected to achieve before
purchase is approved. A bid process should be established for assets of high value. When practical, fixed
assets should be delivered to the receiving department. This may not be possible for fixed assets such as
those that must be installed at the user location. Expected life and salvage values should be estimated
for each asset instead of using the same values as the previous purchase.

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