Question

Payroll Expense Handout

You work for the accounting firm of D&E and are currently assigned to the audit of Kiwi Company for the year ended 6/30/2013. You have been assigned to audit payroll expense which totals $68,257,321.01 for the year ended 6/30/2013. You know that payroll expense has been assessed as low risk based on favorable results from the tests of controls. Because risks are low and plausible relationships exist that are sufficiently stable and predictive, the auditors plan to rely on substantive analytical procedures alone (i.e. tests of details will not be performed).

D&E has set the tolerable difference as the lower of +/-5% of the client’s recorded amount or tolerable misstatement. You know that materiality for the audit has been set at $7 million and that tolerable misstatement for payroll expense has been set at 50% of materiality. You are also aware from your conversations with the client that employees received an average raise of 5% this year and that the average number of employees for FY 2013 was 2,305. You also know from looking at last year’s work papers that for the year ended 6/30/2012 payroll expense was $59,290,202 and the average number of employees was 2,150.

1. Use the information provided to determine if you can conclude that payroll expense for the year ended 6/30/2013 is complete and accurate.

2. How does your answer change if payroll expense for the year ended 6/30/2013 is $71,257,321.47?

3. What if payroll expense for the year ended 6/30/2013 is $71,257,321.01 and a one time severance payment of $2 million was made during FY 2013. How does this affect your audit work? What is your conclusion regarding payroll expense now?

4. How could you corroborate the average raise?

Answer 1

a)
Last year's payroll expense	$        59,290,202
Last year's employees	2150
Average salary per employee	$                27,577
Yearly rise of 5%	$                28,956
Current year number of employees	2305
Current year's estimated payroll expense	$        66,742,843
Current year's Actual payroll expense	$        68,257,321
variation	2%
The said variation is within the acceptable limit of tolerance. Therefore, substantial audit procedures are sufficient.
b)
Current year's Actual payroll expense	$        71,257,321
variation	7%
The variation exceeds the tolerance level of 5%, but for the payroll expense tolerable misstatement level is 50% of Materiality.
The materiality level of audit is $7 mn, 50% of it being $3.5 mn.
The said variation is within the acceptable limit of tolerance. Therefore, substantial audit procedures are sufficient.
c)
Current year's Actual payroll expense	$        71,257,321
One time severance payment	$          2,000,000
Total	$        73,257,321
The one time severance payment is made for the employees leaving the organization, sample tests can be performed for it and concerned controls can be checked.
The rise in employee cost above the 5% estimated level is due to rise in level of salary as the employee is promoted. The slab changes and the salary also increases.