Problem

HOLLY COMPANY—PAYROLL SYSTEMS (SMALL COMPANY USES MANUAL PROCEDURES WITH PC SUPPORT) H...

HOLLY COMPANY—PAYROLL SYSTEMS (SMALL COMPANY USES MANUAL PROCEDURES WITH PC SUPPORT)

Holly Company is a small family-run manufacturer of wooden garden furniture, sheds, and storage containers. The company is located outside Pittsburgh, Pennsylvania, and currently employs 185 workers. Much of the manufacturing work involves casual labor in the lumberyard and sawmill. The work is hard, and employees often move on after a few months.

Although the company does not issue audited financial statements, its owner has retained your firm to conduct a review of its internal controls. The focus of your review at this time is the payroll process.

Payroll Processing System

Holly employees use a time clock in an unsupervised area to record their time on the job. The timekeeping clerk tries to monitor the process but is often distracted by other duties. Every Friday, the shop foremen collect the time cards for their subordinates, review and approve them, and deliver them to the payroll clerk.

The payroll clerk uses a stand-alone PC to record the employee earnings in the employee records and print a hard-copy payroll register. The payroll clerk sends one copy of the payroll register to the accounting department. The clerk then files the time cards and a copy of the payroll register in the payroll department.

The accounting department clerk receives the payroll register, reviews it for accuracy, and uses the department computer to record the transaction by posting to subsidiary and general ledger accounts, including wages expense, cash, and various withholding accounts. The clerk then prints the hard-copy checks, which are written on the general cash account. The clerk signs the paychecks and sends them to the foremen who distribute them to the employees. Finally, the clerk files the payroll register in the department.

Required

a. Prepare a data flow diagram of the current system.

b. Prepare a system flowchart of the existing system.

c. Describe the uncontrolled risks associated with this system as it is currently designed.

d. Describe the physical and IT controls needed to reduce the risks identified in “C” above.

Solution 1

Step #1 of 5

Holly Company- Payroll System

Holly Company is small-scale company which manufactures some items. Another firm which is responsible to conduct a review of internal controls focuses on the Payroll process of Holly Company.

Step #2 of 5

Data Flow Diagram:

Data flow diagram (DFD) represents the flow of the data in the system with the users processing on it and its store. Following DFD showing the current system of Holly Company:

• In the above DFD, Timer, Record timing is used to record the total number of product produce by Production department in specific time period after that shop foreman record the time card that deliver to the payroll clerk.

• The payroll clerk is used to record the earning of each employee and take the hard copy of each payroll register.

• Each payroll clerk sends the payroll register to accounts department and finally distributes it to each employee.

Step #3 of 5

System Flow Chart: The System Flowchart for the existing system is shown below:

• In the above flow chart, rectangle represents the starting point of flow chart. Input the time of each action and create the Time cards.

• According to the employee earning update the Payroll register, General Ledger and general cash accounts.

• Finally distribute the paychecks to each employee.

Step #4 of 5

Weaknesses & suggestions in physical control:

There are six categories of physical controls which are reviewed to determine the accuracy in the system’s work flow. They are described below for this system:

• Transaction Authorization:

A supervision authority to supervise the time entries must be there for stopping the payroll fraud. Personnel Action Forms must be maintained for maintaining the employees’ files.

• Segregation of Duties:

If the time keeping clerk is involved with other functions so he or she could not supervise and maintain exact time record. Time keeping function and personnel functions must be separated.

• Supervision:

A supervision authority to supervise the time entries must be there for stopping wrong entries.

• Accounting Records:

Job tickets and disbursement vouchers must be created. Journal Information must be kept. Subsidiary Ledger Accounts must also be maintained which contains employee records, WIP and various expense accounts.

• Access Control:

It is maintained in this system because individual departments must be authorized for accessing certain records.

• Independent Verification:

Time verification by a specialized authority, other than supervisor (who could be included in payroll fraud), called paymaster must be done. Accuracy of payroll register must be verified by AP clerk before creating disbursement voucher.

Step #5 of 5

Consider the following IT Controls which place in this system:

• Input Controls:

Data should be checked for correctness and integration. Entries must be reviewed by an authority. Digital controls on checks must be there.

• Process Control:

Error messages on wrong entries and operations must be there. Passwords must only be in authorized hands and not be shared and leaked. Backup procedures must be there to protect computerized files.

• Output Controls:

Secured process of preparation and distribution of paychecks, journals and accounts must be employed.

Redesigning System Flowchart for resolving Control Weaknesses are shown below:

• In the above flow chart, rectangle represents the starting point of flow chart. Input the time of each action and create the Time cards.

• In the above modified flow diagram only update the records without changing the whole records.

• First, review the all records and according to need only update the required information.

• Finally distribute the paychecks to all employees by using paymaster.

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