You are assessing internal control in the audit of the human resources and payroll cycle for the Kowal Manufacturing Company, a company specializing in assembling computer systems from purchased parts. Kowal employs approximately 200 hourly and 30 salaried employees in three locations. Each location has one foreman who is responsible for overseeing operations. The owner of the company lives in Victoria, British Columbia, and is not actively involved in the business. The two key executives are the vice president of sales and the controller, both of whom have been employed by the company for more than 15 years.
Whenever there is a job opening at a location, the factory foreman interviews applicants and, on the basis of the interview, either hires or rejects them. When applicants are hired, they prepare a TD1 (employee's withholding exemption certifi cate) and give it to the foreman. The foreman writes the hourly rate of pay for the new employee in the corner of the TD1 form and then gives the form to the location's offi ce manager as notice that the worker has been employed. The foreman verbally advises the offi ce manager when there are wage rate adjustments.
Since each hourly employee works independently, Kowal has a highly fl exible work schedule policy, as long as employees start after 7:00 a.m. and are fi nished by 6:00 p.m. Employees are issued magnetic stripe cards with a PIN (personal identifi cation number) that they use to scan in and out. Every Friday at 6:00 p.m., the offi ce manager retrieves the time records and prints the time records with hours worked. The foreman reviews the list and signs and dates it indicating his approval. Once the time records are approved, the offi ce manager transmits the time records to head offi ce in Mississauga, Ontario. Employees without a time record do not receive pay. In Mississauga, the accounting supervisor retrieves the fi le for transfer into the payroll system, which is used to calculate the pay amounts and create a payroll journal. The payroll journal for the three locations is printed and reviewed by the controller. The payroll package then generates a direct deposit fi le, which is sent to the bank by the accounting supervisor every Monday afternoon.
Except for the foremen and offi ce managers, all salaried employees work at the Mississauga location. The vice president of sales or the controller hires all salaried employees, depending on their responsibilities, and determines their salaries and salary adjustments. The owner determines the salary of the vice president of sales and the controller. The accounting supervisor processes the payroll transactions for salaried employees using the same payroll software that is used for hourly employees. The monthly payroll journal is approved by the controller before the offi ce manager transmits the salaried payroll direct deposit fi le to the bank. The payroll software package has access controls that are set up by the controller. She is the only person who has access to the salary and wage rate module of the software.
She updates the software for new wage rates and salaries and makes changes to existing ones. The accounting supervisor has access to all other payroll modules. The controller's assistant has been taught to reconcile bank accounts and does the monthly payroll bank reconciliation.
REQUIRED
a. List the risks of error or fraud that are present at Kowal Manufacturing. For each risk, state the type of misstatement that could occur.
b. State whether the fraud risk could lead to misappropriation of assets or fraudulent financial reporting. Explain how these frauds could take place.
c. For each risk of error or fraud, provide both preventive and detective controls to prevent or detect the fraud.