You are the auditor of Dynamic Clothes Ltd. The company manufactures clothing for the fashion industry. A production manager heads the manufacturing division. He controls the work of 20 foremen and approximately 500 workers. Wages are paid every Friday, based on hours worked during the previous calendar week.

Question

New workers are employed by the foremen. At the start of each working week (Monday), each foreman hands a blank clock card to each of his workers. The workers insert their names and employee numbers on the clock cards and then use the cards for that working week. The clocking device is situated at the entrance to the factory. Workers clock in and out at the entrance to the factory by inserting their clock cards in the clocking device.

The foremen hand the used clock cards to a wage clerk on Monday mornings. The clock cards are divided alphabetically amongst four wage clerks. Each clerk is always allocated the same section of the alphabet for which he/she is fully responsible.

The clerks perform the following work on the clock cards:

Calculate the total number of hours worked per clock card and record this on the relevant clock card.
Enter the hours worked per individual (by employee number) into the weekly wages file on the computer.
After each wage clerk has entered the hours worked into the computer, the computer calculates each worker's gross pay, deductions, and net pay by using the wage rates and deductions in accordance with the personnel information kept on a database. The weekly wages report is then printed by the computer. This report is kept in the wages department.

One of the wage clerks verbally informs the accountant of the amount needed for the week’s net wages. The accountant then prepares a cash cheque for the exact amount of the week’s net wages, after which the cheque is cashed by a wage clerk.

The computer prints pay envelopes for the workers to be paid, bearing the workers' names and employee numbers. Each wage clerk fills the pay envelopes according to the letters of the alphabet for which he/she is responsible. After all the pay envelopes are filled, no money should be left over. If a discrepancy occurs, the pay envelopes are checked and corrected by the wage clerks.

The pay envelopes are then sealed. On Friday afternoons, the pay envelopes are handed to the relevant foremen for the weekly payout. Each foreman pays out the wages to the workers working for him. Unclaimed wages are returned by the various foremen to a wage clerk.



REQUIRED:
Identify the weaknesses in the wage system described above and recommend improvement(s) for each weakness identified. (40 MARKS)

Please includes auditing jargons and IAS's also make it more because its out of 40 marks

Answer 1

The wage system at Dynamic Clothes Ltd exhibits several weaknesses that can significantly increase the risk of errors, fraud, and inefficiencies. Below, I will identify these weaknesses, referencing relevant auditing concepts and International Accounting Standards (IAS), and provide recommendations for improvements.

Weaknesses in the Wage System

1. Manual Handling of Clock Cards

   • Weakness: The use of paper clock cards increases the risk of loss, tampering, or unauthorized alterations. Workers might not accurately record their own hours, leading to errors in wage calculations.
   • Recommendation: Implement an electronic timekeeping system with biometric authentication (e.g., fingerprint or facial recognition) to capture workers' clocking in and out. This reduces manual intervention and provides a secure and accurate record of hours worked, thus complying with IAS 8 (Accounting Policies, Changes in Accounting Estimates and Errors).

2. Division of Responsibilities

   • Weakness: The same clerks are responsible for calculating hours, entering data, and reconciling wage envelopes. This creates a lack of segregation of duties, which is a fundamental principle of internal controls (COSO framework).
   • Recommendation: Introduce a segregation of duties by assigning separate employees for data entry and review, calculation, and envelope preparation. This can enhance internal controls over the wage processing cycle and decrease the possibility of fraud or errors.

3. Limited Oversight and Reconciliation

   • Weakness: The verification of hours worked and net wages is based solely on clerical calculation without an independent review process. This can lead to mistakes going unnoticed.
   • Recommendation: Establish an independent review process where a designated supervisor or internal auditor conducts regular audits of the wage calculations, reconciles the total hours worked with the payroll output, and ensures payments align with the wages report. This adheres to IAS 33 (Earnings per Share), relating to the accuracy and reliability of financial reporting.

4. Communication of Payment Amounts

   • Weakness: The verbal communication of net wages from clerks to the accountant increases the risk of miscommunication, leading to incorrect cheque amounts.
   • Recommendation: Change the process to a written report generated by the computer system that includes detailed breakdowns of gross pay, deductions, and net pay. This report should be formally signed off by the wage clerks before being presented to the accountant, ensuring accuracy and reducing discrepancies.

5. Physical Custody of Cash Cheques

   • Weakness: The responsibility for cashing the cheque lies with one wage clerk, posing a risk of loss or misappropriation of funds.
   • Recommendation: Introduce a dual control mechanism for cash handling where at least two clerks are involved in the cashing of cheques (e.g., one to prepare and one to collect and distribute). This diminishes the risk of theft and supports compliance with IAS 1 (Presentation of Financial Statements) regarding transparency and accountability.

6. Envelope Filling Process

   • Weakness: Each wage clerk fills envelopes for their respective section without an independent verification process, which may lead to errors in distributions.
   • Recommendation: Implement a checklist system where each filled envelope is confirmed against the wages report and signed off by the responsible wage clerk. An independent party can conduct spot checks for accuracy at the time of filling pay envelopes, thus improving the overall reliability of wage disbursement.

7. Collection of Unclaimed Wages

   • Weakness: The process for handling unclaimed wages appears informal, with no documentation or reconciliation, potentially leading to losses or misappropriation.
   • Recommendation: Establish a formalized process for unclaimed wages that includes reporting and documenting any unclaimed amounts alongside a clear procedure for returning these amounts to the company or addressing them in the next payroll cycle. This also aligns with IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets) in recognizing possible liabilities appropriately.

8. Lack of Periodic Audits

   • Weakness: Regular audits of the wage system and payroll processes appear to be absent.
   • Recommendation: Conduct periodic internal audits and reconciliations of the payroll processes to ensure compliance with established procedures and identify areas for improvement regularly. This promotes a culture of accountability and enhances operational efficacy.

Conclusion

The wage system at Dynamic Clothes Ltd presents several inherent risks that can compromise the integrity and accuracy of payroll processing. By addressing these weaknesses through the recommended improvements, the organization can enhance its internal controls, comply with relevant accounting standards, and foster greater trust among employees regarding their compensation. Regular audits and adherence to established policies will help mitigate risks and maintain robust payroll functionality.