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 include auditing jargons and IAS's

Answer 1

Weaknesses in the Wage System and Recommendations for Improvement

1. Lack of Biometric Controls at Clocking In/Out

   • Weakness: The current system relies on manual clock cards, which can be easily manipulated. A worker could clock in/out for another worker, leading to wage fraud.
   • Recommendation: Implement a biometric clocking system (such as fingerprint or facial recognition) to ensure that the person clocking in and out is indeed the employee. This mitigates the risk of impersonation and strengthens internal controls in accordance with IAS 5 (Information to be disclosed in the financial statements).

2. No Independent Reconciliation of Hours Worked and Payroll

   • Weakness: The process allows for potential errors or manipulation in both the calculation of hours worked and payroll processing since clerks and foremen are not independent of each other.
   • Recommendation: Establish a separate payroll reconciliation function, potentially involving a different department or an independent third party to verify that hours reported correspond accurately with payroll processed. This aligns with the principles of internal control as outlined by COSO (Committee of Sponsoring Organizations of the Treadway Commission).

3. Absence of Documentation for Changes in Wage Rates and Deductions

   • Weakness: If there are changes to wage rates or deductions, the system as described does not specify how these changes are documented or communicated, leading to potential errors.
   • Recommendation: Formalize a procedure for documenting changes in wage rates and deductions. Ensure that there is a dedicated approval process by management, which ensures compliance with IAS 10 (Events after the Reporting Period), as changes need to be accurately reflected in the financial records.

4. Limited Worker Awareness and Training Regarding Timekeeping

   • Weakness: Workers may lack training on accurately documenting their time, which can lead to discrepancies between actual hours worked and what is reported.
   • Recommendation: Implement regular training sessions for employees on proper timekeeping procedures and expectations. In conjunction with this, produce user-friendly guides for reference to help maintain accurate (and compliant) timekeeping practices in line with IAS 1 (Presentation of Financial Statements).

5. Manual Duplication of Efforts in Wage Calculation

   • Weakness: The clerks individually calculate hours worked and enter data manually, increasing the chances for human error in wage calculations.
   • Recommendation: Automate the payroll process fully where the system captures clocking data and calculates wages directly without manual entry. This would minimize redundancy and aligns with the framework of IAS 6 (Exploration for and Evaluation of Mineral Resources), advocating for reliable technology to ensure accurate reporting.

6. Inconsistency in the Handling of Unclaimed Wages

   • Weakness: The unclaimed wages are returned to a wage clerk, which can lead to errors or mismanagement of returned funds.
   • Recommendation: Develop a clear, documented procedure for handling unclaimed wages, including proper documentation and authorized sign-offs for return and reallocation. This ensures traceability and accountability, critical components identified under IAS 24 (Related Party Disclosures).

7. Lack of Oversight and Audit Trail

   • Weakness: There is no clear oversight mechanism for evaluating the payroll process and ensuring all aspects are monitored and recorded properly.
   • Recommendation: Introduce regular internal audits of the payroll and wage distribution processes. An independent audit committee should review these transactions routinely to ensure compliance with accounting standards, which aligns with IAS 240 (The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements).

8. Inadequate Controls Over the Cash Cheque Preparation

   • Weakness: The accountant prepares the cheque upon verbal communication of required amounts, which introduces a risk of miscommunication or fraud.
   • Recommendation: Implement a formal approval system where the accountant must receive documented verification of the net wages required, preferably through an automated report generated by the payroll system. This helps mitigate risks associated with cash management and complies with IAS 7 (Statement of Cash Flows).

Conclusion

The wage system at Dynamic Clothes Ltd. presents several weaknesses that create opportunities for errors and fraudulent activities. By implementing the recommended improvements, the company can enhance the integrity of its payroll process, ensure compliance with relevant International Accounting Standards (IAS), and bolster its overall internal control environment.