 Hello and welcome to this session in which we will discuss the payroll and human resources cycle or HR cycles. This is one of the six cycles that we need to learn about for our CPA exam, which are revenue cycle, expenditure cycle, financing, production, HR and payroll cycle. This is the one that we're going to be focusing on today. The payroll and HR cycle simply put involve the hiring and the payment of employees as well as the termination of employees. We should all be familiar with this cycle because at some point we were hired by a company or at least I hope so. What is unique about this cycle? Well, this cycle deals with mostly transaction based transaction versus account balances from an accounting perspective. What we do is we pay employees on regular basis. So they work for us. We pay and simply put once we pay the cycle ends. So the employee works, we pay them. Now in between, we might have a liability for a short period of time, then we pay them. So there's going to be no account balances. So at the end of the year, you might see some accrued liabilities fine for employees that work for us, but haven't paid. But those amount are insignificant. You might also see some taxes related to payroll, but those amounts are insignificant. What is significant about the payroll cycle is the amount of the transaction. Because some companies pay weekly, some companies pay bi-weekly, some company pay bi-monthly. So there's a lot of transaction and less account balances from a fraud perspective. What data shows is payroll fraud happens in mostly in medium companies, not in small and large. And I'll explain why this is what the data shows. Just an FYI type of thing. In small companies, the owner is in charge. The owner supervises the whole process because the owner's money is on the line, or that's the assumption. In large companies, large companies will have plenty of resources to have what's called separation or segregation of duties, which we'll talk about. So what happened in medium companies? Well, the owner is busy not to be able to supervise everything and they don't have enough resources. And this is where most fraud and payroll occurs, which is adding fictitious ghost employees or overpaying employees, which we'll talk about the risks in the payroll cycle. Also, we'll talk about the risk and what documents are involved. Again, I'm going to show you how the payroll cycle relate to other cycles because in every cycle, that's what we did. The payroll cycle needs to be financed from the financing cycle. So they need money. They need cash from the financing cycle. The payroll cycle feeds into the production cycle. If we are a production company or basically if we are a service company, we need employees to perform the work. So the payroll provide labor. That's what it provides. And obviously provide data to the general ledger and reporting cycle. And all cycles provide data to the general ledger and reporting cycles. So it's very important to look from an accounting perspective at this cycle just to remind ourselves how the payroll cycle and accounting cycle work from an accounting perspective. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. Simply put, the process starts by hiring an employee and ends with paying the employee. Now, also we terminate the employee, but that will be a different step. And in between, we have withholding. Let's look at an example. First, let's assume an employee worked for us and they earned $10,000. That's a step one. So we debit direct labor, $10,000. And let's assume we haven't paid them yet. We are going to accrue this amount. Also, from this amount, we're going to have withholding such as taxes, 401K, health insurance, so on and so forth. Let's assume the withholdings are $3,000 and we're going to pay them $7,000 net. Now, at the same time, so we pay them. Simply, we accrue the pay for now. We're going to pay them shortly and we will have the withholding. At the same time, because this employee earned $10,000, the company will have to accrue some payroll taxes like social security, Medicare. So the company will also have, will have its own taxes for that employee. Simply put, if you work for a company, the company pays social security on your behalf, pays Medicare on your behalf. You pay it and this withholding, but they have to match it. They also pay federal unemployment, state unemployment. So we also have tax expenses that the company incurred on your behalf. And let's assume the amount is 10% $300. So the company will debit payroll tax expense and they will accrue this payroll tax expense. What happened here is now we have direct labor. This is going to call it expense. So we expensed $10,300 and we have liabilities of $10,300. Well, at the end of the period, at the end when we pay the employees, what's going to happen? We're going to pay for everything. So simply put, we're going to debit the liability credit cash. Well, that's gone. This is $7,000 gone. We're going to debit, we're going to send the taxes and the withholding and pay it. That's gone too. Then we're going to pay our accrued payroll for our share of taxes and pay it. Notice what happened. All these balances went down to zero. This is gone. This is gone. This is gone. And this is what I meant. It's a transaction base. Now, again, what happened to the expenses? The expenses at the end of the accounting period, they also, they get closed as well. Okay, but this is foreclosing and everything is paid in. We end up paying $10,000. We just, we end up paying $10,300. And this is basically, from an accounting perspective, what the payroll cycle would look like in a, in a brief. I do have payroll covered and intermediate accounting in depth, but that's not what you need for now. You just need an overall picture. Now, also what we need to know in this cycle, we need to have separate department. Remember, we have to have segregation of duties. We're going to have the HRN personnel is one department payroll is two. And we're going to have the treasurer as three. Now you also have the controller as four. Basically, the controller is going to overlook this whole process. So basically you have four. The assumption is not the assumption in large companies, you would have four different department or four different individuals or four different people should be looking over the payroll cycle at least. And we're going to look at the role of each one of these, each one of these department, the controller again is going to supervise the whole process and review everything. Starting with the HR cycle. The HR cycle is an independent department independent from payroll independent from the treasure. What what's the role of the HR? They recruit people. They hire people. They make sure they do a background check. They train them. They develop skills. They verify wage information. They delete employees once, you know, they are terminated. And if there's any changes in wages and deduction, they perform this process. This is the HR cycle. This is the HR role. What documents are involved here? Well, when you are hired, they'll give you a W for W for basically to tell them how much you want access to be deducted. They're going to have your employment application. When you initially apply, you have to fill out an employment. They're going to do a background checks on you basically a credit, a criminal employment background check. They're going to determine your rate of pay. They're going to authorize your deductions based on your W for they're going to evaluate and eventually you're going to be terminated either voluntarily or involuntarily. And all these documents are part of the HR cycle. Now, what are the risks in an HR cycle is ghost employees simply put someone in HR, add their spouse friend, boyfriend, girlfriend relative to the payroll, which is called ghost employee add them for someone that don't really exist. Or paying employees after termination. You terminate the employee that you keep them on the HR, which is if you keep them on HR. And somehow they stayed in payroll, they will get paid in large companies that this could happen. The control is every time you need a need, you need to add an employee, you need multiple approvals from different departments. For example, the hiring manager, someone in HR and maybe a third party. All three parties, they'll have to review all the paperwork before a person is added. Therefore, not anyone can add an employee. This is some of the controls that we can implement payroll cycle. What documents are involved in the payroll cycle? Well, we have time record payroll basically keeping track of how long you work. When did you start? When did you end up? Now automation is better in this process. And most companies nowadays, for example, if you work at a company, you have your ID. And once you walk in, you will scan your ID. This is time record, assuming you are being paid hourly and many jobs, they get paid hourly. Also, they need to keep track of your job time sheet. That's for internal purposes for job costing purposes. So for indicating which jobs employee work on jobs means let's assume we are a manufacturing company. Well, if we are manufacturing product A and product B, we need to keep track of how much time you spend on product A, how much time you spend on product B. We call product A a job and we call product B a job. So it tells us how long you stay there. Why? Because for costing purposes, we need to know how much it costs us to produce product A versus product B. They also keep track of a record of your cumulative earnings, which is called cumulative earning register. It shows your accumulated gross year to date gross pay, how much you were paid so far, how much deduction we're taking from you and what's the net pay. There is also tax related forms such as your W2, which is at the end of the year you would receive a record of how much you were paid, the deduction and your net pay. This way tells you how you should complete your taxes. W3 is a summary of your W2s. So they add up older W2s and it becomes W3. They send this to the government. They are responsible for filing US Form 941, which is a tax form on a quarterly basis. How much taxes are responsible for? They're responsible for the US Form 1099 for contractors. Those are the forms that are involved. The risk here mainly is paying more hours than actually work. So overpaying employees because there is no risk for underpaying someone because if you underpay someone, if you report it less time, they will complain. They will say something about it. The risk here for the company is you are reporting more hours. The control for this is you don't issue a payment one from the treasurer unless the supervisor reviewed it. There is the supervisor's approval. They say, okay, what if the supervisor is fudging the numbers? And yes, then they are defeating the control. But the control is, well, you submit your paperwork, the supervisors approve it. Now, you could have two approvals. That's even better. But again, that's going to cost time and money. Or you can set budgets. For example, for a particular period, you can only have that many hours. So you cannot approve more than these hours. And you want to make sure the employees are working those hours. Then the third piece of this is the treasurer is the payment of payroll. Because the people that cut the check should be also independent from the hiring, should be independent from timekeeping, from payroll. So therefore, that's the treasurer. The payroll distribution are usually processed separately from other distributions. So they have payroll as a separate distribution. And it's your better even outsourcing the whole payroll process for that matter. And the payment should be made by a check or direct deposit. Most of the time these days, it's direct deposit. And why? Well, checks and direct deposit, there's a record. You can always know exactly who we pay, how much we pay, when did we pay them. And a good control here is to have what's called an impressed payroll account. This is a good way, a good control. And basically, what this impressed payroll account means is every period, we know we are going to have, based on the budget, $35,000 in payroll expense. Let's assume that's the case. We will have a bank account, and for that period, we transfer only $35,000 because we know this is how much we should have. Then what happened? The employee got their paycheck. And obviously, either they get their paycheck or they get direct deposit. If they get their paycheck, they're going to cash it. And if they get direct deposit, the money is transferred. So once everything said and done, this account goes down to zero. Okay? Why? Well, now we know if someone was overpaid, if we overpaid someone, guess what? Someone will not be able to cash their check or someone will not get their direct deposit and someone will complain. When someone complains, we would say, hold on a second, we're supposed to have $35,000 in this impressed payroll account for the month of June. Okay? Why did we issue more than we'll have an investigation? So basically, the impressed payroll account work as a form of control for overpayment. Now, the other alternative is to have your, you know, having the money deducted from your other account where you have, for example, a million dollar and $35,000 was deducted. And for some reason, two people were overpaid and $37,000 was deducted. No one will pay attention because the checks were cleared and no one's going to say, well, I was not able to clear my check. But if you transferred $35,000 for that specific bank account, it's called impressed payroll account. And everybody cleared their account, you would see it's zero and no one's going to complain. So this is basically an overview of the payroll and HR cycle. What should you do now? Go to FARHAT lectures and work MCQs through FALSE. Look at additional resources. That's going to help you understand these cycles. Understanding the cycles is important, whether you are studying for the exam or a CPA candidate. And also this is important for the audit, understanding the audit because you have to audit each cycle separately. Invest in your career. Good luck study hard and stay safe.