Reference no: EM131821188

Synopsis

In this brief case, a long-time and trusted employee of the Los Angeles Dodgers engaged in a large scale payroll fraud to embezzle funds from the organization. Over a period of several years, this fraudulent scheme cost the owners of the Dodgers several hundred thousand dollars. Contributing to the success of the fraud was the laxity of the Dodgers' internal controls. Eventually, the fraud was exposed when the individual who masterminded the scheme was hospitalized on an emergency basis and thus unable to "cover his tracks" for a period of time.

Instructional Objectives

1. To identify key internal control issues for an organization's payroll function.

2. To identify audit procedures that may result in the discovery of fraudulent payroll schemes.

3. To emphasize the need for auditors and client management to exhibit some degree of skepticism regarding the motives and integrity of even the most trusted client employees.

The Trolley Dodgers-Key Facts

1. The top executives of the Dodgers organization apparently placed a great deal of trust in their subordinates.

2. Campos, the Dodgers' operations payroll chief, was a respected and trusted member of the Dodgers organization.

3. The Dodgers' payroll system was not only supervised by Campos but had also been designed by him.

4. Campos was involved in such menial tasks in the payroll function as preparing employees' weekly payroll cards.

5. Campos would return to oversee the preparation of the Dodgers' payroll even when he was on vacation.

Suggestions for Use

This case deals exclusively with an organization's payroll function and thus would articulate well with classroom coverage of the payroll transaction cycle. Alternatively, the case could be used to introduce students to key internal control concepts including the following: the need for management to resist placing too much trust or reliance on any one employee, the need for periodic rotation of accounting responsibilities and/or mandatory annual vacations for all accounting employees, and the old truism that an internal control system is only as good as the people operating it (or is only as reliable as the least reliable person within it).

Suggested Solutions to Case Questions

1. An auditor‘s principal objective in performing tests of controls on a payroll transaction cycle, as with any transaction cycle, is to assess the level of control risk latent within that cycle. An auditor assesses control risk for a transaction cycle to obtain the evidence needed to determine the nature, extent, and timing of the year-end substantive tests to be applied to the account balances produced by that transaction cycle.

The two most important account balances yielded by a payroll transaction cycle are typically accrued payroll and payroll expense. As for most liability and expense accounts, the auditor‘s principal concern regarding these two accounts is violation of the "completeness" assertion. In assessing the reasonableness of periodic payroll expense, an auditor usually makes extensive use of analytical procedures. For instance, an auditor typically develops an expectation regarding the client‘s payroll expense for a given period by reviewing the payroll expense reported by the client in a comparable prior period and by considering such factors as the most recent average employee pay raise granted by the client. If the client‘s recorded payroll expense varies significantly from the auditor's expectation, additional substantive tests will be required to investigate this difference. Regarding the year-end accrued payroll, the auditor must first determine the length of time over which payroll, both hourly and salaried, should have been accrued by the client. Then, the auditor must determine whether the accrued payroll expense reported by the client is reasonable given the length of that time period.

2. The following internal control weaknesses were apparent in the Dodgers' payroll system:

a. the extent of control that one person had over the payroll system, which began with that individual's design of the system and included his involvement in the system's operational details,

b. the lack of enforced vacations for key personnel, and

c. an apparent lack of periodic testing of the payroll transaction cycle by internal auditors or a similar control group, testing that should have resulted in the discovery of the fraudulent scheme.

3. Listed next are examples of audit tests that might have led to the discovery of Campos' embezzlement scheme. (Note: The auditors who tested the Dodgers' payroll transaction cycle should have recognized that the control risk associated with that cycle was relatively high given the fact that one person had almost complete responsibility for the payroll function-with very little accompanying accountability. Such an assessment of control risk, ceteris paribus, should have dictated a fairly rigorous audit scope for year-end testing of the payroll-related account balances. Regarding these latter tests, the external auditor's principal concern would have been violations of the completeness assertion. However, in this case, the existence (account balance-related) and occurrence (transaction-related) assertions, rather than the completeness assertion, were violated, implying that the auditors may have spent much of their time searching for the wrong type of errors.)

a. A surprise distribution of payroll checks for selected departments might have resulted in unclaimed checks and thus discovery of Campos' fraud.

b. Manual or computer-based "limit tests" should have disclosed instances of employees being paid for an excessive number of hours.

c. Analytical procedures to assess the reasonableness of the Dodgers' periodic payroll expense by department might have revealed that certain departments' payroll expenditures were "out of line."