Chapter 10

Step 3 for Cash Audit: Assess the risks of material misstatement of cash and design tests of controls and substantive procedures that:

(a) Substantiate the existence of recorded cash and occurrence of the related transactions (b) Establish the completeness of recorded cash (c) Verify the cutoff and accuracy of cash transactions (d) Determine that the client has rights to recorded cash (e) Determine that the presentation and disclosure of cash, including restricted funds, are appropriate

The standard form is agreed to by whom?

-AICPA -American Bankers Association -Bank Administration Institute

FASB No. 133 "Accounting for Derivative Instruments and Hedging Activities"

-All derivative instruments valued at fair values -Unrealized gains or losses depend on classification as hedges

Examples of Internal Controls over financial Investments

-Establishment of formal investment policies Review and approval of investment activities by the investment committee of the board of directors -Separation of duties among employees -Authorizing purchases and sales -Having custody of the securities -Maintaining records -Detailed records of all securities owned and the related revenue from interest and dividends -Registration in the name of the company Periodic physical inspection of securities -Determination of accounting for complex instruments by competent personnel

How do you audit Financial Investments? What specialized knowledge to you need?

-Identifying controls at service organizations that provide financial services -Obtaining an understanding of information systems for securities and derivatives -Applying complex accounting principles to various types of financial investments. -Understanding the methods used to determine the fair values of financial investments -Assessing inherent and control risk for assertions about derivatives used in hedging

Potential Misstatements for Cash Disbursements

-Inaccurate recording of a purchase or disbursement -Duplicate recording and payment of purchases -Unrecorded disbursements

Internal Controls over Collections of Receivables

-Initial listing of cash receipts -Custody and depositing of cash receipts -Maintenance of customer account records -Reconciliation of customers' ledgers with control accounts -Mailing monthly statements to customers -Collection activity and past-due accounts -Direct receipt of funds by financial institution

Internal Controls Cash Receipts---Cash Sales

-Involvement of two or more employees -Cash Registers -Electronic point of sales systems

Internal Control Cash Disbursements

-Segregation of duties -Payment by check or electronic funds transfer -Pre-numbered check -Match of purchase order and receiving documents with vendor's invoice -Review of supporting documents by authorized check signer -Cancel of supporting documents -Authorized check signer should mail checks -Monthly bank reconciliation

Internal Control Guidelines for Cash (List first 5 )

1. Do not permit any one employee to handle a transaction from beginning to end. 2. Separate cash handling from record keeping. 3. Centralize receiving of cash to the extent practical. 4. Record cash receipts on a timely basis. 5. Encourage customers to obtain receipts and observe cash register totals.

Examples of Substantive Procedures

1. Obtain analyses of cash balances and reconcile them to the general ledger. 2. Send standard confirmation forms to financial institutions to verify amounts on deposit. 3. Obtain or prepare reconciliations of bank (financial institution) accounts as of the balance sheet date and consider the need to reconcile bank activity for additional months. 4. Obtain a cutoff bank statement containing transactions of at least seven business days subsequent to balance sheet date. 5. Count and list cash on hand. 6. Verify the client's cutoff of cash receipts and cash disbursements. 7. Analyze bank transfers for the last week of audit year and the first week of following year. 8. Investigate any checks representing large or unusual payments to related parties. 9. Evaluate proper financial statement presentation and disclosure of cash.

Procedures Involved in the Audit of Cash

A. Use the understanding of the client and its environment to consider inherent risks B. Obtain an understanding of internal control over cash. C. Assess the risks of material misstatement and design further audit procedures D.Perform further audit procedures—tests of controls. E. Perform further audit procedures—substantive procedures for cash transactions and balances.

Steps for Auditing Financial Investments

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks related to financial investments. B. Obtain an understanding of internal control over financial investments C. Assess the risks of material misstatement and design further audit procedures. D. Perform further audit procedures—tests of controls.(If necessary, revise the risk of material misstatement based on the results of tests of controls.) E. Perform further audit procedures—substantive procedures for investment transactions and year-end balances.

Substantive Procedure Cash: Analyze bank transfers occurring near year end.

Completeness

Substantive Procedure Cash: Obtain analyes of cash balances and reconcile them with the general ledger

Existence and Accuracy

Substantive Procedures Investments -Inspect securities on hand and review agreements underlying derivatives. -Confirm Securities and derivative instruments with holders and counterparties. -Vouch selected purchases and sales of investments during the year. -Verify the client's cutoff of investment transactions.

Existence and Rights Occurrence and Accuracy Completeness Cutoff Valuation

Examples of Fraud with Cash

Fraud that may be disclosed: -Interception of cash receipts before any record is made -Payment for materials not received -Duplicate payments -Overpayments to employees or payments to fictitious employees -Payments for personal expenditures of officers or related parties

Substantive Procedure Cash: investigate payments to related parties. Evaluate financial statement presentation and disclosure.

Presentation and Disclosure

What are the objectives for auditing financial investments?

Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to financial instruments Obtain an understanding of internal control over financial instruments. Assess the risks of material misstatement of financial instruments and design tests of controls and substantive procedures that:

Potential Misstatements for Financial Investments

-Misstatement of recorded value of investments -Unauthorized investment transactions -Incomplete recording of investments -Inadequate disclosure of the nature of investment activities

Substantive Procedures for Investment Transactions Steps 1-5

1. Obtain or prepare analyses of the investment accounts and related revenue, gain, and loss accounts and reconcile them to the general ledger. 2. Inspect securities on hand and review agreements underlying derivatives. 3. Confirm securities and derivative instruments with holders and counterparties. 4. Vouch selected purchases and sales of financial investments during the year and verify the client's cutoff of investment transactions. 5. Review investment committee minutes and reports.

3 objectives for the audit of cash

1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to cash 2. Obtain an understanding of internal control over cash. 3. Assess the risks of material misstatement of cash and design tests of controls and substantive procedures

Internal Control Guidelines Cash (List last 6)

6. Do not permit any one employee to handle a transaction from beginning to end. 7. Separate cash handling from recordkeeping. 8. Centralize receiving of cash to the extent practical. 9. Record cash receipts on a timely basis. 10. Encourage customers to obtain receipts and observe cash register totals.

Substantive Procedures Financial Investments Steps 6-11

6. Perform analytical procedures. 7. Make independent computations of revenue from securities. 8. Inspect documentation of management's intent to classify derivative transactions as hedging activities. 9. Evaluate the method of accounting for investments. 10. Test the valuation of financial investments. 11. Evaluate financial statement presentation and disclosure of financial investments

What does the standard form address?

Addresses only the client's deposit and loan balances

FASB No. 159

Allows companies to choose to use fair value accounting rather than approach in FASB No. 133

How can auditors detect kiting?

Auditors can detect kiting by preparing a schedule of bank transfers for a few days before and after balance sheet date

What is the proof of cash used to identify?

Cash receipts and disbursements recorded in the accounting records, but not on the bank statement. Cash deposits and disbursements recorded on the bank statement, but not on the accounting records. Cash receipts and disbursements recorded at different amounts by the bank than in the accounting records.

Audit Time for Cash

Cash typically has a small account balance, but auditors devote a large proportion of total audit hours because: (a) Liabilities, revenues, expenses and most other assets flow through cash (b) Most liquid asset so greater temptation for misappropriation (c) High risk account

What is the check 21 Act?

Checks may be processed electronically Electronic processing creates a substitute check - an electronic image of check Legal equivalent of original check for all purposes

What is a standard Confirmation?

Confirmation of amounts on deposit by direct communication with financial institution officials

Kiting misstatements

Date of recording per transfer per the books are from different financial statement periods Date the check was recorded by the bank is from financial statement period prior to books

Substantive Procedures Financial Investments: -Perform analytical procedures -Make independent computations of revenue from securities

Existence Rights Occurrence Completeness

Substantive Procedure Cash: Send Standard Confirmation forms to financial institutions. Obtain reconciliations of Bank Balances and consider reconciling bank activity. Obtain Bank Cutoff Statement. Count Cash on Hand

Existence, occurrence, accuracy, cutoff, rights

What assurance does management provide?

Finance and accounting department work together to provide assurance that: All cash that should have been received was in fact received, recorded accurately and deposited promptly Cash disbursements have been made for authorized purposes only and have been properly recorded Cash balances are maintained at adequate, but not excessive, levels by forecasting

What is Kiting?

Manipulations that utilize temporarily overstated bank balances to conceal cash shortage or meet short-term cash needs

Audit Implications of Check 21 Act

Need to rely on substitute check for evidence of check Impossible for clients to kite checks (manipulate bank balances to conceal cash shortage)

Which FASB Standards deal with testing valuation?

No. 133 No. 159

Substantive procedures Financial Investments -Evaluate financial statement presentation and disclosure of financial investments

Presenation

What is proof of cash?

Reconciles the account balance and reconciles cash transactions during a specified period.

Assess the risks of material misstatement of financial instruments and design tests of controls and substantive procedures that:

a. Substantiate the existence of recorded financial investments and the occurrence of investment transactions. b. Establish the completeness of financial investments and investment transactions. c. Verify the cutoff of investment transactions. d. Determine that the client has rights to recorded investments.

Examples of Test of Controls

a. Test the accounting records and reconciliations by reperformance. b. Compare the details of a sample of cash receipts listings to the cash receipts journal, accounts receivable postings, and authenticated deposit slips. c. Compare the details of a sample of recorded disbursements in the cash payments journal to account payable postings, purchase orders, receiving reports, invoices, and paid checks.

Tests of Controls for Financial Investments

a. Trace several transactions for purchases and sales of investments through the accounting system. b. Review and test reports of investment activity prepared for the investment committee. c. Inspect reports by internal auditors regarding their periodic inspection and review of securities and derivative instruments. d. Inspect monthly reports on securities owned, purchased, and sold and amounts of revenue earned and budgeted.

Substantive Procedures investments: -Review investment committee minutes and reports

completness

Substantive Procedure Cash: Verify the clients cutoff of transactions.

cutoff, existence, occurrence, and rights

substantive procedures financial investments: Obtain analysis of investments and related accounts and reconcile ledger

existence and rights and occurrence

Sources of Cash

general checking account payroll checking accounts petty cash savings account

Cash Equivalents

money market funds certificates of deposit savings certificates

Substantive Procedures investments: -Inspect documentation of management's intent to classify derivative transactions as hedges -Evaluate method for accounting for investments -Test the valuation of financial investments

valuation presentation