Chapter 10 audit final

Another reason for extensive auditing of cash is that cash is the most liquid of assets and offers the greatest temptation for:

- theft, embezzlement, and misappropriation. Inherent risk is high for liquid assets, -auditors tend to respond to high-risk situations with more intensive investigation. - the detection of fraud is relevant to the overall fairness of the client's financial statements only if such fraud is material in amount.

A four column bank reconciliation ("proof of cash") will generally assist an auditor in detecting:

An unrecorded (on the books) deposit made at the beginning of the month; the amount was withdrawn late in the month, again with no book entry.

How to catch kiting?

Bank transfer schedule

which procedure or document is most effective for detecting kiting?

Bank transfer schedule

The entity borrowed funds from a financial institution. Although the transaction was properly recorded, the auditor suspects that the loan created a lien on the entity's real estate that is not disclosed in its financial statements

Confirm the terms of borrowing arrangements with the lender.

If a check doesn't appear on a cutoff statement

Deposit should be traced to cash disbursements journal

To confirm a customer note collected by bank

Inspect bank credit memo.

Which of the following is confirmed on the standard form used for cash balances at financial institution?

Loans payable

The only source for the balance per books

The general ledger

Obtain bank cutoff statements.

Verify reconciling items on the year-end bank reconciliation.

Use a standard confirmation form to confirm account balance information.

Verify year-end cash and liability balance information.

The most important group of financial investments, from the viewpoint of the auditors,

consists of marketable stocks and bonds because they are found more frequently and usually are of greater dollar value than other kinds of investment holding

In the area of cash and financial investments,

management is particularly concerned with business risks related to the possible theft of these liquid assets. This is also a significant concern of the auditors as most misstatements of assets involve overstatement.

In addition to the preceding list, the auditors might add a valuation objective that relates to procedures for

reconciling underlying records to the general ledger results and, if appropriate, proper valuation of foreign currency translation

Therefore, review of the documentation of management's intent is essential

to the audit of the client's accounting for derivative instruments.

Additional controls for large checks

-Additional controls may be established for large checks, such as the requirement for a second manual signature.

control listing

-This listing shows the amount received from each customer and identifies the customer by name or account number.

EFT and EDI

-Electronic funds transfer (EFT) systems process funds-related transactions for customers as an alternative to paying by check. -Increasingly, electronic data interchange (EDI) systems, which allow the interchange of data from one company's computer to another's, are electronically transferring funds between companies' bank accounts.

In some situations, the auditors may need to consider controls at a service organization because it provides services that are part of the client's information system.

-Such services include those that affect the initiation of transactions, accounting processing or accounting records, or financial statement reporting. As an example, the auditors should be concerned about the controls of a stockbroker that initiates purchases and sales of investments and reports the results to the client.

Advances to vendors

-When advances are made, the auditors should ascertain that procedures are being followed to ensure that deductions from the invoices are being made in accordance with the terms of the agreement. - In some industries, it is common practice to make advances to vendors, which are recovered by making percentage deductions from invoices

In many concerns, segregation of the functions of custody and record keeping is achieved by the use of an

-independent safekeeping agent, such as a stockbroker, bank, or trust company. -IF NOT-, use a joint bank deposit-box in the name of the company that requires two company officials to be present to handle the securities.

Testing cash disbursements

-involves tracing selected items back through the cash disbursements journal to original source documents -The auditors also may review the file of paid checks to test the client's procedures for accounting for the numerical sequence of checks.

Reconciliation of monthly bank statements

-is essential to adequate internal control over cash receipts and disbursements. -an employee having no part in authorizing or accounting for cash transactions or in handling cash should reconcile bank statements

Confirming cash balance

-substantiate the existence of the amount of cash shown on the balance sheet. -confirm amounts on deposit and obtain or prepare reconciliations between bank statements and the accounting records.

Audit Documentation for Cash

-working papers for cash typically include a flowchart or a written description of controls. An internal control questionnaire is also often used, especially in larger companies. A related working paper will summarize tests of controls for cash transactions and the assessments of risk for the financial statement

Internal control weakness factors that increase risk of mistatement of incomplete recording of investments

Inadequate accounting personnel Inadequate monitoring by internal auditors

Four collumn proof of cash helps to

Reconcile cash receipt and disbursement totals between company records and bank records.

This standard confirmation form,

agreed to by the AICPA, the American Bankers Association, and the Bank Administration Institute, addresses only the client's deposit and loan balances. - the form is primarily used to corroborate the existence of recorded information. -the confirmation may also lead to the discovery of additional accounts or loans and, therefore, it provides limited evidence about the completeness of recorded amounts.

A voucher

is an authorization sheet that provides space for the initials of the employees performing various authorization functions. -Authorization functions include such procedures as extending and footing the vendor's invoice; determining the agreement of the invoice, purchase order, and receiving report; and recording the transaction in the accounts. -Transactions are recorded in a voucher register

- To provide assurance that cash receipts have been deposited intact,

the auditors should compare the detail of the original cash receipts listings (mailroom listings and register tapes) to the detail of the daily deposit tickets

To determine that investments purchased and sold during the period are recorded properly,

the auditors vouch a sample of transactions by reference to brokers' advices and cash records. -In addition they review transactions for one or two weeks after the balance sheet date to ensure a correct cutoff of transactions

Review of investment committee minutes and reports may disclose unrecorded purchases and sales of securities or other financial instruments. This procedure is especially important if

the client uses derivatives because transactions giving rise to derivatives may not involve the payment or receipt of cash. For example, if a client engages in a foreign exchange forward contract

Substantive procedures for financial investments: primary audit objectives

-Existence -Rights -Obligations

The examination of cash transactions assists the auditors in the substantiation of many other items in the financial statements.

-Liabilities, revenue, expenses, and most other assets flow through the Cash account; that is, these items either arise from or result in cash transactions. Auditing cash helps all of this out

the functions of the finance department and the accounting department should be integrated in a manner that provides assurance that:

1.)-All cash that should have been received was in fact received, recorded accurately, and deposited promptly. 2.)-Cash disbursements have been made for authorized purposes only and have been properly recorded. 3.)-Cash balances are maintained at adequate, but not excessive, levels by forecasting expected cash receipts and payments related to normal operations. The need for obtaining loans or for investing excess cash is thus made known on a timely basis.

Checking Account Disbursements

-A principal advantage of requiring disbursement by check is obtaining evidence of receipt from the payee in the form of an endorsement on the check. Other advantages include (1) the centralization of disbursement authority in the hands of a few designated officials— only persons authorized to sign checks; (2) a permanent record of disbursements; and (3) a reduction in the amount of cash kept on hand. -To secure in full the internal control benefits implicit in the use of checks, it is essential that all checks be prenumbered and all numbers in the series be accounted for.

Fraud resulting from immaterial cash amounts

-After determining that such fraud could not have a material effect upon the financial statements, the auditors should review the situation with the management and the audit committee of the board of directors -. This discussion will alert the client to the situation, protect the auditors from charges of negligence, and avoid wasting audit time on matters that are not material to the financial statements

For most clients, the primary risks are that errors or fraud either (cash)

1) create a situation in which $250,000 overstates actual cash, -a shortage may have been concealed merely by the insertion of a fictitious check in the cash on hand at year-end, or by the omission of an outstanding check from the year-end bank reconciliation (2) create a situation in which the $250,000 recorded year-end balance should be higher. -Concerning the second risk—the year-end cash is correct, but should be higher—the auditors' problem is not misstated cash, but fraud and its effect on other accounts.

The protective features of cash registers include

(1) visual display of the amount of the sale in full view of the customer; (2) a printed receipt, which the customer is urged to take with the merchandise; and (3) accumulation of the total of the day's sales

Normal internal control activities and cash

(e.g., reconciliation of bank accounts) detect most errors that occur in these accounts. On the other hand, the liquid nature of cash increases the risk of fraud, which may be more difficult to detect.

Collections from Credit Customers

- little threat of defalcation unless one employee is permitted to receive and deposit these checks and also to record the credits to the customers' accounts.

Understanding of internal control over cash

-After the auditors have prepared a flowchart (or other description) of internal control, they will conduct a walk-through of the system. -The term walk-through means to trace a transaction or a few transactions through each step of the system to determine that transactions actually are being processed in the manner indicated by the flowchart.

Electronic Point-of-Sale Systems

-Besides providing strong control over cash sales, electronic point-of-sale systems often may be programmed to perform numerous other control functions. -verify the credit status of charge account customers, update accounts receivable and perpetual inventory records, and provide special printouts accumulating sales data by product line, salesperson, department, and type of sale. -online computer terminals. Often, an electronic scanner reads the universal product code on the product.

Lockbox

-Businesses receiving a large volume of cash through the mail may use a lockbox system to strengthen internal control and hasten the depositing of cash receipts. -The lockbox is actually a post office box controlled by the company's financial institution

Balance per bank can be confirmed by:

-Confirm directly with bank. (Standard form) -Trace items on the bank reconciliation to cutoff statement.

Internal control weakness factors that increase risk of mistatement of recorded value of investments

-Inadequate accoutning manual; incompetent accounting personel -Ineffective board of directors, audit comitee, or internal audit function -"Tone at the top" issues

Internal control weakness factors that increase risk of mistatement of unauthorized investment transactions

-Inadequate segragation of duties of record keeping for and custody of securities

Client-owned securities and other financial instruments will often be in the hands of brokers or banks for safekeeping. In such cases, the auditors send

a confirmation request, signed by the client, to the holders of the investments to determine existence and ownership

The detail of cash receipts refers to

a listing of the amount of each individual check and the total amount of currency composing the day's receipts.

Dividends that should have been received and recorded can be computed by referring to

dividend record books published by investment advisory services. These books show dividend declarations, amounts, and payment dates for all listed stocks. -Interest earned on bonds and notes also can be computed independently by the auditors and compared with recorded amounts in the client's records -Confirms they actually earned and it wasn't fraud/embezzled funds.

The use of derivatives almost always increases the risk of

material misstatement of the financial statements

The auditors may verify the beginning balances of investments by

reference to the prior year's audit working papers. If numerous purchases and sales of investments have occurred during the year, separate schedules of those transactions may support an overall summary schedule of investments.

When the client's records indicate that a particular security has been held since the last audit,

the auditors may compare the serial number of the certificate with that shown in the prior year's working papers. -This will allow the auditors to detect securities that have been sold without authorization during the year and replaced before this year's audit.

compensating balance.

the cash in a company's general account sometimes must be maintained at a specified minimum balance

The fair value of securities and derivatives in many situations may be obtained by reference

to sales prices on organized exchanges, from active markets for similar instruments, or valuation model techniques such as scholes

Petty cash imprest

-Audit tests of petty cash emphasize transactions rather than the year-end balance. The auditors may test one or more replenishment transactions by examining petty cash vouchers and verifying their numerical sequence. -Internal control over payments from an imprest petty cash fund is achieved when the custodian of the petty cash fund reviews support from employees seeking reimbursement for their small expenditures on behalf of the company. -basic assumption of limited disbursements and review at the time of replenishing the fund.

The major elements of adequate internal control over financial investments include the following:

-Formal investment policies that limit the nature of investments in securities and other financial instruments. -An investment committee of the board of directors that authorizes and reviews financial investment activities for compliance with investment policies. -Separation of duties between the executive authorizing purchases and sales of securities and derivative instruments, the custodian of the securities, and the person maintaining the records of investments. -Complete detailed records of all securities and derivative instruments owned and the related provisions and terms. -Registration of securities in the name of the company. -Periodic physical inspection of securities on hand by an internal auditor or an official having no responsibility for the authorization, custody, or record keeping of investments. -Determination of appropriate accounting for complex financial instruments by competent personnel.

Cash sales controls

-If tickets or sales checks are serially numbered and all numbers accounted for, this separation of responsibility for the transaction is an effective means of preventing fraud. -Control over cash sales is strongest when two or more employees (usually a salesclerk and a cashier) participate in each transaction with a customer.

Testing controls

-auditors perform tests of the accuracy of the client's journals and ledgers -They may select a sample of the reconciliations performed during the year, noting who performed them, and reperform the reconciliation process by reference to accounting records, bank statements, and canceled checks. - To provide assurance that cash receipts have been deposited intact, the auditors should compare the detail of the original cash receipts listings (mailroom listings and register tapes) to the detail of the daily deposit tickets

Comparison of the daily entries in the cash receipts journal with bank deposits may disclose a type of fraud known as:

-lapping. -Lapping is the concealment of a cash shortage by delaying the recording of cash receipts. -Lapping is most easily carried on when an employee who receives collections from customers is responsible for the posting of customers' accounts. -The auditors may detect such an ongoing scheme by comparing the details of the bank deposit slips with receipts recorded in the accounting records

How to catch checks being reported before year end even though they were earned after year end

Obtain the cutoff bank statement and compare the cleared checks to the year-end bank reconciliation.

Cash and it's total importance to an audit

The counting of a small petty cash fund, which is inconsequential in relation to the company's overall financial position, accomplishes little in achieving the auditors' objective of expressing an opinion on the financial statements. Nevertheless, auditors do devote a larger proportion of the total audit hours to cash than might be suggested by the relatively small amount of cash shown on the balance sheet.

Vendors'statements, received monthly,

should be reconciled promptly with the accounts payable ledger or list of open vouchers, and any discrepancies should be fully investigated