Ch 10 - Key Terms

Tests of Control for CASH

- Test the accounting records and reconciliations by reperformance - Compare the details of a sampleof cash receipts listings to the cash receipts journal, accounts receivable postings, and authenticated deposit slide - Compare the details of a sample of recorded disbursements in the cash payment jounral to account payable postings, purchase orders, receiving reports, invoices, and paid checks

Need for specialized knowledge

- identify controls at a service organization - understanding of information systems for securities and derivatives dependent on technology - apply complex accounting principles - understanding methods used to determine fair values of complex investements - assess inherent and control risk for hedging activities.

Processes related to cash handling

- responsibility of the finance department - handling and depositing cash receipts; signing checksl investing idle cash; maintaining custody of cash, marketable securities, and other negotiable assets. >> Forecash Long AND Short term financing arrangements

If checks are not signed by computer

- they will need to be send to the vouchers payable department for mailing - Computer software should be designed to identify unusual disbursements for review

Elements of Internal Control

-Formal investment policies that limit nature of investments in securities - review F/S for compliance w/ investment policies - Seperation of duties between executive authorizing purchases and sales of securities, custodian of securities, and person maintaining records - Registration of securities in name of company - Periodic physical inspection - Determine accounting for complex financial instruments

Substantive procedures over cash

1. Existence of recorded cash and occurence of cash transactions 2. accuracy of transactions 3. Completeness of recorded cash 4. Verify cutoff of cash transactions 5. Client has rights to recorded cash 6. presentation and disclosure of cash (including restricted funds like sinking funds) are appropriate

Electronic Data Interchange

A computer network between companies that allows the interchange of data from one company's computer to the other's

Analyze Bank transfers for the last week of the audit year and first week ofthe following year

cutoff, existence, occurance, and rights.

Identify and investigate unsual cash receipts and disbursements

existence, occurance, accuracy, cuttoff, and rights

Cash equivalents

money market funds, certificated of deposit, savings certificates, and other deposits >> needs to be able to convert to cash quickly

Joint Control

neither of the two custodians may have access to the securities except in the presence of the other

Electronic point of sale systems

scan a universal product code which are used on most electronic cash registers >> price is stored in computer so it reduces risk of fake prices May verify credit status of charged account, update A/R and perpetual inv records, record salesperson who sold, the department, and type of sale.

Window Dressing

Action taken by the client shortly before the balance sheet date to improve the financial picture presented in the financial statements

Obtain analysis of investments and related accounts and reconcile to ledger

Existence and Rights, occurance

Year end cash is correct, but should be higher

This would be due to fraud

- Inspect documentation of managements intent to classify derifvative transactions as hedges - Evaluate the method of accounting for investments (impair if needed) - Test the valuation of financial investments

Valuation Presentation

Evaluate financial statement presentation and disclosure of financial investments

presentation

Payment Date Voucher

voucher and supporting documents are removed from the tickler file and the check is prepared but not signed. - Voucher, supporting papers, and the unsigned check are forwarded to the finance department for signature.

Collections from Credit Customers

- Cash receipts include checks received through the mail

4 Advantages of requiring disbursement by check

1. Receipt from the payee in form of endorsement on the check 2.Centralization of disbursement authority in hand of few people, only one can sign 3. Permanent record of disbursements 4. Reduction in the amount of cash kept on hand

Key points questionairre should have

1. whether checksigning authority (electric or manual) is restricted to selected executives not having access to accounting records or to vouchers and other documents supporting checks submitted for signature 2. Whether checks are sent directly to the payees after being signed. 3. Cash disbursements for payroll and for dividends, as well as bank reconciliation.

Voided Checks

A check that is not negotiable (null and void) - Should be defaced to eliminate any possibility or further use and filed in the regular sequence of paid checks. (voided check = error in preparing check)

Voucher

A document authorizing a cash disbursement. A voucher usually provides space for employees to initiail after they have performed approval functions.

Review investment committee minutes and reports

Completeness

Lapping

Concealment of a cash shortgage by delaying the recording of cash receipts. >> Most easily carrier on when an employee who receives collections from customers is responsible for the posting of customer accounts

Decription of Misstatement: Early (late) recognition of cash receipts "cutoff problems" (error)

Error: Recording cash receipts based on bad information about date of receipt Internal Control Weakness: failure to list and deposit cash receipts on a timely basis

-Perform analytical procedures -Make independent computations of revenue from securities **Dividends that should have been recieved and recorded can be computed by referring to the dividend record book

Existence Rights Occurence Completeness

Obtain analyses of cash balances and reconcile them to general ledger

Existence, accuracy, cutoff

Audit of Cash

Follows the same general procedures:

Description of Misstatement: Unrecorded Disbursements (Fraud)

Fraud: In conjuction with unrecorded (but deposited) cash receipts, an employee writes and cashes an unrecorded check for the identical amount. Internal Control Weakness: Ineffective control over record keeping for and access to cash

Evaluate proper financial statement presentation and disclosure of cash

Maintain compensating balance , disclose cash and cash equivalents

Detail of cash receipts

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

Interim Audit Work on Cash

- CPA's try to complete audit procedure on interim basis if possible - Audit work on cash at year end can then be limited to each substatntive procedures as a reveiw of the clients bank reconciliations, confirmation of year end balances, investigation of the year end cutoff, and a GENERAL review of cash transactions during interval between interim and end of period

Recording Cash Receipts

- Cash receipts program creates a file of cash receipt transactions that is used to update the general ledger and the master file of accounts receivable - Computer totals and makes exception reports - Manual follow-up procedres on exceptions reports and the reconciliations of control totals

Further audit procedures for investment transactions

- prepare analyses o investment accounts - inspect securities on hand - confirm securities and derivative instruments with holders and counterparties - vouch selected purchases and sales of FI investments during the year and clients cutoff of investment transactions - review invstment committee minutes and reports - perform analytical procedures - make independent computaitons of revenue from securities - inspect documentation of management's intent to classify derivative transactions as hedging activities - evaluate method of accounting for investments - test for impairment - evaluate F/S presentation

Auditors objectives in auditing financial investments

- understand inherent risks - Understand internal control - Assess RMM and design COVERU principles

Inconsistent transactions

- will not be processed - will be listed on an exception report for review and follow-up by the operations control group

Computerized purchasing system

-Invoice information will be entered by the accounting (AP) department - matched by computer with Purchase order and receiving info that was entered by other departments.

Integration of finance and accounting departement provides assurance that:

1. Cash was received, recorded accurately, and deposited promptly 2. Cash disbursements ahve been made for authorized purposes only and have been properly recorded 3. Cash balances are held at the amount that is not excessive >> forecast expected cash receipts and payments related to normal operations

Concealed Checks

A check the amount of which has been subtracted from the depositors account and has been marked as "canceled" by a financial institution. A canceled check has been endorsed by the payee and paid by the drawee financial institution. A canceled check is in contract to a voided check, a check that has not been process AND will not be.

Electronic Funds Transfer Systems (EFT)

A computer system that transmits and processes funds-related cash disbursement and receipt transactions. Increasingly, companies are elctronically transferring funds between bank account rather than issuing checks.

Standard confirmation form

A confirmation form, agreed to by the AICPA, the American Bankers Association, and the Bank Administration Institute, that is designed to provide corroborating evidence about the client's account balances and outstanding loans.

Overstated 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

Proof of Cash

An audit procedure that reconciles the bank's record of cash activity with the client's accounting records for a test period. The working paper used for the proof of cash is a four-column bank reconciliation. **Fraud detection procedure that may be used for any months during the year

Time to audit cash

Auditors devote a larger proportion of the total audit hours to cash than might be suggested by the relativeley small amount of cash on the B/S - Almost everything flows through cash account so its high risk plus liquid = risk

Internal Control over Cash Disbursements

Cash disbursements should be made by check, electronic transfor, or petty cash.

Sources and Nature of Cash

Cash includes general, payroll, petty cash, and savings accounts. May need to maintain a minimum balance (known as compensating balance)

Check 21 Act

Checks can be processed electronically in place of hard copy chekcs. **Purpose = Decrease time for checks to clear 1. Client checks are processed electronically 2. Virtually impossible for client to kite checks (kite = manipulate bank balances so that temporarily overstated cash balances conceal a cash shortage)

Description of Misstatement: Incomplete recording of investments

Error: Failure to record derivative agreements that are embedded in other agreeements Internal Control Weakness: - Inadequate accounting manual; incompetent accounting personnel - Inadeqate monitoring by internal auditors

Count AND list cash on hand

Existence, occurence, accuracy, cuttoff, and rights **custodian of the funds should be present during an auditors count and the custodian should sign saying they were there >> avoids custodian blaming the auditor.

Confirm cash balances with financial institutions

Existence, occurrence, accuracy, cutoff, and rights

Description of Misstatement: Inaccurate Recording of Purchase or Disbursement (fraud)

Fraud: A bookkeeper prepares a check to himself and records it as having been issued to a major supplier Internal control weakness: Inadequate segragation of duties of record keeping a preparing cash disbursements, or check signer does not review and cancel supporting documents

Decription of Misstatement: Early (late) recognition of cash receipts "cutoff problems" (fraud)

Fraud: Holding the cash receipts journal open to record next year's cash receipts as having occurring in this year Internal Control Weakness: Ineffective board of directors, audit committee, or internal audit function; "tone at the top" not conducive to ethical conduct; undue pressure to show improved financial position

Description of Mistatement: Unauthorized Investment Transaction

Fraud: An employee with access to securities converts them for personal use Internal Control Weakness: Inadequate segregation of duties of record keeping for and custody of securities

Type of Mistatement: Recording fictitious cash receipts

Fraud: Overstating cash receipts on the books by transferring cash between bank accounts without appropriate recording of the transfer to cover up an embezzelement of cash Internal control weakness: Lack of segregation of duties of functions (access of cash and record keeping), no effective review of bank reconciliations.

Kiting

Manipulations causing an amount of cash to be included simultaneously in the balance of two or more bank accounts. Kiting schemes are based on the float period—the time necessary for a check deposited in one bank to clear the bank on which it was drawn. **manipulations to utilize temporary overstated bank balances to conceal cash shortage or meet short term cash needs

Monitoring cash transactions

Manual system >> management or internal auditor review cash journal and ledgers for unusual transactions or entries IT System >> data analytic software may be used to continuously monitor cash transactions for those that may be erroneous or fraudulent

Forms of bank reconciliation (ends with unadjusted balance per accounting records)

Permits auditors to post adjusting entries affecting cash directly to the bank reconciliation working paper so the final adjusted balance can be cross referenced to the cash lead schedule or to the working trial balance.

Inestigate Payments to related parties

Presentation 1. Are transactions properly authorized and recorded 2. Are the transactions adequately disclosed in the financial statement

Purpose of Bank transfers?

To disclose overstatements of cash balances resulting from kiting (bank transfer is moving cash from one account to another >> usually electronically)

Risk of Material Misstatement (RMM)

arise jointly from inherent risk and control risk

Segregation of duties

- Inspect various documents and reconciliations - Cash forecasts or budgets will be inspected - Auditors follow-up on variances from forecasted amounts of receipts and disbursements

Description of Misstatement: Inaccurate Recording of Purchase or Disbursement (error1)

Error: Adisbursement is made to pay an invoice for goods that have not been received Internal Control Weakness: Ineffective controls for matching invoices with recieving documents before disbursements are authorized

Voucher System of Control

Establishes procedures for verifying, approving, and recording obligations for eventual cash disbursement. **Accounting department is responsible for assembling the approproariate documentation to support every cash disbursement.

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

Existence, occurence, accuracy, cutoff, and rights.

Description of Mistatement: Misstatement of recorded value of investment (fraud)

Fraud: Misstatement of the value of closely held investment, recording fictitious securities. Internal Control Weakness: Ineffective board or directors audit committee, or internal audit function; "tone at the top" not conducive to ethical conduct; undue pressure to meet earnings targets

Cash and Credit Card Sales

- Control over cash sales is strongest when 2 or more employees (salesclerk and cashier) participate in transaction with a customer.

Petty cash

- Rarely material - Auditors focus on the transactions rather than the year end balance - P-Card have low limits of spending

Performing further audit procedures for Cash

Existence and Accuracy: obtain analyses of cash balances and reconcile them to the general ledger Existence, Occurence, Accuracy, Cutoff, and Rights: Confirm dash balances with financial institutions; Obtain reconciliations of bank balances and consdier the need to reconcile bank activity; Obtain a cutoff bank statement (7 days after B/S); Identify and investigate unusual cash receipts and disbursements; Count and list cash on hand Cutoff, Existence, Occurence, Rights, and Completeness: Verify the clients cutoff of cash transactions; Analyze bank transfers for the last week of the audit year and the first week of the following year Presentation and Disclosure: Investigate payments to related parties; Evaluate financial statement presentation and disclosure

Internal control over employee reimbursement

- Company must establish effective controls over employee reimbursements - Reports are approved by the employee's supervisor and submitted to the accounting department for processing - Ofter reimbursed through direct deposit to their bank acounts - Many companies issue business credit cards to employees that spend a lot for the company - Document credit card expenditures and maintain receipts.

Financial Investments

- Consist of marketable stocks and bonds, becuase they have greater dollar value than any other kind of investment holding ** auditors care about derivatives used to hedge financial and operational risks or for speculation.

Mailroom Operations

- Open mail in mailroom - Employee endorses check "for deposit only" and prepares control listing for incoming cash receipts - Listing show amount recieved from each customer and identifies customer by name or ID number - Copy of control lsting goes to the controller - Copy of control listing AND cash receipts are forewarded to the cashier - Another listing is forwarded to employee responsible for the account

Tests of Control for Investments

- Trace several tranasctions for purcahses and sales of investements through the accounting system - Review and test reports of investment activitiy prepared for the investment committee - Inspect reports by internal auditors regarding their periodic inspection and review of securities owned, purchased, and sold and amounts of revenue earned and budgeted

Audit documentation for cash

- Working papers for cash >> auditors include flowchart or written description of controls, Questionairre for larger companies Can Include: documentation of risk assessments, an audit plan, a lead schedule, cash count sheets, bank confirmation, bank reconciliations, interbank transfer schedules, lists of outstanding checks, checks being investigated, recommendations for client, and notes for proper presentation and disclosure of client B/S

Basic questions the auditors should ask in regard to cash

1. Do the clients records reflect all cash transactions that took place during the year 2. Were all cash payments properly authorized and for a legitimate business purpose

Fraud that may be disclosed

1. Interception of cash receipts before any record is made 2. Payment for materials not recieved 3. Duplicate payments 4. overpayment to exployees or payments to ficticious employees 5. Payments for personal expenditures of officers or related parties.

Guideline for internal control over cash

1. No employee should handle transaction beginning to end 2. Seperate cash handling (custody) 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 / observe cash register totals 6. Deposit cash DAILY 7. Make disbursements by check / electronic fund transfer if not using petty cash 8. monthly bank rec prepared by employees who dont make cash payment or have custody of cash >> Review by official too 9. Use software to monitor unusual transactions in cash receipts and disbursements >> compare recorded amounts to budgeted amounts

Objectives of audit of cash / cash equivalents

1. Use understanding of the client / environment to consider inherant risks (including fraud) 2. Understand Internal controls over cash 3. Assess risk of material Misstatement and design controls and substantive procedures

Protective features of Cash Registers

1. Visual display of the amount of the sale in full view of customer 2. printed receipt >> Customer is urged to take 3. accumulation of the days total sales

Voucher Register

A special journal used to record the liabilities for payment originating in a voucher system. The debit entires are the cost distribution of the transaction, and the credits are vouchers payable. Every transaction recorded in a voucher register corresponds to a voucher authorizing future payment of cash

Verify the clients cutoff of cash reciepts and cash disbursements

Cutoff, existence, occurence, and rights **auditors can verify the cuttoff of cash receipts by determining that deposits in transit as shown on year end bank rec appear the same as the bank statement on the first business day of the year ** be aware of window dressing of cash transactions

Description of Misstatement: Duplicate recording and payment of purcahses (error)

Error: A purchase is recorded when an invioce is received from a vendor and recorded again when a duplicate invoice is sent by the vendor Internal Control Weakness: Ineffective controls over the input of invoices that allow invoices from the same vendor with the same invoice number to be processes more than once

Description of Misstatement: Inaccurate Recording of Purchase or Disbursement (error2)

Error: Disbursements for travel and entertainment are improperly included with merchandise purchases Internal Control Weakness: Ineffective accounting coding procedures may result from incompetence accounting personnel, inadequate chart of accounts, or no controls over the posting process.

Description of Misstatement Failure to record cash from collection of accounts receivable (fraud)

Example 1: A cashier embezzles cash payments by customers on recievable, without recording the receipts in the customers accounts Internal Control Weakness: Lack of segregation of duties between personnel who have access to cash receipts and those who make entires into the accounts receivable records

Description of Misstatement Failure to record cash from collection of accounts receivable (fraud)

Example 2: A bookkeeper who has access to cash receipts embezzles cash collected from customers and writes off the related receivables Internal Control Weakness: Lack of proper authorization of write-offs and lack of segregation of duties between personnel who have access to cash receipts and those who make entries into the accounts receivable records

Description of Misstatement: Failure to record receipts from cash sales (fraud)

Example: A cashier fails to ring up and record cash sales and embezzles the cash Internal control weakness: Inadequate supervision of cashiers; failure to encourage custoemrs to obtain cash receipts

Description of Misstatement Failure to record cash from collection of accounts receivable (Error)

Example: A bookkeeper accidentally fails to record payment on a receivable Internal Control Weakness: Inadequate reconciliations of subsidiary records of accounts receivable with the general ledger control account

Description of Mistatement: Misstatement of recorded value of investment (error)

Example: Failure to record changes in market values of investment Internal control weakness: inadequate accounting manual; incompetent accounting personel

Description of Misstatement: Failure to record receipts from cash sales (error)

Example: A bookkeeper accidentally omits the recording of the recipts from one cash register for the day Internal Control Weakness: Inadequate controls for reconciling cash register tapes and accounting records: inadequate controls for reconciling bank accounts.

Obtain cutoff bank statement containing transactions of at least 7 business days subsequent to the balance sheet date

Exisetence, occurence, accuracy, cutoff, and rights **Prepare the cutoff bank statement and mail it directly to the auditors

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

Existence and Rights Occurance and accuracy Completeness Cutoff Valuation

Lockbox

a post office controlled by the companies financial institution >> Internal control is strengthened by the fact that the financial institution has no access to the company's accounting records