ACCT 320 Chap 10

1. Electronic funds transfer (EFT) system - what is it and how is it used in accounting/auditing?

A computer system that transmits and processes funds-related cash disbursement and receipt transactions. Increasingly, companies are electronically transferring funds between bank accounts rather than issuing checks. See also electronic data interchange. - Actually paying over the interest

1. Lockbox - what is it and how does it contribute to internal control?

A post office box controlled by a company's bank at which cash remittances from customers are received. The bank picks up the remittances, immediately credits the cash to the company's bank account, and forwards the remittance advices to the company. - Payment goes directly to the bank and bank sends copy and information to company - Great internal control

Which of the following controls would most likely reduce the risk of diversion of customer receipts by a client's employees? A bank lockbox system. Prenumbered remittance advices. Monthly bank reconciliations. Daily deposit of cash receipts.

A bank lockbox system. A bank lockbox is a post office box controlled by a company's bank at which cash remittances from customers are received. With such a system the bank collects the remittances, immediately credits the cash to the company's bank account, and forwards the remittance advices to the company. Use of a bank lockbox system makes it extremely difficult for employees to divert cash receipts since those cash receipts are sent directly to the post office box controlled by the bank. Answer (Prenumbered remittance advices.) is incorrect because remittance advices may be prenumbered, but since they come from various customers, they do not have one overall sequence for the client. Answers (Monthly bank reconciliations.) and (Daily deposit of cash receipts.), are incorrect because bank reconciliations, and daily deposit of cash receipts, are controls, but controls that ordinarily are not as effective at preventing the diversion of customer receipts.

1. Electronic data interchange (EDI) - what is it and how is it used in accounting/auditing?

A computer network between companies that allows the interchange of data from one company's computer to the other's (e.g., allows purchases and sales between two firms to be processed electronically).

3. Explain the nature of the cash receipts and disbursements cycles

many are responsibility of finance department -under direction of treasurer - depositing cash receipts - signing checks - investing idle cash - maintaining custody - marketable securities -forcast cash requirements

10. Identify tests of controls & substantive procedures used to audit FI

test of controls: Management review controls Reviews conducted by management of estimates and other kinds of financial information for reasonableness. They often involve the use of significant judgment, knowledge, and experience in comparing recorded amounts with expectations of the reviewers. They often are considered monitoring controls but may relate to any of the other COSO components that have the common characteristic of management review of information to identify misstatements or breakdowns in other controls.

5. Obtain an understanding of internal control over cash.

- may prepare description of controls ( based on questions or observation) - flowchart or I/C questionnaire - conduct a walkthrough of the system (trace a transaction) - - helps see I/C actually put into practice -

test of controls examples for cash

- over accuracy and completeness of accounting records and bank reconciliation - over accuracy and completeness of processing cash receipts and recording them in the accounting records - accuracy and completeness of cash disbursements and recording them in the accounting records - test management review controls

1. Describe the sources and nature of cash.

- payroll - petty cash - savings accounts - checking accounts - cash - cash equivalents * the liquid nature of cash increases the risk of fraud, which may be more difficult to detect than an error

Prepare a bank transfer schedule.

. Detect kiting.

9. Describe internal controls over business processes re: financial investments.

1. formal investment policies that limit the nature of investment in securities and other financial instruments 2. an investment committee of board of directors that authorizes and reviews financial investment activities for compliance and investment policies 3. 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 3. complete detailed records of all securities and derivative instruments owned and the related provisions and terms 4. registration of securities in the name of the company 5. 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 6. management reviews of the activity in investment accounts and the relationship between amounts of investment income and recorded investment or the amounts of forecasted income 7. establishing appropriate controls over valuation processes including the use competent personnel or appropriate outside experts

describe the fundamental controls over the business processes related to cash.

1. do not permit any one employee to handle a transaction from beginning to end 2. separate cash handling (custody) from record keeping 3. centralized 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 6. deposit cash receipts daily 7. make all disbursements by check or electronic funds transfer, with the expectation of small expenditures from petty cash 8. have monthly bank reconciliations prepared by employees not responsible for making cash payments or custody of cash. The completed reconciliation should be reviewed promptly by an appropriate official 9. monitor cash receipts and disbursements by using software to identify unusual transactions and comparing recorded amounts to budgeted amounts

substantive procedures for cash transactions and balancs

1. obtain analyses of cash balances and reconcile them to the GL 2. confirm cash balances with financial institutions 3. obtain or prepare reconciliations of bank accounts as of the balance sheet date and consider he need to reconcile bank activity for additional months 4. obtain a cutoff bank statement containing transactions of at least seven business days subsequent to the balance sheet date 5. identify and investigate unusual cash receipts and disbursements 6. count and list cash on hand 7. verify the clients cutoff of cash receipts and cash disbursements 8. analyze bank transfers for the last week of the audit year and the first week of the following year 9. investigate payment to related parties 10. evaluate proper financial statement presentation and discourse of cash

substantive procedures used to audit FI

1. obtain or prepare analyses of the investment accounts and related revenue gain and loss accounts and reconcile them to the GL 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 6. perform analytical procedure or data analytics 7. make independent computations of revenue from securities 8. inspect documentation of management's intent to classify derivative transactions as hedging activates 9. evaluate the method of accounting for investments 10. test the estimates of the fair value financial investments including valuations used for tests of impairment 10. test estimates of the fair value financial investments including valuations used for test of impairment 11. evaluate financial statement presentation and disclosure of financial investments

8. Identify the auditors' objectives in the audit of financial investments (FI).

1. use understanding of client and their environment to assess inherent risks including fraud risks 2. obtain an understanding of internal control over investments 3. assess the risk of material misstatement of investments and design further audit procedures that - existence - occurrence - completeness - cutoff -rights - valuation - presentation and disclosure

2. Identify the auditors' objectives in the audit of cash. .

1. use understanding of clients environment to consider inherent risks (including fraud) 2. obtain understanding of I/C over cash 3. assess risk of material misstatement of cash and design tests of controls and substantive procedures that: - substantiate the existence or recorded cash and occurrence of cash transactions - determine the accuracy of cash transactions - establish the completeness of recorded cash - verify the cutoff of cash transactions - determine that the client has rights to recorded cash - determine that the presentation and disclosure of cash including restricted fund are appropriate

Check Clearing for the 21st Century Act ("Check 21 Act)

This act allows financial institutions to create and process electronic "substitute checks" in place of customer written hard-copy checks. The purpose of this act is to decrease the time for check clearing.

The auditors who physically examine securities should insist that a client representative be present in order to:

Acknowledge the receipt of securities returned. Because of the liquidity of many securities, the auditor should insist that a client representative be present in order to acknowledge the receipt of securities returned. In the event of subsequent "disappearance" of a security the auditor will not be a suspect.

Hall Company had large amounts of funds to invest on a temporary basis. The board of directors decided to purchase securities and derivatives and assigned the future purchase and sale decisions to a responsible financial executive. The best person or persons to make periodic reviews of the investment activity would be:

An investment committee of the board of directors. The investment committee of the board of directors is not involved in the routine of making buy and sell decisions and can therefore review the transactions objectively. On the other hand, the chief operating officer, the controller, and the treasurer may be closely associated on a daily basis with the financial executive responsible for the investment decisions.

1. Data analytics - formal definition and a description of how it's being used in accounting/auditing

Analyses applied to raw data with the purpose of drawing conclusions about relationships. Data analytics is being used by management to get insights into how to improve the effectiveness and efficiency of operations. It is also used as a part of the management review to monitor the performance of other internal controls. Auditors are increasingly using data analytics to improve the effectiveness of certain audit procedures. - Taking raw data make making useful information out of it

1. Compensating balance and imprest accounts - what are these and why is the auditor interested?

Compensating balance: Minimum amount needed to be kept in an account based on an agreement Imprest accounts: for small routine expenses - funded for pretty much the exact amount that the expense is

You have been assigned to the year-end audit of a financial institution and are planning the timing of audit procedures relating to cash. You decide that it would be preferable to:

Coordinate the count of cash with the count of marketable securities and other negotiable assets. Unless all negotiable assets are verified at one time, an opportunity exists for a dishonest officer or employee to conceal a shortage by transferring it from one asset category to another a step ahead of the auditors. For example, marketable securities could be pledged as collateral for a loan. The cash thus obtained could be included with other cash being counted by the auditors. After the cash count, the cash derived from the securities could be removed and used to redeem the pledged securities which would then be available for counting by the auditors. Of course, this type of manipulation could hardly be carried on unless there were weaknesses in internal control. Answer (Count the cash in advance of the balance sheet date in order to disclose any kiting operations at year-end.) is incorrect because counting cash in advance of the balance sheet date does not relate to kiting. Answer (Coordinate the count of cash with the cutoff of accounts payable.) is not persuasive because accounts payable cannot be substituted for cash as can negotiable assets. Answer (Count the cash immediately upon the return of the confirmation letters from the financial institution.) is not correct because there is no particular significance to the amount of cash on hand on the day the bank confirmation letters happen to be returned.

The auditors suspect that a client's cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditors most likely would compare the:

Details of bank deposit slips with details of credits to customer accounts. Lapping will result in a delay in the recording of specific remittance credits in the financial records, but the checks will be deposited in the bank as they are received. Therefore, a comparison of the checks deposited to the credits to customer accounts will likely uncover the scheme.

1. Proof of cash - who typically does this procedure and why?

Done by auditor from bank information to make sure they actually have the cash they say they do 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.

1. Derivatives - what are they?

Financial instruments that "derive" their value from other financial instruments, underlying assets, or indexes. Examples are options, forward contracts, and futures contracts. - Interest rate swaps - Can be very good or bad - Hard to determine what the actual value is

To gather evidence regarding the balance per bank in a bank reconciliation, the auditors would examine any of the following except:

General ledger. The general ledger will not have information on the balance per bank. The cutoff bank statement, year-end bank statement and bank confirmation will all include information on the balance per bank.

1. Cutoff bank statement - what is it/how is it used?

Good tool to use to help audit cash balance- show activity that has happened after balance sheet date A bank statement covering a specified number of business days (usually 7 to 10) after the client's balance sheet date. Auditors use this statement to determine that checks issued on or before the balance sheet date and paid during the cutoff period were listed as outstanding on the year-end bank reconciliation. Another use is to determine that reconciling items shown on the year-end bank reconciliation have cleared the bank within a reasonable amount of time.

Search for large checks to directors, officers, and employees.

Identify related party transactions.

In testing controls over cash disbursements, the auditors most likely would determine that the person who signs checks also:

Is responsible for mailing the checks. When checks are signed they should not be returned to the accounting department. This control is used so as to avoid a situation in which the accounts payable department fabricates documents, and then collects the checks. Not returning the checks makes it more difficult for this sort of fraud in that the perpetrator must also establish a "safe" address for the check to be mailed to. Answer (Reviews the monthly bank reconciliation.) is incorrect because control is stronger if individuals who are otherwise independent of the cash function prepare and review the monthly bank reconciliation. Answer (Returns the checks to accounts payable.) is incorrect because, as discussed, the checks should not be returned to accounts payable. Answer (Is denied access to the supporting documents.) is incorrect because the individual signing the checks needs access to the supporting documents so he or she can determine whether the expenditure is proper.

Which of the following procedures would the auditors most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet?

Observe the consistency of the employees' use of cash registers and tapes. The use of cash registers and tapes helps assure that all sales of a retail store are recorded. Answer (Inquire about employees' access to recorded but undeposited cash.) is incorrect because the cash has already been recorded. Answer (Trace deposits in the cash receipts journal to the cash balance in the general ledger.) is incorrect because the procedure only deals with recorded deposits and, therefore, the completeness assertion is not addressed as directly as in answer (Observe the consistency of the employees' use of cash registers and tapes.). Answer (Compare the cash balance in the general ledger with the bank confirmation request.) is incorrect because one would not expect the cash balance in the general ledger to agree with the bank confirmation request due to items in transit and checks outstanding.

Reconciliation of the bank account should not be performed by an individual who also:

Processes cash disbursements. The individual who reconciles the bank account should not be involved in the processing of cash receipts or disbursements. Therefore, answer (Processes cash disbursements.) is correct. All of the other functions are compatible with reconciliation responsibilities.

Prepare a four-column proof of cash.

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

In order to guard against the misappropriation of company-owned marketable securities, which of the following is the best course of action that can be taken by a company with a large portfolio of marketable securities?

Require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent. Having the securities held in safekeeping by a bank or stockbroker provides strong internal control because they are not available to employees responsible for maintaining the accounting records of the securities. Thus the separation of the custody of securities from the accounting function is complete.

The best way to verify the amounts of dividend revenue received during the year is:

Verification by reference to dividend record books. Comparing the recorded amount of dividend revenue with dividend record books (published by investment advisory services) provides evidence of the amount of dividend revenue that should have been received during the year. It is virtually impossible to confirm the receipt of dividends with the company paying those dividends.

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.

4. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to cash.

concerned with possible theft and misstatement (overstatement) - cash improperly abstracted during period (error or fraud) private companies might understate cash to lessen income tax

7. Describe the risks involved in auditing financial investments, including why the auditors might need specialized skills.

need for specialized knowledge: - investments can be very complex - marketable stocks and bonds are found more frequently and usually are of greater dollar value than other kinds of investment holdings

To provide assurance that each voucher is submitted and paid only once, the auditors most likely would examine a sample of paid vouchers and determine whether each voucher is:

stamped "paid" by the check signer. The auditors will determine whether each voucher is stamped "paid" by the check signer to avoid a situation in which supporting documents are used a second time to elicit a second payment.

6. Assess risks of material misstatement of cash & design further audit procedures, including tests of controls & substantive procedures, to address risks.

what could go wrong Cash receipts: 1. recording fictitious cash receipts 2. failure to record receipts from cash 3. failure to record cash from collection of accounts receivable 4. early (late) recognition of cash receipts - Cutoff problems" cash disbursements: 1. inaccurate recording of a purchase or disbursement 2. duplication recording and payment of purchases 3.unrecoreded disbursements

Window dressing

· Action taken by the client shortly before the balance sheet date to improve the financial picture presented in the financial statements. o Not illegal unless breaking another law

canceled checks

· Canceled = A check the amount of which has been subtracted from the depositor's 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 contrast to a voided check, a check that has not been processed and will not be.

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. o Need check coming in to cover check going out o Hoping don't cash check for a few days

voided checks

· Voided: A check that is not negotiable (null and void). A voided check usually results from an error in preparing the check. In contrast a canceled check is one that has been paid by the bank.

1. Voucher and Voucher register - describe/explain how these work/how they are used/purpose.

· Voucher: A document authorizing a cash disbursement. A voucher usually provides space for the initials of employees performing various approval functions. The term voucher also may be applied to the group of supporting documents used as a basis for recording liabilities or for making cash disbursements. · Voucher register: A special journal used to record the liabilities for payment originating in a voucher system. The debit entries 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.

Lapping

· altering A/R to hide cash stolen from company o Using customer payments to cover taking o Only way to check is to have confirmation to customer

◦Assess RMM and design tests of controls and substantive procedures to determine whether the following assertions have been violated:

◦Existence of recorded financial investments/occurrence of investment transactions ◦Valuation of financial investments; determine whether such valuation is in accordance w/ the cost, fair value, or equity method of accounting and that any unrealized appreciation/depreciation in value is appropriately recorded ◦Completeness of financial investments and investment transactions ◦Cutoff of investment transactions ◦Rights (and obligations) to recorded investments ◦Presentation & disclosure of financial investments and realized/unrealized gains and losses

auditors objectives in the audit of cash

◦Identify and consider RMM (i.e., inherent risk * control risk) ◦Obtain an understanding of I/C over cash ◦Assess RMM and design tests of controls and substantive procedures to determine whether the following assertions have been violated: ◦Existence of recorded cash/occurrence of cash transactions ◦Accuracy of cash transactions ◦Completeness of recorded cash ◦Cutoff of cash transactions ◦Rights (and obligations) to recorded cash ◦Presentation & disclosure of cash