Audit CH 6 Employee Fraud and the Audit of Cash

Extended Procedures to Detect Fraud

(1) Count and recount petty cash on same day (2) Examine endorsements on canceled checks (3) Retrieve customers' checks (4) Use marked coins and currency (5) Analyze the mix of cash and checks in deposits (6) Measure deposit lag time (7) Document examination (8) Inquiry (fraud audit questioning FAQ) (9) Covert Surveillance (10) Horizontal (across yrs) and Vertical Analyses (proportion of a base) (11) Net worth Analysis (12) Expenditure Analysis (13) Reasonableness Tests

Cash: Relevant Assertion from most risky to less risky

1 Existence 2 Valuation 3 Presentation & Disclosure

Misappropriation of Assets/ Employee Fraud

1.Fraudulent act (1-3 above) 2.Conversion of assets to cash 3.Cover up the fraudulent act

Fraud

1.Material misrepresentation of fact 2.Intent that someone act on the falsehood and 3.Incur a loss or damage

Clerk 3 mails the checks and remittances after they have been signed.

A company employs three accounts payable clerks and one treasurer. Their responsibilities are as follows: Employee Reviews Clerk 1 Review vendor invoices for proper signature approval. Clerk 2 Enters vendor invoice into the accounting system and verifies payment terms. Clerk 3 Posts entered vendor invoices to accounts payable ledger for payment and mails checks. Treasurer Review the vendor invoices and signs each check. Which of the following would indicate a weakness in the company's internal controls? -Clerk 3 mails the checks and remittances after they have been signed. -The treasurer uses a stamp for signing checks. -Clerk 2 reconciles the accounts payable ledger with the general ledger monthly. -Clerk 1 opens all of the incoming mail.

request a cutoff bank statement be mailed to the client

An audit plan of substantive procedures for cash would not include: -request a cutoff bank statement be mailed to the client. -request client to prepare bank reconciliations. -obtain a written client representation concerning compensating balance agreements. -prepare a schedule of interbank transfers for a period of ten business days before and after year-end date.

the results of alternative procedures that were performed compensate for the omission.

An auditor is considering whether the omission of the confirmation of investments impairs the auditor's ability to support a previously expressed unmodified opinion. The auditor need not perform this omitted procedure if: -the omission is documented in a communication with the audit committee. -the results of alternative procedures that were performed compensate for the omission. -the auditor's assessed level of detection risk is low. -no individual investment is material to the financial statements taken as a whole.

observation and inquiry.

An auditor wishes to perform tests of controls on a client's cash disbursements procedures. If the control activities leave no audit trail of documentary evidence, the auditor most likely will test the activities by: -confirmation and observation. -inquiry and analytical procedures. -analytical procedures and confirmation. -observation and inquiry.

a bank lockbox system.

An entity with a large volume of customer remittances by mail could most likely reduce the risk of employee misappropriation of cash by using: -daily check summaries. -a bank lockbox system. -independently prepared mailroom prelists. -employee fidelity bonds.

Inadequate internal control because of a lack of separation of duties.

As payments are received, one mailroom employee is assigned the responsibility of prelisting receipts and preparing the deposit slip prior to forwarding the receipts, deposit slip, and remittance advices to accounts receivable for posting. Accounts receivable personnel re-foot the deposit slip, stamp a restrictive endorsement on the back of each check, and then forward the receipts and deposit slip to the treasury department. Evaluate the internal control of the described process. Which of the following is a reasonable assessment of internal control in this process? -Inadequate internal control because mailroom employees should not have access to cash. -Inadequate internal control because of a lack of separation of duties. -Adequate internal control. -Inadequate internal control because treasury employees should prepare the deposit slip.

Positive Pay.

At the end of each business day, Safe Company sends its bank a listing of all checks written during the day including the check number, payee, and amount. When a check is sent to the bank for payment the bank compares the payee and the amount with the listing provided by Safe Company. This system is called: -Pay-As-You-Go. -Positive Pay. -Pay Master. -PayChex.

seek information about contingent liabilities and security agreements.

Auditors ordinarily send an electronic confirmation request to all banks with which the client has done business during the year under audit, regardless of the year-end balances. A purpose of this procedure is to: -provide the data necessary to prepare a proof of cash. -detect questionable bank activities that may otherwise not be discovered. -request that a cutoff bank statement and related checks be sent to the auditor. -seek information about contingent liabilities and security agreements.

•Bank reconciliations:

Compares book cash balance to bank cash balance

Internal Control Evaluation for Employee Fraud in Cash Disbursements

Control activities to prevent and detect employee fraud in cash disbursements: •Separation of: -Custody: of blank checks and documents -Authorization: of payments based on supporting vouchers -Dual authorization for high-dollar payments -Recording: of cash disbursements -Reconciliation: of the bank statement

•Cash receipts journal

Detail of deposits/DR Cash entries

•Cash disbursements journal

Detail of payments/CR Cash entries

differences between management and the auditor's judgment regarding estimates.

Each of the following is a type of known misstatement, except: -a difference between the classification of a reported financial statement element and the classification according to generally accepted accounting principles. -the misapplication of accounting principles. -an inaccuracy in processing data. -differences between management and the auditor's judgment regarding estimates.

•Canceled checks:

Images of cashed checks from bank

test the propriety of items appearing on the client's year-end bank reconciliation.

In the audit of cash the auditor obtains a bank cutoff statement primarily to: -obtain direct confirmation of the client's bank balances as of year-end. -obtain sufficient information to reconcile the client's bank account as of year-end. -identify old outstanding checks that the client may exclude from the year-end bank reconciliation in order to misappropriate cash. -test the propriety of items appearing on the client's year-end bank reconciliation.

Dual control (joint custody) is established over the contents of the night depository box from the time of removal until initial recording is completed.

Narbona, CPA, is reviewing controls over cash received through a bank night depository. Which controls would she find most important? -Vacations are required for all employees engaged in night depository activities. -Responsibilities are rotated for processing night depository receipts among employees of the various departments. -Dual control (joint custody) is established over the contents of the night depository box from the time of removal until initial recording is completed. -All deposit tickets related to night deposits are numbered.

The Fraud Triangle

Opportunity: •Weak internal control •IC circumvention (collusion; override) •The higher the position; the greater trust and access to assets Incentive/Pressure: Unshareable financial need •House payment •Medical bills •Gambling •Luxury lifestyle •Investments Attitude: Rationalization •I'm borrowing the money. •Everybody does it. •The company is big and will never miss it. •Nobody will get hurt. I am underpaid, so this is due compensation

•Bank statements:

Shows cash activity for the period

Internal Control Evaluation for Employee Fraud in Cash Receipts

There is always fraud risk in cash because it is liquid, transportable, and not easily identifiable Control activities to prevent and detect employee fraud in cash receipts: •Dual custody of cash at all times (prevents skimming) •Lockbox •Separation of custody, recording, and reconciliation •Reconciliation of deposits to customer accounts (detects lapping) •Fidelity bonds

stamped "paid" by the check signer.

To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is: supported by a vendor's invoice. approved for authorized purchases. prenumbered and accounted for. stamped "paid" by the check signer.

ideological

When an employee embezzles company funds from an electric utility company for the purpose of paying expenses of an anti-nuclear protest organization, the fraudster's motive is said to be: -egocentric. -economic. -ideological. -psychotic.

all of the these choices are correct.

When auditing financial statements and finding indications of a possible misappropriation of assets, independent auditors should: -identify a person(s) who are likely responsible for the misappropriation and obtain evidence about some other fraud indications in their work. -determine the methods by which the misappropriation was carried out. -investigate fully to determine the total amount of the misappropriation. -determine which accounts are affected and the amount by which they are overstated or understated. all of the these choices are correct.

Lack of training.

Which of the following is not considered one of the three factors increasing the probability of fraud? -Opportunity. -Lack of training. -Motive. -Rationalization.

Measuring performance and awarding bonuses based on short-term operating results.

Which of the following management policies would increase the probability of fraud in a company? -Establishing work teams that share responsibilities, performance, and bonuses based on collective efforts. -Measuring performance and awarding bonuses based on short-term operating results. -Diversifying authority throughout divisions and subsidiaries in the organization. -Giving employees performance feedback that considers positive and constructive praise along with critical and negative observations on their work.

Cash in bank and collateral for loans.

Which of the following sets of information does an auditor usually confirm on one form? -Accounts payable and purchase commitments. -Inventory on consignment and contingent liabilities. -Accounts receivable and accrued interest receivable. -Cash in bank and collateral for loans.

A large number of bearer bonds on hand

Which of the following situations most likely represents the highest risk of a misstatement arising from misappropriation of assets? -A large number of bearer bonds on hand. -A large number of fixed assets with easily identifiable serial numbers. -A large number of transactions processed in a short period of time. -A large number of inventory items with low sales prices.

The total of the accounts receivable subsidiary ledger balances is less than the accounts receivable control account.

Which of the following would be consistent with an employee taking cash receipts from customers on account? -The total of the accounts receivable subsidiary ledger balances is greater than the accounts receivable control account. -Total cash receipts from customers for the month are greater than credit sales for the month. -Total cash receipts from customers for the month are less than credit sales for the month. -The total of the accounts receivable subsidiary ledger balances is less than the accounts receivable control account.

preparation and review of standard bank confirmation inquiries.

Your client is in the process of acquiring another company. You have been requested to verify that cash for the company being acquired is properly stated. The audit technique that will yield the most persuasive evidence is: -analytical computations comparing current cash in the bank with previous accounting periods. -preparation and review of standard bank confirmation inquiries. -interview with the company's treasurer and cash manager. -examination of the company's escrow account.

For audits of cash

•Auditors rarely use substantive analytical procedures •Best procedure is to test the details of the bank reconciliation

Tests of Detail over the Bank Reconciliation

•Balance per bank •CONFIRM (ELECTRONIC BANK CONFIRMATION) directly with bank •Agree amount to CUTOFF BANK STATEMENT •Add deposits-in-transit •TRACE to cash receipts journal •VOUCH to CUTOFF BANK STATEMENT •Subtract Outstanding Checks •VOUCH to cash disbursements journal •TRACE checks cleared from cutoff bank statement •Add/Subtract other Debit/Credit Memos •Inspect bank credit/debit memo and audit for reasonableness. Examine relevant supporting documentation. •Balance per books •FOOT the entire reconciliation for mathematical accuracy •TRACE the amount to the trial balance

Management- Prepared Source Documents Used to Audit Cash

•Cash receipts journal •Cash disbursements journal •Bank reconciliations •Canceled checks •Bank statements

Typical White-Collar Criminal

•Has education beyond high school •Is likely to be married •Is member of a mosque, temple, or church •Ranges in age from teens to over 60 •Is socially conforming •Has an employment tenure from 1 to 20 years •Has no arrest record •Usually acts alone

Fraud Prevention

•Strong control environment/tone at the top •Managing pressures in the workplace •Counseling services •Anonymous hotlines •Ethics officers •Proper segregation of duties is critical - cash disbursements example: •Authorization of disbursements •Custody of blank checks •Recordkeeping for payments •Reconciliation of bank accounts to general ledger •Controls should balance fraud prevention/detection with trust needed to run the business

Two types of substantive tests

•Substantive analytical procedures •Test of details