Chapter 10 - Cash and Financial Investments

major element of adequate internal control over financial investments include

-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

electronic funds transfer (EFT) systems

a computer system that transmits and processes funds-related cash disbursement and receipt transactions

brokers' advices

a notification sent by a stockbrokerage firm to a customer reporting the terms of a purchase or sale of securities

Substantive procedures of audit of cash should

a. substantiate the existence of recorded cash and the occurrence of cash transactions b. determine the accuracy of cash transactions c. establish the completeness of recorded cash d. verify the cutoff of cash transactions e. determine that the client has rights to recorded cash f. determine that the presentation and disclosure of cash, including restricted funds, are appropriate

voucher system

accounting department is responsible for assembling the appropriate documentation to support every cash disbursement

voucher

an authorization sheet that provides space for initials of the employees performing various authorization functions

critical audit matter

audit of very complex financial instruments

dividend record books

books that show dividend declarations, amounts, and payment dates for all listed stocks

derivatives

instruments that get their value from other financial instruments, underlying assets, or indexes

bank transfers

moving cash from one bank account to another. Generally performed electronically. Could be between two accounts in the same bank

lockbox

post office box controlled by the company's financial institution

proof of cash

reconciles cash transactions during a specified period -fraud detection procedure

lapping

the concealment of a cash shortage by delaying the recording of cash receipts

walk-through

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 flow chart

objectives in the audit of cash and cash transactions

1. use the understanding of the client and its environment to consider inherent risks, 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

cutoff bank statement

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 hat 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.

standard confirmation form

A 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.

window dressing

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

Substantive Procedure for Cash transactions and balances #8

Analyze bank transfers for the last week of the audit year and the first week of the following year -kiting

A practical and effective audit procedure for the detection of lapping is:

Comparing recorded cash receipts in detail against items making up the bank deposit as shown on duplicate deposit slips validated by the bank.

Substantive Procedure for Cash transactions and balances #2

Confirm Cash balances with Financial Institutions -standard confirmation form -financial institution can provide auditors access to a secure website with the requested information with the client's authorization

Substantive Procedure for Financial Investments #3

Confirm securities and derivative instruments with holders and counterparties -auditors send a confirmation request, signed by the client, to the holders of the investments to determine existence, ownership, and, if appropriate, market value

To establish the existence and ownership of a large long-term investment in the common stock of a publicly traded company, the auditors ordinarily perform a security count or:

Confirm the number of shares owned that are held by an independent custodian.

Substantive Procedure for Cash transactions and balances #6

Count and list cash on hand -insist custodian of funds be present throughout count

Substantive Procedure for Financial Investments #9

Evaluate financial statement presentation and disclosure of financial investments -auditors should determine that investments are properly separated into short-term and long-term portfolios

Substantive Procedure for Cash transactions and balances #10

Evaluate proper financial statement presentation and disclosure of cash

Substantive Procedure for Financial Investments #8

Evaluate the methods used and test valuation -fair value

Paid checks in the cutoff bank statement that were not included in the year-end bank reconciliation as outstanding indicate that the cash balance was understated at year end.

False

The person who signs checks should not be the person who also mails the checks.

False

Voided checks should be destroyed to eliminate any possibility of further use

False

Substantive Procedure for Cash transactions and balances #5

Identify and investigate unusual cash receipts and disbursements -data analytics may be used to perform these procedures

Which of the following is an unacceptable form of window dressing at year end?

Including a few days of cash received after year end as deposited as of year-end.

Substantive Procedure for Financial Investments #7

Inspect documentation of management's intent to classify derivative transaction as hedging activities

Substantive Procedure for Financial Investments #2

Inspect securities on hand and review agreements underlying derivatives -record in the working papers a description of the securities, including the serial numbers -auditors will also review and analyze the derivative instruments and other agreements that may contain embedded derivates

Substantive Procedure for Cash transactions and balances #9

Investigate payments to related parties -ensure payments were properly authorized and recorded -ensure adequately disclosed in the financial statements

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.

Substantive Procedure for Cash transactions and balances #1

Obtain Analyses of Cash Balances and Reconcile Them to the General ledger -auditors will trace and reconcile all accounts to the general ledger

Substantive Procedure for Cash transactions and balances #4

Obtain a Cutoff Bank Statement containing transactions of at least seven business days subsequent to the balance sheet date -provides assurance that the amount of cash shown on the balance sheet was not overstated by omission of one or more checks from the list of checks outstanding

Substantive Procedure for Cash transactions and balances #3

Obtain or Prepare reconciliations of Bank accounts as of the balance sheet date and consider the need to reconcile bank activity for additional months -includes verifying arithmetical accuracy, comparing balances to the bank statement and ledger account, and investigating the reconciling items -auditors should investigate any checks outstanding for a long period of time -proof of cash

Substantive Procedure for Financial Investments #1

Obtain or prepare analyses of the investment accounts and related revenue, gain, and loss accounts and reconcile them to the general ledger

Substantive Procedure for Financial Investments #6

Perform analytical procedures and make independent computations of revenue from securities

When a client engages in transactions involving derivatives, the auditor should:

Review agreements underlying the derivative.

Substantive Procedure for Financial Investments #5

Review investment committee minutes and reports -may disclose unrecorded purchases and sales of securities or other financial instruments

Having a disbursement recorded in one bank account in a different accounting period than it was recorded as received in another bank account is a sign of kiting.

True

Petty cash funds are becoming much less common as companies move toward using purchasing or procurement cards.

True

Which of the following manipulations of cash transactions would overstate the cash balance on the financial statements?

Understatement of outstanding checks

Substantive Procedure for Cash transactions and balances #7

Verify the Client's cutoff of cash receipts and Cash disbursements -essential to a proper statement of cash on balance sheet -window dressing

Substantive Procedure for Financial Investments #4

Vouch selected purchases and sales of financial investments during the year and verify the client's cutoff of investment transactions -auditors vouch a sample of transactions by reference to brokers' advice and cash records