CHAPTER 18 AUDIT INVESTMENTS
AND CASH BALANCES
Learning Check 18-1.
The nature of investments investments in securities issued by other entities entities the ownership of certificates of deposit, preferred and common stocks of other entities, and corporate and government bonds. The audit area of investments in marketable securities interfaces interfaces with two other cycles. The receipt of interest and dividends from investments relates to the revenue cycle. The purchase of securities for cash pertains to cash disbursement transactions in the expenditure cycle.
18-2. The audit obect obectives ives for each of the managem management ent assertions assertions that that pertain pertain to investme investments nts in marketable securities are! "xistence or occurrence • #ecorded investment asset and e$uity balances represent investments that exist at the balance sheet date. • %nvestment revenues, reali&ed gains and losses, and unreali&ed holding gains and losses included in income resulted from transactions and events that occurred during the period. 'ompleteness • (ll investments are included in the balance sheet investment accounts.. • The income statement effects of all investment transactions and events during the period are included in the income statement accounts. #ights and obligations • (ll recorded investments are owned by the reporting entity. )aluation or allocation • %nvestments are reported on the balance sheet at fair value, cost, amorti&ed cost, or the amount determined by the e$uity method, as appropriate for particular investments. • %nvestment revenues, and reali&ed and unreali&ed gains, and losses are reported at proper amounts. *resentation and disclosure • %nvestment balances are property identified and classified in the financial statements. • (ppropriate disclosures are made concerning +1 related party investments, +2 the ba ses for valuing the investments, and + the pledging of investments as collateral.
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18-1
18- 18-.. a.
had had is is inco incorr rrec ectt abou aboutt the the bal balan ance ce shee sheett ina inasm smuch uch as mark market etabl ablee sec secur urit itie iess hel held d as as short-term investments may be material to a company4s short-term solvency, and securities held as long-term investments may be material to total assets. had may be incorrect about the income statement for a company that has trading securities, held to maturity securities when amorti&ation is significant, or available-for-sale securities for which unreali&ed holding gains and losses become reali&able due to sale or reclassification.
b.
5eri is incorrect. The audit strategy strategy decision is generally based on the fre$uency of investing transactions. 3hen there are relatively few transactions, the auditor generally uses a primarily substantive approach. 3hen there are many transactions, it may be more cost-efficient for the auditor to use a lower assessed level of control risk approach.
18-6. Typicall Typically, y, the the control control environment environment pertainin pertaining g to investments investments in marketable marketable securit securities ies enhances internal control. 7or example, the authority and responsibility for investing transactions is often assigned to a company officer such as the treasurer. The accounting system must include provision for capturing and retaining all the necessary cost, fair value, and other data re$uired for each method of accounting for the various categories of investments in e$uity and debt securities, both at ac$uisition and at subse$uent reporting dates. "ach of the categories of control activities is applicable. everal common documents and records are used in investing activities, and internal auditors may be involved in monitoring investment activities and balances. 18- 18-.. a.
b.
Thee func Th functi tion onss and and rela relate ted d cont contro rols ls in in the the inve invest stin ing g cycl cyclee cons consis istt of the the foll follow owin ing! g! • (uthori&ing investment transactions! *urchasing securities. o • #eceive or deliver securities! #eceiving safeguardingdelivering securities. o #eceiving periodic income. o • #ecording transactions! #ecording purchases, sales, and income. o #ecording market adustments and reclassifications. o • ettle transactions! #eceiving cash. o 9isbursing cash. o (ssessing investment performance and reporting. o The following table summari&es internal controls that might might be found in the investing cycle for each assertion +audit obective.
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(ssertion +(udit :bective "xistence and :ccurrence +:ccurrence
'ompleteness +'ompleteness
"xistence and :ccurrence 'ompleteness +'utoff
)aluation )aluation and (llocation +(ccuracy *resentation and 9isclosure +'lassification
#ights and :blig ligation ions
'ontrol The computer checks for authori&ation to purchase or sell securities before recording the transaction.
Test of 'ontrols
#ecorded securities are regularly compared with broker;s statements.
:bserve evidence of reconciling recorded securities with the broker;s statements and reperform control on a test basis.
The computer prepares an exception report of authori&ed investment transactions that have not been recorded. The computer compares the accounting period in which the transaction was recorded with the settlement date on the broker;s advice. The computer compares recorded $uantities and prices with the underlying broker;s advice. ( disclosure committee reviews classification of securities as held to maturity, available for sale, or trading securities. ( disclos losure co comm mmiittee tee re reviews security transactions to determine if disclosures are appropriate of securities are pledged as collateral for loans or margin trades.
18-=. The acceptable acceptable level level of detectio detection n risk is derived derived from from the audit audit risk risk model. model. %nherent %nherent risk for for investment balances involves consideration of +a the vulnerability vu lnerability of the securities to theft and misappropriation +existence or occurrence assertion, +b the possibility of misclassification of investments +presentation and disclosure assertion, and +c the complexities pertaining to the valuation methods such as the e$uity method of accounting +valuation or allocation assertion. 'ontrol risk, under the primarily substantive approach is at the maximum or slightly below the maximum. %n such cases, the acceptable level of detection risk will be low. 18-> 18->.. a.
b.
The pre The preca caut utio ions ns are! are! +1 +1 the the custo custodi dian an shoul should d be be pre prese sent nt durin during g the the count count,, +2 +2 a receipt should be obtained from the custodian when the securities are returned to the client, and + all securities, cash and other negotiable investments should be controlled during the count. This test applies to four assertions! +1 +1 existence or occurrence, +2 completeness, + rights and obligations, and +6 presentation and disclosure.
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18-8. The working working papers papers for securit securities ies should should show the the certificat certificatee number, number, name of owner owner,, description of the security, number of shares or bonds, and name of issuer. 18-? 18-?..
a.
b.
ecur ecurit itie iess hel held d by by oth other erss for for the the cli clien entt shou should ld be posi positi tive vely ly conf confir irme med d wit with h the the custodian as of the date securities held by the client are counted. This date is often at or near the balance sheet date. This test provides evidence about four assertions, +1 existence or occurrence, +2 completeness, + rights and obligations, and + valuation at historical cost.
18-10. 'ash accounts accounts that should should be included as cash balances balances on the balance sheet include include undeposited receipts on hand, cash in bank in general checking and saving accounts, and imprest accounts such as petty cash and payroll bank account. 'ash accounts that should not be classified as cash balances on the sheet include certificates of deposit, bond sinking fund cash, certain foreign currency balances, and other accounts that have restrictions on their use. These accounts should be classified as investments. 18-11. 18-11. The transacti transaction on cycles that that affect affect cash are! • #evenue +cash sales and receivable collections • "xpenditure +cash purchases and payments on account • *ersonnel services +payment of employees and taxing authorities • %nvesting +The purchase of long-term assets, the purchase and sale of securities, and the receipt of interest and dividends. • 7inancing +%ssuing debt and e$uity securities, redeeming bonds and retiring stock, the purchase and sale of treasury stock, payment of interest and dividends. 18-1 18-12. 2. a.
Thee accou Th account nt bala balanc ncee audi auditt obe obect ctiv ives es for for cash cash are are as foll follow ows! s! Specific Audit Objectives Transaction Objectives receipts and 'hapter 1 for audit audit Occurrence. ee 'hapter 16 for audit obectives related to cash receipts obectives related to cash disbursements. receipts and 'hapter 1 for Completeness. ee 'hapter 16 for audit obectives related to cash receipts audit obectives related to cash disbursements. Accuracy. ee 'hapter 16 for audit obectives related to cash receipts and 'hapter 1 for audit obectives related to cash disbursements. receipts and 'hapter 1 for audit audit Cutoff. ee 'hapter 16 for audit obectives related to cash receipts obectives related to cash disbursements. receipts and 'hapter 1 for Classification. ee 'hapter 16 for audit obectives related to cash receipts audit obectives related to cash disbursements. Balance Objectives @ear end transfers of !istence. #ecorded cash balances exist at the balance sheet date +O". @ear cash between banks are recorded in the proper period #O$%. Completeness. #ecorded cash balances balances include the effects effects of all transactions that have occurred occurred +C". @ear @ear end transfers of cash between banks are recorded recorded in the proper period + C$. balances shown at the balance sheet sheet &ights and Obligations. The entity has legal title to all cash balances date +&O". balances are reali&able at the amounts stated stated on the 'aluation 'aluation and Allocation. #ecorded cash balances balance sheet and agree with supporting schedules #'A"% .
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18-6
(isclosure Objectives events and transactions transactions have occurred occurred Occurrence and &ights and Obligations. 9isclosed cash events and pertain to the entity #)("%. Completeness. (ll cash disclosures that should have been included in the financial statements have been included #)($%. *nderstandability. (ll cash disclosures are appropriately presented and information in disclosures is understandable to users #)(+%. accurately and at appropriate appropriate amounts Accuracy and 'aluation. 'aluation. 'ash information is disclosed accurately #)(,%.
b.
%nherent risk for cash balances is fre$uently assessed as high for the the existence or occurrence and completeness assertions because of the high volume of cash transactions and the vulnerability of cash to misappropriation. %n c ontrast, lower assessments of inherent risk may be made for the other assertions assertions because because they do not involve any contentious accounting issues.
18-1. (lthough the portion of current or total assets at any point in time represented represented by cash balances may be very smallA with five of the six transaction cycles affecting affecting cash the amount of cash flowing through the accounts accoun ts over a period of time that is susceptible to misappropriation can be very large. large. The volume of transactions, transactions, and the susceptibility of a valuable asset to misappropriation are the key reasons that strong internal controls over cash is important. 18-16. Because of the uni$ue aspects of cash, auditors tend to to plan their procedures procedures to detect much smaller levels of misstatements than for other accounts. 7urther, management may re$uest that the auditor plan work in the cash areas with a more extensive scope than would otherwise be re$uired due to the inherent risks in this area. Cence, the auditor may follow a primarily substantive approach. 3hen an entity has strong strong internal controls controls and many cash accounts the lower assessed assessed leve le vell of control risk approach may be used to limit the number of cash accounts where substantive tests may be performed. 18-1. 18-1. a.
b.
18-1 18-1=. =. a. a.
Three Three differ different ent tests tests of detail detailss of of tran transac sacti tions ons that that can can be perfor performed med in auditin auditing g cash cash balances are! • *erform cash cutoff tests for cash receipts and cash disbursements. • Trace bank transfers. • *repare proof of cash. ( proof of cash need not be prepared when control risk pertaining pertaining to cash transactions and balances is low and the entity4s bank accounts have been reconciled. 5iti 5iting ng is is an irre irregul gular arit ity y in which which a bank bank tra trans nsfe ferr is reco record rded ed as as a dep depos osit it in in the the receiving bank and is intentionally not recorded as a deduction from the bank on which it is drawn. To illustrate, illustrate, an unauthori&ed check is drawn on bank ( to cover a shortage in bank B. The check is included in the 9ecember 1 deposit de posit of bank B. Cowever, no 9ecember book entries are made for the check on Bank (.
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b.
5iting can be detected by +1 tracing bank transfers and +2 by using a bank cutoff statement.
18-1>. To property count cash on hand, the auditor should +1 control control all cash and negotiable instruments held by the client until all funds have been counted, +2 insist that the custodian of the cash be present throughout throughou t the count, + obtain a signed receipt from the custodian on return of the funds to the client, and +6 ascertain that all undeposited checks are a re owned by the client either directly or through endorsement. 18-1 18-18 8 a.
Dappi Dapping ng is is an an form form of frau fraud d tha thatt res resul ults ts in the the deli delibe bera rate te mis misap appr prop opri riat atio ion n of cash cash receipts. %t may involve either a temporary or a permanent abstraction of cash receipts for the personal use of the individual perpetrating the unauthori&ed act.
b.
Dapping is usually associated with collections from customers, customers, but it may also involve other types of cash receipts. 'onditions conducive to lapping exist when an individual who handles cash receipts also maintains the accounts receivable ledger.
18-1?. 18-1?. a.
The inform informati ation on re$ues re$uested ted in confir confirmi ming ng bank deposit deposit and loan loan balanc balances es consis consists ts of +1 deposit balances, +2 loan balances, and + other deposit and loan accounts that may have come to the attention of the authori&ed bank official.
b.
18-20. 18-20. a.
b.
18-2 18-21. 1. a.
Tests Tests to detect lapping are only performed when control risk for cash receipts transactions is moderate or high. There are three procedures that should detect lapping! o 'onfirm (ccounts #eceivable. o /ake a urprise 'ash 'ount. o 'ompare 9etails of 'ash #eceipts ournal "ntries with the 9etails of 'orresponding 9aily 9eposit lips. %n an effort effort to conceal conceal the sho shorta rtage, ge, the embe&& embe&&ler ler usu usuall ally y att attemp empts ts to +1 keep bank bank and book amounts in daily agreement so that a bank reconciliation will not detect the irregularity and +2 correct the customer;s account within three to four days of actual collection so that any discovered discrepancy in the customer;s account can be explained as a delay in receiving the money or posting. This test provides evidence primarily for the existence or occurrence and rights and obligations assertions for cash balances. %t contributes to the completeness assertion but it cannot be relied upon entirely because the respondent is not re$uired to search bank records for deposit and loan balances other than the ones listed on the re$uest. ( compe compens nsat atin ing g bank bank bal balanc ancee is the the mini minimu mum m bala balanc ncee the the depo deposi sito torr mus mustt mai maint ntai ain n to have an established line of credit with a bank.
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18-=
b.
The auditor4s primary source of evidence for compensating bank balances is obtained from confirming other arrangements with banks. The primary assertion related to compensating bank balances is presentation and disclosure.
18-22. 3hen the acceptable level of detection detection risk is high, the auditor may scan the client prepared prepared bank reconciliation and verify its mathematical accuracy. accuracy. %f detection risk is moderate, the auditor may review the client4s reconciliation. ( review includes vouching reconciling items to supporting documentation, and investigating old and unusual items. 3hen the acceptable level of detection risk is low, the auditor may prepare the bank reconciliation using bank data in the client4s possession. 3hen detection risk is very low, the auditor may obtain the bank statement directly from the bank for use in preparing the bank reconciliation. 18-2 18-2. . a.
b.
The bank The bank cut cutof offf sta state teme ment nt sho shoul uld d be obtai obtaine ned d at a poin pointt in time time tha thatt will will permi permitt the the outstanding checks to clear the bank, and the cutoff statement should be obtained by the auditor directly from the bank.. (fter receiving the cutoff bank statement, the auditor should! prior-year dated checks to the outstanding checks listed on the bank • Trace all prior-year reconciliation. • Trace deposits in transit on the bank reconciliation to deposits on the cutoff statement • can the cutoff statement and enclosed data for unusual items.
18-26. "xamples of circumstances circumstances that affect affect the presentation presentation and disclosure assertion assertion for cash include the existence of +a a bond sinking fund that should be classified as a noncurrent asset, +b disclosure of arrangements with banks, and +c a bank overdraft that should be reported as a current liability. The auditor should review the minutes of board of directors meetings as well as make in$uiry of management as to restrictions on the use of cash balances.
Comprehensive -uestions 18-2. +"stimate +"stimated d time - 2 minutes minutes a.
ever everal al of of the the cat categ egor orie iess of of int inter erna nall cont contro roll act activ ivit itie iess have have bee been n viol violat ated. ed. • egregation of duties. The treasurer executes transactions, records the transactions, and has custody of the resulting assets. %t is proper for the treasurer to execute the securities transactions. Cowever, accounting personnel should record the transactions, and another officer or an outside independent agent should be the custodian. • *roper authori&ation. 7or proper control, the board of directors +or a finance committee of the board should authori&e each purchase and sale of securities. • 9ocuments and records. The securities are apparently registered in the name of the treasurer. They should be registered in the name of the company.
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•
•
b.
(ccess controls. Eo mention is made of storing the '9s in a vault or safety deposit box. uch controls should be used and access should be limited to authori&ed personnel. %ndependent checks. Eo comparison is made of recorded accountability with existing assets. This should be done independently at reasonable intervals and investigation should be made of any difference.
The substantive tests that would detect the irregularity are +1 inspect inspect and count securities on hand, +2 vouch entries in investment accounts, and + recalculate revenue earned.
18-2=. +"stimate +"stimated d time - 2 minutes minutes a. Substantive Test
1. 2.
#ecalculate re revenue ea earned )ouch uch entr entrie iess in in inv inves esttment ment accounts to broker;s advice.
.
'onf 'onfir irm m secu securi ritties ies held held by others
6.
b. inancial Statement Assertion )aluation of of allocation (ll assertions
c. Type of vidence /athematical 9ocumentary
"xistence or occurrence, completeness, rights and obligations (ll except rights and obligations (ll assertions
'onfirmation
%nsp %nspec ectt and and coun countt sec secur uriities ties on hand . )ouch uch entr entrie iess in in inv inves esttment ment accounts to broker;s advice. =. %nsp %nspec ectt and and coun countt sec secur uriities ties (ll except rights and on hand obligations >. #evie view docum umen enttation )aluation or allocation concerning market values 8. )erify rify accu accurracy acy of of bal balan ance ces, s, )aluation or or allocation schedules and subsidiary ledgers ?. 'ompare statement *res *resen enta tattion ion and disc discllosur osuree presentation with F((* 10. 10. 'om 'ompare pare sta stattemen ementt *res *resen enta tattion ion and disc discllosur osuree presentation with F((*
*hysical, documentary 9ocumentary *hysical, documentary 9ocumentary /athematical
9ocu 9ocum ment entary ary 9ocu 9ocum ment entary ary
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18-8
18-2>. +"stimate +"stimated d time - 0 minutes minutes a.
The obe The obect ctiv ives es of the the '* '*(4s exam examin inat atio ion n of the the inv inves estm tment ent acco account unt can can be be summari&ed as follows. Specific Audit Objectives Transaction Objectives receipts and 'hapter 1 for audit audit Occurrence. ee 'hapter 16 for audit obectives related to cash receipts obectives related to cash disbursements. receipts and 'hapter 1 for Completeness. ee 'hapter 16 for audit obectives related to cash receipts audit obectives related to cash disbursements. Accuracy. ee 'hapter 16 for audit obectives related to cash receipts and 'hapter 1 for audit obectives related to cash disbursements. receipts and 'hapter 1 for audit audit Cutoff. ee 'hapter 16 for audit obectives related to cash receipts obectives related to cash disbursements. receipts and 'hapter 1 for Classification. ee 'hapter 16 for audit obectives related to cash receipts audit obectives related to cash disbursements. Balance Objectives @ear end transfers of !istence. #ecorded cash balances exist at the balance sheet date +O". @ear cash between banks are recorded in the proper period #O$%. balances include the effects effects of all transactions that have occurred occurred Completeness. #ecorded cash balances +C". @ear @ear end transfers of cash between banks are recorded recorded in the proper period + C$. balances shown at the balance sheet sheet &ights and Obligations. The entity has legal title to all cash balances date +&O". balances are reali&able at the amounts stated stated on the 'aluation 'aluation and Allocation. #ecorded cash balances balance sheet and agree with supporting schedules #'A"% . (isclosure Objectives events and transactions transactions have occurred occurred Occurrence and &ights and Obligations. 9isclosed cash events and pertain to the entity #)("%. Completeness. (ll cash disclosures that should have been included in the financial statements have been included #)($%. *nderstandability. (ll cash disclosures are appropriately presented and information in disclosures is understandable to users #)(+%. accurately and at appropriate appropriate amounts Accuracy and 'aluation. 'aluation. 'ash information is disclosed accurately #)(,%.
b.
The '*( would accept a confirmation of the securities on hand from the custodian in lieu of personally inspecting and counting the securities after investigating and satisfying him or herself as to the standing of the custodian. The '*( would probably be satisfied upon finding the custodian to be a well-known, reliable financial institution, completely independent of the client and with resources substantially larger in amount than the securities of the '*(4s '*(4s client that are on deposit. 7urthermore, to be acceptable as accounting evidence, the confirmation should be delivered de livered directly to the '*( by the custodian without passing through the client4s hands. The confirmation should contain a statement to the effect that securities were the property of the depositor on a specified date. %n examining the investment account and the custodian4s detailed statements, the '*( would expect to find few, if any, any, errors made by the custodianA the discovery of errors on the part of the custodian would cast serious doubt on the reliability of the confirmation.
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c.
The '*( The '*( woul would d reco recomm mmen end d that that ful fulll disc disclo losu sure ress be made made in in a foot footnot notee of the the sale sale and repurchase of the securities so that readers of the financial statements will have ade$uate information to compare the current c urrent report with reports for prior years. The gain on the securities transactions would be reported in the income statement on a separate line after the results of operations for the year. The loss on operations for the year must be clearly set forth in the income statement so that readers can make meaningful comparisons with prior years. The securities should be reported in the balance sheet at their new cost or repurchase price. The sale of the securities resulted resulted in cash that could have been used to purchase other securities or in other ways. That management had planned to repurchase the same securities does not alter the fact that alternative uses for the cash existed. %f the cash c ash had been used to buy other securities, these new securities would have been recorded at their cost--the cash expended to ac$uire them. The same treatment should be accorded to the actual transactions.
18-28. +"stimate +"stimated d time - 2 minutes minutes a. The fo followi owing in information is is m miissing! • The date of purchase of security • The date of purchase and sale of # security • 9ata concerning the accrual andor receipt of interest due on # to date of sale • 9ata concerning the accrual andor payment of interest due on to the date of purchase. • ustification for accrual of dividends • (ccounting treatment of bond discount • 9ata concerning the 9ecember 1, 1?G1, revenue accruals • 9ata re$uired to evaluate the classification of securities b.
ubstantive tests noted as having been performed are! • The initial procedure of tracing beginning balances to prior year4s working papers. • The initial procedure of obtaining a client-prepared schedule of investments and footing and crossfooting the schedule and reconciling selected totals with corresponding general ledger balances. • Dimited vouching of transactions to supporting documentation. The following substantive tests were not noted as having ha ving been performed +this was not a stated re$uirement of the $uestion! • The securities were not physically inspected or confirmed. • The broker4s advice +or other independent corroborating evidence verifying the sale of # was not examined. • 9ividend rates were not verified by reference to public records +tandard H *oor4s of dividend declarations. • The stated interest rates, maturity dates, and market values were no t verified. • 'omputations of year-end accruals were not made.
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18-10
•
Eot all amounts +for example, loss on sale of # were traced to the general ledger.
18-2?. +"stimated time - 20 minutes Category %nitial *rocedures
(nalytical *rocedures Tests of 9etails of Transactions
Tests of 9etails of Balances
*resentation and 9isclosure
Substantive Test :btain an unders understandin tanding g of the the business business and industry industry and determin determine! e! a The signif significance icance of cash cash balances balances and and transac transactions tions on on the entity entity.. b The entity;s policies for forecasting forecasting cash balances and investing surplus cash balances. 2 *erform *erform initial procedu procedures res on cash balance balancess and records records that will be subected subected to further further testing. testing. a Trace Trace beginning beginning balance balance for for cash on hand hand and in bank bank to prior prior year;s year;s working working papers. papers. b #eview activity in general ledger accounts for cash and investigate entries that appear unusual in amount or source. c) :btain client-prepared schedules of cash on hand and in bank, verify mathematical accuracy and determine agreement with general ledger.
1
*erfor *erform m anal analytic ytical al proced procedure ures! s! a 'ompare 'ompare cash cash balances balances with budgete budgeted d amounts, prior prior year year balances balances,, or other expected expected amounts. amounts. b 'alculate cash as a percent of current assets and compare with expectations. expectations. 6 *erform *erform cash cutoff cutoff tests tests +note these these test may have have been performed performed as part part of the audit programs programs for accounts receivable and accounts payable! a :bserve :bserve that all cash cash received received through through the close close of busines businesss on the last last day of the fiscal fiscal year year is included in cash on hand or deposits in transit and that no receipts of the subse$uent period are included, or b #eview documentation such as daily cash summaries, duplicate deposit slips, and bank statements covering several days before and after year-end date to determine proper cutoff. c :bserve :bserve the last last check issued issued and mailed mailed on the last last business business day of of the fiscal fiscal year year and trace trace to accounting records to determine the accuracy of the cash disbursements cutoff, or d 'ompare 'ompare dates on checks checks issued issued for several several days days before and after after the year-end year-end date date to the dates the checks were recorded to determine proper cutoff. Trace Trace bank transfer transferss for several several days before and after after the year-end year-end date to determine determine that each transfer transfer is properly recorded as a disbursement and a receipt receipt in the same accounting period and is properly reflected in bank reconciliations when applicable. = *repare *repare proof of cash cash for any bank bank accounts accounts that the entity has has been unable unable to reconcile reconcile or for which which there is a high risk that fraudulent transactions have occurred. > 'ount undepos undeposited ited cash cash on hand and and determine determine that such such amounts amounts are include included d in cash balance balances. s. 8 'onfir 'onfirm m bank depo deposit sit and and loan bala balance ncess with banks. banks. ? 'onfirm 'onfirm other arrange arrangements ments with banks banks such as lines lines of credit, compens compensating ating balance balance agreemen agreements, ts, and loan guarantees or other parties. 10 :btain scan, review, review, and prepare prepare bank reconciliations reconciliations as appropriate. 11 :btain and use bank cutoff statements to verify bank reconciliation items, detect detect any unrecorded unrecorded checks that have cleared the bank, and look l ook for evidence of window dressing. 12 'ompare 'ompare statement statement presentation presentation with F((*. F((*. a 9etermine 9etermine that cash cash balances balances are properly properly identified identified and classifie classified d in the financial financial statements. statements. b 9etermine that bank overdrafts are reclassified as current current liabilities. c /ake in$uire in$uiress of managemen management, t, review corre correspond spondence ence with banks, banks, and and review review minutes of board of directors meetings to determine matters re$uiring disclosure such as lines of credit, loan guarantees, compensating balance agreements, or other restrictions on cash balances. a "valuate "valuate the completene completeness ss of presentatio presentation n and disclosures disclosures for for receivables receivables in drafts drafts of financial financial statements to determine conformity to F((* by reference to disclosure checklist. d #ead disclos disclosures ures and and independe independently ntly evaluate evaluate their their understan understandability dability..
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18-11
18-0. +"stimate +"stimated d time - 0 minutes minutes a. *atricia 'ompany 'omputation of (mount (bstracted by 'ashier Eovember 0, 20G: 'ash balance, per books Eovember 0, 20G: (dd! 'redit by bank (dusted cash balance +on hand and in bank Dess adusted bank balance! Bank balance, Eovember 0, 20G: Dess outstanding checks! =2 18 2 28 6 8 =2 1 8 =2 8 = 2 'ash which should be on hand for deposit 'ash reported (mount of theft
I18,?01.=2 100.00 I1?,001.=2 I1,0.00
I11=.2 10.00 2.2 1?0.>1 20=.80 16.28
1,0=2.2?
16,68>.>1 I 6,1.?1 ,>?6.61 I >1?.0
b.
The cashier removed I>1?.0. Ce attempted to conceal his theft by! o Eot listing all outstanding checks. o
c.
Two controls that were lacking are! omeone other than the cashier should trace cash receipts to the deposits depo sits in the o bank omeone other than the cashier should be responsible for preparing bank o reconciliation.
18-1. +"stimate +"stimated d time - 2 minutes minutes Other Audit )rocedures &eason for Other Audit )rocedures ources of debit entries in general ledger cash ince the auditor, using standard account, other than from cash receipts ournals, procedures, only examines the cash receipts should be investigated and supporting ournal, he or she must investigate the documents examined. validity of all other sources of cash receipts which are not recorded in these ournals.
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Other Audit )rocedures ( surprise examination of cash receipts should be performed. *rior to the accounts receivable clerk obtaining the cash receipts, the auditor should make a list of them without the clerk4s knowledge. The undeposited mail receipts should then be controlled after completion of their preparation for deposit and after postings have been made to the subsidiary accounts receivable ledger. The deposit slip should be totaled and compared to the remittances and the list prepared by the auditor for accuracy. ac curacy. %ndividual items on the deposit slip should be compared to postings to the subsidiary accounts receivable ledger. The auditor should ask Fut&ler to ask the bank to send the statement containing that deposit directly to the auditor.
&eason for Other Audit )rocedures ince there are no initial controls over cash receipts established prior to the time the accounts receivable clerk obtains the cash, a surprise examination is the only method of determining if cash receipts are being recorded and deposited depo sited properly.
*ostings from other deposit slips should be traced to the cash receipts ournal and the subsidiary accounts receivable ledger. (lso, (lso, entries in the subsidiary accounts receivable ledger should be traced to the cash receipts ournal and to the deposit slips.
ince there is no separation of duties between cash receipts and accounts receivable, the accounts receivable clerk may have been careless in performing posting duties. This procedure may also disclose whether the accounts receivable clerk may have been lapping the accounts.
#eview the subsidiary accounts receivable ledger and confirm accounts that have abnormal transaction activity such as consistently late payments.
:nce more, there is no separation of duties between cash receipts and accounts receivable. %f the accounts receivable clerk was careless in performing posting duties, this procedure may also disclose whether the accounts receivable clerk may have been lapping the accounts.
%f Fut&ier allows customers to take discounts, the amount of such discounts and the discount period should be checked.
ince there is no separation of duties between cash receipts and accounts receivable, the accounts receivable clerk may have appropriated discounts which could have been, but were not, taken, or may have been careless in checking the appropriateness of discounts taken.
9ates and amounts of daily deposits per bank
ince there are no initial controls over cash
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Other Audit )rocedures statements should be compared with entries in the cash receipts ournal
( proof-of-cash working paper should be prepared which reconciles total cash receipts with credits per bank statements. The opening and closing reconciliation of the proof of cash should be compared to the comparable reconciliation prepared by the controller.
&eason for Other Audit )rocedures receipts established prior to the time the accounts receivable clerk obtains the cash, the clerk may have become careless about promptly depositing the daily receipts. ince internal control over cash receipts is weak, the auditor should perform that overall check to help substantiate that he or she has investigated all material items during the detail tests.
*repare a ratio analysis of monthly collections to total sales of the preceding month or monthly collections to total accounts receivable at the beginning of the month and compare this analysis with a similar analysis for the preceding year.
ince internal control over cash receipts is weak, this overall test may highlight points of irregularities, is such exist.
)isit the client on the balance sheet date or the next business day to determine that an appropriate cutoff of cash receipts has been made.
ince internal control over cash receipts is weak, the auditor needs to be satisfied that cash receipts are recorded in the appropriate period.
7or those periods for which the above audit procedures were not performed and for a period after the balance sheet date, scan the cash receipts ournal and bank statements for unusual items.
ince internal control over cash receipts is weak, the auditor should perform that review to help substantiate that all material items not covered during other tests have been investigated.
18-2. +"stimate +"stimated d time - 0 minutes minutes a. Thee purpo Th purpose sess of aud audit itin ing g bank bank tran transf sfer erss are are to +1 +1 det deter ermi mine ne tha thatt bank bank bal balan ance cess are are correctly stated at the balance sheet date and +2 to detect kiting. b.
Bank (ccounts Ck. /o.
26 >= 28 ?0 1 60 ( 10 0= ( 12 6 6 02
rom '--#eg '--#eg '--#eg /--pec /--pec '--#eg
To '--*ay '--*ay /--pec '--pay '--#eg /--pec
(mount of 'heck I 100 ,000 200 ,000 10 0 ,00 0 0 ,000 2 ,0 0 0 12,000
#eceipt 9ate
(isbursement (ate Books =2 =2 =28 =2? =0 >1
Bank =0 >2 > >= >> >
Books =2 =2> =0 >1 >2 =0
olutions /anual to Modern Auditing: 'opyright © 200, ohn 3iley 3iley and ons, %nc.
Bank =2 =2> =0 >1 >2 =0
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c. 'ity Bank--*ayroll Bank 'learing +9ue to /etro Bank--pecial
0,000
'ity Bank--#egular Bank 'learing +9ue to /etro Bank--pecial
2,000
Bank Bank 'lea 'leari ring ng +9ue +9ue from from /etr /etro o BankBank-- -pe peci cial al 'ity Bank--#egular
0,000
2,000
12,0 12 ,000 00 12,000
d.
:uts :utsta tand ndin ing g che check cks! s! 28?0 28?0,, 160 160,, 602 602,, (100= 100=,, (126 126 9eposits in transit! 602
e.
'heck 'heck 602 602 is is ind indic icat ativ ivee of kiti kiting ng beca becaus usee the the check check was was rec recei eive ved, d, rec recor orde ded, d, and and deposited on une 0, but was not recorded as a disbursement until uly 1.
18-. +"stimate +"stimated d time - 1 minutes minutes %n order to determine whether lapping exists, ex ists, tanley would test the aging of accounts receivable and then /ail positive accounts receivable confirmation re$uests directly to all customers with o old balances. o %nvestigate all exceptions noted on confirmations. o :btain authenticated deposit slips directly from the bank. o 'ompare individual customers4 names, dates, and amounts shown on the customer4s remitta remittance nce advices with the names, dates, and amounts recorded in the cash receipts ournal, individual customer ledger accounts, and deposit slips +if practicable. practicable. )erify )erify the propriety of noncash credits to accounts ac counts receivable +for example, sales o discounts, sales returns, bad debt deb t write-offs. *erform a surprise inspection of deposits. o 7oot the cash receipts ournal, the customers4 ledger accounts, and the accounts o receivable control account. o #econcile the total of the individual customers4 cu stomers4 accounts with the accounts receivable control account. 'ompare information in copies of monthly customers4 statements with information in o customers4 ledger accounts.
Cases 18-6. +"stimated time time - 0 minutes a. and b.
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This case study contains information for a discussion of audit procedures for investment securities and related income in a situation involving strong internal controls. Thus, recognition recognition of the effect effect of such controls on the nature, timing, and extent of resulting substantive tests is essential. The solution provides for an evaluation of the appropriateness of each procedure in the order in which they are presented in the audit program. <.. Fovernment securities *repare schedule of securities. %nappropriate. The schedule should be prepared by the o client. the auditor should only verify the accuracy of the schedule and compare it with the ledger balance. This audit test relates to the valuation or allocation obective. :btain direct confirmation from
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o
o
o
c.
9iscuss 9ecember 1 statements with management. %nappropriate. 9iscussion should be directed at propriety of method used, not unrecorded amounts, since internal control is strong. "stablish that intercompany accounts are in agreement. (ppropriate. This procedure is needed to meet the valuation or allocation assertion. #ecord e$uity in net assets. %nappropriate. The company is using the cost method. (lso inappropriate in that auditor would be making the entry. %f client agrees to adopt e$uity method, an adustment should be proposed by the auditor to meet the valuation or allocation assertion. The program also fails to re$uire the auditor to determine whether the investment should be written down at 9ecember 9e cember 1.
:ther points o The program does not re$uire the auditor to apply analytical procedures on the investment accounts. This substantive test is important in meeting the existence or occurrence, completeness, valuation or allocation, and presentation and disclosure assertions. The program does not re$uire the auditor to determine the propriety of the statement o presentation and disclosure, including the proper classification of the investment investment securities as trading, available-for-sale, held-to-maturity, held-to-maturity, or e$uity method investments. This should be done by making appropriate in$uiries of management to learn management4s intent regarding holding periods, assessing its abilities regarding holding periods, and comparing the financial statement presentation to F((*, F((*, including including the treatment of any reali&ed and unreali&ed gains and losses due to changes in market value. The auditor may learn of the existence of any liens from an inspection of the minutes book and by in$uiry of management.
)rofessional )rofessional Simulations &esearch Situation
Audit )lanning
Audit )rocedures
(< 2,> and .8 addresses how the auditor should obtain to evaluate assertions about securities based on management;s intent intent and ability. These paragraphs are presented below. =
Fenera Fenerally lly accept accepted ed accoun accountin ting g princ principl iples es re$u re$uire ire that that manag manageme ement; nt;ss inte intent nt and and abil ability ity be considered in valuing certain securitiesA for example, whetherK L 9ebt 9ebt sec secur urit itie iess are are cla class ssif ifie ied d as held held-t -too-ma matu turi rity ty and and repo report rted ed at at the their ir cost cost depen depends ds on management;s intent and ability to hold them to their maturity. maturity. L "$ui "$ uity ty secu securi riti ties es are are rep repor orte ted d usi using ng the the e$ui e$uity ty meth method od depe depends nds on manag managem ement ent;;s ability to significantly influence the investee. L "$ui "$ uity ty secu securi riti ties es are are cla class ssif ifie ied d as as tra tradi ding ng or avai availa labl ble-f e-for or-s -sal alee depe depend ndss on on management;s intent and obectives in investing in the securities.
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.>
%n evalua evaluatin ting g mana manageme gement; nt;ss intent intent and abilit ability y, the the audi auditor tor sho should uldK K a. :btai :btain n an und under erst stan andi ding ng of of the the proc proces esss used used by manag managem ement ent to cla class ssif ify y secur securit itie iess as trading, available-for-sale, or held-to-maturity. held-to-maturity. b. 7or an investment accounted for using the e$uity method, in$uire of management as to whether the entity has the ability a bility to exercise significant influence over the operating and financial policies of the investee and evaluate the attendant circumstances that serve as a basis for management;s conclusions. c. %f the the ent entit ity y acco account untss for for the the inve invest stme ment nt con contr trar ary y to the the pre presu sump mpti tion on esta establ blis ished hed by by generally accepted accounting principles for use of the e$uity method, obtain sufficient competent evidential matter about whether that presumption has been overcome and whether appropriate disclosure is made regarding the reasons for not accounting for the investment in keeping with that presumption. d. 'ons 'onsid ider er whet whethe herr manage manageme ment; nt;ss acti activi viti ties es corr corrob obor orat atee or conf confli lict ct with with its its sta state ted d intent. 7or example, the auditor should evaluate an assertion that management intends to hold debt securities to their maturity by examining ex amining evidence such as documentation of management;s strategies and sales and other historical activities with respect to those securities and similar securities. e. 9ete 9eterm rmin inee wheth whether er gene genera rall lly y accep accepte ted d accou account ntin ing g princi principl ples es re$u re$uir iree manag managem ement ent to to document its intentions and specify the content and timeliness of that documentation. fn 1? The auditor should inspect the documentation and obtain evidential matter about its timeliness.
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Audit )lanning &esearch Situation
Audit )rocedures
To! (udit 7ile #e! taff Training Training for (udit of 'ash Balances 7rom! 7rom! '*( '*( 'andid 'andidate ate The following table contrasts the audit of cash balances b alances when the client has good go od controls over cash balances vs. having poor controls over cash balances. 0ood 1nternal Controls over Cash Transactions Transactions and Cash Balances 3hen control risk is low +and detection risk is high, the auditor may scan the client-prepared bank reconciliation and verify the mathematical accuracy of the reconciliation. %f detection risk is moderate, the auditor may review the client;s bank reconciliation more carefully. The review will normally include 'omparing the ending bank balance with the balance • confirmed on the bank confirmation form )erifying )erifying the validity of deposits in transit and • outstanding checks "stablishing the mathematical accuracy of the • reconciliation )ouching )ouching reconciling items such as bank charges and • credits and errors to supporting documentation %nvestigating old items such as checks outstanding for • a long period of time and unusual items
2eak 1nternal Controls over Cash Transactions Transactions and Cash Balances 3hen control risk is high or maximum +and detection risk is low, the auditor may prepare the bank reconciliation using bank data in the client;s cli ent;s possession. possession. 3hen detection risk is very low or the auditor suspects possible material misstatements, the auditor may obtain the year-end bank statement directly from the bank and prepare the bank reconciliation. To do so, the auditor must re$uest the client to instruct the bank to send the bank statement and accompanying data +paid checks, debit memos, etc. directly to the auditor. This procedure will prevent the client from making alterations of the data to cover any misstatements.
The evidence provided by a bank reconciliation alone is generally not considered sufficient to verify the balance of cash in bank because of uncertainties concerning the following two most important reconciling items! +1 deposits in transit and +2 outstanding checks. uch evidence is obtainable only by tracing these items to the bank statement in the next accounting period. The procedure of obtaining a bank cutoff statement is designed, in part, for this purpose. 3hen the cutoff statement validates these and other reconciling items, the reliance that an auditor can place on a bank reconciliation is significantly enhanced.
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Audit )rocedures &esearch Situation
Audit )lanning
The following table explains the auditing procedures that should be performed associated with the legend identified as a through i.
Legend a b
c d e f g h i
Audit )rocedure (gre (greed ed ban bank k cuto cutoff ff stat statem emen entt rec recei eive ved d dire direct ctly ly fro from m the the ban bank. k. )ouched to bank cutoff statement. 'ash receipts ournal show deposit in 9ecember of 20G and bank cutoff statements shows deposit per bank in anuary 20G6. )ouched uched to bank bank cuto cutoff ff stat statem emen ent. t. Th Thee chec check k was was dat dated ed pri prior or to to 9ece 9ecemb mber er 1, 1, 20G 20G and it check cleared the bank in anuary 20G6. E7 E7 chec check k vouc vouche hed d to bank bank doc docum umen enta tati tion on acc accom ompa pany nyin ing g the the retu return rn of of the the cus custo tome mers rs check. Bank Bank cha charg rges es vouc vouche hed d to to bank bank sta state teme ment nt rec recei eive ved d in in an anua uary ry 20x6 20x6.. 'hec 'heck k numb number er was was reco record rded ed in in erro errorr. )ouched uched to actu actual al check check that that clea cleare red d the the bank, bank, bank statement, and cash disbursements ournal. )ouched uched to to remit remitta tanc ncee advic advicee recei receive ved d from from the the bank bank with with noti notifi fica cati tion on of coll collec ecti tion on of note from customer. Traced aced to gene genera rall led ledge gerr at at 9ec 9ecem embe berr 1, 1, 20x6 20x6.. foot
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