Professional Documents
Culture Documents
Chapter 13
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Cash Accounts
General checking accounts
Cash management accounts
Payroll checking accounts
Marketable Security Accounts
Marketable securities (held as temporary
investments)
Short-term cash management securities
(Treasury bills, CDs, etc)
Short-term hybrid-type securities
Planning for Audits of Cash and
Marketable Securities
Materiality and Risk Considerations
Volume of transactions flowing through the account
Liquidity and easy transferability
Automated systems and increased computerization of
account activity
Importance in meeting debt covenants
With smaller clients, auditors usually concentrate
on substantively testing year-end Cash account
balances
With large clients, auditors focus on evaluating and
testing internal controls
Planning for Audits of Cash and
Marketable Securities (continued)
Inherent risk for cash and marketable securities is
high
Liquidity of assets
Susceptibility of mishandling
Difficulty in understanding financial risks associated
with derivatives
Complexity of some financial instruments
Control risk
Analysis of control environment over cash and
marketable securities should occur during planning of
the audit
Cash Management Techniques
Speed collection and deposit of cash
Minimize possibility of error or fraud
Reduce paperwork
Automate cash management process
Techniques include
Lockboxes
Electronic funds transfers
Cash management agreements with financial
institutions
Compensating balances
Evaluating Control Risk: Cash
Accounts
Appropriate internal controls would include:
Adequate separation of incompatible duties
Cash receipts deposited daily and intact
Restrictive endorsements on checks received
Independent reconciliation of cash records including bank
statement
Computerized control totals and edit tests
Authorization of transactions
Use of prenumbered documents and turnaround documents
Periodic internal audits
Competent, well-trained employees
Access to assets and accounting records restricted
Understanding and Testing
Internal Controls
Understanding of internal control is obtained through
inquiry, observation, and review of client documentation
Auditors use flowcharts, memos, and questionnaires to
document their understanding
If auditor assesses control risk as low and believes it is
cost-effective to rely on the controls, an audit program
for testing the controls is developed
The program is designed around the basic control
objectives and is cross-referenced to the audit objectives
Based on the results of testing, the auditor reassesses
control risk and develops procedures to substantively
test Cash account balances
Substantive Testing of
Cash Balances
Common types of misstatements regarding
cash include:
Transactions recorded in the wrong period
Embezzlements covered up by omitting or
under-footing outstanding checks on the bank
reconciliation
Manipulating accounts to record the same
cash in two accounts at the same time (kiting)
Substantive Testing of
Cash Balances (continued)
Independent bank reconciliation
Bank cutoff statement
Bank confirmation
Obtaining year-end cutoff
information
Independent Bank Reconciliation
Reconciles year-end general ledger Cash account
balance to year-end bank statement balance
Two-part bank reconciliation:
Start with year-end bank balance and adjust for items
recorded in the books, but not by the bank
Start with year-end general ledger Cash balance and
adjust for items recorded by the bank, but not on the
books
Adjusted book balance must equal adjusted bank
balance
The Use of the Bank Cutoff
Statement
Bank cutoff statement:
Normal bank statement for the first few weeks
after year-end
Sent directly to the auditor
Includes canceled deposit slips and checks
Allows auditor to verify existence and amount
of deposits in transit and outstanding checks
on the bank reconciliation
What is the bank confirmation
used for?
Auditor usually sends a confirmation to each bank
with which the client transacted business during
the year
Confirmation is usually open form:
Respondent (bank) fills in the form
Auditor reconciles provided information with client
records
Standard confirmation has two parts:
First part seeks information on client's account
balances
Second part seeks information on any loans or
collateral agreements the client may have with the bank
Bank confirmations are generally considered to be
reliable evidence
Why obtain year-end cutoff
information?
Management manipulation of cash includes:
Over-recording cash receipts
Under-recording cash disbursements
If the auditor assesses the risk of such irregularities as
high, following procedures may be used:
Obtain information on last checks issued during the audit period
Number of last check issued
Observe that all previous checks had been mailed and corroborate
by timely clearing of the bank per the bank cutoff statement
Obtain information of last cash receipts
Note last few receipts
Trace receipts to bank reconciliation and bank cutoff statement
How is a bank transfer schedule
used?
Kiting involves transferring funds from one bank account to
another just before year-end in order to overstate cash:
Deposit is recorded into the second account before year-end
Disbursement is not recorded in the first account until after year-
end
Auditor tests for kiting by preparing a bank transfer schedule:
Schedule lists all transfers between company bank accounts for
a few days before, and a few days after year-end
Schedule lists dates transfers cleared the bank and dates they
were recorded in the books
Auditor checks to see deposit and withdrawal were BOTH
recorded in the same accounting period
Operational Audits of Cash
Internal auditors often use the following procedures to
test the effectiveness of internal controls over cash
accounts:
Review procedures for handling cash receipts
Review procedures for identifying and investing excess of idle
funds
Measure and evaluate the effectiveness of cash management
and budgeting
Review arrangements with financial institutions to identify risks
Determine compliance with company policies
Evaluate effectiveness of controls over electronic transfers
Evaluate effectiveness of controls to minimize loss of misuse of
cash
Determine if payments made timely to take advantage of cash
discounts
Marketable Securities and
Financial Instruments
Marketable securities are
Debt or equity securities that are readily
marketable
That management intends to hold for a short
time
Includes commercial paper, marketable
equity securities, and marketable debt
securities
Substantive Audit Procedures: Other
Short-Term Securities
Client prepares schedule of marketable
securities activity including
Marketable securities held at year-end
Audit period transactions - purchases and disposals
Interest and dividend revenue
The schedule is footed to determine
mathematical accuracy
Auditor verifies cost or sales price by examining
broker's advices
Auditor recalculates gains/losses on disposal of
securities
Substantive Audit Procedures: Other
Short-Term Securities (continued)
Existence of securities owned at year-end is verified by
physically examining securities held by the client, or
confirmation with client's broker for securities held by the
broker
Current market values are verified by referring to market
sources
Auditor recomputes interest and dividend income, and
realized and unrealized gains and losses
Auditor asks management about any changes in the
expected holding period, and any restrictions on
securities
Auditor reviews investment or loan agreements that
specify the securities as collateral for disclosure issues
Auditing Other Financial
Instruments and Derivatives
During last the 20 years, a number of new financial
instruments have been developed:
Some have been created to take advantage of short-
term anomalies
Others have been developed to remove liabilities from
the balance sheet
Examples:
Event-risk protected debt
Floating rate note
Junk bond
Pay-in-kind (PIK) debenture
Zero-coupon bond
Securities sold with a put option
Collateralized mortgage obligation
Securitized receivables
Management Control Considerations for
Companies That Use Financial
Instruments
Identify the risk management objectives
Understand the product
Understand the accounting and tax ramifications
Develop corporate policies and procedures
Monitor and evaluate results
Understand the credit risk
Control collateral when risk is not acceptable