Auditing Principles - CH10 - Cash and Finanical Investments

• ØSources
• lGeneral checking account
• lPayroll checking accounts
• lPetty cash
• lSavings accounts

• ØCash equivalents
• lMoney market funds
• lCertificates of deposit
• Savings certificates

1.Use the understanding of the client 

2.Obtainan understanding of internal control 

3.Assess the risks of material misstatement and substantive procedures that:

• a.Substantiate the existence of recorded cash and occurrence of the related transactions
• b.Establish the completeness of recorded cash
• c.Verify the cutoff and accuracy of
• cash transactions
• d.Determine that the client has rights to
• recorded cash 
• e.Determine
• that the presentation and disclosure of
• cash, including restricted funds, are appropriate

ØCash typically has a small account balance, but auditors devote a large proportion of total audit hours because:

• lLiabilities, revenues, expenses and most other assets flow through cash
• lMost liquid asset so greater temptation for misappropriation
• lHigh risk account

• Finance and accounting department work together to provide assurance that:
• lAll cash that should have been received was in fact received, recorded accurately and deposited promptly

• lCash disbursements have been made for authorized purposes only and have been
• properly recorded

lCash balances are maintained at adequate, but not excessive, levels by forecasting

1.Do not permit any one employee to handle a transaction from beginning to end.

2.Separate cash handling from recordkeeping.

3.Centralize 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 exception of
• small expenditures from petty cash.

8.Have monthly bank reconciliations prepared by employees not responsible for the issuance of checks or custody of cash. The completed reconciliation should be reviewed promptly by an appropriate official.

• 9.Monitor cash receipts and disbursements by comparing recorded amounts to forecasted
• amounts

• §Cash sales
• iInvolvement of two or more employees
• iCash Registers
• iElectronic point of sales systems

• §Collections of receivables
• iInitial listing of cash receipts
• iCustody and depositing of cash receipts
• iMaintenance of customer account records
• iReconciliation of customers’ ledgers with
• control accounts
• iMailing monthly statements to customers
• iCollection activity and past-due accounts
• iDirect receipt of funds by financial
• institution

ØSegregation of duties

ØPayment by check or electronic funds transfer

ØPre-numbered check

ØMatch of purchase order and receiving documents with vendor’s invoice

ØReview of supporting documents by authorized check signer

ØCancel of supporting documents

ØAuthorized check signer should mail checks

ØMonthly bank reconciliation

ØDo the client’s records reflect all cash transactions that took place during the year?

ØWere all cash payments properly authorized and for a legitimate business purpose?

• ØFraud that may be disclosed
• lInterception of cash receipts before any record is made
• lPayment for materials not received
• lDuplicate payments
• lOverpayments to employees or payments to fictitious employees
• lPayments for personal expenditures of officers or related parties

ØInaccurate recording of a purchase or disbursement

ØDuplicate recording and payment of purchases

ØUnrecorded disbursements

ØConfirmation of amounts on deposit by direct communication with financial institution officials

• ØStandard form agreed to by:
• lAICPA
• lAmerican
• Bankers Association

• lBank
• Administration Institute

• ØAddresses only the client’s deposit and loan balances
• ØThe confirmation process may be performed electronically if properly controlled

ØReconciles the account balance and reconciles cash transactions during a specified period.

• ØUsed to identify:
• lCash receipts and disbursements recorded in the accounting records, but not on the bank statement.
• lCash deposits and disbursements recorded on the bank statement, but not on the accounting records.
• lCash receipts and disbursements recorded at different amounts by the bank than in the accounting records.

ØChecks may be processed electronically

ØElectronic processing creates a substitute check – an electronic image of check

ØLegal equivalent of original check for all purposes

• ØAudit implications
• lNeed to rely on substitute check for evidence of check
• lImpossible for clients to kite checks (manipulate bank balances to conceal cash shortage)

ØManipulations that utilize temporarily overstated bank balances to conceal cash shortage or meet short-term cash needs

ØKiting schemes rely upon the existence of a “float period” in which transactions are not processed in real time; increased electronic processing has made kiting more difficult through reducing (or eliminating the float period).

• ØAuditors can detect kiting by preparing a schedule of bank transfers for a few days
• before and after balance sheet date

• ØMisstatements 
• lDate of recording per transfer per the books are from different financial statement periods
• lDate the check was recorded by the bank is from financial statement period prior to books

• ØIdentifying controls at service organizations that provide financial services and are part
• of the client’s information system.

• ØObtaining an understanding of information systems for securities and derivatives that are
• highly dependent on computer technology.

ØApplying complex accounting principles to various types of financial investments.

ØUnderstanding the methods used to determine the fair values of financial investments, especially those that must be valued using complex valuation models.

• ØAssessing inherent and control risk for assertions about derivatives used in hedging
• activities.

1.Use the understanding of the client and its environment 

2.Obtain an understanding of internal control over financial instruments.

• 3.Assess the risks of material misstatement of financial instruments and design tests of
• controls and substantive procedures that:

• a. Substantiate the existence  of recorded financial investments and the occurrence
• of investment transactions.

b.  Establish the completeness of financial investments and investment transactions.

c.  Verify the cutoff of investment transactions.

• d.  Determine that the client has rights
• to recorded investments.

ØEstablishment of formal investment policies

• ØReviewand approval of investment activities by the investment committee of the board
• of directors

• ØSeparation of duties among employees
• 1.Authorizing purchases and sales
• 2.Having custody of the securities
• 3.Maintaining records

ØDetailed records of all securities owned and the related revenue from interest and dividends

ØRegistration in the name of the company

ØPeriodic physical inspection of securities

ØDetermination of accounting for complex instruments by competent personnel

ØFASB requirements for derivative instruments and hedging activities:

lAll derivative instruments valued at fair values

lUnrealized gains or losses depend on classification as hedges

• ØFASB requirements allow companies to choose to use fair value accounting in this
• area.