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CHAPTER 18 AUDIT INVESTMENTS AND CASH BALANCES

Learning Check
18-1. The nature of investments in securities issued by other 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 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 ob ectives for each of the management assertions that pertain to investments 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 bases for valuing the investments, and +-, the pledging of investments as collateral.

.olutions /anual to Modern Auditing: 'opyright 2001, 2ohn 3iley and .ons, %nc.

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18--. a.

.had is incorrect about the balance sheet inasmuch as marketable securities held 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. 5eri is incorrect. The audit 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.

b.

18-6. Typically, the control environment pertaining to investments in marketable securities 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. 18-1. a. The functions and related controls in the investing cycle consist of the following! (uthori&ing investment transactions! o *urchasing securities. #eceive or deliver securities! o #eceiving8 safeguarding8delivering securities. o #eceiving periodic income. #ecording transactions! o #ecording purchases, sales, and income. o #ecording market ad ustments and reclassifications. .ettle transactions! o #eceiving cash. o 9isbursing cash. o (ssessing investment performance and reporting. The following table summari&es internal controls that might be found in the investing cycle for each assertion +audit ob ective,.

b.

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(ssertion +(udit :b ective, "xistence and :ccurrence +:ccurrence,

'ontrol The computer checks for authori&ation to purchase or sell securities before recording the transaction. #ecorded securities are regularly compared with broker;s statements.

Test of 'ontrols <se '((Ts to test the control by submitting data that should be re ected by the control. :bserve evidence of reconciling recorded securities with the broker;s statements and reperform control on a test basis. <se '((Ts to test the control by submitting data that should be re ected by the control. <se '((Ts to test the control by submitting data that should be re ected by the control. <se '((Ts to test the control by submitting data that should be re ected by the control. #ead the minutes of the disclosure committee and make in$uiries about issues discussed by a disclosure committee. #eview documentation of follow-up on disclosure committee actions. #ead the minutes of the disclosure committee and make in$uiries about issues discussed by a disclosure committee. #eview documentation of follow-up on disclosure committee actions.

'ompleteness +'ompleteness, "xistence and :ccurrence 8 'ompleteness +'utoff,

)aluation and (llocation +(ccuracy, *resentation and 9isclosure +'lassification,

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. ( disclosure committee reviews security transactions to determine if disclosures are appropriate of securities are pledged as collateral for loans or margin trades.

#ights and :bligations

18-=. The acceptable level of detection risk is derived from the audit risk model. %nherent risk for investment balances involves consideration of +a, the vulnerability 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->. a. The precautions are! +1, the custodian should be present during the count, +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, existence or occurrence, +2, completeness, +-, rights and obligations, and +6, presentation and disclosure.

b.

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18-8. The working papers for securities should show the certificate number, name of owner, description of the security, number of shares or bonds, and name of issuer. 18-?. a. .ecurities held by others for the client should be positively confirmed with 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.

b.

18-10. 'ash accounts that should be included as cash balances on the balance sheet 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. The transaction cycles that 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$uity securities, redeeming bonds and retiring stock, the purchase and sale of treasury stock, payment of interest and dividends,. 18-12. a. The account balance audit ob ectives for cash are as follows!
Specific Audit Objectives Transaction Objectives Occurrence. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Completeness. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Accuracy. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Cutoff. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Classification. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Balance Objectives !istence. #ecorded cash balances exist at the balance sheet date + O",. @ear end transfers of cash between banks are recorded in the proper period # O$%. Completeness. #ecorded cash balances include the effects of all transactions that have occurred +C",. @ear end transfers of cash between banks are recorded in the proper period +C$,. &ights and Obligations. The entity has legal title to all cash balances shown at the balance sheet date +&O",. 'aluation and Allocation. #ecorded cash balances are reali&able at the amounts stated on the balance sheet and agree with supporting schedules #'A"%.

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(isclosure Objectives Occurrence and &ights and Obligations. 9isclosed cash events and transactions have occurred 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 #)(+%. Accuracy and 'aluation. 'ash information is disclosed accurately and at appropriate amounts #)(,%.

b.

%nherent risk for cash balances is fre$uently assessed as high for the existence or occurrence and completeness assertions because of the high volume of cash transactions and the vulnerability of cash to misappropriation. %n contrast, lower assessments of inherent risk may be made for the other assertions 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 by cash balances may be very smallA with five of the six transaction cycles affecting cash the amount of cash flowing through the accounts over a period of time that is susceptible to misappropriation can be very large. The volume of 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$ue aspects of cash, auditors tend to plan their procedures to detect much smaller levels of misstatements than for other accounts. 7urther, management may re$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 internal controls and many cash accounts the lower assessed level of control risk approach may be used to limit the number of cash accounts where substantive tests may be performed. 18-11. a. Three different tests of details of transactions that can be performed in auditing 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 to cash transactions and balances is low and the entity4s bank accounts have been reconciled. 5iting is an irregularity in which a bank transfer is recorded as a deposit in the receiving bank and is intentionally not recorded as a deduction from the bank on which it is drawn. To 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 of bank B. Cowever, no 9ecember book entries are made for the check on Bank (.

b. 18-1=. a.

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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 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 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 owned by the client either directly or through endorsement. 18-18 a. Dapping is an form of fraud that results in the deliberate misappropriation of 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. Dapping is usually associated with collections from 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. The information re$uested in confirming bank deposit and loan balances consists of +1, deposit balances, +2, loan balances, and +-, other deposit and loan accounts that may have come to the attention of the authori&ed bank official. Tests to detect lapping are only performed when control risk for cash receipts transactions is moderate or high. There are three procedures that should detect lapping! o 'onfirm (ccounts #eceivable. o /ake a .urprise 'ash 'ount. o 'ompare 9etails of 'ash #eceipts 2ournal "ntries with the 9etails of 'orresponding 9aily 9eposit .lips. %n an effort to conceal the shortage, the embe&&ler usually attempts to +1, keep bank and book amounts in daily agreement so that a bank reconciliation will not detect the irregularity and +2, correct the customer;s account within three to four days of actual collection so that any discovered discrepancy in the customer;s account can be explained as a delay in receiving the money or posting. This test provides evidence primarily for the existence or occurrence and rights and obligations assertions for cash balances. %t contributes to the completeness assertion but it cannot be relied upon entirely because the respondent is not re$uired to search bank records for deposit and loan balances other than the ones listed on the re$uest. ( compensating bank balance is the minimum balance the depositor must maintain to have an established line of credit with a bank.

b.

18-1?. a.

b.

18-20. a.

b.

18-21. a.

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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 risk is high, the auditor may scan the client prepared bank reconciliation and verify its mathematical 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-. a. The bank cutoff statement should be obtained at a point in time that will permit 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! Trace all prior-year dated checks to the outstanding checks listed on the bank 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.

b.

18-26. "xamples of circumstances that affect the presentation and disclosure 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
18-21. +"stimated time - 21 minutes, a. .everal of the categories of internal control activities have been violated. .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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(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.

b.

The substantive tests that would detect the irregularity are +1, inspect and count securities on hand, +2, vouch entries in investment accounts, and +-, recalculate revenue earned.

18-2=. +"stimated time - 21 minutes, a. Substantive Test 1. 2. -. 6. 1. =. >. 8. ?. 10. #ecalculate revenue earned )ouch entries in investment accounts to broker;s advice. 'onfirm securities held by others %nspect and count securities on hand )ouch entries in investment accounts to broker;s advice. %nspect and count securities on hand #eview documentation concerning market values )erify accuracy of balances, schedules and subsidiary ledgers 'ompare statement presentation with F((* 'ompare statement presentation with F((* b. .inancial Statement Assertion )aluation of allocation (ll assertions "xistence or occurrence, completeness, rights and obligations (ll except rights and obligations (ll assertions (ll except rights and obligations )aluation or allocation )aluation or allocation *resentation and disclosure *resentation and disclosure c. Type of vidence /athematical 9ocumentary 'onfirmation *hysical, documentary 9ocumentary *hysical, documentary 9ocumentary /athematical 9ocumentary 9ocumentary

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18-2>. +"stimated time - -0 minutes, a. The ob ectives of the '*(4s examination of the investment account can be summari&ed as follows.
Specific Audit Objectives Transaction Objectives Occurrence. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Completeness. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Accuracy. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Cutoff. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Classification. .ee 'hapter 16 for audit ob ectives related to cash receipts and 'hapter 11 for audit ob ectives related to cash disbursements. Balance Objectives !istence. #ecorded cash balances exist at the balance sheet date + O",. @ear end transfers of cash between banks are recorded in the proper period # O$%. Completeness. #ecorded cash balances include the effects of all transactions that have occurred +C",. @ear end transfers of cash between banks are recorded in the proper period +C$,. &ights and Obligations. The entity has legal title to all cash balances shown at the balance sheet date +&O",. 'aluation and Allocation. #ecorded cash balances are reali&able at the amounts stated on the balance sheet and agree with supporting schedules #'A"%. (isclosure Objectives Occurrence and &ights and Obligations. 9isclosed cash events and transactions have occurred 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 #)(+%. Accuracy and 'aluation. 'ash information is disclosed accurately and at appropriate amounts #)(,%.

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 client that are on deposit. 7urthermore, to be acceptable as accounting evidence, the confirmation should be delivered 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, 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. 18-?

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c.

The '*( would recommend that full disclosures be made in a footnote of the sale and repurchase of the securities so that readers of the financial statements will have ade$uate information to compare the current report with reports for prior years. The gain on the securities transactions would be reported in the income statement on a separate line after the results of operations for the year. The loss on operations for the year must be clearly set forth in the income statement so that readers can make meaningful comparisons with prior years. The securities should be reported in the balance sheet at their new cost or repurchase price. The sale of the securities resulted in cash that could have been used to purchase other securities or in other ways. That management had planned to repurchase the same securities does not alter the fact that alternative uses for the cash existed. %f the cash had been used to buy other securities, these new securities would have been recorded at their cost--the cash expended to ac$uire them. The same treatment should be accorded to the actual transactions.

18-28. +"stimated time - 21 minutes, a. The following information is missing! The date of purchase of . security The date of purchase and sale of # security 9ata concerning the accrual and8or receipt of interest due on # to date of sale 9ata concerning the accrual and8or payment of interest due on . to the date of purchase. 2ustification for accrual of dividends (ccounting treatment of bond discount 9ata concerning the 9ecember -1, 1?G1, revenue accruals 9ata re$uired to evaluate the classification of securities b. .ubstantive tests noted as having been performed are! The initial procedure of tracing beginning balances to prior year4s working papers. The initial procedure of obtaining a client-prepared schedule of investments and footing and crossfooting the schedule and reconciling selected totals with corresponding general ledger balances. Dimited vouching of transactions to supporting documentation. The following substantive tests were not noted as having been performed +this was not a stated re$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 not verified. 'omputations of year-end accruals were not made.

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Eot all amounts +for example, loss on sale of #, were traced to the general ledger.

18-2?. +"stimated time - 20 minutes,


Category %nitial *rocedures Substantive Test 1, :btain an understanding of the business and industry and determine! a, The significance of cash balances and transactions on the entity. b, The entity;s policies for forecasting cash balances and investing surplus cash balances. 2, *erform initial procedures on cash balances and records that will be sub ected to further testing. a, Trace beginning balance for cash on hand and in bank to prior year;s working 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. -, *erform analytical procedures! a, 'ompare cash balances with budgeted amounts, prior year balances, or other expected amounts. b, 'alculate cash as a percent of current assets and compare with expectations. 6, *erform cash cutoff tests +note these test may have been performed as part of the audit programs for accounts receivable and accounts payable,! a, :bserve that all cash received through the close of business on the last day of the fiscal year is included in cash on hand or deposits in transit and that no receipts of the subse$uent period are included, or b, #eview documentation such as daily cash summaries, duplicate deposit slips, and bank statements covering several days before and after year-end date to determine proper cutoff. c, :bserve the last check issued and mailed on the last business day of the fiscal year and trace to accounting records to determine the accuracy of the cash disbursements cutoff, or d, 'ompare dates on checks issued for several days before and after the year-end date to the dates the checks were recorded to determine proper cutoff. 1, Trace bank transfers for several days before and after the year-end date to determine that each transfer is properly recorded as a disbursement and a receipt in the same accounting period and is properly reflected in bank reconciliations when applicable. =, *repare proof of cash for any bank accounts that the entity has been unable to reconcile or for which there is a high risk that fraudulent transactions have occurred. >, 'ount undeposited cash on hand and determine that such amounts are included in cash balances. 8, 'onfirm bank deposit and loan balances with banks. ?, 'onfirm other arrangements with banks such as lines of credit, compensating balance agreements, and loan guarantees or other parties. 10, :btain scan, review, and prepare bank reconciliations as appropriate. 11, :btain and use bank cutoff statements to verify bank reconciliation items, detect any unrecorded checks that have cleared the bank, and look for evidence of window dressing. 12, 'ompare statement presentation with F((*. a, 9etermine that cash balances are properly identified and classified in the financial statements. b, 9etermine that bank overdrafts are reclassified as current liabilities. c, /ake in$uires of management, review correspondence with banks, and 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 the completeness of presentation and disclosures for receivables in drafts of financial statements to determine conformity to F((* by reference to disclosure checklist. d, #ead disclosures and independently evaluate their understandability.

(nalytical *rocedures Tests of 9etails of Transactions

Tests of 9etails of Balances

*resentation and 9isclosure

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18--0. +"stimated time - -0 minutes, a. *atricia 'ompany 'omputation of (mount (bstracted by 'ashier Eovember -0, 20G: 'ash balance, per books Eovember -0, 20G: (dd! 'redit by bank (d usted cash balance +on hand and in bank, Dess ad usted bank balance! Bank balance, Eovember -0, 20G: Dess outstanding checks! =2 182 286 8=21 8=28=-2 'ash which should be on hand for deposit 'ash reported (mount of theft b. I11=.21 110.00 21-.21 1?0.>1 20=.80 161.28 I18,?01.=2 100.00 I1?,001.=2 I11,110.00

1,0=2.2?

16,68>.>1 I 6,11-.?1 -,>?6.61 I >1?.10

The cashier removed I>1?.10. Ce attempted to conceal his theft by! o Eot listing all outstanding checks. o <nderfooting outstanding checks shown on the reconciliation. o .ubtracting an item from the bank balance that should be added to book balance. Two controls that were lacking are! o .omeone other than the cashier should trace cash receipts to the deposits in the bank o .omeone other than the cashier should be responsible for preparing bank reconciliation.

c.

18--1. +"stimated time - 21 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.

.olutions /anual to Modern Auditing: 'opyright 2001, 2ohn 3iley and .ons, %nc.

18-12

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. %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. *ostings from other deposit slips should be traced to the cash receipts ournal and the subsidiary accounts receivable ledger. (lso, entries in the subsidiary accounts receivable ledger should be traced to the cash receipts ournal and to the deposit slips. #eview the subsidiary accounts receivable ledger and confirm accounts that have abnormal transaction activity such as consistently late payments.

&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 properly.

.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. :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. .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.

%f Fut&ier allows customers to take discounts, the amount of such discounts and the discount period should be checked.

9ates and amounts of daily deposits per bank

.ince there are no initial controls over cash

.olutions /anual to Modern Auditing: 'opyright 2001, 2ohn 3iley and .ons, %nc.

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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. *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. )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. 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.

&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. .ince internal control over cash receipts is weak, this overall test may highlight points of irregularities, is such exist.

.ince internal control over cash receipts is weak, the auditor needs to be satisfied that cash receipts are recorded in the appropriate period. .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. +"stimated time - -0 minutes, a. The purposes of auditing bank transfers are to +1, determine that bank balances are correctly stated at the balance sheet date and +2, to detect kiting. b. Bank (ccounts Ck. /o. 26>= 28?0 -160 (100= (1261 -602 .rom '--#eg '--#eg '--#eg /--.pec /--.pec '--#eg To '--*ay '--*ay /--.pec '--pay '--#eg /--.pec (mount of 'heck I100,000 200,000 100,000 10,000 21,000 121,000 (isbursement (ate Books =82=821 =828 =82? =8-0 >81 Bank =8-0 >82 >81 >8= >8> >81 #eceipt 9ate Books =821 =82> =8-0 >81 >82 =8-0 Bank =821 =82> =8-0 >81 >82 =8-0

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c. 'ity Bank--*ayroll Bank 'learing +9ue to /etro Bank--.pecial, 'ity Bank--#egular Bank 'learing +9ue to /etro Bank--.pecial, Bank 'learing +9ue from /etro Bank--.pecial, 'ity Bank--#egular d. e. 10,000 10,000 21,000 21,000 121,000

121,000

:utstanding checks! 28?0, -160, -602, (100=, (1261 9eposits in transit! -602 'heck -602 is indicative of kiting because the check was received, recorded, and deposited on 2une -0, but was not recorded as a disbursement until 2uly 1.

18---. +"stimated time - 11 minutes, %n order to determine whether lapping exists, .tanley would test the aging of accounts receivable and then o /ail positive accounts receivable confirmation re$uests directly to all customers with 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 remittance advices with the names, dates, and amounts recorded in the cash receipts ournal, individual customer ledger accounts, and deposit slips +if practicable,. o )erify the propriety of noncash credits to accounts receivable +for example, sales discounts, sales returns, bad debt write-offs,. o *erform a surprise inspection of deposits. o 7oot the cash receipts ournal, the customers4 ledger accounts, and the accounts receivable control account. o #econcile the total of the individual customers4 accounts with the accounts receivable control account. o 'ompare information in copies of monthly customers4 statements with information in customers4 ledger accounts.

Cases
18--6. +"stimated time - 10 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 of the 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 o *repare schedule of securities. %nappropriate. The schedule should be prepared by the 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 ob ective. o :btain direct confirmation from <tah Banking. (ppropriate. The assertions are existence or occurrence, completeness, and rights and obligations. o Trace confirmations to schedules. (ppropriate. (ssertions are the same as +2,. o )erify interest earned and accrued. (ppropriate. Cowever, test only needs to be done on a limited basis because of internal control. (ssertions are existence or occurrence, completeness, rights and obligations, and valuation or allocation. o Trace appropriate totals to general ledger. (ppropriate. (ssertion is valuation or allocation. (vailable-for-sale securities o *repare analysis, including market values. %nappropriate. This information should be provided by the client. The auditor should verify accuracy of schedule and some market values. (ssertion is valuation or allocation. o 'ount securities at 9ecember -1. (ppropriate. %n principal, the count is necessary to meet the existence or occurrence, completeness, and rights and obligations assertions. Cowever, the count may be made at any time close to 9ecember -1. The program fails to specify that the auditor should determine whether or not the securities have been endorsed to other parties. o )ouch purchases and sales. (ppropriate. Cowever, this only needs to be done on a select basis. (ssertions are existence or occurrence, rights and obligations, and valuation or allocation. o 'ompare dividends received with published dividend record. (ppropriate, if done on a test basis. (ssertions are existence or occurrence, completeness, rights and obligations, and valuation or allocation. o )erify recorded gain on sale. (ppropriate. This ordinarily is done as part of vouching purchases and sales. Because of strong internal control, only material gains or losses need to be verified. (ssertions are the same as for vouching purchases and sales. %nvestment in =0J owned subsidiary o #e$uest confirmation. (ppropriate. This is necessary to meet the existence or occurrence, completeness, and rights and obligations assertions. o #eview monthly statements, etc. %nappropriate. The subsidiary investment is carried at cost. The main concern here is to determine whether management can ustify using this method, since it is contrary to the presumption stated in (*B Eo. 18. %f no ustification, the client should change method or auditor should $ualify the audit report.

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o 9iscuss 9ecember -1 statements with management. %nappropriate. 9iscussion should be directed at propriety of method used, not unrecorded amounts, since internal control is strong. o "stablish that intercompany accounts are in agreement. (ppropriate. This procedure is needed to meet the valuation or allocation assertion. o #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 ad ustment should be proposed by the auditor to meet the valuation or allocation assertion. The program also fails to re$uire the auditor to determine whether the investment should be written down at 9ecember -1. c. :ther points o The program does not re$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. o The program does not re$uire the auditor to determine the propriety of the statement presentation and disclosure, including the proper classification of the investment securities as trading, available-for-sale, held-to-maturity, or e$uity method investments. This should be done by making appropriate in$uiries of management to learn management4s intent regarding holding periods, assessing its abilities regarding holding periods, and comparing the financial statement presentation to F((*, including the treatment of any reali&ed and unreali&ed gains and losses due to changes in market value. The auditor may learn of the existence of any liens from an inspection of the minutes book and by in$uiry of management.

)rofessional Simulations
&esearch Situation Audit )lanning Audit )rocedures

(< --2,1> and .18 addresses how the auditor should obtain to evaluate assertions about securities based on management;s intent and ability. These paragraphs are presented below. 1= Fenerally accepted accounting principles re$uire that management;s intent and ability be considered in valuing certain securitiesA for example, whetherK L 9ebt securities are classified as held-to-maturity and reported at their cost depends on management;s intent and ability to hold them to their maturity. L "$uity securities are reported using the e$uity method depends on management;s ability to significantly influence the investee. L "$uity securities are classified as trading or available-for-sale depends on management;s intent and ob ectives in investing in the securities.

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.1>

%n evaluating management;s intent and ability, the auditor shouldK a. :btain an understanding of the process used by management to classify securities as trading, available-for-sale, or 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 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 entity accounts for the investment contrary to the presumption established by generally accepted accounting principles for use of the e$uity method, obtain sufficient competent evidential matter about whether that presumption has been overcome and whether appropriate disclosure is made regarding the reasons for not accounting for the investment in keeping with that presumption. d. 'onsider whether management;s activities corroborate or conflict with its stated intent. 7or example, the auditor should evaluate an assertion that management intends to hold debt securities to their maturity by examining evidence such as documentation of management;s strategies and sales and other historical activities with respect to those securities and similar securities. e. 9etermine whether generally accepted accounting principles re$uire management 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. <nlike the formal documentation re$uired for hedging activities, evidential matter supporting the classification of debt and e$uity securities may be more informal. f. 9etermine whether management;s activities, contractual agreements, or the entity;s financial condition provide evidence of its ability. "xamples follow! +1, The entity;s financial position, working capital needs, operating results, debt agreements, guarantees, alternate sources of li$uidity, and other relevant contractual obligations, as well as laws and regulations, may provide evidence about an entity;s ability to hold debt securities to their maturity. +2, /anagement;s cash flow pro ections may suggest that it does not have the ability to hold debt securities to their maturity. +-, /anagement;s inability to obtain information from an investee may suggest that it does not have the ability to significantly influence the investee. +6, %f the entity asserts that it maintains effective control over securities transferred under a repurchase agreement, the contractual agreement may be such that the entity actually surrendered control over the securities and therefore should account for the transfer as a sale instead of a secured borrowing.

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Audit )lanning &esearch Situation Audit )rocedures

To! (udit 7ile #e! .taff Training for (udit of 'ash Balances 7rom! '*( 'andidate The following table contrasts the audit of cash balances when the client has good controls over cash balances vs. having poor controls over cash balances.
0ood 1nternal Controls over Cash 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 the validity of deposits in transit and outstanding checks "stablishing the mathematical accuracy of the reconciliation )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 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 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 (greed bank cutoff statement received directly from the bank. )ouched to bank cutoff statement. 'ash receipts ournal show deposit in 9ecember of 20G- and bank cutoff statements shows deposit per bank in 2anuary 20G6. )ouched to bank cutoff statement. The check was dated prior to 9ecember -1, 20Gand it check cleared the bank in 2anuary 20G6. E.7 check vouched to bank documentation accompanying the return of the customers check. Bank charges vouched to bank statement received in 2anuary 20x6. 'heck number was recorded in error. )ouched to actual check that cleared the bank, bank statement, and cash disbursements ournal. )ouched to remittance advice received from the bank with notification of collection of note from customer. Traced to general ledger at 9ecember -1, 20x6. foot

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