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Chapter 16Chapter 16
Auditing the Financing/Investing Process: Cash and Investments
McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved
Balance Sheet
AssetsCashInvestmentsReceivablesPrepaidsInventoryPP and EOther assets -
intangibles
Liabilities and EquityAccounts payableAccrued liabilitiesDebtCommon stockRetained earnings
16-3
Cash and the Effect of Other Business Processes
“Cash” reported in the financial statements represents currency on hand and cash on deposit in bank accounts, including certificates of deposit,
time deposits, and savings accounts.
“Cash” reported in the financial statements represents currency on hand and cash on deposit in bank accounts, including certificates of deposit,
time deposits, and savings accounts.
“Cash equivalents” are frequently combined with cash for presentation in the financial statements.
Definition: Short-term, highly liquid investments that are readily convertible to cash or so near their maturity that there is little risk of change in their value.
Examples: Treasury bills; commercial paper; and money market funds.
LO# 1
16-4
Cash and the Effect of Other Business Processes
LO# 1
16-5
Types of Bank Accounts
In order to maximize its cash position, an entity implements procedures for accelerating the collection of cash receipts and properly delaying the payment of
cash disbursements.
General Cash Account
Impress Cash Accounts
Branch Accounts
Types of Bank Accounts
LO# 2
16-6
Substantive Analytical Procedures—Cash
This limited use of substantive analytical procedures is normally offset by (1) extensive tests of controls and/or substantive tests of transactions for cash
receipts and disbursements or (2) extensive tests of the entity’s bank reconciliations.
Because of the residual nature of the cash account, the auditor’s
use of substantive analytical procedures for auditing cash is
limited to . . .
Because of the residual nature of the cash account, the auditor’s
use of substantive analytical procedures for auditing cash is
limited to . . .
comparisons with prior years’ cash
balances.
comparisons with prior years’ cash
balances.
comparisons with budgeted amounts.
comparisons with budgeted amounts.
LO# 3 & 4
16-7
Substantive Tests of Details of Transactions and Balances
LO# 3 & 4
16-8
The Effects of Controls
The reliability of the client’s controls over cash affects
the nature and extent of the auditor’s tests of details.
Controls for Cash Receipts
Controls for Cash
Disbursements
Completion of Monthly Bank Reconciliation
LO# 3, 4, & 5
16-9
Balance-Related AssertionsLO# 3
& 4
16-10
Auditing the General Cash Account
Copy of Bank Reconciliation
Standard Bank Confirmation
Cutoff Bank Statement
To audit a cash account, the auditor should obtain these
items.
LO# 5
16-11
Bank Reconciliation Working Paper
LO# 5
16-12
Standard Bank Confirmation Form
LO# 5
16-13
Cutoff Bank Statement
Date of Last Bank
Reconciliation
7 to 10 Days
A cutoff bank statement normally covers the 7- to 10-day period after the date on which the bank account is
reconciled.
Any reconciling item should have cleared the client’s bank account during the 7- to 10-day period.
LO# 5
16-14
Tests of the Bank ReconciliationThe auditor uses the following audit procedures to test the
bank reconciliation:
1. Test the mathematical accuracy and agree the balance per the books to the general ledger.
2. Agree the bank balance on the reconciliation with the balance shown on the standard bank confirmation.
3. Trace the deposits in transit on the bank reconciliation to the cutoff bank statement.
4. Compare the outstanding checks on the bank reconciliation with the canceled checks in the cutoff bank statement for proper payee, amount and endorsement.
5. Agree any charges included on the bank statement to the bank reconciliation.
6. Agree the adjusted book balance to the cash account lead schedule.
LO# 5
16-15
Auditing a Payroll or Branch Impress Account
The audit of any impress cash account such as payroll or a branch account follows the same basic audit steps
discussed under the audit of the general cash account.
The audit of any impress cash account such as payroll or a branch account follows the same basic audit steps
discussed under the audit of the general cash account.
LO# 5
16-16
Auditing Petty Cash
Usually not material.
Potential for defalcation.
Seldom perform substantive
tests.
Document controls.
LO# 5
16-17
Disclosure Issues for CashLO# 5
16-18
Disclosure Issues for CashLO# 5
16-19
Disclosure Issues for CashLO# 5
16-20
Fraud-Related Audit ProceduresExtended Bank Reconciliation
Procedures
Proof of Cash
Tests for Kiting
LO# 6
16-21
Extended Bank Reconciliation Procedures
In some instances, the year-end bank reconciliation can be used to cover cash defalcations. This is usually
accomplished by manipulating the reconciling items in the bank reconciliation. For example, suppose a client employee was able to steal $5,000 from the client. The client’s cash balance at the bank would then be $5,000 less than reported on the client’s books. The employee
could “hide” the $5,000 shortage in the bank reconciliation by including a fictitious deposit in transit.
In some instances, the year-end bank reconciliation can be used to cover cash defalcations. This is usually
accomplished by manipulating the reconciling items in the bank reconciliation. For example, suppose a client employee was able to steal $5,000 from the client. The client’s cash balance at the bank would then be $5,000 less than reported on the client’s books. The employee
could “hide” the $5,000 shortage in the bank reconciliation by including a fictitious deposit in transit.
LO# 6
16-22
Proof of CashLO# 6
16-23
Kiting
Cash stolen by employee
Transfers money from one bank account to another
Recorded improperly on books.
16-24
Tests for KitingLO# 6
16-25
Investments
Common Stock Preferred Stock
Debt Securities Hybrid Securities
LO# 7
16-26
Control Risk Assessment—Investments
Occurrence and
Authorization
Completeness
Accuracy and Classification
Here are some of the more important assertions for
investments.
LO# 8
16-27
Segregation of Duties
LO# 9
16-28
Substantive Procedures for Testing Investments
LO# 10
16-29
Tests of Details—Investments
ExistenceAuditing Standards state that the auditor should perform one of the following procedures when gathering evidence for existence:
Physical examination Confirmation with the issuer Confirmation with the custodian Confirmation of unsettled transactions with the broker-
dealer Confirmation with the counterparty Reading executed agreements
16-30
Tests of Details—Investments
Valuation and Allocation
The auditor must also determine if there has been any permanent decline in the value of an investment security. Auditing and accounting standards provide guidance for determining whether a decline in value below amortized cost is other than temporary.
16-31
Tests of Details—Investments
Valuation and AllocationHere are some factors that may indicate a non-temporary impairment of investment value:
Fair value is significantly below cost Decline in fair value is attributable to specific adverse
conditions Management does not possess both the intent and
ability to hold the investment long enough to allow for recovery in fair value
A debt security has been downgraded by a rating agency
The financial condition of the issuer has deteriorated
Permanently Impaired = Write down to new carrying amount
16-32
Tests of Details—Investments
Disclosure Assertions Marketable securities need to be properly
classified as held-to-maturity, trading, and available-for-sale.
Held-to-maturity securities and individual available-for-sale securities should be classified as current or non-current assets based on whether management expects to convert them to cash within 12 months
All trading securities should be classified as current assets
16-33
End of Chapter 16
