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 objectives for each of the management assertions that pertain to investments in marketable securities are: Existence or occurrence • Recorded investment asset and equity balances represent investments that exist at the balance sheet date. • Investment revenues, realized gains and losses, and unrealized holding gains and losses included in income resulted from transactions and events that occurred during the period. Completeness • All 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. Rights and obligations • All recorded investments are owned by the reporting entity. Valuation or allocation • Investments are reported on the balance sheet at fair value, cost, amortized cost, or the amount determined by the equity method, as appropriate for particular investments. • Investment revenues, and realized and unrealized gains, and losses are reported at proper amounts. Presentation and disclosure • Investment balances are property identified and classified in the financial statements. • Appropriate disclosures are made concerning (1) related party investments, (2) the bases for valuing the investments, and (3) the pledging of investments as collateral.
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18-3. a.
Shad is incorrect about the balance sheet inasmuch as marketable securities held as short-term investments may be material to a company's short-term solvency, and securities held as long-term investments may be material to total assets. Shad may be incorrect about the income statement for a company that has trading securities, held to maturity securities when amortization is significant, or available-for-sale securities for which unrealized holding gains and losses become realizable due to sale or reclassification.
b.
Keri is incorrect. The audit strategy decision is generally based on the frequency of investing transactions. When there are relatively few transactions, the auditor generally uses a primarily substantive approach. When there are many transactions, it may be more cost-efficient for the auditor to use a lower assessed level of control risk approach.
18-4. Typically, the control environment pertaining to investments in marketable securities enhances internal control. For 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 required for each method of accounting for the various categories of investments in equity and debt securities, both at acquisition and at subsequent reporting dates. Each of the categories of control activities is applicable. Several common documents and records are used in investing activities, and internal auditors may be involved in monitoring investment activities and balances. 18-5. a.
b.
The functions and related controls in the investing cycle consist of the following: • Authorizing investment transactions: o Purchasing securities. • Receive or deliver securities: o Receiving/ safeguarding/delivering securities. o Receiving periodic income. • Recording transactions: o Recording purchases, sales, and income. o Recording market adjustments and reclassifications. • Settle transactions: o Receiving cash. o Disbursing cash. o Assessing investment performance and reporting. The following table summarizes internal controls that might be found in the investing cycle for each assertion (audit objective).
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Assertion (Audit Objective) Existence and Occurrence (Occurrence)
Completeness (Completeness) Existence and Occurrence / Completeness (Cutoff)
Valuation and Allocation (Accuracy) Presentation and Disclosure (Classification)
Rights and Obligations
Control The computer checks for authorization to purchase or sell securities before recording the transaction.
Test of Controls Use CAATs to test the control by submitting data that should be rejected by the control.
Recorded securities are regularly compared with broker’s statements.
Observe evidence of reconciling recorded securities with the broker’s statements and reperform control on a test basis. Use CAATs to test the control by submitting data that should be rejected by the control.
The computer prepares an exception report of authorized 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 quantities and prices with the underlying broker’s advice. A disclosure committee reviews classification of securities as held to maturity, available for sale, or trading securities. A disclosure committee reviews security transactions to determine if disclosures are appropriate of securities are pledged as collateral for loans or margin trades.
Use CAATs to test the control by submitting data that should be rejected by the control. Use CAATs to test the control by submitting data that should be rejected by the control. Read the minutes of the disclosure committee and make inquiries about issues discussed by a disclosure committee. Review documentation of follow-up on disclosure committee actions. Read the minutes of the disclosure committee and make inquiries about issues discussed by a disclosure committee. Review documentation of follow-up on disclosure committee actions.
18-6. The acceptable level of detection risk is derived from the audit risk model. Inherent 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 equity method of accounting (valuation or allocation assertion). Control risk, under the primarily substantive approach is at the maximum or slightly below the maximum. In such cases, the acceptable level of detection risk will be low. 18-7. 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 (3) all securities, cash and other negotiable investments should be controlled during the count.
b.
This test applies to four assertions: (1) existence or occurrence, (2) completeness, (3) rights and obligations, and (4) presentation and disclosure.
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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. 18-9.
a.
Securities 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.
b.
This test provides evidence about four assertions, (1) existence or occurrence, (2) completeness, (3) rights and obligations, and (3) valuation at historical cost.
18-10. Cash 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. Cash 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: • Revenue (cash sales and receivable collections) • Expenditure (cash purchases and payments on account) • Personnel services (payment of employees and taxing authorities) • Investing (The purchase of long-term assets, the purchase and sale of securities, and the receipt of interest and dividends). • Financing (Issuing debt and equity 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 objectives for cash are as follows: Specific Audit Objectives Transaction Objectives Occurrence. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Completeness. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Accuracy. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Cutoff. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Classification. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Balance Objectives Existence. Recorded cash balances exist at the balance sheet date (EO1). Year end transfers of cash between banks are recorded in the proper period (EO2). Completeness. Recorded cash balances include the effects of all transactions that have occurred (C1). Year end transfers of cash between banks are recorded in the proper period (C2). Rights and Obligations. The entity has legal title to all cash balances shown at the balance sheet date (RO1). Valuation and Allocation. Recorded cash balances are realizable at the amounts stated on the balance sheet and agree with supporting schedules (VA1).
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Disclosure Objectives Occurrence and Rights and Obligations. Disclosed cash events and transactions have occurred and pertain to the entity (PD1). Completeness. All cash disclosures that should have been included in the financial statements have been included (PD2). Understandability. All cash disclosures are appropriately presented and information in disclosures is understandable to users (PD3). Accuracy and Valuation. Cash information is disclosed accurately and at appropriate amounts (PD4).
b.
Inherent risk for cash balances is frequently 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. In contrast, lower assessments of inherent risk may be made for the other assertions because they do not involve any contentious accounting issues.
18-13. Although the portion of current or total assets at any point in time represented by cash balances may be very small; 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. 18-14. Because of the unique aspects of cash, auditors tend to plan their procedures to detect much smaller levels of misstatements than for other accounts. Further, management may request that the auditor plan work in the cash areas with a more extensive scope than would otherwise be required due to the inherent risks in this area. Hence, the auditor may follow a primarily substantive approach. When 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. 18-15. a.
Three different tests of details of transactions that can be performed in auditing cash balances are: • Perform cash cutoff tests for cash receipts and cash disbursements. • Trace bank transfers. • Prepare proof of cash.
b.
A proof of cash need not be prepared when control risk pertaining to cash transactions and balances is low and the entity's bank accounts have been reconciled.
18-16. a.
Kiting 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 unauthorized check is drawn on bank A to cover a shortage in bank B. The check is included in the December 31 deposit of bank B. However, no December book entries are made for the check on Bank A.
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b.
Kiting can be detected by (1) tracing bank transfers and (2) by using a bank cutoff statement.
18-17. 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, (3) obtain a signed receipt from the custodian on return of the funds to the client, and (4) ascertain that all undeposited checks are owned by the client either directly or through endorsement. 18-18 a.
Lapping is an form of fraud that results in the deliberate misappropriation of cash receipts. It may involve either a temporary or a permanent abstraction of cash receipts for the personal use of the individual perpetrating the unauthorized act.
b.
Lapping is usually associated with collections from customers, but it may also involve other types of cash receipts. Conditions conducive to lapping exist when an individual who handles cash receipts also maintains the accounts receivable ledger.
18-19. a.
The information requested in confirming bank deposit and loan balances consists of (1) deposit balances, (2) loan balances, and (3) other deposit and loan accounts that may have come to the attention of the authorized bank official.
b.
18-20. a.
b.
18-21. a.
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 Confirm Accounts Receivable. o Make a Surprise Cash Count. o Compare Details of Cash Receipts Journal Entries with the Details of Corresponding Daily Deposit Slips. In an effort to conceal the shortage, the embezzler 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. It contributes to the completeness assertion but it cannot be relied upon entirely because the respondent is not required to search bank records for deposit and loan balances other than the ones listed on the request. A compensating bank balance is the minimum balance the depositor must maintain to have an established line of credit with a bank.
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b.
The auditor's 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. When the acceptable level of detection risk is high, the auditor may scan the client prepared bank reconciliation and verify its mathematical accuracy. If detection risk is moderate, the auditor may review the client's reconciliation. A review includes vouching reconciling items to supporting documentation, and investigating old and unusual items. When the acceptable level of detection risk is low, the auditor may prepare the bank reconciliation using bank data in the client's possession. When detection risk is very low, the auditor may obtain the bank statement directly from the bank for use in preparing the bank reconciliation. 18-23. a.
b.
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.. After 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 • Scan the cutoff statement and enclosed data for unusual items.
18-24. Examples 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 inquiry of management as to restrictions on the use of cash balances.
Comprehensive Questions 18-25. (Estimated time - 25 minutes) a.
Several of the categories of internal control activities have been violated. • Segregation of duties. The treasurer executes transactions, records the transactions, and has custody of the resulting assets. It is proper for the treasurer to execute the securities transactions. However, accounting personnel should record the transactions, and another officer or an outside independent agent should be the custodian. • Proper authorization. For proper control, the board of directors (or a finance committee of the board) should authorize each purchase and sale of securities. • Documents 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.
Access controls. No mention is made of storing the CDs in a vault or safety deposit box. Such controls should be used and access should be limited to authorized personnel. Independent checks. No 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 and count securities on hand, (2) vouch entries in investment accounts, and (3) recalculate revenue earned.
18-26. (Estimated time - 25 minutes) a. Substantive Test 1. 2.
Recalculate revenue earned Vouch entries in investment accounts to broker’s advice.
3.
Confirm securities held by others
4.
Inspect and count securities on hand Vouch entries in investment accounts to broker’s advice. Inspect and count securities on hand Review documentation concerning market values Verify accuracy of balances, schedules and subsidiary ledgers Compare statement presentation with GAAP Compare statement presentation with GAAP
5. 6. 7. 8. 9. 10.
b. Financial Statement Assertion Valuation of allocation All assertions
c. Type of Evidence Mathematical Documentary
Existence or occurrence, completeness, rights and obligations All except rights and obligations All assertions
Confirmation
All except rights and obligations Valuation or allocation
Physical, documentary
Valuation or allocation
Mathematical
Presentation and disclosure
Documentary
Presentation and disclosure
Documentary
Physical, documentary Documentary
Documentary
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18-27. (Estimated time - 30 minutes) a.
The objectives of the CPA's examination of the investment account can be summarized as follows. Specific Audit Objectives Transaction Objectives Occurrence. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Completeness. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Accuracy. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Cutoff. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Classification. See Chapter 14 for audit objectives related to cash receipts and Chapter 15 for audit objectives related to cash disbursements. Balance Objectives Existence. Recorded cash balances exist at the balance sheet date (EO1). Year end transfers of cash between banks are recorded in the proper period (EO2). Completeness. Recorded cash balances include the effects of all transactions that have occurred (C1). Year end transfers of cash between banks are recorded in the proper period (C2). Rights and Obligations. The entity has legal title to all cash balances shown at the balance sheet date (RO1). Valuation and Allocation. Recorded cash balances are realizable at the amounts stated on the balance sheet and agree with supporting schedules (VA1). Disclosure Objectives Occurrence and Rights and Obligations. Disclosed cash events and transactions have occurred and pertain to the entity (PD1). Completeness. All cash disclosures that should have been included in the financial statements have been included (PD2). Understandability. All cash disclosures are appropriately presented and information in disclosures is understandable to users (PD3). Accuracy and Valuation. Cash information is disclosed accurately and at appropriate amounts (PD4).
b.
The CPA 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 CPA 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 CPA's client that are on deposit. Furthermore, to be acceptable as accounting evidence, the confirmation should be delivered directly to the CPA by the custodian without passing through the client's hands. The confirmation should contain a statement to the effect that securities were the property of the depositor on a specified date. In examining the investment account and the custodian's detailed statements, the CPA would expect to find few, if any, errors made by the custodian; 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 CPA 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 adequate 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. If the cash had been used to buy other securities, these new securities would have been recorded at their cost--the cash expended to acquire them. The same treatment should be accorded to the actual transactions.
18-28. (Estimated time - 25 minutes) a. The following information is missing: • The date of purchase of S security • The date of purchase and sale of R security • Data concerning the accrual and/or receipt of interest due on R to date of sale • Data concerning the accrual and/or payment of interest due on S to the date of purchase. • Justification for accrual of dividends • Accounting treatment of bond discount • Data concerning the December 31, 19X1, revenue accruals • Data required to evaluate the classification of securities b.
Substantive tests noted as having been performed are: • The initial procedure of tracing beginning balances to prior year's 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. • Limited vouching of transactions to supporting documentation. The following substantive tests were not noted as having been performed (this was not a stated requirement of the question): • The securities were not physically inspected or confirmed. • The broker's advice (or other independent corroborating evidence) verifying the sale of R was not examined. • Dividend rates were not verified by reference to public records (Standard & Poor's) of dividend declarations. • The stated interest rates, maturity dates, and market values were not verified. • Computations of year-end accruals were not made.
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•
Not all amounts (for example, loss on sale of R) were traced to the general ledger.
18-29. (Estimated time - 20 minutes) Category Initial Procedures
Substantive Test 1) Obtain 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) Perform initial procedures on cash balances and records that will be subjected to further testing. a) Trace beginning balance for cash on hand and in bank to prior year’s working papers. b) Review activity in general ledger accounts for cash and investigate entries that appear unusual in amount or source. c) Obtain client-prepared schedules of cash on hand and in bank, verify mathematical accuracy and determine agreement with general ledger.
Analytical Procedures
3) Perform analytical procedures: a) Compare cash balances with budgeted amounts, prior year balances, or other expected amounts. b) Calculate cash as a percent of current assets and compare with expectations. 4) Perform cash cutoff tests (note these test may have been performed as part of the audit programs for accounts receivable and accounts payable): a) Observe 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 subsequent period are included, or b) Review 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) Observe 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) Compare 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. 5) 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. 6) Prepare 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. 7) Count undeposited cash on hand and determine that such amounts are included in cash balances. 8) Confirm bank deposit and loan balances with banks. 9) Confirm other arrangements with banks such as lines of credit, compensating balance agreements, and loan guarantees or other parties. 10) Obtain scan, review, and prepare bank reconciliations as appropriate. 11) Obtain 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) Compare statement presentation with GAAP. a) Determine that cash balances are properly identified and classified in the financial statements. b) Determine that bank overdrafts are reclassified as current liabilities. c) Make inquires of management, review correspondence with banks, and review minutes of board of directors meetings to determine matters requiring disclosure such as lines of credit, loan guarantees, compensating balance agreements, or other restrictions on cash balances. a) Evaluate the completeness of presentation and disclosures for receivables in drafts of financial statements to determine conformity to GAAP by reference to disclosure checklist. d) Read disclosures and independently evaluate their understandability.
Tests of Details of Transactions
Tests of Details of Balances
Presentation and Disclosure
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18-30. (Estimated time - 30 minutes) a. Patricia Company Computation of Amount Abstracted by Cashier November 30, 20XO Cash balance, per books November 30, 20XO Add: Credit by bank Adjusted cash balance (on hand and in bank) Less adjusted bank balance: Bank balance, November 30, 20XO Less outstanding checks: 62 182 284 8621 8623 8632 Cash which should be on hand for deposit Cash reported Amount of theft
$18,901.62 100.00 $19,001.62 $15,550.00 $116.25 150.00 253.25 190.71 206.80 145.28
1,062.29
14,487.71 $ 4,513.91 3,794.41 $ 719.50
b.
The cashier removed $719.50. He attempted to conceal his theft by: o Not listing all outstanding checks. o Underfooting outstanding checks shown on the reconciliation. o Subtracting an item from the bank balance that should be added to book balance.
c.
Two controls that were lacking are: o Someone other than the cashier should trace cash receipts to the deposits in the bank o Someone other than the cashier should be responsible for preparing bank reconciliation.
18-31. (Estimated time - 25 minutes) Other Audit Procedures Sources of debit entries in general ledger cash account, other than from cash receipts journals, should be investigated and supporting documents examined.
Reason for Other Audit Procedures Since the auditor, using standard procedures, only examines the cash receipts journal, he or she must investigate the validity of all other sources of cash receipts which are not recorded in these journals.
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Other Audit Procedures A surprise examination of cash receipts should be performed. Prior to the accounts receivable clerk obtaining the cash receipts, the auditor should make a list of them without the clerk's 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. Individual items on the deposit slip should be compared to postings to the subsidiary accounts receivable ledger. The auditor should ask Gutzler to ask the bank to send the statement containing that deposit directly to the auditor.
Reason for Other Audit Procedures Since 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.
Postings from other deposit slips should be traced to the cash receipts journal and the subsidiary accounts receivable ledger. Also, entries in the subsidiary accounts receivable ledger should be traced to the cash receipts journal and to the deposit slips.
Since 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.
Review the subsidiary accounts receivable ledger and confirm accounts that have abnormal transaction activity such as consistently late payments.
Once more, there is no separation of duties between cash receipts and accounts receivable. If 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.
If Gutzier allows customers to take discounts, the amount of such discounts and the discount period should be checked.
Since 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.
Dates and amounts of daily deposits per bank
Since there are no initial controls over cash
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Other Audit Procedures statements should be compared with entries in the cash receipts journal A 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.
Reason for Other Audit Procedures 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. Since 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.
Prepare 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.
Since internal control over cash receipts is weak, this overall test may highlight points of irregularities, is such exist.
Visit the client on the balance sheet date or the next business day to determine that an appropriate cutoff of cash receipts has been made.
Since internal control over cash receipts is weak, the auditor needs to be satisfied that cash receipts are recorded in the appropriate period.
For those periods for which the above audit procedures were not performed and for a period after the balance sheet date, scan the cash receipts journal and bank statements for unusual items.
Since 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.
18-32. (Estimated time - 30 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 Accounts Ck. No. 2476 2890 3140 A1006 A1245 3402
From C--Reg C--Reg C--Reg M--Spec M--Spec C--Reg
To C--Pay C--Pay M--Spec C--pay C--Reg M--Spec
Amount of Check $100,000 200,000 100,000 50,000 25,000 125,000
Disbursement Date Books 6/23 6/25 6/28 6/29 6/30 7/1
Bank 6/30 7/2 7/5 7/6 7/7 7/5
Receipt Date Books 6/25 6/27 6/30 7/1 7/2 6/30
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Bank 6/25 6/27 6/30 7/1 7/2 6/30
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c. City Bank--Payroll Bank Clearing (Due to Metro Bank--Special)
50,000
City Bank--Regular Bank Clearing (Due to Metro Bank--Special)
25,000
Bank Clearing (Due from Metro Bank--Special) City Bank--Regular
50,000 25,000
125,000 125,000
d.
Outstanding checks: 2890, 3140, 3402, A1006, A1245 Deposits in transit: 3402
e.
Check 3402 is indicative of kiting because the check was received, recorded, and deposited on June 30, but was not recorded as a disbursement until July 1.
18-33. (Estimated time - 15 minutes) In order to determine whether lapping exists, Stanley would test the aging of accounts receivable and then o Mail positive accounts receivable confirmation requests directly to all customers with old balances. o Investigate all exceptions noted on confirmations. o Obtain authenticated deposit slips directly from the bank. o Compare individual customers' names, dates, and amounts shown on the customer's remittance advices with the names, dates, and amounts recorded in the cash receipts journal, individual customer ledger accounts, and deposit slips (if practicable). o Verify the propriety of noncash credits to accounts receivable (for example, sales discounts, sales returns, bad debt write-offs). o Perform a surprise inspection of deposits. o Foot the cash receipts journal, the customers' ledger accounts, and the accounts receivable control account. o Reconcile the total of the individual customers' accounts with the accounts receivable control account. o Compare information in copies of monthly customers' statements with information in customers' ledger accounts.
Cases 18-34. (Estimated time - 50 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. U.S. Government securities o Prepare schedule of securities. Inappropriate. 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 objective. o Obtain direct confirmation from Utah Banking. Appropriate. The assertions are existence or occurrence, completeness, and rights and obligations. o Trace confirmations to schedules. Appropriate. Assertions are the same as (2). o Verify interest earned and accrued. Appropriate. However, test only needs to be done on a limited basis because of internal control. Assertions are existence or occurrence, completeness, rights and obligations, and valuation or allocation. o Trace appropriate totals to general ledger. Appropriate. Assertion is valuation or allocation. Available-for-sale securities o Prepare analysis, including market values. Inappropriate. This information should be provided by the client. The auditor should verify accuracy of schedule and some market values. Assertion is valuation or allocation. o Count securities at December 31. Appropriate. In principal, the count is necessary to meet the existence or occurrence, completeness, and rights and obligations assertions. However, the count may be made at any time close to December 31. The program fails to specify that the auditor should determine whether or not the securities have been endorsed to other parties. o Vouch purchases and sales. Appropriate. However, this only needs to be done on a select basis. Assertions are existence or occurrence, rights and obligations, and valuation or allocation. o Compare dividends received with published dividend record. Appropriate, if done on a test basis. Assertions are existence or occurrence, completeness, rights and obligations, and valuation or allocation. o Verify recorded gain on sale. Appropriate. 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. Assertions are the same as for vouching purchases and sales. Investment in 60% owned subsidiary o Request confirmation. Appropriate. This is necessary to meet the existence or occurrence, completeness, and rights and obligations assertions. o Review monthly statements, etc. Inappropriate. The subsidiary investment is carried at cost. The main concern here is to determine whether management can justify using this method, since it is contrary to the presumption stated in APB No. 18. If no justification, the client should change method or auditor should qualify the audit report.
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o Discuss December 31 statements with management. Inappropriate. Discussion should be directed at propriety of method used, not unrecorded amounts, since internal control is strong. o Establish that intercompany accounts are in agreement. Appropriate. This procedure is needed to meet the valuation or allocation assertion. o Record equity in net assets. Inappropriate. The company is using the cost method. Also inappropriate in that auditor would be making the entry. If client agrees to adopt equity method, an adjustment should be proposed by the auditor to meet the valuation or allocation assertion. The program also fails to require the auditor to determine whether the investment should be written down at December 31. c.
Other points o The program does not require 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 require 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 equity method investments. This should be done by making appropriate inquiries of management to learn management's intent regarding holding periods, assessing its abilities regarding holding periods, and comparing the financial statement presentation to GAAP, including the treatment of any realized and unrealized 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 inquiry of management.
Professional Simulations Research Situation
Audit Planning
Audit Procedures
AU 332,57 and .58 addresses how the auditor should obtain to evaluate assertions about securities based on management’s intent and ability. These paragraphs are presented below. 56
Generally accepted accounting principles require that management’s intent and ability be considered in valuing certain securities; for example, whether— • Debt 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. • Equity securities are reported using the equity method depends on management’s ability to significantly influence the investee. • Equity securities are classified as trading or available-for-sale depends on management’s intent and objectives in investing in the securities.
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.57
In evaluating management’s intent and ability, the auditor should— a. Obtain an understanding of the process used by management to classify securities as trading, available-for-sale, or held-to-maturity. b. For an investment accounted for using the equity method, inquire 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. If the entity accounts for the investment contrary to the presumption established by generally accepted accounting principles for use of the equity 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. Consider whether management’s activities corroborate or conflict with its stated intent. For 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. Determine whether generally accepted accounting principles require management to document its intentions and specify the content and timeliness of that documentation. fn 19 The auditor should inspect the documentation and obtain evidential matter about its timeliness. Unlike the formal documentation required for hedging activities, evidential matter supporting the classification of debt and equity securities may be more informal. f. Determine whether management’s activities, contractual agreements, or the entity’s financial condition provide evidence of its ability. Examples follow: (1) The entity’s financial position, working capital needs, operating results, debt agreements, guarantees, alternate sources of liquidity, 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) Management’s cash flow projections may suggest that it does not have the ability to hold debt securities to their maturity. (3) Management’s inability to obtain information from an investee may suggest that it does not have the ability to significantly influence the investee. (4) If 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 Planning Research Situation
Audit Procedures
To: Audit File Re: Staff Training for Audit of Cash Balances From: CPA Candidate 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. Good Internal Controls over Cash Transactions and Cash Balances When 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. If detection risk is moderate, the auditor may review the client’s bank reconciliation more carefully. The review will normally include • Comparing the ending bank balance with the balance confirmed on the bank confirmation form • Verifying the validity of deposits in transit and outstanding checks • Establishing the mathematical accuracy of the reconciliation • Vouching reconciling items such as bank charges and credits and errors to supporting documentation • Investigating old items such as checks outstanding for a long period of time and unusual items
Weak Internal Controls over Cash Transactions and Cash Balances When 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. When 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 request 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. Such 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. When 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 Procedures Research Situation
Audit Planning
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 Procedure Agreed bank cutoff statement received directly from the bank. Vouched to bank cutoff statement. Cash receipts journal show deposit in December of 20X3 and bank cutoff statements shows deposit per bank in January 20X4. Vouched to bank cutoff statement. The check was dated prior to December 31, 20X3 and it check cleared the bank in January 20X4. NSF check vouched to bank documentation accompanying the return of the customers check. Bank charges vouched to bank statement received in January 20x4. Check number was recorded in error. Vouched to actual check that cleared the bank, bank statement, and cash disbursements journal. Vouched to remittance advice received from the bank with notification of collection of note from customer. Traced to general ledger at December 31, 20x4. foot
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