ACC 3603
Assurance & Attestation
Seminar 7:
Audit of
Cash, Borrowings &
Related Party Transactions (RPT)
Ms Chu Mui Kim
bizchum@nus.edu.sg
Seminar 7: Learning Outcomes
7.1 Cash at Bank
- Bank confirmation and bank reconciliations
- Kiting
7.2 Cash on Hand
- Cash Count
- Teeming and lading
7.3 Borrowings
2
Where is
the cash?
• http://www.hindustantimes.com/business/satyam-scam-allyou-need-to-know-about-india-s-biggest-accountingfraud/story-YTfHTZy9K6NvsW8PxIEEYL.html
• www.scirp.org/journal/PaperDownload.aspx?paperID=30220
Cash & Fraud
• Cash is susceptible to misappropriation & fraud
• Satyam: cash balances inflated by 50 billion rupees (S$1.45 billion)
• Oriental Century Ltd, cash balances of 234 million yuan substantially
inflated; diverted unspecified sums to an interested party.
• Fibrechem Technologies Ltd: “auditors encountered difficulties
finalising audit of trade receivables and cash balances.”
• China Hongxing Sports Ltd after a sell-down in its share price with
high transaction volume – the media and blogs questioned if the cash
is in the company when it did not declare a final dividend.
That led the company to issue a statement to the effect that it had
1.98 billion yuan cash as at Dec 31, with borrowings of just six million
yuan.
4
What are the Assertions?
• Completeness – Cash balances include all cash
transactions that have taken place during the
period.
• Rights and Obligations – the organization has title
to the cash accounts as at balance sheet date.
• Existence – cash balances exist at the balance
sheet date
• Valuation – recorded cash balances reflect the
true underlying economic value of those assets.
5
Control considerations
• Cash & banking covenants
• Bank recons:
– Performed regularly? By who? Shd be someone indep of
handling cash or making postings for AR/AP
– Evidence of review
• Segregation of duties
– Cash custodian vs accounting
• Avoid cash cheques or pre-signed cheques
7.1 Audit of Cash at Bank:
What are the most important
procedures?
• Bank confirmation
• Review of bank reconciliation
Why so ???
7
Cash At Bank: Bank Confirmation
• At the start of each audit engagement, a bank
confirmation letter should be requested from the client’s
bankers at the year-end date. A standard format is
submitted to the bank for completion. Bank
confirmations are required for all bank accounts opened
or closed during the year.
• For new bank account opened or existing bank account
closed during the year, ensure that they are supported by
directors’ resolution and that authorization has been
obtained with authorized signatories corresponding to
those required by the account mandates.
8
Cash At Bank
• Information to be confirmed:
– Balance at year end
– Interest charges/income during the year
– Loan details  principal, interest terms,
repayment terms & any asset pledged as security
– Any outstanding derivatives
– Existence of any guarantees
– Audit procedures  trace information confirmed
to GL or disclosure in FS
9
Bank Confirmation – How?
• Obtain a list of bank balances – listing the bank, account
number and balances. Plus list of full banking relationships.
• Cast the list and agree the total to the cash book/general
ledger.
• Select bank accounts for direct confirmation:
– Material balances are selected
– Negative balances or zero balance are selected
– Others – random sampling
In practice, ALL are selected for confirmation
• Obtain client permission to send bank confirmation request
– WHY?
10
Bank Confirmation – How?
• Bank confirmation request to be on client’s
letterhead and signed by client’s bank signatories
• Review bank’s response and ensure all items have
been accurately recorded and disclosed by the client
• Check whether bank confirmed balances are the
same or different from the cashbook balances
• Check bank reconciliation – reconciliation between
bank balances and cash book balances.
11
Example of Standard Bank Confirmation
12
Nick Leeson / Barings
(1995)
•
•
•
•
•
Leeson was having trouble explaining the loss of 7.8bn yen
(pounds 50m), which he had tried to disguise by alleging that
an American customer would be paying this sum back to
Barings.
Forged letters from the customer stating that the cash would
be paid. As the auditors closed in, he devised a plan to
transfer the missing money from one Barings bank account to
another, before swiftly moving it back to the account to which
it belonged.
Objective: To show that the alleged debt had been repaid.
However, the statement which showed the payment, also
showed the transfer.
So Leeson set about cutting and pasting the bank statement to
remove references to the transfer.
The cut and pasted statement was then photocopied and
passed on to the auditors.
If bank confirmation procedures are followed, are
there guarantees that conf received are real?
• Collusion between companies & bank officers in certain markets
have led to new audit procedures – visit to banks by auditors to
secure bank confirmations.
• PWC report on Sino-Env's: Management arranged for PwC to visit
the Quanzhou rep office of the Xiamen International Bank:
• “On arrival, PwC discovered that a specific bank officer had been
pre-arranged to meet with them and that this officer already had
statements and documents for PwC to examine. PwC was unable
to verify the information with the bank's IT system.”
• There were only three staff members in the office, including the
'branch manager' who was not willing to answer any questions and
subsequently chased the PwC auditors out of the premises.
Bank Reconciliation
• Why does the balance in bank statement or
bank confirmation reply differs from balance
in the cash book (i.e. accounting record):
– Uncleared lodgement
– Unpresented cheques
– Recording errors
16
Uncleared lodgment
• Amount recorded as deposit in the cash book but
not recorded in the bank statement as deposit.
• This could be due to bank’s processing time lag.
– For example, cheque deposits can take between one
to three days to be processed by the bank. Cheques
issued by overseas banks may take up to a month for
processing. Thus, cheque deposited into bank on the
balance sheet date will appear in the next month bank
statement. The bank statement balance as at balance
sheet date will not reflect such deposit and thus show
a lower balance.
17
Unpresented cheques
• Payment by cheques issued by audit client to
creditors is recorded as withdrawal in the cash
book and reduces the bank balances in the cash
book.
• Creditors may not deposit the cheques in their
banks in the same month, i.e. they may present
the cheques in the subsequent month.
– Thus, the cheque payment issued before year end
reduces cash book balance. The creditors deposited
the cheques after year end and thus will not be
reflected as withdrawal in the bank statement as at
year end.
18
Recording errors
• Could be recorded errors by audit client or
bank.
What are the
audit
procedures?
19
Audit Bank Reconciliation
• Obtain bank reconciliation from audit client
• Cast the list
• Agree balance per cash book in the
reconciliation statement to cash book balance
• Agree balance per bank statement in the
reconciliation statement to the bank statement
and bank confirmation reply
• Outstanding lodgments
20
Audit Bank Reconciliation
• Uncleared lodgments
– Inspect bank deposit slips to ensure money was
deposited on or before year end.
– Trace lodgments to next month bank statements –
they would appear as deposit in the first week of
next month.
• Unpresented cheques
– Inspect _______________ to ensure payment was
approved on or before year end
– Trace payment details to next month bank
statement.
21
Bank Reconciliation Statement
Balance per bank statement – 31/12/2007
$10,000
Add: unpresented lodgments
DBS123
$20,000
UOB9318
$30,000
Citi2033
$ 3,000
Less: unpresented cheques
OCBC 1123 $5,000
OCBC 1125 $7,000
OCBC 1126 $3,000
Balance per cash book – 31/12/2007
$53,000
($15,000)
$48,000
Look out for evidence of management
review too!
22
AY2014-15 Sem 2 Exam
Audit associate, Morrison Chew
commented in the work papers:
“According to the CFO, Ms Susan
Sian, the suspense account
relates to complicated and
irreconcilable foreign exchange
translation differences brought
forward a long time ago from
Mr Qing Caizuo. Even her
predecessor, Mr Grey, was
unable to figure out what was
wrong with it. Ms Sian proposed
ignoring it as the amount is
immaterial compared to either
profit before tax, total cash and
bank balances and total asset. I
agree with this analysis.”
23
AY2014-15 Sem 2 Exam
With reference to the bank reconciliation for DBS Bank Account 1,
(i) Describe the procedures you would perform to verify the uncleared
deposits from customers and unpresented cheques in the bank
reconciliation.
(ii) Do you agree with the statement made by Morrison Chew? Discuss
with reference to elements of the bank reconciliation. Also highlight
any concerns you have relating to the bank reconciliation.
(ii) List two issues you would like to highlight in the management letter if
you are the engagement partner from S&B. You need not prepare a
draft of the management letter. Focus on accounting matters, and
ignore human resource management or operational issues for this
question.
24
Kiting
• Transfer of money from a/c A to a/c B but
recording deduction from a/c A only after y/e.
• Have bank-in slip for B as evidence of deposit.
• Purpose: To show inflated cash balance or
manipulate covenant ratios. Cash book of
both accounts A & B show money present.
• How to detect: Investigate major cash
movements between co’s accounts near y/e.
Bank Transfer Schedule to detect Kitting
DATE DEPOSITED
Transferred
from Branch
Cheque
number
Amount
Per Books
Per Bank
Orchard
Orchard
Jurong
Orchard
Jurong
15910
15980
8702
16110
8725
45000
100000
87000
25000
65000
26-Dec
28-Dec
30-Dec
3-Jan
5-Jan
27-Dec
29-Dec
31-Dec
4-Jan
7-Jan
DATE WITHDRAWN
Per Branch
Books
Per Bank
26-Dec
27-Dec
2-Jan
2-Jan
4-Jan
30-Dec
31-Dec
3-Jan
5-Jan
8-Jan
How will you audit this schedule?
Can you spot the unusual transfer?
26
Cash Receipts
• A company may have “cash” in different forms: coins
and currency, current accounts with banks, petty cash
and/or money market account for temporary
investment of excess cash.
• For entities involved in cash sales (e.g. retail
companies, “cash” includes “credit card vouchers” and
electronic funds transfer at point-of-sales.)
• One risk of fraud that can happen when cash receipts
are not properly controlled is the “teeming and lading”
fraud (also known as lapping fraud)
27
Teeming and lading (UK) / Lapping (US)
• Teeming and lading is a situation where incoming
cash receipts from customers are misappropriated
(stolen) by an employee.
• This theft is then hidden by posting the customer’s
account as being paid at a later date using cash
receipts from other customers.
• The net result is that today’s receipts are stolen and
tomorrow’s receipts are posted to today’s
customers. This process must continue indefinitely
or until the funds are returned.
• “Teeming and lading” fraud can be prevented by the
entity through effective segregation of duties
relating to cash receipts.
28
This is how effective segregation of duties can make
“teeming & lading” fraud” difficult to be perpetuated
Compare cash deposited and accounting record
Cash deposited in
bank account$300
Cash received $500
8 Mar 03
Cash Book $300
Cash stolen $200
8 Mar 03
Bank deposit slip $300
Comparison will not identify the missing cash
The above can happen because cash recording & custody
are performed by the same person
Copyright 2003
Created by HAPS for Mr. Chee Hay Kheong
29
4
When cash recording is segregated from
custody of cash
Cash deposited in
bank account$300
Cash received $500 Cash stolen $200
8 Mar 03
Cash Book $500
Copyright 2003
8 Mar 03
Bank deposit slip $300
Comparison will identify the discrepancies
Created by HAPS for Mr. Chee Hay Kheong
5
30
Segregation of duties
• Cashier to handle the cash/cheques received
• Independent person to record receipts in the
accounting records
• Cash and cheques received should be deposited in
the bank account promptly, in the same day or within
the next day
• Bank deposit slips should be checked against total
receipts recorded in the accounting record
31
Internal controls relating to cash collected from cash sales
• Segregation of duties are very important  cashier to handle
cash receipts and not allowed to perform any recording to cash
sales
• Cash count  at end of each cashier shift of work, cash is counted
and tally with the amount in cash sales record (e.g. cash receipts
that are stored in the electronic point-of-sales system or cashier
machine  this is known as the “audit till roll”)
• Cash collected from cash sales (which is expected to be large, for
example, in a supermarket) should be deposited in the bank
promptly  to reduce the risk of cash being stolen or robbed
• Encourage customers to obtain receipts and observe cash register
totals.
• Cash kept in office premises should be locked in a safe.
• Other physical controls relating to cash collected from cash sales:
– Use Close Circuit TV (CCTV) to monitor cashier activities  to
prevent or detect cash misappropriation by cashier
– Deploy security guard or arm the alarm protection system
during off hours
32
Gaelic Inns v Patrick Lee PAC
•
Gaelic’s Inn former group finance manager devised and carried out a "teeming and lading"
scheme, whereby she delayed banking in cash on the day of sales into the company’s bank
account, and instead used the cash for her personal benefit. To make up for the resulting
shortfall, she would bank in an equivalent amount of cash subsequently collected from later
sales. The misappropriation of funds, roughly $1m in total, was not detected by the auditor
due to a failure to appreciate the significance of large sums of cash in the company’s accounts
and to inquire into a bank reconciliation statement which reflected a threefold increase of
cash not deposited amounting to $0.6m.
•
http://www.singaporelaw.sg/sglaw/laws-of-singapore/case-law/free-law/high-courtjudgments/13105-gaelic-inns-pte-ltd-v-patrick-lee-pac-2007-2-slr-146-2007-sghc-13
33
Gaelic Inns v Patrick Lee PAC
• Auditor was held liable for breach of duty based on the following;
• ‘when Phong (the audit manager) had seen the bank reconciliation statement
("BRS") for December 2003 ("the December 2003 BRS") indicating substantial
unlodged cash deposits of $672,253.94, he should have been put on inquiry.
Phong had reacted inadequately by merely waiting for the bank statement and
requesting that the respondent's employees provide information relating to the
subsequent clearance dates. Instead, Phong ought to have investigated the
irregularity immediately, and this would in turn have divulged a "pattern of
continuing and unabated increase in the amount of 'unlodged cash deposits'"
that would have led him to conclude that "something serious was amiss" .
• In failing to review the monthly BRSs throughout 2003, Phong had failed to
discharge his duty of care, thereby preventing the audit client from confronting
Ang earlier and avoiding the financial detriment which it suffered in 2004.
• ... Phong was aware from the previous audits that there would be cash sales
which [were] not deposited in the bank as at 31 December and he ought to have
informed Tow of the position so that a cash count of the "unlodged cash
deposits" could be carried out on 2 January 2004.
34
SSA240: Duty to detect fraud
• Who has the primary responsibility to detect fraud?
– SSA 240 para 4
• What is auditor’s responsibility towards fraud detection?
– Professional Scepticism
para 12-14
– Discussion among engagement team
para 15
– Risk assessment procedures & fraud risk factors para 16-24
– Responses to assessed RMM due to fraud
para 28-33
– If unable to continue the engagement
para 38
– Written representations
para 39
– Reporting of fraud
para 40-43
35
7.2 Petty Cash
• Small amounts of cash held for transactionary
purposes.
• Unless there are specific reasons, amounts are
unlikely to be material.
36
Internal controls relating to petty cash
• Use an imprest system to operate the petty cash
system
• Designate a person responsible for the custody of
petty cash
• Designate a person responsible for the approval of
petty cash usage
• Cash count
• Physical control over petty cash, e.g. kept in
locked drawer or safe
• Monitoring of petty cash expenses  not
expected to be significant
37
Audit procedures relating to “cash count”
• Auditor may attend cash count to observe
cash count conducted by the entity’s staff 
this is a test of control to see whether cash
count is carried out properly or not
• Auditor may perform cash count, typically at
year end, to verify the existence and amount
of cash on hand at balance sheet date, i.e.
substantive procedures
38
Audit Procedures on Petty Cash
• Perform analytical procedures on petty cash
expenditure (i.e. the usage of petty cash). If there
appears to be unusual items, fluctuations, further
investigation should be conducted.
• Obtain written representation from management on
the amount of petty cash balance on balance sheet
date.  This is commonly known as “petty cash
certificate”
• If petty cash balance is considered material, there are
unusual items, auditor may also conduct a “surprise”
physical cash count on balance sheet date.
39
Other Substantive Procedures
• Review for large and unusual cash movements
linked to
– Related parties
– Unusual parties
Borrowings
41
Borrowings: Controls
• Board of directors approval
• Monitoring of covenants
42
Borrowings: Audit Procedures
•
•
•
•
•
•
Examine documentation & agreement
Confirmation
Vouch borrowings & repayments
Computation of interest expense & payable
Test covenants
Examine disclosure of principal, interest &
security/pledges
• Split between current/non-current portions
43
44
SSA 550: Related parties
The existence of the following relationships may indicate the presence of control or
significant influence:
(a) Direct or indirect equity holdings or other financial interests in the
entity.
(b) The entity’s holdings of direct or indirect equity or other financial
interests in other entities.
(c) Being part of those charged with governance or key management
(that is, those members of management who have the authority
and responsibility for planning, directing and controlling the
activities of the entity).
(d) Being a close family member of any person referred to in
subparagraph (c).
(e) Having a significant business relationship with any person referred
to in subparagraph (c).
45
Who are related parties?
Family Relationships
• Spouse, siblings, parents, child, in-laws, cousins etc
Company relationships
• Parent / holding company, subsidiary
• Associates of the holding company
• Associates of the listed entity
46
47
48
Inherent Risks associated with related party
transactions (RPT)
The nature of related party relationships and transactions may, give
rise to higher RMM of the financial statements. For example:
• Related parties may operate through an extensive and complex
range of relationships and structures, with a corresponding
increase in the complexity of related party transactions.
• Information systems may be ineffective at identifying or
summarizing transactions and outstanding balances between an
entity and its related parties.
• Related party transactions may not be conducted under normal
market terms and conditions; for example, some related party
transactions may be conducted with no exchange of consideration.
49
Inherent Risks associated with related party
transactions (RPT)
• The circumstances or conditions of the entity that may indicate the
existence of related party relationships or transactions that
management has not identified or disclosed to the auditor ,e.g.:
- a complex organizational structure
- use of special-purpose entities for off-balance sheet transactions
- an inadequate information system.
•
The importance that management and those charged with
governance attach to the identification, appropriate accounting for,
and disclosure of related party relationships and transactions, and
the related risk of management override of relevant controls.
50
51
Role of External Auditor
External Auditors complement the role of the Board in
monitoring and curbing abusive RPTs.
SSA 550 – Auditing Standard – guide to auditing RPT
• Are they arms length transactions?
• Is the pricing right for both recurring and one – off
deals?
• What is the best method to identify RPTs?
• Are RPTs reported by the company complete?
• Are there missing transactions?
52
Audit Procedures
The auditor shall inquire of management regarding:
(a) The identity of the entity’s related parties, including changes from
the prior period;
(b) The nature of the relationships between the entity and these
related parties; and
(c) Whether the entity entered into any transactions with these
related parties during the period and, if so, the type and purpose
of the transactions.
53
Audit Procedures
The auditor shall inquire of management and others within the entity,
and perform other risk assessment procedures considered
appropriate, to obtain an understanding of the controls, if any, that
management has established to:
(a) Identify, account for, and disclose related party relationships and
transactions in accordance with the applicable financial reporting
framework;
(b) Authorize and approve significant transactions and arrangements
with related parties; and
(c) Authorize and approve significant transactions and arrangements
outside the normal course of business.
54
Audit Procedures
Matters that may be addressed in the discussion among the
engagement team include:
• The nature and extent of the entity’s relationships and transactions
with related parties (using, for example, the auditor’s record of
identified related parties updated after each audit).
• An emphasis on the importance of maintaining professional
skepticism throughout the audit regarding the potential for MM
associated with related party relationships and transactions.
• The records or documents that may indicate the existence of
related party relationships or transactions.
55
Audit Procedures
The auditor shall inspect the following for indications of the existence of
related party relationships or transactions that management has not
previously identified or disclosed to the auditor:
(a) Bank and legal confirmations obtained as part of the auditor’s
procedures;
(b) Minutes of meetings of shareholders and of those charged with
governance; and
(c) Such other records or documents as the auditor considers necessary in
the circumstances of the entity.
If such relationships or transactions are identified, the auditor shall inquire of
management about:
(a) The nature of these transactions; and
(b) Whether related parties could be involved.
56
Audit Procedures
If the auditor identifies related parties or significant related party transactions that
management has not previously identified or disclosed to the auditor, the auditor
shall:
(i)
(ii)
(iii)
(iv)
(v)
Request management to identify all transactions with the newly identified
related parties for the auditor’s further evaluation; and
Inquire as to why the entity’s controls over related party relationships and
transactions failed to enable the identification or disclosure of the related party
relationships or transactions;
Perform appropriate substantive audit procedures relating to such newly
identified related parties or significant related party transactions;
Reconsider the risk that other related parties or significant related party
transactions may exist that management has not previously identified or
disclosed to the auditor, and perform additional audit procedures as necessary;
and
If the non-disclosure by management appears intentional (and therefore
indicative of a risk of material misstatement due to fraud), evaluate the
implications for the audit.
57
Audit Procedures
For identified significant related party transactions outside the entity’s
normal course of business, the auditor shall:
(a) Inspect the underlying contracts or agreements, if any, and evaluate
whether:
(i) The business rationale (or lack thereof) of the transactions suggests
that they may have been entered into to engage in fraudulent
financial reporting or to conceal misappropriation of assets
(ii) The terms of the transactions are consistent with management’s
explanations; and
(iii) The transactions have been appropriately accounted for and disclosed
in accordance with the applicable financial reporting framework; and
(b) Obtain audit evidence that the transactions have been appropriately
authorized and approved.
58
Audit Procedures
Written Representations
The auditor shall obtain written representations from management
and, where appropriate, those charged with governance that:
(a) They have disclosed to the auditor the identity of the entity’s
related parties and all the related party relationships and
transactions of which they are aware; and
(b) They have appropriately accounted for and disclosed such
relationships and transactions in accordance with the
requirements of the framework.
59