Cash and Financial Investments
Slide 10-1
© The McGraw-Hill Companies, Inc., 2006
Key Internal Controls
Cash Receipts


Cash sales
 Involvement of 2 or more employees
 Cash Registers
 Electronic point of sale (POS) systems
Collections of receivables
 Initial listing of cash receipts (mailroom)
 Custody and prompt depositing of cash receipts
 Maintenance of customer account records
 Reconciliation of customer subledgers with control A/Cs
 Mailing monthly statements to customers
 Collection and follow-up past-due accounts
Slide 10-2
© The McGraw-Hill Companies, Inc., 2006
Most Likely Misstatements
Cash Receipts
Recording fictitious cash receipts
Not recording receipts from cash sales
Early (late) recognition of cash receipts
Not recording cash from collection of
accounts receivables
Slide 10-3
© The McGraw-Hill Companies, Inc., 2006
Lapping
Definition: Starts with embezzling customer payments
(usually by accounts receivable clerk) and then
concealing it by posting subsequent payments from other
customers on a continual overlapping basis to keep
individual accounts as current as possible.
Prevention: (1)Segregate payment from remittance
advice form or (2)making a record of the payments before
sending to accounts receivable clerk and comparing list to
daily deposit details.
Audit Detection: (1)confirmation of balance with
customers or (2)comparing accounts receivable subledger credits per day to daily deposit details.
Slide 10-4
© The McGraw-Hill Companies, Inc., 2006
Lapping
Date
Dec 1
Actual
Received
Cash
From
Received
Abbott
$750
Recorded as
Received
Cash
From
Received Theft
-0$750
Dec 1
Crane
1,035
Crane
$1,035
Dec 2
Barstow
750
Abbott
750
Dec 2
White
130
White
130
Dec 3
Crawford
1,575
Barstow
750
Dec 4
Miller
400
Miller
400
Slide 10-5
825
© The McGraw-Hill Companies, Inc., 2006
Key Internal Controls
Cash Disbursements

Segregation of duties

Payment by check or electronic funds transfer

Match of purchase order and receiving documents with
vendor’s invoice

Review of supporting documents by authorized check
signer

Cancel supporting documents

Authorized check signer should mail checks
Slide 10-6
© The McGraw-Hill Companies, Inc., 2006
Most Likely Misstatements
Cash Disbursements
Inaccurate recording of a purchase or
disbursement
Duplicate recording/payment of purchases
Unrecorded disbursements
Slide 10-7
© The McGraw-Hill Companies, Inc., 2006
Audit Objectives
Substantive Tests of Cash





Substantiate the Existence of recorded cash
Establish the Completeness of recorded cash
Determine that the client has Rights to
recorded cash
Establish the clerical accuracy of cash
schedules
Determine that the Presentation and
disclosure of cash
Which Assertion is missing?
Slide 10-8
© The McGraw-Hill Companies, Inc., 2006
Audit Objectives
Substantive Tests of Cash






Substantiate the Existence of recorded cash
Establish the Completeness of recorded cash
Determine that the client has Rights to recorded cash
Establish the clerical accuracy of cash schedules
Determine that the Presentation and disclosure of cash,
including restricted funds, are appropriate
Determine proper Valuation per GAAP
Slide 10-9
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests - Cash Balances

Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks

Consider reconciling bank activity(proof of cash)

Slide 10-10
© The McGraw-Hill Companies, Inc., 2006
Proof of Cash: Why Perform?
Reconciles bank account balance and activity
(cash in bank transactions) during a
specified period between client & bank
records.
Used to identify:
 Cash receipts & disbursements recorded in the
accounting records, but not on the bank statement.
 Cash deposits & disbursements recorded on the bank
statement, but not in the accounting records.
 Cash receipts and disbursements recorded at different
amounts by the bank than in the accounting records.
Slide 10-11
© The McGraw-Hill Companies, Inc., 2006
Proof of Cash (Transactions)



Start with what the bank statement shows as to
balances (beginning & ending), credits and
debits to A/C.
Then, we either add or subtract from these four
amounts to attempt to reconcile to GL
beginning and ending balances and deposits
and disbursements.
Most are timing differences (DIT, outstanding
checks at beg and end of period)or items not
recorded yet (bank charges).
Slide 10-12
© The McGraw-Hill Companies, Inc., 2006
Proof of Cash Worksheet
Reconciling
Items
Per Bank
Beg Deposits/ Checks/ Ending
Balance Receipts Disb. Balance
XXX
XXX
XXX
XXX
Beginning:
DITs
Outstanding Cks
Ending:
DITs
Outstanding Cks
Other
Per G/L
XXX
XXX
XXX
XXX
Substantive Tests - Cash Balances

Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks
Consider reconciling bank activity (proof of cash)

Obtain reconciliations of yearend bank balances


Slide 10-14
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests - Cash Balances

Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks
Consider reconciling bank activity (proof of cash)
Obtain reconciliations of yearend bank balances

Obtain bank cutoff statement



Slide 10-15
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests - Cash Balances

Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks
Consider reconciling bank activity (proof of cash)
Obtain reconciliations of yearend bank balances
Obtain bank cutoff statement

Count cash on hand, if significant




Slide 10-16
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests - Cash Balances

Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks
Consider reconciling bank activity (proof of cash)
Obtain reconciliations of yearend bank balances
Obtain bank cutoff statement
Count cash on hand, if significant

Verify the client’s cutoff of cash transactions





Slide 10-17
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests - Cash Balances








Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks
Consider reconciling bank activity (proof of cash)
Obtain reconciliations of yearend bank balances
Obtain bank cutoff statement
Count cash on hand, if significant
Verify the client’s cutoff of cash transactions
Analyze bank transfers occurring around
yearend
Slide 10-18
© The McGraw-Hill Companies, Inc., 2006
Kiting – 3 Types
1.Transferring funds between bank accounts,
but recording the increase (debit) in the
current FY and the decrease (credit) in the
next FY (funds on B.S. twice).
2.Depositing funds in current FY, but recording
the deposit in the next FY (to cover a cash
shortage or when bank balance < GL).
3.Taking advantage of float or bank check
clearance time to cover temporary cash
shortage or to earn interest on same funds
being transferred between bank accounts.
Slide 10-19
© The McGraw-Hill Companies, Inc., 2006
Schedule of Yearend Bank
Transfers to Detect Kiting
Check
Bank Account
From
To
Am't
101
Gen'l
Payroll $1,000
102
Gen'l
Branch
4
996
Branch
2
Gen'l
Slide 10-20
Date of
Date of
Disbursement
Receipt
Books Bank Books Bank
12/28
1/3
12/28
12/28
9,000
1/2
1/4
12/30
12/30
2,000
1/3
1/5
1/3
12/31
© The McGraw-Hill Companies, Inc., 2006
Schedule of Yearend Bank
Transfers to Detect Kiting
Check
Bank Account
From
To
Am't
101
Gen'l
Payroll $1,000
102
Gen'l
Branch
4
996
Branch
2
Gen'l
Slide 10-21
Date of
Date of
Disbursement
Receipt
Books Bank Books Bank
12/28
1/3
12/28
12/28
9,000
1/2
1/4
12/30
12/30
2,000
1/3
1/5
1/3
12/31
© The McGraw-Hill Companies, Inc., 2006
Schedule of Yearend Bank
Transfers to Detect Kiting
Check
Bank Account
From
To
Am't
101
Gen'l
Payroll $1,000
102
Gen'l
Branch
4
996
Branch
2
Gen'l
Slide 10-22
Date of
Date of
Disbursement
Receipt
Books Bank Books Bank
12/28
1/3
12/28
12/28
9,000
1/2
1/4
12/30
12/30
2,000
1/3
1/5
1/3
12/31
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests - Cash Balances








Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks
Obtain reconciliations of bank balances and consider
reconciling bank activity (proof of cash)
Obtain bank cutoff statement
Count cash on hand, if significant
Verify the client’s cutoff of cash transactions
Analyze bank transfers occurring around year-end
Investigate payments to/receipts from related
parties
Slide 10-23
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests - Cash Balances









Obtain analyses of cash balances and reconcile to GL
Send standard confirmation forms to banks
Obtain reconciliations of bank balances and consider
reconciling bank activity (proof of cash)
Obtain bank cutoff statement
Count cash on hand, if significant
Verify the client’s cutoff of cash transactions
Analyze bank transfers occurring around year-end
Investigate payments to related parties
Evaluate financial statement presentation and
disclosure
Slide 10-24
© The McGraw-Hill Companies, Inc., 2006
Key Internal Controls Over
Financial Investments

Separation of duties among employees
 Authorizing purchases and sales
 Having custody of the securities
 Maintaining records

Registration in the name of the company

Detailed records of all securities owned and the related
revenue from interest and dividends

Periodic physical inspection of securities

Determination of accounting for complex instruments by
competent personnel.
Slide 10-25
© The McGraw-Hill Companies, Inc., 2006
Most Likely Misstatements
Financial Investments
Fictitious investments in securities
Over Valued Securities
Double Counting
Unauthorized security transactions
Incorrect Classification or Accounting
Inadequate disclosure of the nature of
investment activities
Slide 10-26
© The McGraw-Hill Companies, Inc., 2006
Audit Objectives
Financial Investments






Determine the Existence of recorded financial
investments and that the client has rights to the
investments.
Establish the Completeness of recorded investments.
Determine any Rights restrictions.
Determine that the Valuation of investments is in
accordance with GAAP.
Establish the clerical accuracy of schedules of
investments.
Determine that the Presentation and disclosure of
investments are appropriate.
Slide 10-27
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests
Financial Investments











Obtain an analysis of securities/related accounts; reconcile to ledger.
Review Bd of Dir Minutes (Maybe the Investment Committee).
Inspect securities on hand.
Confirm securities and derivative instruments held by others.
Vouch selected securities transactions.
Verify the client’s cutoff of investment transactions.
Perform analytical procedures.
Compute revenue from investments.
Determine market or estimated values.
Evaluate method of accounting.
Inspect management’s documentation of intent to classify derivative
transactions as hedges.
Slide 10-28
© The McGraw-Hill Companies, Inc., 2006
Derivatives - Risks

May present the client with a high degree of
business risk (e.g., risk of losses).

May involve complex accounting and valuation
methods (i.e., estimating fair values).

Rules for maintaining and acquiring a
derivative as a hedge are complex.

May be difficult to identify (May be acquired
without an outlay of assets until a future date).

Several SFASs from FASB.
Slide 10-29
© The McGraw-Hill Companies, Inc., 2006
Auditing Fair Values (Estimates)
Inputs for Applying Valuation Techniques
(FAS 157)
Level 1 – Observable quoted prices in active markets for
identical assets or liabilities
Example: A closing stock price in WSJ.
Level 2 – Observable quoted prices, generally for similar
assets or liabilities in active markets
Example: Company discounts future cash flows on its not
publicly traded debt securities at rate used by market for
publicly traded debt securities.
Level 3 – Unobservable for the assets or liabilities
Example: A private company uses judgment to determine a
proper rate to discount the future cash flows of its not publicly
traded securities.
Slide 10-30
© The McGraw-Hill Companies, Inc., 2006
Substantive Tests
Financial Investments












Obtain an analysis of securities/related accounts and reconcile to ledger.
Review Bd of Dir Minutes (Maybe the Investment Committee).
Inspect securities on hand.
Confirm securities and derivative instruments held by others.
Vouch selected securities transactions.
Verify the client’s cutoff of investment transactions.
Perform analytical procedures.
Compute revenue from investments.
Determine market or estimated values.
Evaluate method of accounting.
Inspect management’s documentation of intent to classify derivative
transactions as hedges.
Evaluate the financial statement presentation
and disclosure.
Slide 10-31
© The McGraw-Hill Companies, Inc., 2006