Auditing the cash-received system and bank account
Auditing the cash-received system
This stage concludes the audit of the debtors' ledger, in which debtors settle their
accounts and in which they may receive cash discount in the process. This stage of the
audit also includes other sales systems, such as cash sales, in which the money is paid
into the bank, using the same principles.
Audit evidence will be sought for the completeness, accuracy and validity of amounts
received and recorded. The audit will be 'planned, controlled, and recorded' on the
basis of the Auditing Guideline, and the 'accounting system' and 'internal control' will
be tested to ensure that the asset 'cash' is safe and is properly recorded. Finally a
'review of financial statements' will conclude whether the audit evidence on cash
leads to an unqualified audit opinion.
Internal Control Questionnaire (ICQ)
1. Can cash or checks received through the post be lost?
The criteria are as follows:
a. Mail received in a locked mailbox.
b. Opening of a mail is supervised by a responsible official.
c. All checks and postal orders are to be restrictively endorsed 'not negotiable'.
d. People who open the mail must have no other duties as cashier or recording
in ledgers.
e. Remittances must be banked intact daily, and the checks, and postal orders
must be date stamped as proof of the time of paying in.
f. Renumbered receipts may be made out by the cashier and sent to all the
people who request receipts.
g. The cashier enters in the cash book amounts received and banked and any
related discounts allowed.
h. Discounts allowed should be officially authorized.
i. Regular bank reconciliation should be made to prove that amounts received
have been cleared through the bank.
2. Can remittances received from counter sales be stolen or not recorded?
The criteria are as follows:
a. Salespersons have renumbered sales invoices, of which one copy is to
remain as evidence in the sales invoice book, and the amount recorded on it is to be
listed in the salesperson's abstract.
b. The customer's copy is to be marked 'Paid' and a further copy is to be kept
by the cash till operator when the customer has paid.
c. The goods sold are to be released by the salesperson on evidence of the paid
invoice.
d. The supervisor should reconcile amounts paid into the bank intact daily
with the cashbook and bank statement figures.
3. Can remittances collected by traveling salespersons be lost or not recorded?
The criteria are as follows:
a. Stock should be issued to the traveler by an independent person, who
records the quantity issued. On the traveler's return, the stock unsold should be
counted and the quantity sold determined.
b. The quantity of stock sold multiplied by the selling price must be agreed to
the sales abstract of the traveler.
c. The sales abstract of the traveler must be agreed to the sales on credit and
the cash sales slips.
d. The main cashier must daily reconcile cash banked by the traveler.
e. Amounts paid into the bank must be agreed by the sales department with
cash collected in respect of cash sales. The cashier should issue official receipts in
respect of cash collected as proof of receipts.
f. Expenses incurred by the traveler must be supported by vouchers, which
must be authorized by the sales manager.
g. The debtors' ledger will record sales on credit and amounts paid by debtors.
4. Can cash floats be subject to manipulation?
The criteria are as follows:
a. The cash held by a petty cashier should be a fixed float.
b. A cash check is signed by a director and entered by the cashier in the
payments cashbook. The petty cashier enters the amount in the petty cash book as a
receipt.
c. All expense vouchers are authorized by departmental heads and are limited
to agreed amounts.
d. The amounts expended are recorded in the petty cash book payments.
e. When the cash balance needs to be increased to its level, the cashier agrees
the petty cash book balance with the petty cash left.
a. The expenditure is analyzed and recorded in the ledger.
Auditing the bank account
The auditor should seek audit evidence relating to his client's dealing with the bank,
which will provide him/her with sufficient, relevant and reliable audit evidence to
draw reasonable conclusions there from. This will include ascertaining whether the
balance of cash at the bank or the overdraft is correct, and will also disclose other
dealings with the bank. The system of internal control over bank transactions must be
tested for reliability.
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Internal Control Questionnaire (ICQ)
Key internal control evaluation questions:
1. Can checks, which are not authorized, be paid?
2. Can payments be made for goods or services whose benefits have not been
received?
3. Can payments be made but not recorded?
4. Can amounts be received but not banked?
5. Can amounts be received but not recorded?
6. Can direct debits and credits from the bank statement go unrecorded in the
cashbook?
7. Can other transactions with the bank go unrecorded?
Ownership and existence of bank transactions:
The procedure is as follows:
a. The standard letter should be sent to the client 's banks by the auditor on his
own notepaper.
b. The client must give his authority to the banks to disclose information to the
auditor.
c. The letter should reach the banks two weeks before the financial year-end.
d. The auditor must ensure the banks have answered all questions in full.
Auditing the stock and work in progress cycle
The auditor should obtain sufficient relevant and reliable audit evidence to enable him
to draw reasonable conclusions there from.
The auditor should ascertain and record the system of accounting and internal control.
Internal Control Features
a. A raw material store control account and a finished goods store control
account should deal with the balances on the bin cards and should be agreed finally to
the physical stock in the warehouse, under what is called a continuous stocktaking
system, which represents sound internal control.
b. The separate centers at which goods are held, should be safeguarded from
theft and damage
c. Stocks should be controlled by the warehouse through recording movements
on bin cards
d. Receipts of goods should be independently recorded on goods received
notes. Issues to production of raw materials should be recorded on material requisition
notes, which should be authorized by the factory manager. Transfers from production
of finished goods should be made on the basis of signed finished goods, transfer notes
authorized by the factory manager. Sales of goods involve transfer of goods from
finished goods store to the customer on the basis of an authorized delivery note. All
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movements of goods should be based on authorized documents, which are
renumbered for control.
e. Regular reviews of damaged stock will allow them to be written down to
reflect their disposal value.
f. Work-in-progress should be recorded in the cost records, using actual or
standard costs, and should be valued at prime cost plus factory overheads.
Internal control questionnaire (ICQ)
1.What methods of recording are used for:
a. raw materials,
b. work-in-progress,
c. finished goods?
Y/N
2. Is the issue of raw materials authorized?
Y/N 3. Are finished goods transfers from production made on authorized finished
goods transfer notes?
4. How is the cost of sales calculated for the sale of finished goods?
Y/N
5. If standard costs are used, are the variances clearly identifiable?
Y/N 6. If standard costs are used to value stock and work-in-progress, are the
standard costs close to actual costs?
Y/N 7. Are continuous stocktaking systems in operation acting as a basis for
determining the physical accuracy of stock?
If the answer to above is 'no', then it means that there is a problem in frequency of
taking stock.
Preliminary evaluation of internal control
1. Can stock be lost or stolen?
The criteria are as follows:
a. There should be proper systems for purchasing raw materials and matching
goods received notes with purchase invoices.
b. Transfers of raw materials to production should be on authorized material
requisition notes signed by the works manager.
c. Transfers of finished goods from work in progress to finished goods stores
must be on signed finished goods transfer notes authorized by the works foreman.
d. Continuous stocktaking should take place, with stores control accounts
independently controlling bin cards and physical stocks, and stocks should be counted
at regular intervals during the year.
e. Delivery of goods to customers should be authorized on signed delivery
notes by the sales department and not the warehouse.
2. Can work in progress be incorrectly stated?
The criteria are as follows?
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a. Work-in-progress is based on prime cost; recorded from material
requisitions, labor sheets and other documents for direct expenses. Factory overheads
are recovered on the basis of normal levels of activity, taking one year with another.
b. Physical work in progress is checked regularly against the recording thereof
in the cost records.
c. The cost system should be integrated with the financial records.
d. Cost variances should be considered while valuing work-in-progress, which
should be based as close to actual cost as possible if normally accounted for, using
standard costs.
e. Standard costs should be regularly reviewed to see if they are at realistic
levels.
On the basis of the preliminary evaluation the auditor will plan the main compliance
and substantive tests. Extended substantive tests will be done in weak areas of internal
control.
Stock and work-in-progress are shown under current assets as follows:
a. raw materials and consumables;
b. work-in-progress;
c. finished goods;
d. payments on account.
Valuation of stock and work-in-progress:
Cost of stock and work-in-progress consists of all costs incurred in bringing the
product to its present location and condition.
A company may adopt any of the following methods:
a. First-in, first out (FIFO);
b. Last-in, first out (LIFO);
c. Weighted average price;
d. Any similar method.
LIFO is not accepted by: Where replacement cost is used instead of actual cost, and if
stocks are slow-moving, there may be a material difference between the two bases.
Auditing fixed assets
The auditor will look first at the nature of the enterprise being audited, including the
investment in fixed assets and whether this capitalization is sufficient to sustain the
enterprise as a going concern. The auditor will also determine the age, condition and
relevance of the fixed assets, and whether the depreciation policy is appropriate to
their condition.
The auditor will plan, control and record the fixed asset audit in the audit working
papers.
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The auditor will ascertain and record the system of accounting and internal control, as
follows:
Accounting
a. Nominal ledger. This ledger will contain the asset account and the related
depreciation account, together with other accounts for repairs, renewals, and
government grants receivable.
b. Depreciation register. The nominal ledger provides brief financial details of
the asset. The asset register expands the information relating to the asset: it says
where the asset is situated in the factory area, and restates the nominal ledger
reference.
The asset register will also specify what the asset does, detail its condition (e.g. how
much has been spent on repairs), and record the board of directors' minute authorizing
the acquisition or disposal of the asset.
Internal control
The separation of duties between assets, their recording in the nominal ledger and in
asset registers, and the authorization to buy and sell fixed assets, should be part of the
system of management internal control. Other aspects of internal control are:
a. Application to purchase fixed assets to be supported by discounted cash
flow submissions for net present value evaluation and return on capital employed, and
authorization by the board of directors.
b. Disposal of major fixed assets is to be agreed by the board of directors.
c. Depreciation should be kept for all major fixed assets as the physical control
over fixed assets.
d. Part of the custody procedures (safeguarding the asset) relates to their
physical protection through adequate fire precautions, physical protection, and
adequate insurance.
e. Depreciation rates should be authorized by the board of directors, who will
select an appropriate basis for writing down the asset in accordance with Accounting
standards.
f. Regular physical inspection of fixed assets should be made, and checked
against the depreciation register and accounting records in the nominal ledger.
Evaluation
The auditor will then evaluate the strength of internal control over the fixed assets by
asking key internal control questions, an internal control evaluation questionnaire:
a. Can fixed assets be stolen or misused?
b. Can fixed assets be lost and under-insured?
c. Can depreciation policies be inadequate, so that assets are over-started?
d. Can government grants be overlooked?
e. Can fixed assets be acquired or disposed of without proper authority?
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Main testing
The auditor should replan the audit on the basis of his findings at the evaluation stage
of the audit. Weak systems require extended substantive testing. Positive systems of
internal control require limited compliance and substantive testing. After the main
tests are carried out, the auditor will compare the balances in the underlying records in
respect of fixed assets with the balances on the financial statements.
Verification of Intangible Assets
Patents
The auditor must ensure the renewal fee is paid. He/she must also determine whether
the client is the owner of the patent and whether rights in it have been assigned. The
auditor must determine that the value of the patent in the balance sheet is worth a
realistic actual value, and will need to take specialist advice on this point. The
verification of patents is as follows:
a. Presentation in the balance sheet: Patents will appear under intangible fixed
assets.
b. Recording and internal control.
c. Ownership, valuation and existence.
Trademarks
The verification of trademarks is as follows:
a. Presentation in the balance sheet: Trademarks will appear under intangible
fixed assets.
b. Recording and internal control.
c. Ownership, valuation and existence.
Goodwill
The verification of goodwill is as follows:
a. Presentation in the balance sheet: Goodwill will appear under intangible
fixed assets.
b. Recording and internal control.
c. Ownership, valuation and existence.
There are a number of factors, which may be relevant in a determination of the useful
economic life of purchased goodwill. These factors should be assessed at the time the
acquisition is made and include:
a. Expected changes in products, markets and technology;
b. Expected period of future service of key employees;
c. Expected future demand, competition or other economic factors, which
might affect current trading advantages.
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Copyrights
The verification of copyright is as follows:
a. Presentation in the balance sheet: Copyrights will under intangible fixed
assets.
b. Recording and internal control.
c. Ownership, valuation and existence.
Verification of Tangible Fixed Assets
Land and buildings
The auditor should examine the title deeds to the property. The auditor must check
whether the property is mortgaged, and to whom and for how much. This information
should be confirmed in writing with the lender. The auditor will check that the
mortgage is recorded at the Land Registry Office if the property is registered.
Plant and machinery, furniture and fixtures, and motor vehicles
Disclose details of these assets in the fixed assets schedule as cost or valuation less
accumulated depreciation.
Assets registers are useful controls for the auditor to determine the location of the
asset for purposes of physical inspection.
Investment
The auditor will inspect the investment register and reconcile it to the investment
held, represented in the main by share certificates, and to the figures in the nominal
ledger.
The auditor should confirm that these figures agree to the investments shown in the
movements of fixed assets schedule supporting the balance sheet. The auditor will
review internal control again to ensure it has not weakened.
The auditor should inspect these or write to third parties who hold them as security or
safekeeping, for confirmation of their existence.
Auditing Share Capital
The auditor will engage on a system-based audit in order to seek evidence that the
share capital of the company is true and fair.
The final audit, presentation in the balance sheet:
a. It is a required the following to be stated:
1. The authorized share capital;
2. Where more than one class of share has been allotted, the number
and nominal value of each class of share allotted.
b. In respect of redeemable shares:
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1. The earliest and latest dates on which the company has power to
redeem those shares;
2. Whether they must be redeemed in any event or are liable to be
redeemed at the option of the company.
c. Where the company has allotted any shares during the financial year?
1. The reason for the allotment;
2. The classes of shares allotted;
3. For each class of shares, the number allotted, their aggregate
nominal value, and the consideration received by the company.
d. Where there is an option to subscribe for shares and any other right to
require shares to be allotted to any person:
1. The number, description and amount of shares;
2. The period during which the right is exercisable;
3. The price to be paid for the shares allotted.
The auditor will review the recording of transactions in relation to the issue of shares
and will carry out substantive tests. The separation of duties within the system of
internal control will be established and the auditor will ensure there is proper
management supervision. The following checks should be carried out:
a. The cash received on application will be checked in:
1. The application;
2. The application and allotment sheets;
3. The application cashbook and bank statement.
b. The cash returned if application fails must be checked from the payments
application cashbook to the application and allotment sheets.
c. Shares allotted should be checked in:
1. The application and allotment sheets;
2. The cash received in the allotment cashbook;
3. The share register;
4. The directors' minute book, where allotments have been stated;
5. The allotment bank statements.
d. Calls on shares should be checked in the calls cashbook, bank statement,
share register and directors' minutes.
e. The balances on the share register should be checked in the balance sheet
share capital figure for issued and authorized share capital.
f. The auditor should ensure that the issue is within the limits of the articles of
association.
g. Permission to deal must be allowed by the Stock Exchange and SPK.
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Debentures
A debenture is a written acknowledgement by a company, usually under seal, of a
loan made to it, and contains provisions as to payment of interest and repayment of
capital. The system-based audit will be planned in order to check that the following
has been complied with:
a. The liability for the debenture has been properly recorded in the balance
sheet,
b. The client has complied with debenture trust deeds in respect of the issue
and redemption of the debenture, the payment of interest, and the maintenance of
security required in respect of the loan.
The Final Audit
a. Where debentures have been issued in the year:
1. The reason for the issue;
2. Class of debentures issued;
3. For each class, the amount issued and the consideration received.
b. Where debentures have been redeemed in the year:
1. Redemptions of debentures in the year reconcile the opening and
closing balance on debentures.
2. The terms of repayment and the rates of interest payable.
3. Particulars of redeemed debentures, which can be reissued.
4. The amount of discount allowed on any issue of debentures in so far
as not written off.
a. Details of interest paid and accrued.
Computer Auditing
The program
In a computer system the program simulates the working of the human brain, being a
copy of the logical thought processes that humans want simulated. This process is
known as the study of cybernetics.
A symbolic language, known as the source program is converted, by means of
computer software called the compiler or assembler, into a machine language which is
in the form of an object program. This program controls the working of the Central
Processing Unit (CPU), which calculates and stores data as part of the computer
processing.
The source program in Stage 1 produces the object program, and this is used in Stage
2 for processing, either by means of an off-line system or an on-line system. The input
in Stage 2 in an off-line system must first be converted from paper source documents
into machine sensible form, e.g. paper tape, or magnetic tape. The tape is processed
by the object program, as the tape represents the input of data into the system. The
input in Stage 2 in an on-line system is automatically converted by the program to a
machine-sensible form that the object program will process. The input of source
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documents is through a terminal, and the operator has to make a series of key
depressions to achieve the input.
Computer model
Stage 1: Program conversion
(a) Source program
(b) Compiler/assembler
(c) Object program
Stage 2: Off-line systems
(a) Input source
(b) Convert documents
(c) Object program documents into tape for input (paper form) to computer
(d) Output
Stage 2: On-line processing system
(a) Input source
(b) Program converts
(c) Object program documents via input to machine computer terminal
sensible form immediately
(d) Output
Master Files
In a manual system of bookkeeping, the data are recorded in the ledger accounts. In a
computerized system the equivalent of the ledger is the master file, which may be in
the form of magnetic tape.
The essential computer hardware necessary for processing is the Central Processing
Unit and the essential computer software consisting of the computer program, the
master files and other computer records on disc or tape. The auditor will be concerned
with what transpires in these areas in order to produce financial information that is
complete, accurate and valid.
Audit Evidence in Management Reports and Data Files
Computer processing of the revenue and cash receipts transactions enables
management to generate several reports that can provide important audit evidence.
These would include:
I. Pending Order Master File: Contains sales transactions started but not
completed.
II. Credit Check Files: Files for automatic credit checks of customers.
III. Price List Master File: Files of prices for automatic pricing of customer
invoices.
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IV. Sales Detail (Sale Journal) File: Contains detailed sales entries.
V. Sales Analysis Reports: Various sales analysis, for example, by product line or
region.
VI. Accounts Receivable Aged Trial Balance: List of balances owed by
customers, including aging information.
VII. Cash Receipts Journal: Detail entries for cash deposits and credits to various
accounts.
Besides, computer processing of acquisition and payment transactions enables
management to generate several reports that can provide important audit evidence.
These include:
(1) Open Purchase Orders: Contains purchase orders for goods ordered but not yet
received.
(2) Unmatched Receiving Reports: Reports for goods received for which the vendor
invoice has not yet been received or matched.
(3) Unmatched Vendor Invoices: Invoices received for goods not yet received or
matched.
(4) Accounts Payable Trial Balance: A list of balances owed to specific vendors.
(5) Purchase Journal: A detailed list of all purchases for the period.
(6) Inventory Reports (Trial Balance): A detailed list of all inventory items.
(7) Fixed Asset Reports: A detailed list of all fixed assets.
(8) Cash Disbursements Report: A detailed list of all cash disbursements (cash
disbursements journal).
In addition, a computerized production accounting system produces timely reports to
supervise and control production. They can be used as supporting evidence for
assertions. These include:
(1) Sales Forecasts: Provides the basis for management planning.
(2) Production Plans and Reports: Production plans, based on sales forecasts.
(3) Depreciation Schedule: A detailed schedule of depreciation on fixed assets,
prepared by cost accounting.
Advantages of computerization
The computer:
(i) is program-controlled to carry out routines automatically and quickly;
(ii) provides management information, which is up to date for purposes of
decision-making;
(iii) produces exception reports on which management can act and take
remedial action speedily;
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(iv) will handle large volumes of data in any way that the user decides through
programming the computer;
(v) might reduce departmental staff.
Disadvantages of computerization
The disadvantages of using a computer include:
(i) the danger of using incorrect programs, which provide unreliable
information;
(ii) the danger that programs can be tampered with to create fraudulent
situations or corrupted information;
(iii) the danger that hardware might fail, with no back-up facility available, or
that software might fail, with a loss of information, especially if no master files were
kept;
(iv) failure by the system to cope with growing volumes of data, and difficulty
expanding the system through lack of finance, time or other constraint;
(v) the lack of trained computer staff or user staff, with the result that the
operation of the system is not understood;
(vi) the fact that all processing is “invisible”, as it is on magnetic medium, and
can only be seen if printed out,
(vii) the danger of over-writing a “live” tape, hence losing information.
Controlling small computers
A small business can be seriously affected by poor control procedures, which could
lead to lost orders, incorrect invoicing, failure to keep track of debtors and creditors
opportunities for fraud. There may even be a failure to keep proper accounting
records, as required by the Ministry of Finance.
(i) Control in small computer systems requires consideration of:
1) Practical limitations resulting from the resources available;
2) Technical constraints imposed by the hardware and software;
3) Opportunities resulting from the availability of telecommunications
software and networks, giving access to additional sources of relevant information;
4) The risks to the business, including legal risks, arising from failure to
control and manage information;
5) The need for proper controls is also one of the data protection principles.
(ii) The statement (controlling small computer systems) identifies seven aspects of
control, which should be considered:
1) Completeness and accuracy of data;
2) File storage and back up;
3) Documentation of procedures;
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4) Security of computers and data;
5) Maintenance;
6) Insurance;
7) Contingency planning for alternative processing.
Audit of Computer Systems
The use of a computer for processing accounting information does not change the
basic concepts of auditing. The auditor must still check input from the user
department (sales department generates sales invoices for processing), through to
processing of the data by computer.
General controls
Controls, other than application controls, which relate to the environment within,
which computer-based accounting systems are developed, maintained and operated,
and which are therefore applicable to all the operations, is called general controls. The
objectives of general controls are to ensure the proper development and
implementation of applications, and the integrity of the program and data files and
computer operations. General controls may be either manual or programmed.
The Systems-Based Audit
The systems-based audit approach results in the following stages:
1) Plan the audit, including the computer audit.
2) Ascertain and record the systems, using narrative, internal control questionnaires,
internal auditors’ working papers, computer organization flowcharts, and information
obtained from examinations, interviews, discussions, and observations.
3) Walk through the system to confirm that is does operate,
4) Evaluate the system by means of internal control evaluation questionnaire, in order
to determine if there are any key areas of weakness in internal control.
5) The main tests will include tests on:
(i) Internal control within the computer system;
(ii) Recording, which includes tapes, discs, punched cards, printouts, and
control records (kept on the master file, which is the computer equivalent of manual
ledger accounts);
(iii) Accounting, which is the output derived from information in the records.
Tests will include limited compliance and substantive tests relative to testing
computer systems.
6) Compare the underlying computerized records with the information on the
financial statements, and verify the financial statements.
7) Review the financial statements for a true and fair view, and report to the members.
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The systems-based audit approach should be used as the standard approach to all
audits, as it represents best practice by applying the Auditing Standards and Auditing
Guidelines.
Controls over an on-line system
A computerized accounting application will have two aspects that the auditor will
now need to consider. There is still the audit of the manual side of the transaction,
which will have manual controls to check; the auditor will want to ensure all input
from the user is controlled to see that it is complete, accurate and valid. Then there are
the computer control procedures, which are program controlled and are found during
the edit run on data input as well as during normal update processing by the computer.
The controls over the on-line system include the following:
(a) The computer can be programmed so that only operators with authorized
passwords can gain access to specific master files and programs,
(b) In order to further protect the programs and master files, there should be
restricted access to the terminal for authorized people only,
(c) Passwords should be the subject of regular change,
(d) All unauthorized attempts to use the computer or actual use of the
computer by unauthorized people should be recorded on a security disc or tape,
(e) Any terminal, which has been activated should be automatically cut off if
not used after a given period.
Methods of testing
Computer-assisted audit techniques include a variety of methods.
Test packs
In this compliance test of the program, test data is processed, using the client’s
operational computer programs in conjunction with copies of the master files.
Computer audit programs
These computer programs are used by the auditor to read files and to extract specific
information for audit purposes, and to carry out audit work on the contents of the
files.
Utility programs
Manufacturers produce the utility programs, and they copy data from disc to tape or
sort files into sequence.
Integrated audit monitors
This technique uses the facilities of the computer to check transactions, which have
been signalled to be of audit interest as they are processed.
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Tracing
Tracing uses embedded audit routines to test that a programmed control is working or
that the program itself is operating correctly.
Mapping
Mapping is provided by a specialist hardware, which checks the operation of the
computer program and identifies unauthorized program operation.
Parallel simulation
This is a compliance test in which the auditor compares the output of data passing
through his control copy of the computer program against the output of the
operational program in use.
Program code comparison
A special computer program compares the source program coding currently in use
against the auditor’s control copy of the source program.
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