Auditing
A Risk-Based Approach To Conducting A Quality Audit
10th edition
Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg
CHAPTER 10
AUDITING CASH AND
MARKETABLE SECURITIES
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
Identify the significant accounts, disclosures, and
relevant assertions in auditing cash accounts
Identify and assess inherent risks of material
misstatement in cash accounts
Identify and assess fraud risks of material misstatement
in cash accounts
Identify and assess control risks of material
misstatement in cash accounts
Describe how to use planning analytical procedures to
identify possible material misstatements for cash
accounts, disclosures, and assertions
10-2
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVES
6.
7.
8.
9.
Determine appropriate responses to identified risks of
material misstatement for cash accounts, disclosures, and
assertions
Determine appropriate tests of controls and consider the
results of tests of controls for cash accounts, disclosures,
and assertions
Determine and apply sufficient appropriate substantive
audit procedures for testing cash accounts, disclosures,
and assertions
Identify types of marketable securities, articulate the risks
and controls typically associated with these accounts, and
outline an audit approach for testing these accounts 10-3
Copyright © 2016 South-Western/Cengage Learning
THE AUDIT OPINION FORMULATION
PROCESS
10-4
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LEARNING OBJECTIVE 1
IDENTIFY THE SIGNIFICANT ACCOUNTS,
DISCLOSURES, AND RELEVANT ASSERTIONS IN
AUDITING CASH ACCOUNTS
MAJOR TYPES OF CASH ACCOUNTS
• General checking accounts
• Cash management accounts
• Imprest payroll accounts
• Petty cash accounts
• Marketable security accounts: A security that is
readily marketable and held by a company as an
investment
10-6
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CASH MANAGEMENT TECHNIQUES
Lockboxes
Electronic
Funds Transfers
Cash
Management
Agreements
with Financial
Institutions
Compensating
Balances
10-7
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RELEVANT FINANCIAL STATEMENT
ASSERTIONS RELEVANT TO CASH
Existence or occurrence
• Cash balances exist at balance sheet date
Completeness
• Cash balances include all cash transactions that occurred during the period
Rights and obligations
• Company has title to the cash accounts as of balance sheet date
Valuation or allocation
• Recorded balances reflect true underlying economic value of those assets
Presentation and disclosure
• Cash is properly classified on the balance sheet and disclosed in notes to the
financial statements
10-8
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 2
IDENTIFY AND ASSESS INHERENT RISKS OF
MATERIAL MISSTATEMENT IN CASH ACCOUNTS
REASONS FOR IDENTIFYING CASH AS
HAVING HIGH INHERENT RISK
Volume of activity
Liquidity
Automated systems
Importance in meeting debt covenants
Can be easily manipulated
10-10
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 3
IDENTIFY AND ASSESS FRAUD RISKS OF
MATERIAL MISSTATEMENT IN CASH ACCOUNTS
FRAUD TOPICS TO BE COVERED IN A
BRAINSTORMING SESSION
Incentives
Opportunities
Rationalization
10-12
Copyright © 2016 South-Western/Cengage Learning
FOCUS ON FRAUD - COMMON FRAUD
SCHEMES RELATING TO CASH
• Lapping: Employee steals a payment from one
customer, and covers it up by using payments from
another customer to disguise the theft
• Skimming: Type of fraud that occurs when an
employee makes a sale but does not record it, and
steals the cash
10-13
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 4
IDENTIFY AND ASSESS CONTROL RISKS OF
MATERIAL MISSTATEMENT IN CASH ACCOUNTS
COMMON CONTROLS OVER CASH
Segregation of duties
Restrictive endorsements of customer checks
Independent bank reconciliations by employees who do not handle cash
Computerized control totals and edit tests
Authorization of transactions
Prenumbered cash receipt documents
Turnaround documents
Periodic internal audits
Competent, well-trained employees
10-15
Copyright © 2016 South-Western/Cengage Learning
WEAK CONTROLS
• Implications for the existence assertion
• See Focus on Fraud “The Parmalat Fraud and its Many
Victims”
• Implications for the completeness assertion
• Employee required to record a cash receipt
• Not performing the task
• Not reflecting the cash being received, a sale made, or
reduced accounts receivable
• See Focus on Fraud “Skimming and the Completeness
Assertion”
10-16
Copyright © 2016 South-Western/Cengage Learning
COMMON CONTROLS
Petty Cash
Cash Management Techniques
• Limiting access with a locked
• Lockboxes
box and restricting employees
• Electronic Funds Transfers
who have access
• Cash Management
• Requiring receipts for all petty
Agreements
cash disbursements
• Reconciling the petty cash fund
before replenishing it
• Keeping customer receipts
separate from petty cash funds
• Having internal audit conduct
periodic surprise audits of petty
cash
Copyright © 2016 South-Western/Cengage Learning
10-17
DOCUMENTING CONTROLS
• Documenting auditor’s understanding of internal
controls for:
• Integrated audits
• Financial statement only audits
• A questionnaire often used to guide auditors in
documenting understanding of internal controls
10-18
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 5
DESCRIBE HOW TO USE PLANNING ANALYTICAL
PROCEDURES TO IDENTIFY POSSIBLE MATERIAL
MISSTATEMENTS FOR CASH ACCOUNTS,
DISCLOSURES, AND ASSERTIONS
PERFORMING PLANNING ANALYTICAL
PROCEDURES
• Helps identify areas of potential misstatements when
planning the audit
• Cash is examined in relation to:
• Operational data
• Budgetary forecasts
• Requires awareness of importance of cash balances
to debt covenants
• Review Exhibit 10.4 for relevant trend analyses to use
10-20
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PERFORMING PLANNING ANALYTICAL
PROCEDURES
• Relationships indicating heightened risk of fraud in
cash:
• Consistent profits over several years, but cash flows
are declining
• Unexpected reductions in accounts receivable
collections, or timeliness of collections
• Unexpected declines in petty cash account
10-21
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 6
DETERMINE APPROPRIATE RESPONSES TO
IDENTIFIED RISKS OF MATERIAL MISSTATEMENT FOR
CASH ACCOUNTS, DISCLOSURES, AND ASSERTIONS
RESPONDING TO IDENTIFIED RISKS OF
MATERIAL MISSTATEMENT
• Audit procedures are proportional to assessed risks
• Areas of higher risk receive more audit attention and
effort
• Developing audit approach that contains:
• Tests of controls (if applicable)
• Substantive procedures, including analytical
procedures
• Audit programs are customized based on assessment
of risk of material misstatement
10-23
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 7
DETERMINE APPROPRIATE TESTS OF CONTROLS AND
CONSIDER THE RESULTS OF TESTS OF CONTROLS FOR
CASH ACCOUNTS, DISCLOSURES, AND ASSERTIONS
SELECTING CONTROLS TO TEST AND
PERFORMING TESTS OF CONTROLS
• Tests controls that are important to the auditor’s
conclusion about whether the organization’s controls
adequately address the risk of material misstatement
• Typical tests of controls
• Inquiry of personnel performing the control
• Observation of control being performed
• Inspection of documentation confirming that control
has been performed
• Reperformance of control by individual testing the
control
10-25
Copyright © 2016 South-Western/Cengage Learning
CONSIDERING THE RESULTS OF TESTS
OF CONTROLS
Control deficiencies identified
No control deficiencies identified
Assessing those deficiencies to
determine their severity
Determining that preliminary
assessment of control risk as low
is appropriate
Modifying preliminary control risk
assessment
Determining the extent that
controls can provide evidence
on correctness of account
balances
Documenting implications of
control deficiencies
Determining planned substantive
audit procedures
10-26
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 8
DETERMINE AND APPLY SUFFICIENT APPROPRIATE
SUBSTANTIVE AUDIT PROCEDURES FOR TESTING
CASH ACCOUNTS, DISCLOSURES, AND ASSERTIONS
SUBSTANTIVE ANALYTICS FOR CASH
ACCOUNTS
• Focusing on substantive tests of details
• Minimal substantive analytics to be performed
include identifying significant:
• Fluctuations in cash balances
• Differences between budgeted and actual levels of
cash
10-28
Copyright © 2016 South-Western/Cengage Learning
SUBSTANTIVE TESTS OF DETAILS FOR
CASH ACCOUNTS
Inspecting or reperforming bank
reconciliations
Obtaining bank confirmations and bank
cutoff statements
Preparing interbank transfer schedules
10-29
Copyright © 2016 South-Western/Cengage Learning
EXHIBIT 10.7 - TESTS OF CLIENT’S
BANK RECONCILIATION
10-30
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BANK CONFIRMATION
• Sent to all banks with which the client had business
• Provides information about year-end cash balance
and additional information about loans outstanding
• Seeks information on:
•
•
•
•
•
•
Client’s deposit balances
Existence of loans
Due dates of loans
Interest rates
Dates through which interest has been paid
Collateral for outstanding loans
10-31
Copyright © 2016 South-Western/Cengage Learning
CUTOFF BANK STATEMENTS
• A statement for a period of time shorter than that of
regular month-end statements
• Sent directly to auditor, who uses it to verify
reconciling items on client’s year-end bank
reconciliation
• Consider the number of checks returned listed on
the cutoff statement
10-32
Copyright © 2016 South-Western/Cengage Learning
PREPARING BANK TRANSFER
SCHEDULES
• Kiting: Fraudulent cash scheme to overstate cash
assets at year end by showing the same cash in two
different bank accounts
• Bank transfer schedule: Audit document listing all
transfers between client bank accounts
• Starts shortly before year end and continues for a short
period after year end
• Purpose - Assures that cash in transit is not recorded
twice
10-33
Copyright © 2016 South-Western/Cengage Learning
FRAUD-RELATED SUBSTANTIVE
PROCEDURES FOR CASH ACCOUNTS
Confirming with financial institutions about individuals authorized
to access cash accounts
Scrutinizing checks that are payable to cash
Scrutinizing checks with unusual vendor names
Scrutinizing checks made out to employees outside of normal
payroll processing system
Comparing timing of deposits into bank accounts with timing of
cash receipts, noting any unusual time lags
Investigating voided checks and other voided transactions
10-34
Copyright © 2016 South-Western/Cengage Learning
DOCUMENTATION RELATED TO SUBSTANTIVE
PROCEDURES FOR CASH ACCOUNTS
• Copies of bank reconciliations inspected or
reperformed
• Copies of bank confirmations
• Documentation of oral confirmations
• Copies of bank cutoff statements
• Copies of bank transfer schedules
• Evidence of any restrictions on use of cash balances
or bank compensating balances
10-35
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVE 9
IDENTIFY TYPES OF MARKETABLE SECURITIES,
ARTICULATE THE RISKS AND CONTROLS TYPICALLY
ASSOCIATED WITH THESE ACCOUNTS, AND OUTLINE AN
AUDIT APPROACH FOR TESTING THESE ACCOUNTS
MARKETABLE SECURITIES
• Held as temporary investments
• Short-term cash management securities
• U.S. Treasury bills
• Certificates of deposit (CDs)
• Commercial paper
• Notes issued by major corporations at rates
approximating prime lending rates with high credit rating
10-37
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AUDITOR’S JUDGMENTAL CHALLENGE
Corroborating management’s
intent in classifying assets
Determining fair market value
10-38
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RELEVANT FINANCIAL STATEMENT
ASSERTIONS
Existence or
occurrence
Securities exist at balance sheet date
Securities balances include all securities
transactions taken place during the period
Completeness
Rights and
obligations
Company has title to such securities accounts
as of balance sheet date
Valuation or
allocation
Presentation and
disclosure
Recorded balances reflect true underlying
economic value and are reported in
accordance with the applicable reporting
framework
Properly classifying the securities on balance
sheet and disclosing in notes to financial
statements
10-39
Copyright © 2016 South-Western/Cengage Learning
INHERENT AND FRAUD RISKS
Risk of sudden market declines
Manipulation of classification of
securities
Manipulation of valuation of fair
market value
10-40
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CONTROL RISKS
• Risk of theft of securities if:
• They are not physically controlled
• Authorization and monitoring over their trade is not
effective
• Lack of policies over purchase or sale of securities
• Lack of monitoring of changes in securities balances
• Lack of policies over valuation or classification of
securities
10-41
Copyright © 2016 South-Western/Cengage Learning
CONTROL RISKS
• Lack of segregation of duties between those
responsible for:
• Making investment decisions
• Custody of securities
• Lack of involvement or oversight by internal audit in
relation to securities
• Refer to Exhibit 10.13
10-42
Copyright © 2016 South-Western/Cengage Learning
PLANNING ANALYTICAL PROCEDURES FOR
MARKETABLE SECURITIES
• Developing expectations about level of amounts in
ending balances--based on purchase or sales activity
• Developing expectations about relationship between
balances in marketable securities accounts
• Reviewing changes in:
• Balances
• Risk composition
• Classification types of marketable securities
10-43
Copyright © 2016 South-Western/Cengage Learning
TESTS OF CONTROLS
• Reviewing policies for authorization
• To purchase, sell, and manage such securities
• Inquiring of board of directors
• About board’s oversight of process and examining
related documentation
• Examining documentation of authorization
• For selected purchases and sales
• Reviewing minutes of board meetings
• For reference to investment policies and associated
oversight
10-44
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TESTS OF CONTROLS
• Examining evidence of authorization controls
• For changes in classification of such securities
• Inquiring of management, and reviewing related
documentation about its process for
• Establishing valuation
• Inquiring about process for reclassifications and
reviewing related documentation
• Examining documentation for selected marketable
securities transactions
• Reviewing reports of internal audit
Copyright © 2016 South-Western/Cengage Learning
10-45
ASSERTIONS AND RELATED SUBSTANTIVE TESTS
OF DETAILS - MARKETABLE SECURITIES
Existence or occurrence
• Requesting for a schedule of securities and verifying their existence
Completeness
• Footing schedule of marketable securities and examining them
Rights and obligations
• Examining selected documents to determine any restrictions
Valuation or allocation
• Determining current market value
• Re-computing interest and proper recording of accrued interest
• Determining that unrealized gains and losses are properly accounted for
Presentation and disclosure
• Determining management’s intent and whether securities are properly
classified
Copyright © 2016 South-Western/Cengage Learning
10-46
FOCUS ON FRAUD - AUDIT PROCEDURES USED TO ADDRESS RISK
RELATED TO COMMON FRAUD SCHEMES FOR INVESTMENTS
Employ a specialist to assist in fair value measurements
Conduct background checks on and credit ratings of employees who have
access to investment accounts, or the authorization to purchase or sell securities
Require that the client produce original documentation of securities, not copies
or faxes
Trace dividend payments, interest payments, and sales of securities to cash
deposits recorded on the bank statement
Trace purchases of securities to cash disbursements on the bank statement
Review any unusual journal entries in investment accounts
10-47
Copyright © 2016 South-Western/Cengage Learning
DOCUMENTATION RELATED TO SUBSTANTIVE
PROCEDURES FOR MARKETABLE SECURITIES
• Schedule of marketable securities
• Documentation of any confirmation of securities
• Documentation of securities transactions scrutinized
• Memo containing rationalization for management’s
judgments
• Reports of any outside valuation experts
• Documentation of calculation of potential
impairments
10-48
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