© The McGraw-Hill Companies, Inc., 2006 Slide 10-1 Cash and Financial Investments

© The McGraw-Hill Companies, Inc., 2006 Slide 10-2 Key Internal Controls Cash Receipts l Cash sales  Involvement of 2 or more employees  Cash Registers  Electronic point of sale (POS) systems l 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

© The McGraw-Hill Companies, Inc., 2006 Slide 10-3 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

© The McGraw-Hill Companies, Inc., 2006 Slide 10-4 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 sub- ledger credits per day to daily deposit details.

© The McGraw-Hill Companies, Inc., 2006 Slide 10-5 Lapping

© The McGraw-Hill Companies, Inc., 2006 Slide 10-6 Key Internal Controls Cash Disbursements l Segregation of duties l Payment by check or electronic funds transfer l Match of purchase order and receiving documents with vendor’s invoice l Review of supporting documents by authorized check signer l Cancel supporting documents l Authorized check signer should mail checks

© The McGraw-Hill Companies, Inc., 2006 Slide 10-7 Most Likely Misstatements Cash Disbursements Inaccurate recording of a purchase or disbursement Duplicate recording/payment of purchases Unrecorded disbursements

© The McGraw-Hill Companies, Inc., 2006 Slide 10-8 Audit Objectives Substantive Tests of Cash l Substantiate the Existence of recorded cash l Establish the Completeness of recorded cash l Determine that the client has Rights to recorded cash l Establish the clerical accuracy of cash schedules l Determine that the Presentation and disclosure of cash Which Assertion is missing?

© The McGraw-Hill Companies, Inc., 2006 Slide 10-9 Audit Objectives Substantive Tests of Cash l Substantiate the Existence of recorded cash l Establish the Completeness of recorded cash l Determine that the client has Rights to recorded cash l Establish the clerical accuracy of cash schedules l Determine that the Presentation and disclosure of cash, including restricted funds, are appropriate l Determine proper Valuation per GAAP

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Consider reconciling bank activity(proof of cash)

© The McGraw-Hill Companies, Inc., 2006 Slide 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.

© The McGraw-Hill Companies, Inc., 2006 Slide Proof of Cash (Transactions) l Start with what the bank statement shows as to balances (beginning & ending), credits and debits to A/C. l Then, we either add or subtract from these four amounts to attempt to reconcile to GL beginning and ending balances and deposits and disbursements. l Most are timing differences (DIT, outstanding checks at beg and end of period)or items not recorded yet (bank charges).

Proof of Cash Worksheet

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Consider reconciling bank activity (proof of cash) l Obtain reconciliations of yearend bank balances

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Consider reconciling bank activity (proof of cash) l Obtain reconciliations of yearend bank balances l Obtain bank cutoff statement

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Consider reconciling bank activity (proof of cash) l Obtain reconciliations of yearend bank balances l Obtain bank cutoff statement l Count cash on hand, if significant

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Consider reconciling bank activity (proof of cash) l Obtain reconciliations of yearend bank balances l Obtain bank cutoff statement l Count cash on hand, if significant l Verify the client’s cutoff of cash transactions

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Consider reconciling bank activity (proof of cash) l Obtain reconciliations of yearend bank balances l Obtain bank cutoff statement l Count cash on hand, if significant l Verify the client’s cutoff of cash transactions l Analyze bank transfers occurring around yearend

© The McGraw-Hill Companies, Inc., 2006 Slide 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.

© The McGraw-Hill Companies, Inc., 2006 Slide Schedule of Yearend Bank Transfers to Detect Kiting

© The McGraw-Hill Companies, Inc., 2006 Slide Schedule of Yearend Bank Transfers to Detect Kiting

© The McGraw-Hill Companies, Inc., 2006 Slide Schedule of Yearend Bank Transfers to Detect Kiting

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Obtain reconciliations of bank balances and consider reconciling bank activity (proof of cash) l Obtain bank cutoff statement l Count cash on hand, if significant l Verify the client’s cutoff of cash transactions l Analyze bank transfers occurring around year-end l Investigate payments to/receipts from related parties

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests - Cash Balances l Obtain analyses of cash balances and reconcile to GL l Send standard confirmation forms to banks l Obtain reconciliations of bank balances and consider reconciling bank activity (proof of cash) l Obtain bank cutoff statement l Count cash on hand, if significant l Verify the client’s cutoff of cash transactions l Analyze bank transfers occurring around year-end l Investigate payments to related parties l Evaluate financial statement presentation and disclosure

© The McGraw-Hill Companies, Inc., 2006 Slide Key Internal Controls Over Financial Investments l Separation of duties among employees  Authorizing purchases and sales  Having custody of the securities  Maintaining records l Registration in the name of the company l Detailed records of all securities owned and the related revenue from interest and dividends l Periodic physical inspection of securities l Determination of accounting for complex instruments by competent personnel.

© The McGraw-Hill Companies, Inc., 2006 Slide 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

© The McGraw-Hill Companies, Inc., 2006 Slide Audit Objectives Financial Investments l Determine the Existence of recorded financial investments and that the client has rights to the investments. l Establish the Completeness of recorded investments. l Determine any Rights restrictions. l Determine that the Valuation of investments is in accordance with GAAP. l Establish the clerical accuracy of schedules of investments. l Determine that the Presentation and disclosure of investments are appropriate.

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests Financial Investments l Obtain an analysis of securities/related accounts; reconcile to ledger. l Review Bd of Dir Minutes (Maybe the Investment Committee). l Inspect securities on hand. l Confirm securities and derivative instruments held by others. l Vouch selected securities transactions. l Verify the client’s cutoff of investment transactions. l Perform analytical procedures. l Compute revenue from investments. l Determine market or estimated values. l Evaluate method of accounting. l Inspect management’s documentation of intent to classify derivative transactions as hedges.

© The McGraw-Hill Companies, Inc., 2006 Slide Derivatives - Risks l May present the client with a high degree of business risk (e.g., risk of losses). l May involve complex accounting and valuation methods (i.e., estimating fair values). l Rules for maintaining and acquiring a derivative as a hedge are complex. l May be difficult to identify (May be acquired without an outlay of assets until a future date). l Several SFASs from FASB.

© The McGraw-Hill Companies, Inc., 2006 Slide 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.

© The McGraw-Hill Companies, Inc., 2006 Slide Substantive Tests Financial Investments l Obtain an analysis of securities/related accounts and reconcile to ledger. l Review Bd of Dir Minutes (Maybe the Investment Committee). l Inspect securities on hand. l Confirm securities and derivative instruments held by others. l Vouch selected securities transactions. l Verify the client’s cutoff of investment transactions. l Perform analytical procedures. l Compute revenue from investments. l Determine market or estimated values. l Evaluate method of accounting. l Inspect management’s documentation of intent to classify derivative transactions as hedges. l Evaluate the financial statement presentation and disclosure.