© The McGraw-Hill Companies 2010 Auditing the Financing/Investing Process: Cash and Investments Chapter Sixteen

© The McGraw-Hill Companies 2010 Cash and the Effect of Other Business Processes ‘Cash’ reported in the financial statements represents currency on hand and cash on deposit in bank accounts, including certificates of deposit, time deposits and savings accounts. ‘Cash equivalents’ are frequently combined with cash for presentation in the financial statements. Definition: Short-term, highly liquid investments that are readily convertible to known amounts of cash or which are subject to an insignificant risk of changes in value. Examples: Treasury bills, commercial paper, and money market funds.

© The McGraw-Hill Companies 2010 Cash and the Effect of Other Business Processes

© The McGraw-Hill Companies 2010 Types of Bank Accounts In order to maximize its cash position, an entity implements procedures for accelerating the collection of cash receipts and delaying the payment of cash disbursements, to the extent delay is appropriate. General Cash Account Imprest Cash Accounts Branch Accounts Types of Bank Accounts

© The McGraw-Hill Companies 2010 The Effects of Controls The reliability of the client’s controls over cash affects the nature and extent of the auditor’s tests of details. Controls for Cash Receipts Controls for Cash Disbursements Completion of Bank Reconciliation

© The McGraw-Hill Companies 2010 Substantive Analytical Procedures – Cash This limited use of substantive analytical procedures is normally offset by (1) extensive tests of controls and/or substantive tests of transactions for cash receipts and disbursements or (2) extensive tests of the entity’s bank reconciliations. Because of the residual nature of the cash account, the auditor’s use of substantive analytical procedures for auditing cash is limited to... comparisons with prior years’ cash balances. comparisons with budgeted amounts.

© The McGraw-Hill Companies 2010 Substantive Tests of Details of Transactions and Balances

© The McGraw-Hill Companies 2010 Balance-Related Assertions

© The McGraw-Hill Companies 2010 Auditing the General Cash Account Copy of Bank Reconciliation Bank Confirmation Cut-off Bank Statement To audit a cash account, the auditor should obtain these items.

© The McGraw-Hill Companies 2010 Bank Reconciliation Working Paper

© The McGraw-Hill Companies 2010 Cut-off Bank Statement Date of Last Bank Reconciliation 7 to 10 Days A cut-off bank statement normally covers the 7- to 10-day period after the date on which the bank account is reconciled. For reconciliation purposes, any item should have cleared the client’s bank account during the 7- to 10-day period.

© The McGraw-Hill Companies 2010 Tests of the Bank Reconciliation The auditor uses the following audit procedures to test the bank reconciliation: 1.Test the mathematical accuracy and agree the balance per the books to the general ledger. 2.Agree the bank balance on the reconciliation with the balance shown on the bank confirmation. 3.Trace the deposits in transit on the bank reconciliation to the cut-off bank statement. 4.Compare the outstanding cheques on the bank reconciliation with the cancelled cheques in the cut-off bank statement for proper payee, amount and endorsement. 5.Agree any charges included on the bank statement to the bank reconciliation. 6.Agree the adjusted book balance to the cash account lead schedule.

© The McGraw-Hill Companies 2010 Fraud-Related Audit Procedures Extended Bank Reconciliation Procedures Proof of Cash Tests for Kiting

© The McGraw-Hill Companies 2010 Extended Bank Reconciliation Procedures In some instances, the year-end bank reconciliation can be used to cover cash defalcations. This is usually accomplished by manipulating the reconciling items in the bank reconciliation. For example, suppose a client employee was able to steal €5,000 from the client. The client’s cash balance at the bank would then be €5,000 less than reported on the client’s books. The employee could ‘hide’ the €5,000 shortage in the bank reconciliation by including a fictitious deposit in transit.

© The McGraw-Hill Companies 2010 Proof of Cash

© The McGraw-Hill Companies 2010 Tests for Kiting

© The McGraw-Hill Companies 2010 Auditing a Payroll or Branch Imprest Account The audit of any imprest cash account such as payroll or a branch account follows the same basic audit steps discussed under the audit of the general cash account.

© The McGraw-Hill Companies 2010 Auditing Petty Cash Fund Usually not material. Potential for defalcation. Seldom perform substantive tests. Document controls.

© The McGraw-Hill Companies 2010 Disclosure Issues for Cash

© The McGraw-Hill Companies 2010 Disclosure Issues for Cash

© The McGraw-Hill Companies 2010 Disclosure Issues for Cash

© The McGraw-Hill Companies 2010 Investments Common StockPreferred Stock Debt SecuritiesHybrid Securities

© The McGraw-Hill Companies 2010 Control Risk Assessment – Investments Here are some of the more important assertions for investments. Occurrence and Authorization Completeness Accuracy and Classification

© The McGraw-Hill Companies 2010 Segregation of Duties

© The McGraw-Hill Companies 2010 Substantive Procedures for Testing Investments

© The McGraw-Hill Companies 2010 Tests of Details – Investments Existence The auditor should perform one or more of the following procedures when gathering evidence for existence: Physical examination Confirmation with the issuer Confirmation with the custodian Confirmation of unsettled transactions with the broker-dealer Confirmation with the counter-party Reading executed partnership or similar agreements

© The McGraw-Hill Companies 2010 Tests of Details – Investments Valuation and Allocation The auditor must also determine if there has been any permanent decline in the value of an investment security. Accounting standards provide guidance for determining whether a decline in value below amortized cost is other than temporary.

© The McGraw-Hill Companies 2010 Tests of Details – Investments Valuation and Allocation Here are some factors that may indicate an other-than-temporary impairment of investment value (IAS 39): Significant financial difficulty of the issuer or obligor. A breach of contract, such as a default or delinquency in interest or principal payments. The lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a concession that the lender would not otherwise consider. It becoming probable that the borrower will enter bankruptcy or other financial reorganization. The disappearance of an active market for that financial asset because of financial difficulties. Observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including adverse changes in the payment status of borrowers in the group and national or local economic conditions that correlate with defaults on the assets in the group. Permanently Impaired = Write down to new carrying amount

© The McGraw-Hill Companies 2010 Tests of Details – Investments Disclosure Assertions Marketable securities need to be properly classified as held-to-maturity, trading and available-for-sale. Held-to-maturity securities and individual available-for-sale securities should be classified as current or non-current assets based on whether management expects to convert them to cash within 12 months. All trading securities should be classified as current assets.

© The McGraw-Hill Companies 2010 End of Chapter 16