Copyright © 2016 South-Western/Cengage Learning AUDITING CASH AND MARKETABLE SECURITIES CHAPTER 10 Auditing A Risk-Based Approach To Conducting A Quality

Copyright © 2016 South-Western/Cengage Learning

AUDITING CASH ANDMARKETABLE SECURITIES

CHAPTER 10

AuditingA Risk-Based Approach To Conducting A Quality Audit

10th edition

Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg

Copyright © 2016 South-Western/Cengage Learning10-2

LEARNING OBJECTIVES

1. Identify the significant accounts, disclosures, and relevant assertions in auditing cash accounts

2. Identify and assess inherent risks of material misstatement in cash accounts

3. Identify and assess fraud risks of material misstatement in cash accounts

4. Identify and assess control risks of material misstatement in cash accounts

5. Describe how to use planning analytical procedures to identify possible material misstatements for cash accounts, disclosures, and assertions


LEARNING OBJECTIVES6. Determine appropriate responses to identified risks of material

misstatement for cash accounts, disclosures, and assertions7. Determine appropriate tests of controls and consider the

results of tests of controls for cash accounts, disclosures, and assertions

8. Determine and apply sufficient appropriate substantive audit procedures for testing cash accounts, disclosures, and assertions

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


THE AUDIT OPINION FORMULATION PROCESS

IDENTIFY THE SIGNIFICANT ACCOUNTS, DISCLOSURES, AND RELEVANT ASSERTIONS IN

AUDITING CASH ACCOUNTS

LEARNING OBJECTIVE 1


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


CASH MANAGEMENT TECHNIQUES

LockboxesElectronic

Funds Transfers

Cash Management Agreements

with Financial

Institutions

Compensating Balances


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 periodRights 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 assetsPresentation and disclosure

• Cash is properly classified on the balance sheet and disclosed in notes to the financial statements

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

IDENTIFY AND ASSESS FRAUD RISKS OF MATERIAL MISSTATEMENT IN CASH ACCOUNTS



FRAUD TOPICS TO BE COVERED IN A BRAINSTORMING SESSION


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

IDENTIFY AND ASSESS CONTROL RISKS OF MATERIAL MISSTATEMENT IN CASH ACCOUNTS



COMMON CONTROLS OVER CASH


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”


COMMON CONTROLS

Petty Cash

• Limiting access with a locked box and restricting employees who have access

• Requiring receipts for all petty 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

Cash Management Techniques

• Lockboxes• Electronic Funds Transfers• Cash Management

Agreements


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

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


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

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

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


CONSIDERING THE RESULTS OF TESTS OF CONTROLS

Control deficiencies identified

Assessing those deficiencies to determine their severity

Modifying preliminary control risk assessment

Documenting implications of control deficiencies

No control deficiencies identified

Determining that preliminary assessment of

control risk as low is appropriate

Determining the extent that controls can provide

evidence on correctness of account balances

Determining planned substantive audit

procedures

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


SUBSTANTIVE TESTS OF DETAILS FOR CASH ACCOUNTS

Inspecting or reperforming bank reconciliations

Obtaining bank confirmations and bank cutoff statements

Preparing interbank transfer schedules


EXHIBIT 10.7 - TESTS OF CLIENT’S BANK RECONCILIATION

10.7.png

Audrey A. Gramling

NOTE TO EDITORPlease change to reflect changes in Exhibit 10.7 in text.


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


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


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


FRAUD-RELATED SUBSTANTIVE PROCEDURES FOR CASH ACCOUNTS


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

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


AUDITOR’S JUDGMENTAL CHALLENGE


RELEVANT FINANCIAL STATEMENT ASSERTIONS

Securities exist at balance sheet dateExistence or occurrence

Securities balances include all securities transactions taken place during the period

Completeness

Company has title to such securities accounts as of balance sheet date

Rights and obligations

Recorded balances reflect true underlying economic value and are reported in accordance with the applicable reporting framework

Valuation or allocation

Properly classifying the securities on balance sheet and disclosing in notes to financial statements

Presentation and disclosure


INHERENT AND FRAUD RISKS

Risk of sudden market declines

Manipulation of classification of securities

Manipulation of valuation of fair market value


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


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


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


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


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


ASSERTIONS AND RELATED SUBSTANTIVE TESTS OF DETAILS - MARKETABLE SECURITIES

• Requesting for a schedule of securities and verifying their existence

Existence or occurrence

• Footing schedule of marketable securities and examining them

Completeness

• Examining selected documents to determine any restrictions

Rights and obligations

• Determining current market value• Re-computing interest and proper recording of accrued

interest• Determining that unrealized gains and losses are properly

accounted for

Valuation or allocation

• Determining management’s intent and whether securities are properly classified

Presentation and disclosure


FOCUS ON FRAUD - AUDIT PROCEDURES USED TO ADDRESS RISK RELATED TO COMMON FRAUD SCHEMES FOR INVESTMENTS


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

Documents

Copyright © 2016 South-Western/Cengage Learning AUDITING CASH AND MARKETABLE SECURITIES CHAPTER 10 Auditing A Risk-Based Approach To Conducting A Quality