Chapter 16

1. Chapter 16 Auditing the Financing/Investing Process: Cash and Investments ©2008 The McGraw-Hill Companies, All Rights Reserved McGraw-Hill/Irwin

2. Balance Sheet Assets Cash Investments Receivables Prepaids Inventory PP and E Other assets - intangibles Liabilities and Equity Accounts payable Accrued liabilities Debt Common stock Retained earnings

3. LO# 1 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 cash or so near their maturity that there is little risk of change in their value. Examples: Treasury bills; commercial paper; and money market funds.

4. LO# 1 Cash and the Effect of Other Business Processes

5. Types of Bank Accounts General Cash Account Impress Cash Accounts Branch Accounts LO# 2 Types of Bank Accounts In order to maximize its cash position, an entity implements procedures for accelerating the collection of cash receipts and properly delaying the payment of cash disbursements.

6. 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. LO# 3 & 4 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.

7. LO# 3 & 4 Substantive Tests of Details of Transactions and Balances

8. Controls for Cash Receipts Controls for Cash Disbursements Completion of Monthly Bank Reconciliation LO# 3, 4, & 5 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.

9. LO# 3 & 4 Balance-Related Assertions

10. LO# 5 Auditing the General Cash Account Copy of Bank Reconciliation To audit a cash account, the auditor should obtain these items. Standard Bank Confirmation Cutoff Bank Statement

11. LO# 5 Bank Reconciliation Working Paper

12. LO# 5 Standard Bank Confirmation Form

13. Date of Last Bank Reconciliation 7 to 10 Days LO# 5 Cutoff Bank Statement A cutoff bank statement normally covers the 7- to 10-day period after the date on which the bank account is reconciled. Any reconciling item should have cleared the client’s bank account during the 7- to 10-day period.

14. LO# 5 Tests of the Bank Reconciliation • The auditor uses the following audit procedures to test the bank reconciliation: • Test the mathematical accuracy and agree the balance per the books to the general ledger. • Agree the bank balance on the reconciliation with the balance shown on the standard bank confirmation. • Trace the deposits in transit on the bank reconciliation to the cutoff bank statement. • Compare the outstanding checks on the bank reconciliation with the canceled checks in the cutoff bank statement for proper payee, amount and endorsement. • Agree any charges included on the bank statement to the bank reconciliation. • Agree the adjusted book balance to the cash account lead schedule.

15. LO# 5 Auditing a Payroll or Branch Impress Account The audit of any impress cash account such as payroll or a branch account follows the same basic audit steps discussed under the audit of the general cash account.

16. LO# 5 Auditing Petty Cash Usually not material. Potential for defalcation. Seldom perform substantive tests. Document controls.

17. LO# 5 Disclosure Issues for Cash

18. LO# 5 Disclosure Issues for Cash

19. LO# 5 Disclosure Issues for Cash

20. LO# 6 Fraud-Related Audit Procedures Extended Bank Reconciliation Procedures Proof of Cash Tests for Kiting

21. LO# 6 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.

22. LO# 6 Proof of Cash

23. Kiting • Cash stolen by employee • Transfers money from one bank account to another • Recorded improperly on books.

24. LO# 6 Tests for Kiting

25. LO# 7 Investments Common Stock Preferred Stock Debt Securities Hybrid Securities

26. LO# 8 Control Risk Assessment—Investments Here are some of the more important assertions for investments. Occurrence and Authorization Completeness Accuracy and Classification

27. LO# 9 Segregation of Duties

28. LO# 10 Substantive Procedures for Testing Investments

29. Tests of Details—Investments Existence Auditing Standards state that the auditor should perform one 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 counterparty • Reading executed agreements

30. 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. Auditing and accounting standards provide guidance for determining whether a decline in value below amortized cost is other than temporary.

31. Tests of Details—Investments Valuation and Allocation Here are some factors that may indicate a non-temporary impairment of investment value: • Fair value is significantly below cost • Decline in fair value is attributable to specific adverse conditions • Management does not possess both the intent and ability to hold the investment long enough to allow for recovery in fair value • A debt security has been downgraded by a rating agency • The financial condition of the issuer has deteriorated Permanently Impaired = Write down to new carrying amount

32. 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

33. End of Chapter 16