Auditing Chap 010

8/12/2019 Auditing Chap 010

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Chapter 10 - Cash and Financial Investments

CHAPTER 10

Cash andFinancial Investments

Review Questions

10-1 The following circumstances might cause a client to understate assets:

(1) Management of a privatel held compan ma !e motivated to understate assets so as tominimi"e income ta#es$

(%) &an' accounts ma not !e recorded so as to ma'e possi!le unrecorded illegal paments$() Management ma wish to *manage* earnings ! +deferring, income until a su!seuent

ear$

10-% .or' on cash is li'el to !e more e#tensive than one might e#pect !ecause (onl % reuired):

(1) /lthough the amount of cash shown on the !alance sheet ma appear relativelsmall the amounts flowing into and out of the cash account during the ear are oftengreater than for an other account$ earl all !usiness transactions eventuall reuire acash settlement$ Thus the ear-end cash !alance is not the onl measure of materialit$

(%) Cash is the most liuid of assets and offers the greatest temptation for theftem!e""lement and misappropriation$

() The e#amination of cash transactions assists the auditors in the su!stantiation ofman other items in the financial statements !ecause these other items either arise from orresult in cash transactions$

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10- The uoted statement is not correct$ The purpose of an audit is to gather evidence which willena!le the auditors to e#press an opinion on the financial statements and not to pursue an e#tendedinvestigation of minor fraud$ If the auditors determine that the fraud could not have a materialeffect upon the financial statements the should review the situation with the client !eforeinvestigating further$ This discussion will alert the client to the situation protect the auditors from

charges of incompetence and avoid wasting audit time on matters that are not material withrespect to the financial statements and that ma !etter !e pursued ! client personnel$

10- The two independent records of the client2s cash transactions are: (1) the client2s own cash recordsand (%) the !an'2s records of the client2s account as evidenced ! the monthl !an' statements andthe ear-end !an' confirmation availa!le to the auditor$

10-3 / loc'!o# sstem is one in which a post office !o# is controlled ! a compan2s !an' at whichcash remittances from customers are received$ The !an' receives the remittances immediatelcredits the cash to the compan2s !an' account and forwards the remittance advices to thecompan$

10-4 The description of internal control should !e prepared first$ The areas selected for testing and thesi"e of audit samples will !e determined according to the relative ualit of internal control overcash receipts cash dis!ursements and cash forecasting$ The purpose of tests of controls is todetermine the e#tent to which controls allegedl in use are actuall operating effectivel$

10-5 (1) /ll cash which should have !een received was in fact received and recordedpromptl and accuratel$

(%) Cash dis!ursements are made onl for authori"ed purposes and are recorded properl$

() Cash !alances are maintained at adeuate !ut not e#cessive levels ! forecasting e#pectedcash receipts and paments related to normal operations$ The need for o!taining loans orfor investing e#cess cash is thus made 'nown on a timel !asis$

10-6 (a) /ccounting department7 (!) /ccounting department7 (c) Finance department7 (d) Financedepartment7 (e) Finance department$

10-8 The Chec' Clearing /ct for the %1stCentur allows financial institutions to destro phsical copiesof chec's and use an electronic (su!stitute) cop for chec' clearing purposes$ The auditimplications are:1$ /uditors ma have to rel on electronic (su!stitute) copies of chec's for audit evidence$%$ 9iting !ecomes virtuall impossi!le when the clients financial institutions use electronic

processing !ecause it ta'es hours (or less) rather than das to clear a chec'$

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10-10 The discover of large chec's drawn paa!le to the treasurer and charged to Miscellaneous;#pense suggests the possi!ilit that the funds went to the treasurer personall and were note#pended for !usiness purposes$ The auditors should ascertain whether there is adeuatedocumentar evidence supporting the charge to Miscellaneous ;#pense such as purchase ordersinvoices receipts receiving reports etc$ The auditors should also determine whether the

dis!ursement was specificall approved ! the president or other officer !esides the treasurer!efore issuance of the chec's$ .hen fraud has !een detected the auditor should assurehimself>

/ctuall?eceived From

/ctualCash?eceipts

?ecorded as?eceived From

?eceipts?ecorded and@eposited

?eceipts.ithheld

Aul 1 &a'er Charles

B 00 1 Charles B 1

B00

Aul % Aonesmith

00 3%

&a'ermith

00 3%

Aul Der!ertelson

40 1

Aoneselson

00 1

0EEEE

B160 B1%10 B40

10-1% The old outstanding chec's should !e eliminated as the cause unnecessar clerical wor' in each!an' reconciliation and also represent a threat to good internal control$ / dishonest emploee maconceal a cash shortage merel ! omitting old outstanding chec's from the !an' reconciliation$The auditor should prepare a list of the old chec's and as' the client to contact the paees andreuest them to present the chec's for pament$ If this is not feasi!le the chec's should !eeliminated ! restoring the appropriate amount to the cash !alance and setting up a special lia!ilitaccount$

10-1 The tandard Form to Confirm /ccount &alance Information with Financial Institutions reueststhe financial institution to confirm amounts on deposit whether accounts are interest-!earingand


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10-13 Gpon discover of an apparent shortage during the count of cash the first action ! the auditorsshould !e to review an computations and recount the funds in uestion to rule out an possi!ilitof an error in the count$

/ second step is to give the emploee responsi!le for the fund an opportunit to e#plainthe situation$ @iscrepancies of a small amount ma !e disposed of ! transfer to an over-and-short

account$ If the shortage is material and no satisfactor e#planation is immediatel forthcomingthe matter should promptl !e called to the attention of the auditor-in-charge who will ta'e up thematter with officers of the client compan$

10-14 (a) H!taining a cutoff !an' statement permits the e#amination of man chec's listedas outstanding in the !an' reconciliation and esta!lishes the collecti!ilit of customers2chec's included in undeposited receipts on the !alance sheet date$ /n unrecordedoutstanding chec's at ear-end will also !e disclosed ! the cutoff statement$

(!) & comparing paid chec's returned with the !an' statement to the list of chec'soutstanding in the previous reconciliation the auditors o!tain assurance that the cashcutoff at the !eginning of the !an' reconciliation period is accurate and that cashshortages are not !eing o!scured ! manipulation of the outstanding chec's list$

(c) Tracing all !an' transfers for a short period !efore and after the end of the ear isdesigned to disclose *'iting* where! a chec' drawn on one !an' is not recorded as adis!ursement as of the !alance sheet date although the deposit of the chec' in another!an' is properl recorded$

(d) The purpose of investigating chec's representing large or unusual paments to relatedparties is to determine that the transactions (a) were properl authori"ed and recorded and(!) are adeuatel disclosed in the financial statements$

10-15 To verif the client2s cutoff of cash receipts the auditors ma either (1) !e on hand to count theundeposited cash receipts on the last !usiness da of the period or (%) e#amine the cutoff !an'

statement to determine that deposits reported as !eing in transit at ear-end were received ! the!an' on the following !usiness da$ .hen a client has numerous !ranches the auditors usuallemplo a com!ination of these procedures in verifing the cutoff at the various locations$

10-16 The term *window dressing* refers to actions ta'en shortl !efore the !alance sheet date which aredesigned specificall to improve the cash position or in other was to create an improved financialpicture of the compan$ ome forms of window dressing are legitimate (such as ma'ing allpossi!le shipments and !illings to customers at ear-end)$ Hther methods of window dressing(such as holding the cash ournals open) constitute misrepresentation$

/nother e#ample of window dressing occurs when a corporate officer who has !orrowedmone from the corporation repas the loan ust !efore the !alance sheet date and then promptlo!tains a new loan shortl after the !alance sheet date$

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10-18 /deuate internal control over investment processes should include the following features:

(1) eparation of custod of securities from record'eeping$

(%) @etailed records of securities owned and related revenue from interest and dividends$

() /uthori"ation of purchases and sales ! the investment committee$

() ?egistration of securities in name of compan$

(3) eriodic inspection of securities ! an internal auditor or official not charged with custodof securities or record'eeping$

(4) eriodic review of investment activities ! the internal auditor or another independentofficial$

(5) / !udget for investment revenue$

10-%0 The monthl report relating to securities transactions should show:

(1) ecurities owned at the !eginning of the month$

(%) urchases sales gains and losses during the month$

() @ividends and interest received$

() ecurities owned at the end of the month$

10-%1 Information to !e noted ! the auditors during their inspection of securities includes (a) name ofissuing compan (!) face amount (c) serial num!er (d) maturit date (e) date and rate of interest

or dividends (f) presence of all future interest coupons and (g) name in which registered$

10-%% In accordance with /IC/ /G 4%0 (C/H& 4) the auditors should perform procedures toevaluate the professional ualifications and reputation of the specialistJthe securities appraiser$In addition the auditors should o!tain an adeuate understanding of the methods and assumptionsused ! the specialist and evaluate their relevance and reasona!leness in relation to the auditorsfindings and conclusions$ For e#ample the auditors should assure that the model considers allaspects of ris' such as counterpart credit ris' ris' of adverse changes in mar'et factors and ris'of losses from legal or regulator action$ In addition the auditors should evaluate the relevancecompleteness and accurac of an significant information provided to the specialist ! the client to!e used in appraising the options$

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10-% The audit of financial investments can !e ver comple# and present special ris's reuiringspeciali"ed s'ill or 'nowledge in performing audit tas's such as:

Identifing controls at service organi"ations that provide financial services and are part of

the clients information sstem$

H!taining an understanding of information sstems for securities and derivatives that arehighl dependent on computer technolog$

/ppling comple# accounting principles to various tpes of financial investments$

Gnderstanding the methods of determining the fair values of financial investments

especiall those that must !e valued using comple# valuation models$

/ssessing inherent and control ris' for assertions a!out derivatives used in hedging

activities$

Therefore the auditors ma decide that the assistance of specialists either within or outside thefirm is needed to assist in the audit of comple# financial investments$

10-% The auditors can ma'e an independent computation of dividends earned during the ear !

reference to dividend record !oo's pu!lished ! investment advisor services$

10-%3 If a securit or derivative is not mar'eta!le (has no active mar'et) management ma o!tain anappraisal of fair value from a securities valuation firm (a specialist)$ In such cases the auditorsshould refer to /IC/ /G 4%0 (C/H& 4) which reuires that the consider the professionalualifications and reputation of the appraiser and o!tain an understanding of the methods andassumptions used$ .hen a valuation model such as an option-pricing model is used the auditorsshould assess the reasona!leness and appropriateness of the model and evaluate the reasona!lenessof the underling assumptions$ The auditors should ma'e sure that the model considers all aspectsof ris' such as counterpart credit ris' ris' of adverse changes in mar'et factors and ris' oflosses from legal or regulator action$ In addition the auditors should evaluate the relevancecompleteness and accurac of an significant information provided to the specialist ! the client to

!e used in appraising the options$

Questions Requiring Analsis

10-%4 (a) The prelisting of cash receipts strengthens a compan2s internal control !safeguarding against unauthori"ed removals of incoming cash ! emploees whose dutieswould permit them to conceal the removals$ /n effective sstem of prelisting cash receiptsnormall provides for an emploee with no other cash duties to open the mail and preparea listing of the individual receipts included$ Hne cop of the prelisting must !e controlledand later used ! a responsi!le emploee with no related duties to ascertain that all cashreceived in the mail has !een entered in the cash ournal and credited ! the !an'$

(!) The following duties should !e e#cluded from the wor' of all emploees who are in a

position to intercept cash receipts from trade customers !efore the are recorded so thatnone of the same emploees will have an opportunit also to conceal an unauthori"edremovals:

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(1) Maintaining the cash receipts ournal$(%) Totaling the columns of the cash receipts ournal$() reparing an cash receipts records to !e used in posting$() Hriginating credit memoranda for customers2 accounts$(3) Maintaining the sales and


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10-%8 Cash shortages are sometimes concealed ! intentionall omitting an outstanding chec' from theear-end !an' reconciliation or ! understating the amount of one or more outstanding chec's$These omitted or understated chec's will however pro!a!l !e paid ! the !an' earl in Aanuarand returned with the cutoff !an' statement$ The audit procedure of comparing the paid chec'sreturned with the cutoff !an' statement and dated @ecem!er 1 or earlier with the list of

outstanding chec's at @ecem!er 1 would disclose an omissions or understatements in that list$

10-0 The uoted statement is not accurate$ In their wor' on cash auditors are primaril concerned withthe ris' of an overstatementof the cash !alance$ The listing of a non-e#istent or fictitious chec'on the outstanding list would have the effect of understating the client2s cash position !ecause toolarge an amount for outstanding chec's would !e deducted from the !alance per !an' resulting inunderstatement of the adusted !alance$

The other element of the uoted statement relating to the auditors2 concern over thepossi!le omission of a deposit in transit is also in error$ To omit a deposit in transit would causean understatement of the ear-end cash !alance$

If the uoted statement were revised into accepta!le form it would read along thefollowing lines: *.hen auditors are verifing a client2s !an' reconciliation the are particularlconcerned with the possi!ilit that an outstanding chec' ma !e omitted or that a non-e#istentdeposit in transit ma !e included$*

10-1 (a) The C/s will use the Aul 10 cutoff !an' statement in their review of the Aune 0!an' reconciliation to determine whether:

(1) The !eginning !alance on the cutoff !an' statement agrees with the *!alance per!an'* on the Aune 0 reconciliation$

(%) The Aune 0 !an' reconciliation includes those paid chec's that were returnedwith the cutoff !an' statement and are dated or !ear !an' endorsements prior toAul 1$

() @eposits in transit are cleared within a reasona!le time$() Inter!an' transfers have !een considered properl in determining the Aune 0

adusted !an' !alance$(3) Hther reconciling items which had not cleared the !an' at Aune 0 (such as !an'

errors) clear during the cutoff period$

(!) The C/s ma o!tain other information !:

(1) Investigating unusual entries on the cutoff !an' statement$(%) ;#amining paid chec's particularl noting unusual paees or endorsements$() ?eviewing other documentation supporting the cutoff !an' statement$

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/mong the transactions or circumstances that these procedures might disclose are:

(1) Irregular paments or paments related to matters which the C/ shouldinvestigate$ For e#ample the C/ would want to learn the reason for an unusuallegal fee or a pament to a compan officer$

(%) &orrowings in the new fiscal ear or repament of recorded or unrecorded loansoutstanding at ear-end$

() F chec's applica!le to the ear ended Aune 0$() Material e#penditures during the cutoff period$

10-% The outstanding chec's said ! the controller to have !een distri!uted after @ecem!er 1 should !ereversed to the e#tent that the were actuall distri!uted after that date$ The primar purpose ofthe reversal is to properl cut off the cash and show the proper cash !alance$ howing the correctcash !alance eliminates *window dressing*7 recorded !ut undistri!uted chec's would distort thecurrent ratio ! reducing !oth cash and accounts paa!le$ &ut if the chec's had !een mailed priorto ear-end an overdraft should !e revealed and not !e eliminated ! improper ournal entries$

10- (a) Chec's outstanding at the end of the test period should !e added to the !an' figurefor chec's paid (Column ) to arrive at the accounting record2s figure for dis!ursements$The outstanding chec's should also !e deducted from the ovem!er 0 !alance per !an'(Column )$

(!) The deposit in transit at the !eginning of the test period should !e added to the Hcto!er 1!alance per !an' (Column 1) and deducted from deposits for the period (Column %)$ Thedeposit in transit is deducted from the !an'2s ovem!er deposits !ecause the cash receiptwas recorded in the accounting records in Hcto!er rather than in ovem!er$

(c) / chec' issued and paid during the test period is alread included in !oth the !an'2s figurefor chec's paid and dis!ursements per the accounting records$ Therefore this chec' doesnot appear as a reconciling item in the proof of cash$ .hile drawing chec's paa!le to

*Cash* is a poor practice it does not affect the treatment of the chec' in a !an'reconciliation$

(d) The B1600 in F chec's returned ! the !an' should !e deducted from chec's paid !the !an' (Column ) since these returned items are not considered dis!ursements in theaccounting records$ The B130 redeposited in ovem!er should !e deducted fromdeposits (Column %)7 redepositing chec's does not constitute another receipt of cash in theaccounting records$ The B30 redeposited in @ecem!er was cash on hand at ovem!er 0and should !e added to the ovem!er 0 !alance per !an' (Column ) to attain the cash!alance per the accounting records$

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10- (a) The maor elements of adeuate internal control over derivatives include thefollowing:

Formal investment policies that limit the nature of derivative transactions to those that

are consistent with the ris' appetite of management$

/n investment committee of the !oard of directors that authori"es and reviewsfinancial investment activities for compliance with investment policies$

eparation of duties !etween the e#ecutive authorizingpurchases and sales of

derivative instruments the custodianof the securities and the person maintaining therecordsof investments$

Complete detailed records of derivative instruments owned and the related provisions

and terms$

@etermination of appropriate accounting for comple# financial instruments !

competent personnel$

eriodic audits ! the internal auditors to determine compliance with investment

policies and evaluate level of ris' assumed$

(!) The auditors ma perform su!stantive procedures such as the following:

H!tain or prepare an analsis of the investment account and related revenue gain and

loss accounts and reconcile to the general ledger$

Confirm with Danover2s commodit !ro'er that it is holding the instrument$

Kouch transactions (the purchase and an others) during the ear relating to such

contracts$

?eview investment committee minutes and reports to determine that the transaction

was properl authori"ed$

Ma'e independent computations of revenue from the derivative (if an)$

Inspect documentation of managements intent to classif the derivative transaction as

a hedging activit$ ;valuate the method of accounting for the futures contract$

Test the valuation of the futures contract$

;valuate financial statement presentation and disclosure of the futures contract$

10-3 (a) The purpose of a !an' transfer schedule is to trace !an' transfers to discloseoverstatement of cash !alances resulting from 'iting$ .hen a chec' drawn on one !an' isdeposited in another several das (called the float period) usuall pass !efore the chec'clears the !an' on which it is drawn$ @uring this period the amount of the chec' isincluded in the !alance on deposit at !oth !an's$ 9iting refers to the manipulations thatutili"e such temporaril overstated !an' !alances to conceal a cash shortage or meet short-term cash needs$

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(!) The following chec's should !e investigated

Chec' o$ %0%0: The increase in one !an' account and decrease in the other !an' accountshould occur in the same accounting period$ Dere the cash receipt was recorded prior toear-end while the dis!ursement was recorded after ear-end$ /s a result of recording the

de!it and credit parts of the transaction in different accounting periods cash is overstatedat ear-end$ /lso since the de!it (deposit) was recorded prior to ear-end the auditorsmust investigate where the offsetting credit occurred$

Chec' o$ %15: The entr recorded as a deposit ! the !an' as of ear-end should also!e reflected in the accounting records prior to ear-end$ /n entr such as this one mightindicate the concealing of a cash shortage due to a misappropriation$

10-4 (a) Two potential audit pro!lems are indicated ! the schedule$ First the shares of&eta Corp$ are not pu!licl traded$ Therefore determining the fair value of the securitieswill reuire the use of a valuation model and perhaps a specialist$ econd the Continental/irlines Converti!le &onds are securities with im!edded derivatives$ /ccordinglmanagement should account for the option separatel$ This will reuire the use ofvaluation models to determine the values of the !onds and the options separatel$ It maalso reuire the use of a specialist$

(!) If a securit is not mar'eta!le (has no active mar'et) management ma o!tain anappraisal of fair value from a securities valuation firm$ In such cases the auditors shouldrefer to the auditing standards on using the wor' of a specialist which reuire that theconsider the professional ualifications and independence of the appraiser and o!tain anunderstanding of the methods and assumptions used$ .hen a valuation model is used theauditors should assess the reasona!leness and appropriateness of the model and considerthe reasona!leness of the underling assumptions$ The auditors should ma'e sure that themodel considers all aspects of ris' such as ris' of adverse changes in mar'et factors andris' of losses from legal or regulator action$

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!"#ective Questions

10-5 Multiple Choice Luestions

(a) (1) / !an' loc' !o# is a post office !o# controlled ! a compans

!an' at which cash remittances from customers are received$ .ith such a sstemthe !an' collects the remittances immediatel credits the cash to the compans!an' account and forwards the remittance advices to the compan$ Gse of a !an'loc'!o# sstem ma'es it e#tremel difficult for emploees to divert cash receiptssince those cash receipts are sent directl to the post office !o# controlled ! the!an'$ /nswer (%) is incorrect !ecause remittance advices ma !e prenum!ered!ut since the come from various customers the do not have one overallseuence for the client$ /nswers () and () !an' reconciliations and daildeposit of cash receipts are controls !ut controls that ordinaril are not aseffective as a !an' loc'!o# sstem$

(!) (%) The auditors will determine whether each voucher is stamped+paid, ! the chec' signer to avoid a situation in which supporting documents areused a second time to elicit a second pament$

(c) () .hen chec's are signed the should not !e returned to theaccounting department$ This control is used so as to avoid a situation in which theaccounts paa!le department fa!ricates documents and then collects the chec's$ot returning the chec's ma'es it more difficult for this sort of fraud in that theperpetrator must also esta!lish a +safe, address for the chec' to !e mailed to$/nswer (1) is incorrect !ecause control is stronger if individuals who areotherwise independent of the cash function prepare and review the monthl !an'reconciliation$ /nswer (%) is incorrect !ecause as discussed the chec's shouldnot !e returned to accounts paa!le$ /nswer () is incorrect !ecause the individualsigning the chec's needs access to the supporting documents so he or she can

determine whether the e#penditure is proper$

(d) () The general ledger will not have information on the balance perbank$ The cutoff !an' statement ear-end !an' statement and !an' confirmationwill all include information on the !alance per !an'$

(e) () Gnless all negotia!le assets are verified at one time anopportunit e#ists for a dishonest officer or emploee to conceal a shortage !transferring it from one asset categor to another a step ahead of the auditors$ Fore#ample mar'eta!le securities could !e pledged as collateral for a loan$ The cashthus o!tained could !e included with other cash !eing counted ! the auditors$/fter the cash count the cash derived from the securities could !e removed andused to redeem the pledged securities which would then !e availa!le for counting! the auditors$ Hf course this tpe of manipulation could hardl !e carried onunless there were wea'nesses in internal control$

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/nswer (1) is incorrect !ecause counting cash in advance of the !alancesheet date does not relate to 'iting$ /nswer (%) is not persuasive !ecause accountspaa!le can not !e su!stituted for cash as can negotia!le assets$ /nswer () is notcorrect !ecause there is no particular significance to the amount of cash on handon the da the !an' confirmation letters happen to !e returned$

(f) (1) The use of cash registers and tapes helps assure that all sales of a retailstore are recorded$ /nswer (%) is incorrect !ecause the cash has alread !eenrecorded$ /nswer () is incorrect !ecause the procedure onl deals with recordeddeposits and therefore the completeness assertion is not addressed as directl asin answer (1)$ /nswer () is incorrect !ecause one would not e#pect the cash!alance in the general ledger to agree with the !an' confirmation reuest due toitems in transit and chec's outstanding$

(g) (1) The individual who reconciles the !an' account should not !e involved inthe processing of cash receipts or dis!ursements$ Therefore answer (1) is correct$/ll of the other functions are compati!le with reconciliation responsi!ilities$

(h) (1) =apping will result in a dela in the recording of specific remittancecredits in the financial records !ut the chec's will !e deposited in the !an' as theare received$ Therefore a comparison of the chec's deposited to the credits tocustomer accounts will li'el uncover the scheme$

(i) () Daving the securities held in safe'eeping ! a !an' or stoc'!ro'erprovides strong internal control !ecause the are not availa!le to emploeesresponsi!le for maintaining the accounting records of the securities$ Thus theseparation of the custod of securities from the accounting function is complete$

() (1) The investment committee of the !oard of directors is not involved in theroutine of ma'ing !u and sell decisions and can therefore review the transactions

o!ectivel$ Hn the other hand the chief operating officer the controller and thetreasurer ma !e closel associated on a dail !asis with the financial e#ecutiveresponsi!le for the investment decisions$

(') () &ecause of the liuidit of man securities the auditor should insist that aclient representative !e present in order to ac'nowledge the receipt of securitiesreturned$ In the event of su!seuent +disappearance, of a securit the auditor willnot !e a suspect$

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(l) (%) Comparing the recorded amount of dividend revenue with dividend record!oo's (pu!lished ! investment advisor services) provides evidence of theamount of dividend revenue that should have !een received during the ear$ It isvirtuall impossi!le to confirm the receipt of dividends with the compan paingthose dividends$

10-6 imulation

(a) (%) /nswer (%) is correct !ecause use of a loc' !o# sstem decreases the ris' of assetmisappropriation ! having customer paments deposited directl into the !an'$

(!) () /nswer () is correct !ecause reliance upon .ingo Corporation represents a ris'since .ingo ma find either a su!stitute product to replace Cs Land productor develop its own such product$

(c) (1) /nswer (1) is correct !ecause the simulation emphasi"es the fact that sales aredependent upon economic growth$

(d) (1) /nswer (1) is correct !ecause the competition that has led to decreased salesprices ma ultimatel create a difficult situation for CC$

(e) (%) /nswer (%) is correct !ecause the pressure to o!tain the refinancing createspressure on management$

(f) (1) /nswer (1) is correct !ecause current earnings which are low as compared to thepast ma have created pressure on management to at least e#ceed the previousears net income$

10-8 imulation

(a) (E) 9iting involves manipulations causing an amount of cash to !e includedsimultaneousl in the !alance of two or more !an' accounts$ 9iting schemes are !ased onthe float periodJthe time necessar for a chec' deposited in one !an' to clear the !an' onwhich it was drawn$ To detect 'iting a !an' transfer schedule is prepared to determinewhether cash is improperl included in two accounts$

(!) ($) / comparison of the cleared chec's to the ear-end !an' reconciliation will identifchec's that were not mailed until after the first wee' of the su!seuent ear !ecause mostof those chec's will not !e returned with the cutoff statement and will appear to remainoutstanding an a!normall long period of time$

(c) (H) /mong the terms confirmed for such a !orrowing arrangement will !e information onliens$

(d) (%& ') / repl to the second reuest or information from the credit agenc ma confirm

the e#istence of the new customer$ /lso e#amination of shipping documents will revealwhere the goods were shipped and ordinaril to which part$

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(e)

(f) (P) H!serving the paroll chec' distri!ution on a surprise !asis will assist in detectionsince the auditor will e#amine details related to an pachec's not pic'ed up !emploees$

(g) (Q) Kouching data in the paroll register to document authori"ed pa rates will reveal

situations in which an emploee is earning income at a rate that differs from the authori"edrate$

(h) (A) / comparison of the details of the cash receipts ournal to the details on the daildeposit slips will reveal a circumstance since the details will have !een posted to accountsduring the last wee' of the ear under audit$

(i) (() .hen vouchers are processed for merchandise not ordered or received there will !eno supporting purchase orders and receiving reports and this will alert the auditor to thepro!lem$

() ()) canning the de!its to the fi#ed asset accounts and vouching selected amounts willreveal repairs that have improperl !een capitali"ed$

(') (A& *) =apping involves concealing a cash shortage ! delaing the recording of ournalentries for cash receipts$ ince lapping includes differences !etween the details of postingsto the cash receipts ournal and corresponding deposit slips comparing these records willreveal it$ /lso confirmation reuests ma identif lapping when paments of receiva!les(as indicated ! confirmation replies) appear to have ta'en too much time to !e processed$

(l) (E) Increasing cash ! drawing a chec' in this manner is a form of 'iting (see answer 1)$reparation of a !an' transfer schedule will assist the auditor in identifing suchtransactions$

(m) (*& ') Confirmations will identif overstated accounts receiva!le when customers disagreewith the recorded !alance due$ /lso the related overstated sales will not have shippingdocuments indicating that a shipment has occurred$

10-0 imulation

(a) $& I+ The !alance per !an' ma !e traced to a standard form used to confirm account!alance information with financial institutions and to the cutoff statement (on which willappear the !eginning !alance)$

(!) A& ,& H& I& *+ Hne of the deposits in transit does not appear on the cutoff !an' statement(the 8


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(d) E The credit memo from the !an' for the note collected should !e investigated$

(e) E& I The credit for the chec' that was charged ! the !an' for an incorrect amount should!e investigated on !oth the !an' credit memo and on the cutoff statement$

(f) C The onl source of the !alance per !oo's is the cash general ledger account as of

8


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() The cashier apparentl opens or has access to incoming mail containing customers2remittances$ The mail should !e opened ! someone not connected with the cashier2soffice or the accounts receiva!le ledger$ The person opening the mail should ma'e adetailed listing in triplicate of all remittances received one cop going to the accountingcler' for entr in accounts receiva!le one cop going to the cashier for entr in the cashrecords and one cop going to the controller2s office for su!seuent comparison with the

duplicate deposit slip$

() The cashier who has access to cash funds reconciles the !an' account$ This should !edone ! some person not connected with the cashier2s office$

(3) The amount of the B300 chec' ma indicate that dis!ursements from the pett cash fund!an' account have not !een limited to relativel small amounts$ Consideration should !egiven to esta!lishing a limitation on the si"e of a chec' that ma !e drawn$

10- H=GTIH: partan @rug tore Inc$ (;stimated time %0 minutes)

partan @rug tore Inc$ rocessing Cash Collections Internal Control Luestionnaire

1$ /re customers who pa !e chec' identified via store I$@$ card or other meansO

%$ @oes compan polic prohi!it accepting chec's for anthing e#cept merchandise salesplus a nominal cash amountO

$ Is a receipt produced ! the cash register given to each customerO

$ Is the reading of each cash register ta'en periodicall ! an emploee who is independentof the handling of cash receiptsO

3$ /re cash counts made on a surprise !asis ! an individual who is independent of thehandling of cash receiptsO

4$ Is the reading of each cash register compared regularl to the cash receivedO

5$ Is a summar listing of cash register readings prepared ! an emploee who is independentof phsicall handling cash receiptsO

6$ Is a summar listing of cash register readings prepared ! an emploee who is independentof phsicall handling cash receiptsO

8$ /re receipts forwarded to an independent emploee who ma'es the !an' depositsO

10$ /re each da2s receipts deposited intact dailO

10-15


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11$ Is the summar listing of cash register receipts reconciled to the duplicate deposit slipsauthenticated ! the !an'O

1%$ /re entries to the cash receipts ournal prepared from duplicate deposit slips or thesummar listing of cash register readingsO

1$ /re the entries to the cash receipts ournal compared to the deposits per !an' statementO

1$ /re areas involving the phsical handling of cash reasona!l safeguardedO

13$ /re emploees who handle receipts !ondedO

14$ /re charged !ac' items (F chec's etc$) directed to an emploee who does notphsicall handle receipts or have access to the !oo'sO

10- H=GTIH: Internal Control u!stantive rocedures (;stimated time: %0 minutes)

(a) (1) egregation of the custod and record'eeping functions for mar'eta!leeuit securities is designed to prevent personnel from !eing in a position toa!stract the client2s securities and alter the records to conceal the a!straction$

(%) ?egistration in the compan2s name is designed to prevent emploees with custodof securities from using them for their own purposes$ For e#ample securitiesregistered in the name of the custodian easil could !e used as collateral for apersonal loan to that custodian$

() /n analsis of the investment committee minutes and reports ma discloseunrecorded purchases and sales of securities or other financial instruments as wellas transactions that are not consistent with compan policies$ This procedure isespeciall important if the client engages in derivatives !ecause transactions giving

rise to derivatives ma not involve the pament or receipt of cash$

(!) (1) egregation of duties is tested ! ma'ing inuiries as to which emploeesperformed specific tas's throughout the ear and o!serving personnel performingthose tas's$ The auditors also should ma'e inuiries as to who performs assignedtas's under unusual circumstances such as prolonged illness of an emploee$

(%) ?egistration of securities in the name of the compan could !e tested ! ma'inginuiries regarding the polic and o!serving securities on hand prefera!l on asurprise !asis$

10-16


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() Investment committee minutes ma !e o!tained from the client$

(c) (1) and (%)$ &oth of these wea'nesses might !e compensated for ! performing a surprisecount of mar'eta!le securities$ / comparison could !e made of the serial num!ers onsecurities on hand with those recorded from previous e#aminations$ Misuse of the client2s

securities during the ear also might !e indicated ! analtical procedures such ascomparison of the client2s rate of earning on investments to prevailing rates$

() This wea'ness is li'el to !e ver significant in the sense that unauthori"edpurchases and sales of derivative transactions ma !e involved$ The auditors wille#pand the analsis of derivative transactions to determine e#actl the nature oftransactions that have occurred$ @epending upon the nature of these transactionsthis ma involve an analsis of all investments and possi!l a search of receiptsand dis!ursements transactions related to such transactions$ In addition !ecauseman such transactions ma not involve the receipt or pament of cash it isessential that the auditors understand the natures of the transactions involved$

10-3 H=GTIH: ?elia!le /uto arts Inc$ (;stimated time: 0 minutes)

?;=I/&=; /GTH /?T IC$Corrected roof of Cash for /pril %00>

Aul 1 %00>

&alance Chec's &alance


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10-4 H=GTIH: unset &uilding uppl (;stimated time: %3 minutes)

(a)G;T &GI=@I G=P

Comparison of Chec's and @is!ursements@ecem!er 1 18--

Chec's returned or still outstanding:?eturned in cutoff statement B300Hutstanding chec's on 1


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(3) The amount of a chec' ma have !een raised ! the paee$ The auditors shouldcall this alteration to the attention of the client and propose an adusting entrrecogni"ing a loss and crediting Cash$ (The prospects for recovering stolen fundsseldom ustif recording a receiva!le$)

(4) The !an' ma have charged the !an' account with a chec' drawn on another

account$ The auditors should advise the client to notif the !an' of the error7 noadusting entr is necessar$

(5) / stop pament order ma have !een ignored ! the !an'$ /gain this is a !an'error and no adusting entr is necessar$

10-5 H=GTIH: M= Compan (;stimated time: 3 minutes)

(1) ?eview answers to uestions on confirmation reuests to determine proper recognition inaccounting records and the necessit for financial statement disclosure$

(%) Ma'e inuiries as to compensating !alances and restrictions$

() H!tain copies of the !an' reconciliations as of the !alance sheet date and:

(a) Trace the adusted !oo' !alances to the general ledger !alances$(!) Compare the !an' !alances to the opening !alances on the cutoff !an' statement$(c) Compare the !an' !alances to the !alances on the confirmations$(d) Trace amounts of deposits in transit to the cutoff !an' statements and ascertain

whether the time lags are reasona!le$(e) Kerif the clerical accurac of the reconciliations$(f) H!tain e#planations for unusual reconciling items including chec's drawn to

*!earer* *cash* and related parties$(g) Trace chec's dated prior to the end of the period that were returned with the cut-

off statements to the list of outstanding chec's$(h) Investigate outstanding chec's that did not clear with the cutoff !an' statements$

(i) ;#amine a sample of chec's for paee amount date authori"ed signatures andendorsements to determine an deviations from compan polic$

() repare a !an' transfer schedule from a review of the cash receipts and dis!ursementsournals !an' statements and related paid chec's for the last few das !efore and the firstfew das after the ear-end and:

(a) ?eview the schedule to determine that the deposit and dis!ursement of eachtransfer is recorded in the proper period$

(!) Trace incomplete transfers to the schedule of outstanding chec's and deposits intransit$

10-%1


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In-Class Team Cases

10-6 H=GTIH: teven mith Co$ (;stimated time: %0 minutes)

Trans.er (nderstated&

!verstatedor Correct

E/amle man others are ossi"le2

a$ Correct Book entries: The transfer was recorded in the accounting records as achec' written on the dis!ursing !an' on @ecem!er %8 and acorresponding cash receipt recorded to receiving !an' on that date$Bank entries: The chec' was ta'en to the receiving !an' on @ecem!er%8 and deposited$ The accounts are !oth in the same !an' andaccordingl the transaction was recorded in !oth accounts as of that date$

!$ Correct Book entries: Hn @ecem!er 0 a chec' was written on the dis!ursing!an' recorded as a cash dis!ursement in the cash dis!ursements recordsand recorded as a receipt in the cash receipts records$Bank entries The chec' was deposited in the receiving !an' the ne#t

da @ecem!er 1$ Hn Aanuar % the chec' was received ! thedis!ursing !an'$c$ Gnderstated Book entries: Hn @ecem!er 1 a chec' was written on the dis!ursing

!an' to transfer cash to the receiving !an'$ The ournal entr madehowever was to credit cash and de!it an e#pense account (tofraudulentl decrease %00> profits--perhaps to decrease ta#es) ratherthan to de!it cash in the receiving !an'$ Hn Aanuar % an entr wasmade to de!it cash for the transfer and to credit a revenue account tocorrect the %000> misstatement and to overstate the %00P profits$Bank entries: The chec' was deposited in the receiving !an' on Aanuar%$ Hn Aanuar the chec' was received ! the dis!ursing !an'$

d$ Correct Book entries: Hn @ecem!er 1 a chec' was written on the dis!ursing

!an' recorded as a cash dis!ursement in the cash dis!ursements recordsand recorded as a receipt in the cash receipts records$ The chec' wasmailed to the receiving !an'$Bank entries: The chec' was received ! the receiving !an' on Aanuar%$ Hn Aanuar the chec' was received ! the dis!ursing !an'

10-%%


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e$ Correct Book entries:Hn Aanuar 1 a chec' was written on the dis!ursing !an'recorded as a cash dis!ursement in the cash dis!ursements records andrecorded as a receipt in the cash receipts records$ The chec' was mailedto the receiving !an'$Bank entries:The chec' was received ! the receiving !an' on Aanuar

$ Hn Aanuar the chec' was received ! the dis!ursing !an'$f$ Hverstated Accounting entries: Hn @ecem!er 1 a chec' was written on the

dis!ursing !an' to transfer cash to the receiving !an'$ The improperournal entr made however was to de!it cash (in the receiving !an'2saccount) and credit a revenue account (to fraudulentl increase profits)$Hn Aanuar 1 an entr was made to credit cash for the transfer and tode!it an e#pense account to correct the %000> misstatement and tounderstate the %00P profits$Bank entries: The chec' was deposited in the receiving !an' on@ecem!er 0$ Hn Aanuar % the chec' was received ! the dis!ursing!an'$

g$ Hverstated Book entries: ;arlier during the month that amount of cash (B%000)

had !een stolen from the receiving !an'$ To conceal the shortage on@ecem!er 1 the em!e""ler wrote a chec' transferring B%000 from thedis!ursing !an' to the receiving !an'$ The transfer was not recorded onthe !oo's until Aanuar % of %00PBank entries: The chec' was deposited in the receiving !an' on@ecem!er 1$ Hn Aanuar % the chec' was received ! the dis!ursing!an'$

h$ Correct (The total cash is correct here !ut recorded in the wrong accounts as ofear end$)Book entries: /lthough a chec' is written on the dis!ursing !an' on@ecem!er 0 no entr was made on the !oo's until Aanuar$ Fore#ample assume that a high level emploee had a !lan' chec' wasauthori"ed to sign it and did to transfer the funds at ear end$ he

forgot to record it in the !oo's until Aanuar when she properlrecorded the transfer$Bank entries:The chec' was deposited in the receiving !an' on@ecem!er 0$ &an' /ccount Hne recorded the dis!ursement on@ecem!er 1 the da it was received$

10-%


24/27


10-8 H=GTIH: Rhang Inc$ (;stimated time: %3 minutes)

CA3E Cash Acct. Rec. Inventory CGS Sales Income

1$ Rhang Inc$ left the cash

receipts ournal open afterear-end for an e#tra daand included Aanuar 1cash receipts in the@ecem!er 1 totals$eriodic inventor$ .hateffect would this have on%0>6O

B%300 (o) B%300 (u)

%$ Rhang Inc$ closed thecash receipts ournal at1%8$

eriodic inventor$ .hateffect would this have on%0>6O

B5000 (u) B5000 (o)

$ Rhang Inc$ left the salesournal open after ear-end for an e#tra da andincluded Aanuar 1 salesin the @ecem!er 1 totals$eriodic Inventor$ .hateffect would this have on%0>6O

B300 (o) B300 (o) B300 (o)

$ ame as !ut perpetual

inventor$

B300 (o) B%%00 (u) B%%00 (o) B300 (o) B100 (o)

3$ Rhang Inc$ closed thesales ournal at 1%8$erpetual inventor$.hat effect would thishave on %0>6O

B000 (u) B1800 (o) B1800 (u) B000 (u) B1100 (u)

4$ Rhang Inc$ left !oth thesales ournal and the cashreceipts ournal openthrough Aanuar % and

reported the first two dastransactions in @ecem!erof %0>6$ eriodicInventor$ .hat effectwould this have on %0>6O

B3500 (o) B3500 (u)

B5300 (o)

B5300 (o) B5300 (o)

10-%


25/27


Research and $iscussion Case

10-30 H=GTIH: uncraft /ppliance Corporation (;stimated time: 3 minutes)

The essence of this case is that certain forms of *window dressing* are permissi!le and are in factunderta'en ! most audit clients$ Hther forms however are not accepta!le7 in fact the might !einterpreted ! the courts as acts of fraud$

(a) (1) Tal'ing customers into placing orders earl:This is an accepta!le and commonplace form of *window dressing$* In fact

man companies offer discounts in order to entice customers to place orders priorto ear-end$ /s long as the transaction actuall occurs within the current ear theauditors are hardl in a position to *reassign* it to a future period$

(%) hipping all orders received through @ecem!er 1:If this is *window dressing* it is virtuall impossi!le to distinguish it from

efficient operations$ /gain as long as the transaction is e#ecuted within thecurrent ear it is properl recorded within the current ear$

() Hvershipping orders assuming that returns will not occur until Aanuar:/n overshipment is not a sale$ oods must !e ordered ! the customer not

merel shipped ! the vendor for a legitimate sale to have occurred$ This is notan accepta!le form of *window dressing$* Daving heard this suggestion theauditors should compare a sample of ear-end shipments to the customers2purchase orders and also monitor sales returns in Aanuar to determine whether theclient is engaging in this unaccepta!le practice$

() =a!el orders unshipped as of @ecem!er 1 as sold and record the sale:This is another unaccepta!le form of *window dressing$* / sale occurs when

the title to the merchandise transfers from the seller to the !uer$ ormall this isf$o$!$ destination or f$o$!$ shipping point$ In either case the merchandise mustactuall have !een shipped ! the seller$ This proposal ! the controller amounts

to a cutoff error$(3) ?ecord chec's dated @ecem!er 1 as cash receipts of that date:

This proposal is another cutoff error$ The date to !e used in recording a cashreceipt is the date that the chec' is received not the date that it was written$ Theauditors should trace the @ecem!er 1 deposit in transit to the deposit shown onthe ne#t !an'ing da in the cutoff !an' statement$

(4) Hfficer to repa loan from compan then renew loan:This is a related part transaction which would have to !e full disclosed in

the compan2s financial statements$ .hile the treasurer2s repament and renewalof the loan would !e recorded in the compan2s accounts on the dates that thetransactions occurred it is pro!a!le that the adverse pu!licit generated !complete disclosure of this transaction would more than offset the !eneficial

change in the compan2s ear-end cash position$

10-%3


26/27


(5) @ate cash dis!ursements for current lia!ilities as of @ecem!er 1 !ut do not mailthe chec's:

This is another unaccepta!le form of *window dressing$* /s the client hasnot actuall released the chec's neither the !alance of the Cash account nor of/ccounts aa!le should !e reduced$ To detect this improper scheme to increase

the compan2s current ratio auditors review the cutoff !an' statement todetermine that chec's supposedl issued at ear-end are clearing on a timel !asis$

(6) @efer the write-down of o!solete inventor until ne#t ear:iven that the inventor is o!solete this is an unaccepta!le suggestion$ /

loss should !e recogni"ed as soon as there is o!ective evidence that a loss hasoccurred$ To defer the write-down to a future time period would distort theincome of !oth time periods$

(8) @ela purchase of machiner previousl ordered for @ecem!er:Title to merchandise changes from the seller to the !uer at a specified date

usuall the date of shipment or of deliver$ If the transaction is delaed thecompan ma legitimatel dela the recording of the purchase and the relatedlia!ilit until the transaction actuall occurs$ Thus delaing a purchase is anaccepta!le form of *window dressing$*

(!) o$ /uditors can never assure a client of an unualified opinion until the have completedtheir e#amination$ There are man situations !eond those discussed at the meeting thatma necessitate the auditors issuing something other than an unualified report$

(c) .hether the discussion held ! the client would cause the auditors to withdraw from theengagement is of course a personal decision$ Hn the one hand audit ris' is increased!ecause the client is in financial difficult and has indicated a certain desperation toportra financial health in its financial statements$ Hn the other hand the client has !eenmost straightforward in discussing these proposals in advance with its auditors$ It hascandidl sought the auditors2 advice as to whether or not the proposed actions werelegitimate$ Hur personal decision would not !e to withdraw !ut we would increase our

cutoff procedures and other testing of ear-end transactions$ .e also would devise auditprocedures to test for ever tpe of transaction that we recommend against at the meeting$

Ethics Case

10-31 H=GTIH: Raird S /ssociates (;stimate time: %0 minutes)

(a) The pro!lem here is that ou continue to have a difficult time meeting !udget andarah has at least implicitl suggested that ou !egin to sign off audit stepswithout having performed them$

10-%4


27/27


(!) ossi!le courses of action include:

(1) Follow Sarahs approach. Following arahs approach is li'el to !eeffective in helping the accountant to meet the time !udget$ / difficult isthat it might !e considered fraudulent and at a minimum is dishonest$/ttempt to get students involved in the issue of signing off +unimportant,versus +important, audit procedures$ tudents might argue that if this isonl done for procedures that seem unnecessar the effect will !e minimal$Pet a difficult here is that the accountant ma !e wrong in assessing theimportance of particular steps$ /lso what uite possi!l is an unrealistic!udget pro!a!l remains for ne#t ears audit$ If a particular audit stepappears unnecessar the accountant might discuss the situation with the in-charge senior who might choose to eliminate the step$

(%) Do not follow Sarahs approach. This approach allows the accountant tomaintain honest and wor' performance$ &ut the pro!lem of not !eing

a!le to get wor' done in the !udgeted time remains$

(c) .e strongl recommend notfollowing arahs approach$ This leads todishonest unreasona!le !udgets for su!seuent ears and perhaps misstatementsthat are not identified$

!ther !"servations

Pou might wish to e#tend the discussion at this point and as' whether students!elieve that the individual should tell someone in the C/ firm a!out arahsapproach$ This has a tendenc to lead to a discussion of whether it is appropriate

to disclose to others information provided to ou in confidence versus ourresponsi!ilit to the firm$

In man accounting firms standard auditing programs are read for use$ ince!usiness processes var from firm to firm auditing programs need to !ecustomi"ed accordingl$ .henever accountants encounter a situation wherestandard program does not appl discussions with audit team management arestrongl encouraged$

Auditing Chap 010

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