Chapter 12 Auditing Cash and Other Liquid Assets

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Chapter 12Auditing Cash and Other Liquid Assets

• Acc 4033
• Auditing
• Steve W. Sanders

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A. Introduction.

• This chapter discusses audit approaches to cash
  and related liquid assets in todays
  sophisticated cash management environments.
  Techniques such as electronic transfers of funds,
  lockboxes, and cash management arrangements with
  banks are used by organizations to effectively
  manage cash flow.

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A. Introduction (contd).

• Cash Accounts Affected
• 1. General Checking Accounts.
• This account is used for the majority of cash
  transactions and is subject to various cash
  management techniques.
• 2. Cash Management Accounts.
• Most organizations move excess cash into and out
  of short-term savings accounts to generate extra
  return or apply to revolving loans.
• Imprest Payroll Accounts.
• Petty Cash Accounts

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A. Introduction (contd).

• Types of Marketable Security Accounts.
• 1. Marketable Securities.
• 2. Short-term Cash Management Programs.
• 3. Other short-term hybrid-type securities.

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A. Introduction (contd).

• Planning for Audits of Cash and Marketable
  Securities.
• Materiality and Risk Considerations for Cash and
  Marketable Securities.
• Even though the year-end cash balance is
  generally not large, the cash account is
  considered material to the auditor for the
  following reasons

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A. Introduction (contd).

• The cash account is the culmination of a large
  volume of transactions that occur throughout the
  year.
• The cash account is more susceptible to fraud
  than are most other accounts. Cash is liquid and
  easily transferable. The increasing
  computerization of accounts makes the cash
  account even more susceptible to fraud and/or
  errors.
• Many debt or loan agreements may be tied to cash
  balances or the maintenance of minimum levels of
  working capital.

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A. Introduction (contd).

• Cash Management Techniques
• a. Lockboxes. Customers send their payments
  directly (via a specific post office box number)
  to the clients bank. The bank receives and
  opens the remittances, prepares a list of cash
  receipts by customer, credits the clients
  general cash account, and notifies the client of
  the details of the transaction.

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A. Introduction (contd).

1. Electronic Fund Transfers.
2. Cash Management Agreements with Financial
   Institutions. The auditor is particularly
   interested in the amount of control given to the
   financial institution.
3. Compensating Balances.

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A. Introduction (contd).

• Inherent Risk.
• Inherent Risk for cash and marketable securities
  may be high due to the volume of transactions,
  liquidity of the related assets, the
  susceptibility to mishandling, and the difficulty
  in understanding the risk associated with
  financial derivatives.

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B. Audits of Cash Accounts.

• Evaluating Control Risk Cash Accounts.
• Fundamental control elements the auditor would
  expect to find in place for all cash processing
  systems include the following

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B. Audits of Cash Accounts Types of Controls

• Segregation of Duties
• Restrictive Endorsements
• Independent Reconciliation Control Procedures
• Computerized Control Totals and Edit Tests

• 5. Authorization of Transactions
• Prenumbered Documents and Turnaround Documents
• Periodic Internal Audits
• Competent, Well Trained Employees

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B. Audits of Cash Accounts (contd).

• Understanding and Testing Internal Controls
• Exhibit 12.2 illustrates a questionnaire that
  may be used to guide the auditor to this
  understanding. If the auditor assesses control
  risk as low and believes it cost-efficient to
  test the control procedures, an audit program for
  testing the controls will be developed (Exhibit
  12.3).

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B. Audits of Cash Accounts (contd).

• Substantive Testing of Cash Balances
• When detailed substantive tests of the cash
  balance are deemed necessary, the auditor would
  want to assess these specific risks (1)
  transactions are recorded in the wrong period,
  (2) the account balance is misstated, (3) the
  company is kiting checks, (4) cash is embezzled
  and therefore not recorded, and (5) cash is
  overstated for some other reason.

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B. Audits of Cash Accounts (contd).

• Independent Bank Reconciliations.
• Tests of an independent reconciliation of the
  clients major bank accounts (prepared by client
  personnel) provide strong evidence as to the
  correctness of the year-end cash balance (Exhibit
  12.4).
• a. The Cut-off Bank Statement. The auditor can
  obtain a cut-off bank statement (activity for a
  period less than one month) directly from the
  bank to test the clients previous month-end bank
  reconciliation i.e. test reasonableness of
  deposits in transit, outstanding checks, and
  other reconciling items.

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B. Audits of Cash Accounts (contd).

• The Standard Bank Confirmation.
• Standard bank confirmations seek information on
  client account balances and on the existence of
  loans, due dates of loans, interest rates, dates
  through which interest has been paid, and
  collateral for all loans outstanding at year end
  (see Exhibit 12.5 and 12.6).

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B. Audits of Cash Accounts (contd).

• Obtaining Year-end Cut-off Information.
• Auditors need to obtain evidence to ascertain
  whether the cash receipts book was held open to
  record next years sales in the current period or
  whether checks were mailed to vendors but not
  recorded in the current period.

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B. Audits of Cash Accounts (contd).

• 2. Bank Transfer Schedules.
• Companies wishing to overstate cash (kiting
  (Exh. 12.7)) may make transfers from one bank
  account to another and fail to record the
  disbursement on the first account while recording
  the deposit on the second, thus in consolidation
  counting the same cash twice.
• The most effective way to test for the existence
  of this is to obtain or prepare a bank transfer
  schedule (See Exh. 12.8).

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C. Marketable Securities and Financial
Instruments.

• 1. Audits of Marketable Securities.
• The determination of the proper accounting for
  most marketable securities is usually easy as
  many marketable securities have short durations
  such as 60 or 90 days.

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C. Marketable Securities and Financial
Instruments (contd).

• 2. Audits of Commercial Paper.
• Commercial paper refers to notes issued by major
  corporations that generally have good credit
  ratings. Exhibit 12.9 shows assertion and audit
  procedures for substantively testing commercial
  paper. Exhibit 12.10 illustrates the type of
  worksheet that you would obtain for an analysis
  of marketable securities and related
  interest/dividend income i.e. you need to tie
  beginning balances to prior year audit work
  papers, test additions of securities and
  disposals during year by examining broker advices
  and test year end market values of securities
  held at year end by examining outside source such
  as the Wall Street Journal.

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C. Marketable Securities and Financial
Instruments (contd).

• 3. Audits of Other Short-term Securities.
• Short-term investments in marketable
  securities need to be accounted for on the
  lower of cost or market basis, thus the auditor
  needs to verify market values.
• 3. New Financial Instruments and Marketable
  Securities.
• Exhibit 12.11 provides examples of
  sophisticated types of investments and Exhibit
  12.12 identifies risk factors associated with
  derivative securities.