Module 11 - Cash and Financial Instruments

Question 1

What are the typical cash accounts?

Answer 1

• General cash accounts: Main bank account
• Imprest accont: Cash set aside for specific purpose (payroll)
• Imprest Petty Cash: Acts like bank account; cash set aside for more convenient use
• Branch Bank Account: Local bank account for each operation site
• Cash Equivalents:Highly liquid investments; notes, mutual funds
• Financial Instruments: Debt/equity securities

Question 2

Use this card to understand how the cash accounts interact with one another:

Answer 2

Question 3

Use this card to understand the relationship between cash account and other transaction cycles:

Answer 3

Key takeaway: _{Even when balance in cash is immaterial, cash flow is highly significant and often largest of any cycle}

Question 4

In the audit of cash, auditors must distinguish between:

Answer 4

Verifying the client’s reconciliation of bank statement to balance in GL

and

Verifying whether recorded cash in GL correctly reflects all cash transactions

_{Certain misstatements will not be captured in bank reconciliation}

Question 5

What is the testing focus of the audit of cash?

Answer 5

Test focus: Ending balance

• _{Some Controls test, analaytical procedures, and tests of transactions will be performed for cash receipts and cash disbursements}

_Why:

• Cash receipts are largely tested in sales/collection cycle
• Cash disbursements largely tested in payment cycle

Question 6

Methodology for auditing year-end cash:

Phase 1 - Understanding business risk and Set Performance materiality/inherent risk

Answer 6

Understanding business risk:

• _{Risks associated with inappropriate cash management policies/handling}
• _{Risks associated with financial instruments}

Set ​Performance materiality/inherent risk:

• _{Total transactions is often material}
• _{Cash is more susceptible to theft}

Question 7

Methodology for auditing year-end cash:

Phase 1 - Control Risk

A client’s internal controls can be divided into two categories:

Answer 7

1) Controls over the transactions cycles affecting cash receipts/disbursements:
* S.O.D., prenumbered checks, etc…
2) Independent Bank Reconciliations

Question 8

Methodology for auditing year-end cash:

Explain Phase 3

Answer 8

Design and Perform Analytical Procedures

Rarely performed due to extensive testing of bank reconciliations

Design tests of D.o.B of Cash Balance

Largely based on the confirmation of balances

Question 9

Explain bank reconciliations:

Answer 9

Most important controls test for cash cycle; timely reconciliation of client’s records to bank balance

Company starts with balance per bank

• • add: deposits in transit
    
    • less: outstanding checks
• Company then compares balance per books
  
  • add: transfers not received yet
  • less: bank service charge and NSF checks
• Adjustments made to adjust book balance to bank

Question 10

Explain how bank reconciliations serve as a dual test:

Answer 10

Controls test: Ensure client is performing timely reconciliations and making appropriate adjustments

Substantive test: Ensure accuracy of any number on bank reconciliation (adjustments)

Question 11

What steps does the auditor take in verifying bank reconciliations?

Answer 11

1. Verify balance per bank is the corrent balance
   
   • _{Inspect bank statement or bank confirmation}
2. Verify accuracy of deposits in transit and outstanding checks
   
   • _{Cutoff bank statement: ensure checks cleared in subsequent period}
   • _{Investigate any checks/deposits that have not cleared in next per.}
3. Ensure journal entries have been made for any adjustments to clients books (to reconcile to bank)

Question 12

What evidence is not provided by verification of bank reconciliations?

Answer 12

Basically any cash not received by bank or excessive payments:

• Failure to bill customers (there’s no cash involved)
• Embezzlement of cash receipts (employee stealing cash)
• Duplicate payments
• Payments of materials not received

Question 13

What evidence of misstatements is provided by verification of bank reconciliations?

Answer 13

• Failure to include a check on outstanding check list
• Cash received by client recorded in wrong period
• deposits near year-end, that were wrongly recorded as deposit in-transit
• Payments not recorded in client’s records (automatic payments from bank)

Question 14

What are the primary audit objectives of the cash cycle?

Answer 14

Balance-related:

• Existence
• Accuracy
• Cut-off
• Completeness
• Detail tie-in

Question 15

What are the 3 main procedures auditors perform to gather evidence for each of the 5 balance related audit objectives necessary for cash cycle?

Answer 15

1) Cash/Bank confirmations:

_{Existence and accuracy}

2) Cut-off testing procedures (cut-off bank statement)

_Cut-off

3) Bank Reconciliation procedures

_{Completeness and Detail tie-in}

Question 16

What are bank confirmations?

• Is the procedure required (like it is for accounts receivable)?

Answer 16

Confirmations of cash balance, signed by client, and mailed by auditor or third-party to bank/institution

• Not required, but assumed procedure of cycle

Question 17

Explain this audit evidence:

Cut-off bank statement

Answer 17

Bank statement of subsequent period after end of period under audit

• Usually received as part of bank reconciliation procedure

Question 18

What are fraud-oriented procedures?

What procedures may be performed?

Answer 18

Procedures performed if auditor determines controls are weak or other circumstance increases risk of fraud

includes:

• Extended tests of bank reconciliation
• Proof of Cash
• Verification of interbank transfers

Question 19

What are extended tests of bank reconcilation?

Answer 19

If auditor believes year-end bank reconciliation may be intentionally misstated

Includes:

• Check reconciled items in subsequent statement
• trace all uncleared items to the client’s year-end reconciliation
  
  • verify year-end reconciliation items are items that have not yet cleared the bank

Question 20

What are Proofs of Cash?

Answer 20

Approach balance from transaction perspective:

• All recorded cash receipts were deposited
• All deposits in bank were recorded in accounting records
• All recorded cash disbursements were paid by the bank
• All amounts paid by bank were recorded

Question 21

Use this card to see what a Proof of Cash schedule looks like:

Answer 21

Question 22

Explain the steps in testing a proof of cash statement:

Answer 22

1. Balance on bank statement agrees with GL at beginning of period
2. Test cash receipts: All cash receipts per bank are included in cash receipts journals (and other doc.)
3. Ensure electronic payments/cancelled checks clearing bank reconcile with cash disbursements journal
4. Ending bank statement balance agrees with GL balance at end of proof of cash schedule

Question 23

What are interbank transfers?

Explain this procedure: verification of interbank transfers

Answer 23

Cash is transferred from one bank account to another

Verification:

• Looks for kiting; fraud in which client double counts cash in two bank accounts (the disburser and receiver)
• Auditor verifies info via an interbank transfer schedule

Question 24

Use this card to see what a interbank transfer schedule looks like:

Answer 24

Question 25

Explain what should be audited on the interbank transfer schedule:

Answer 25

• Accuracy of disbursement/receipt info should be verified for accuracy
• Interbank transfers must be recorded in both receiving and disbursing bank
  
  • date of record and disbursement must be in same year
• Disbursements from one bank should be included or excluded as outstanding check on reconciliation
• Receipts of one bank should be correctly included/excluded as deposits-in transit

Question 26

What are the main risks associated with the audit of financial instruments?

Answer 26

Valuation;

Certain instruments do not have observable prices; might need to get info from similar investments

Classification:

investments may be available-for-trade, held to maturity, etc…