Chapter 2

Audit of Cash & Marketable Securities

Audit of Cash
 Why is cash an inherently risky account?
 What controls should be in place to help ensure that
cash accounts are not misappropriated?
 What are the audit implications of poor controls over
cash accounts?
 What types of audit procedures would auditors
employ when auditing cash?

YA AAUSC 1
 …Audit of Cash
 Cash typically has a small account balance, but auditors
devote a large proportion of total audit hours because:
 Many transaction cycles affect cash (Liabilities, revenues,
expenses and most other assets flow through cash)
 It is the most liquid asset with greater temptation for
misappropriation
 Generally classified as High risk account because of its
susceptibility to theft, and can also be significantly
misstated.

YA AAUSC 2
 Major Types of cash Accounts

MAJOR TYPES OF CASH ACCOUNTS

 General checking accounts
 Imprest payroll accounts
 Petty cash accounts
 Marketable security accounts: A security that is readily
marketable and held by a company as an investment

YA AAUSC 3
 …Major Types of cash Accounts
..TYPES OF CASH ACCOUNTS
1. General Cash Account- all cash receipts and
disbursements flow through this account The general
checking account is the principal bank account in most
companies and frequently the only bank account in small
businesses.
 A company deposits in and disburses cash from this account.
 A company cycles all transactions through it. For example, a
company deposits from and disburses to all other bank
accounts through the general checking account.

YA AAUSC 4
 …Major Types of cash Accounts

..TYPES OF CASH ACCOUNTS

2. Imprest Accounts- Established to improve internal control over

disbursements such as payroll
Different types of imprest account may be used: eg.
 One bank account for receipts and a separate one for
disbursements.
 All receipts are deposited in the imprest account, and the total is
transferred to the general account periodically.
 A fixed balance is maintained in the imprest account, and the
authorized personnel use these funds; when depleted, cash will be
transferred from general cash account to this account
YA AAUSC 5
 … Major Types of cash Accounts
3. Branch Bank Account: For organizations with many branches, a
separate bank account is needed at each location
4. Imprest Petty Cash Fund
 It is part of cash on hand account kept to make small payments
for which the use of check is not justified.
5. Cash Equivalents
 These are investments made from temporarily excess cash in the
form of time deposits , certificates of deposit, and money market
funds
In what condition do cash equivalents reported under cash?

YA AAUSC 6
 ..Major Types of cash Accounts

 Cash equivalents, that are highly material, are included in the

financial statements as a part of the cash account under the
following conditions:
 If they are short-term investments that are readily
convertible to known amounts of cash, and
 If there is insignificant risk of a change of value from
interest rate changes.
Marketable securities and longerterm interest-bearing
investments are not cash equivalents

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 Cash Control

Cash Control
Strict Cash Management and Control: Why?
Stronger internal control mechanisms are applied for cash due to the
following reasons:
 Many transactions affect cash in the form of payment and collection,
so it is exposed to misappropriation and embezzlement,
 Cash is the most liquid asset that can easily be misused since
everyone would like to have it,
 Cash lacks identification of ownership

YA AAUSC 8
 ..Cash Control

Principles of internal Control as applied to cash:

 Establishment of responsibility: competent and well-
trained employees should be assigned on the task of
receiving, recording and holding cash
 Segregation of duties: Different persons hsould be
assigned for the task of receiving cash, recording cash
receipts, and holding cash.
 Documentation procedures: pre-numbered cash
receipts, cash sales invoices etc are needed to provide
evidence about the occurrence of cash transactions.
 Any page be it defective, void etc. should be kept in the
pad. YA AAUSC 9
 ..Cash Control

Physical, mechanical, and electronic controls: This

involves the use of use cash registers, safes, vaults, and
safety deposit boxes for cash and business papers helps
to limit access to storage areas.
 Independent internal verification: This involves
reviews, comparisons, and reconciliations of information
from two sources. Eg. preparing bank rreconciliation,
performing audits , daily count of cash receipts and
comparing total receipts to bank deposits daily.
 This control will be more effective when done:
 Periodically on surprise basis, by independent persons, if
corrective action is taken based on reports produced
YA AAUSC 10
 …Cash Control

Other controls: Eg. bonding of employees who handle

cash, rotating employee’s duties

Benefits of Internal Control over cash: It helps

 To minimize fraud and inefficient use;
 To reduce risk of loss of cash,
 To improve accountability and maintain public trust
 To ensure accurate and reliable cash records

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 ..Cash Control

COMMON CONTROLS OVER CASH

COMMON CONTROLS OVER CAS1.doc

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 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 period

Rights 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 assets

Presentation and disclosure - Cash is properly classified on the balance sheet and
disclosed in notes to the financial statements

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 Audit Program for Cash

 Auditing standards require auditors to prepare a written

audit program for each auditable area.

What are included in audit program for cash?

 The audit program for cash includes:
 Audit objectives (Transaction & Balance related
objectives) needed to test financial statement
assertions and
 Audit procedures (tests of controls and
substantive tests) applied to achieve the audit
objectives
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Audit Program for Cash

How is audit program for cash prepared?

 Audit program for cash is prepared after
assessing risks affecting cash.
The auditor is required:
 to assess risk of material misstatement of cash
by identifying risks affecting cash, (inherent
risk, fraud risk, control risk)
 to list audit procedures applied depending on
the risks identified
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Audit Program for Cash-PERFORMING RISK ASSESSMENT PROCEDURES FOR
CASH ACCOUNTS

ASSESSING INHERENT RISK

Auditors collect feedback from the client personnel to
asses inherent risk by asking questions : eg.
 If there is a reason to suspect that management may
desire to misstate the cash balance
 Eg. If the company have significant cash flow problems in
meeting its current obligations on a timely basis?
 If the company made significant changes in its cash
processing in the past year

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Audit Program for Cash-PERFORMING RISK
ASSESSMENT PROCEDURES FOR CASH ACCOUNTS
ASSESSING FRAUD RISK
 Three factors considered in assessing fraud risk:
1.Opportunities- Existence of circumstances such as absence of control,
ineffective control, or the ability of management to override control
2. Incentives/pressures- management or other employees have
incentive/pressure which provides motivation to commit fraud (eg.
someone needs money)

3. Rationalization Those involved in fraud are able to rationalize a

fraudulent act as being normal
Frauds related to cash.doc

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Audit Program for Cash-PERFORMING RISK
ASSESSMENT PROCEDURES FOR CASH ACCOUNTS

ASSESSING CONTROL RISK

 Control systems are designed to minimize
potential risks
 Auditors are required to have an understanding of
internal controls (its strength and weakness)
through procedures such as walkthrough of
process, Inquiry, Observation and Review of
documentation.

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Audit Program for Cash-PERFORMING RISK
ASSESSMENT PROCEDURES FOR CASH ACCOUNTS

….ASSESSING CONTROL RISK

 Questions that are asked include:
 Are cash transactions properly authorized?
 Are bank reconciliations performed on a timely basis?
 Does internal audit department conduct timely
reviews of the process?
 Who is authorized to make cash transfers?
 What procedure is used to assure monitoring of
authorization process?
 Are there any restrictions in getting access to cash?

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Audit Program for Cash-PERFORMING RISK
ASSESSMENT PROCEDURES FOR CASH ACCOUNTS

PERFORMING PRELIMINARY ANALYTICAL

PROCEDURES
 Auditors use trend analysis of account balances and ratios
in preliminary analytical procedures for cash accounts to
identify and locate unusual difference.
Eg.
 Comparing monthly cash balances with past years and
budgets
 Comparing ending balance of cash with previous year
balances
 Performing liquidity tests,
 Comparing cash flow to sales and profitability

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Audit Program for Cash-PERFORMING RISK
ASSESSMENT PROCEDURES FOR CASH ACCOUNTS

IF PRELIMINARY ANALYTICAL PROCEDURES

reveal the following relationships, it indicate
existence of higher 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

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Audit Program for Cash: RESPONDING TO IDENTIFIED
RISKS OF MATERIAL MISSTATEMENT

Auditors response to identified risk

After performing risk assessment, auditors determine on
audit procedures that are proportional to assessed risks.
▪ Areas of higher risk receive more audit attention and
effort.
▪ Auditors customize the audit program (eg more tests of
detail or less)


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Audit Program for Cash: RESPONDING TO IDENTIFIED
RISKS OF MATERIAL MISSTATEMENT

….Auditors response to identified risk

Auditors develop audit procedures that contain:
1. Tests of controls : Transactions are selected to test whether
related controls are working.
2. Substantive procedures, including analytical procedures
 transactions are selected to determine whether monetary errors have
occurred

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Audit Program for Cash: RESPONDING TO IDENTIFIED
RISKS OF MATERIAL MISSTATEMENT

….Auditors response to identified risk

Customizing/modifying audit program based on assessment of
risk of material misstatement:
 For example:
If Risk assessment showed Low Risk:
- reduce substantive tests of details
If Risk assessment showed high Risk:
- increase substantive tests of details
Customizing audit procedures based on assessment of risk of
material misstatement.doc


YA AAUSC 24
Audit Program for Cash: Performing Tests of
Control & Substantive Tests
Performing Tests of Control:
Tests of transactions controls are performed by:
 Inquiry of personnel performing the control
 Observation of control being performed
 Inspection of documentation confirming that control has
been performed
 Re-performance of control by individual testing the control

YA AAUSC 25
Audit Program for Cash: Performing Tests of
Control & Substantive Tests

Performing Substantive tests of details for

Cash Accounts:
These include:
1. Preparing independent bank reconciliations
2. Obtaining bank confirmations and bank
cutoff statements
3. Preparing bank transfer schedules

YA AAUSC 26
Audit Program for Cash: Performing Tests of
Control & Substantive Tests
….Performing Substantive tests of details for
Cash Accounts:
1. Preparing independent bank reconciliations
 Auditor independently verifies the following
items when testing client’s bank reconciliation
▪ Balance as per bank statement
▪ Deposits in transit
▪ Outstanding checks
▪ Other adjustments

YA AAUSC 27
Audit Program for Cash: Performing Tests of
Control & Substantive Tests
….Performing Substantive tests of details for Cash
Accounts:
2. Obtaining bank confirmations and bank cutoff statements
 
Confirmations from bank is essential:
 To verify the actual cash balance,
 To confirm loan balance (the same form can serve both purposes)
 Banks are obligated to inform the CPA firm of any loans not
included on the confirmation about which the bank has
knowledge.
 This helps to achieve completeness objective for unrecorded bank
balances and loans from the bank.

YA AAUSC 28
Audit Program for Cash: Performing Tests of
Control & Substantive Tests
….Performing Substantive tests of details for
Cash Accounts:
Receipt of a Cutoff Bank Statement
 A cutoff bank statement is a partial-period bank
statement and the related documents (copies of
cancelled (paid) checks, duplicate deposit slips, and
other documents included in bank statements), mailed
by the bank directly to the CPA firm’s office.
 If a cutoff statement is not received directly from the
bank, auditors use the subsequent period bank statement

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Audit Program for Cash: Performing Tests of
Control & Substantive Tests
….Performing Substantive tests of details for Cash
Accounts:
3. Preparing bank transfer schedules
 Embezzlers occasionally cover a defalcations of cash by a practice known as
kiting, an act of transferring money from one bank to another and improperly
recording the transaction. It is a fraudulent cash scheme to overstate cash
assets at year end by showing the same cash in two different bank accounts

 A useful approach to test for kiting as well as unintentional errors in recording

interbank transfers, to prepare a bank transfer schedule, an audit document
listing all transfers between client bank accounts starting shortly before year
end and continues for a short period after year end.
 The purpose – of preparing the schedule is to assure that cash in transit is not
recorded twice Bank transfer schedules.doc
YA AAUSC 30
Audit Program for Cash: Performing Tests of
Control & Substantive Tests
DOCUMENTATION RELATED TO SUBSTANTIVE
PROCEDURES FOR CASH ACCOUNTS
 Copies of independent bank reconciliations
 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

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Internal Control over Marketable Securities

Marketable securities
 These are investments in debt and equity securities from
temporarily idle cash (expected to be sold within one-year).
 Based on the management’s intent to hold investments in
securities, three are three classifications:
1. Trading - to be sold in near term (are part of C/Asset)
2. Available for Sale – No immediate plan to sale
(C/Asset or Non current, depends on length of period)
3. Held to Maturity –There is an intenet to held until
maturity (C/Asset or Non current, depends on length of
period
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Internal Control over Marketable Securities

Principles of internal Control as applied to Marketable securities:

 Establishment of responsibility: Competent and well-trained
employees should be assigned on the task of receiving, recording and
holding marketable securities.
 Segregation of duties: There should be a segregation of duties between
those responsible for Making investment decisions and Custody of
securities
 Documentation procedures: Evidences showing purchase and sale of
securities should be properly documents.
 Physical, mechanical, and electronic controls: Eg Use of safety deposit
boxes for securities helps to limit access to storage areas.
  Independent internal verification: involvement or oversight by
internal audit in relation to securities is essential part of control of
securities
YA AAUSC 33
FINANCIAL STATEMENT ASSERTIONS RELEVANT TO Marketable Securities
 

 Existence or occurrence: Securities exist at balance sheet

date
 Completeness: Securities balances include all securities
transactions that occurred during the period
 Rights and obligations: Company has title to such
securities accounts as of balance sheet date
 Valuation or allocation: Recorded balances reflect true
underlying economic value of those assets
 Presentation and disclosure: Securities are properly
classified on the balance sheet and disclosed in notes to the
financial statements
 

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Audit Program for Marketable Securities

As usual, audit program is prepared after assessing

risks:
INHERENT AND FRAUD RISKS related to
Marketable securities:
 Risk of sudden market declines
 Manipulation of classification of securities
 Manipulation of valuation of fair market value

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Audit Program for Marketable Securities

CONTROL RISKS
 This involves assessing risks for
 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
 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
 
YA AAUSC 36
Audit Program for Marketable Securities

ASSESSING INHERENT RISK

Auditors collect feedback from the client personnel
to asses inherent risk by asking questions : eg.
 If there a regular investment in marketable
securities, how it is classified, if there is change
is classification, how it is valued, if there us
segregation of duties and so on

YA AAUSC 37
Audit Program for Marketable Securities

COMMON FRAUD SCHEMES RELATING TO

INVESTMENTS
 Securities purchased, not authorized
 Securities purchased, not recorded as purchased
 Securities recorded as purchased, not purchased
 Securities sold, not recorded as sold
 Securities recorded as sold, not sold
 Investment income is stolen
 Investments are purposely valued inaccurately
 Investment classifications are purposely inaccurate

YA AAUSC 38
Audit Program for Marketable Securities

ANALYTICAL PROCEDURES FOR

MARKETABLE SECURITIES
 Analytical procedures are applied to Review
changes in:
 Balances of marketable securities
 Risk composition of marketable securities
 Classification types of marketable securities

YA AAUSC 39
Audit Program for Marketable Securities

Auditors response to identified risk

As usual, after performing risk assessment,
auditors determine on audit procedures that
are proportional to assessed risks.
▪ Areas of higher risk receive more audit
attention and effort.
▪ Auditors customize the audit program (eg
more tests of detail or less)
YA AAUSC 40
Audit Program for Marketable Securities

….Auditors response to identified risk

As usual, Auditors develop audit procedures that contain: tests of control &
substantive tests
1. Tests of controls : Transactions are selected to test whether related controls
are working. eg
If purchases & sales are authorized, if there is policy regarding boards oversight

role , if there is a policy for valuation of securities, re classification of securities
Reviews of documents such as minutes of the BODs, & reviews of reports of

internal audit
is important for this area of test

YA AAUSC 41
 Audit Program for Marketable Securities

….Auditors response to identified risk

2. Substantive procedures: This involves:
Requesting for a schedule of securities and verifying their existence (to test existence)

Footing schedule of marketable securities and examining them (to test completeness)

Examining selected documents to determine any restrictions (to test rights &

obligations)
  Determining current market value

Re-computing interest and proper recording of accrued interest (to test valuation &

allocation)
 Determining whether securities are properly classified ( to test Presentation and
 (

disclosure)

YA AAUSC 42
 Audit Program for Marketable Securities

….Auditors response to identified risk

Auditors usually
Use the help of specialist that assist in fair value measurements

Conduct background checks of employees having access to investment accounts

Require original documents of securities

Trace dividend payments, interest payments and Sales of securities

Trace purchases of securities to cash disbursements on the bank statement

Review any unusual journal entries in investment accounts


YA AAUSC 43
 Audit Program for Marketable Securities

DOCUMENTATION RELATED TO SUBSTANTIVE PROCEDURES FOR MARKETABLE

SECURITIES
 
Schedule of marketable securities as: Prepared by client
Reviewed by auditor
Documentation of any confirmation of securities
Documentation of securities transactions scrutinized
Memo containing rationalization for judgments about management’s:

Classification of securities
Valuation of securities
Reports of any outside valuation experts
Documentation of calculation of potential impairments

YA AAUSC 44