ACG5647 Chapter 10: Cash and Financial Investments

Cash accounts

General (checking), payroll, petty cash, and less often savings accounts.

How cash accounts increase and decrease

Cash increases through cash sales, collections of receivables, loans, and owner investment; it decreases through expenditures.

Compensating balance

A specified minimum balance in a general bank account that may be required by a loan agreement.

Cash equivalents

Highly liquid items such as money market funds, certificates of deposit, and savings certificates that are reported with cash as cash and cash equivalents.

When is an item not a cash equivalent?

If it cannot be converted to cash on short notice, it is an investment, receivable, or prepaid item—not a cash equivalent.

Why is fraud a major cash risk?

Normal controls such as bank reconciliations catch many errors, but cash is highly liquid and fraud can be difficult to detect.

Imprest accounts

Payroll and petty cash accounts kept at a low, fixed balance. Payroll is funded by transfers from the general account each pay period; petty cash is replenished as needed.

Auditors' objectives in auditing cash

Consider inherent risks, including fraud; understand internal control; assess risks of material misstatement; and design tests of controls and substantive procedures.

Why is cash valuation usually not a separate audit objective?

Cash ordinarily has very limited valuation issues.

Segregation of cash handling and record keeping

The person who handles cash should not also keep the accounting books.

Centralize cash receiving

Keep cash-receipt points as few as practical to reduce opportunities for interception.

Timely recording of receipts

Record cash receipts promptly to shrink the window for manipulation.

Customer receipts and cash-register totals

Encourage customers to obtain receipts and observe cash-register totals.

Daily deposits

Deposit all cash receipts daily to minimize cash held on site.

Cash disbursement control

Pay by check or electronic funds transfer (EFT), except for minor petty-cash payments.

Independent monthly bank reconciliation

Have an employee without payment or cash-custody duties prepare the reconciliation; an appropriate official should promptly review it.

Monitoring cash receipts and disbursements

Management or internal audit reviews, supported by data analytics that flag unusual transactions and budget deviations.

Over-the-counter sales controls

Controls are strongest when at least two employees share a transaction, such as a salesclerk and cashier.

Point-of-sale system controls

The amount is displayed to the customer, a receipt is printed, and a daily total is accumulated.

Why are card sales a stronger control?

The employee never touches cash.

Controls for checks received through the mail

The mailroom endorses checks 'for deposit only' and prepares a customer control listing; copies go to the controller, checks and listing to the cashier for daily deposit, and remittance advices to the AR bookkeeper.

Control listing

A listing of checks received, organized by customer, used to track and reconcile incoming payments.

Reconciling mailroom listings

Reconcile listings to the cash receipts journal and validated deposit slips.

Tracing unrecorded mailed payments

Customer complaints about unrecorded payments can trace the abstraction back to the mailroom.

Lockbox systems, card networks, EFT/EDI

Direct-receipt arrangements through financial institutions that keep client staff away from cash; the bank does not have access to the accounting records.

Why pay by check or EFT?

Checks provide payee-endorsement evidence, centralize authority in a few signers, create a permanent record, and reduce cash on hand.

Prenumbered checks

Account for the full check sequence, safeguard unissued check stock, and deface voided checks and file them in order.

Check protector

A device or computer process that prints dollar amounts to make alteration ('raising' a check) difficult.

Control over check support

At signing, signers review and perforate/deface supporting documents to prevent reuse; they mail checks themselves rather than returning them to accounting.

Independent bank reconciliation controls

An employee with no cash-handling or recording role receives the bank statements unopened and prepares the reconciliation; an official reviews it.

Computerized disbursements

Support is stored and approved online; the computer generates checks or EFTs and should flag unusual disbursements for review.

Voucher system

Accounting assembles support for every disbursement; the purchase order, receiving report, and vendor invoice must agree before a voucher is prepared and filed by due date.

Voucher register

The register in which vouchers are recorded, separating invoice approval from the act of paying.

Voucher payment process

On the due date, the voucher, supporting documents, and unsigned check go to the finance department for signature.

Computer matching in a voucher system

Invoice, purchase-order (PO), and receiving data must agree or the item appears on an exception report; unique invoice numbers help block duplicate payments.

Monthly accounts-payable control

Balance the AP detail to the general-ledger control account; promptly reconcile vendor statements and investigate discrepancies.

Employee reimbursement controls

Require expense reports with receipts and explanations, supervisor approval, and processing through the normal payment system. Business credit cards may suit heavy spenders; automated reviews can flag excessive or fraudulent expenses.

Petty cash imprest controls

The custodian reviews support; at replenishment, a second person reviews and defaces the support, and a check restores the fund to its fixed balance.

How do auditors test petty cash?

Because petty cash is never material in the slide's guidance, auditors test replenishment transactions rather than the year-end balance.

P-cards

Purchasing cards, which are steadily replacing petty cash.

Monitoring cash

Management reviews journals and ledgers for unusual items. Data analytics can continuously screen 100% of cash transactions and reveal when other controls have failed.

Cash audit documentation

Flowchart or control description, internal control questionnaire (ICQ), risk assessments, audit plan, lead schedule, cash-count sheets, bank confirmations and reconciliations, interbank transfer schedules, and outstanding-check lists.

Why is inherent risk high for cash?

Cash is the most liquid asset and every transaction cycle runs through it, so inherent risk—especially fraud risk—is high.

Risk 1: Cash is overstated

Recorded cash is not really there (existence problem). Example: a shortage is hidden by leaving an outstanding check off the bank reconciliation.

Risk 2: True cash should be higher

Cash was not all recorded or payments were not legitimate (completeness/occurrence problems). Examples: receipts stolen before recording, or payments to fake vendors or employees.

Documenting internal controls over cash

Use a written narrative for small clients and a flowchart or internal control questionnaire for larger clients.

Key cash controls auditors look for

Segregation of cash handling from record keeping, prenumbered checks, and independent monthly bank reconciliations.

How do auditors confirm controls are in place?

Observe who performs tasks, ask questions, and inspect reconciliations and other documents.

Potential cash-receipt misstatements

Receipts stolen before recording; collections stolen and covered up through lapping or write-offs; or the receipts journal kept open past year-end (cutoff problem).

Potential cash-disbursement misstatements

Payments to fake vendors or employees; duplicate payments or payments for goods never received; and checks written but never recorded.

Test of accounting records and bank reconciliations

Test journal and ledger accuracy; select a sample of the year's reconciliations, note who prepared them, and reperform them.

Test of cash-receipt processing

Each day's collections should be deposited intact by the next banking day. Compare mailroom-listing/register-tape detail with daily deposit tickets; this can also reveal lapping.

Test of cash-disbursement processing

Trace disbursements to vouchers, POs, receiving reports, invoices, and paid checks; verify support cancellation, authorizations, and numerical check sequence. Analytics can test approval across 100% of transactions.

Test of management review controls

Evaluate relevance and precision; inspect documentation of how flagged items were investigated and resolved; reperform the review on a test basis.

Reassessing cash risks after control tests

Revise the assessed risk of material misstatement for each cash assertion based on test results and adjust planned substantive procedures.

Lapping

Concealing a cash shortage by delaying recording of cash receipts: today's theft is covered with tomorrow's collection.

Why is lapping easiest to carry out?

When one employee both receives collections and posts customer accounts, the shortage can be shifted between accounts—or parked in inventory—indefinitely.

How do auditors detect lapping?

Test cash-receipt controls by comparing deposit-slip detail with postings to customer accounts, and confirm accounts receivable with customers. In the example, the Dec. 2 deposit contains Barstow's $750 check while the books credit Abbott.

Standard bank confirmation form

Covers deposit and loan balances and primarily provides existence evidence; completeness evidence is limited because the bank lists other accounts only if noticed.

Electronic bank confirmation

A service (e.g., Confirmation.com) can provide responses in a day instead of weeks and improve response rates. Auditors vet the service provider, often through a SOC report.

Restrictive language in bank confirmations

Disclaimers such as 'information may be incomplete' may require clarification or additional audit procedures.

Separate bank confirmation letters

Can confirm compensating balances and authorized check signers.

Year-end bank reconciliation audit steps

Prepare the reconciliation or test the client's in detail: verify arithmetic, compare balances with the bank statement and ledger, and investigate reconciling items.

How can shortages be hidden on a bank reconciliation?

An outstanding check may be omitted or an arithmetic error may be deliberately added.

Usual bank reconciliation format

Start with balance per bank and reconcile to unadjusted balance per books. Adjusting entries go directly on the working paper and are cross-referenced to the lead schedule.

Old outstanding checks

Checks outstanding for 6 or more months should be investigated and reclassified as a liability.

Proof of cash

A four-column working paper that reconciles bank and book balances and a month's receipts and disbursements. Used especially when controls are weak; essentially a fraud-detection procedure and usable for any month.

What does a proof of cash detect?

Items recorded in the books but not on the bank statement (or vice versa), or items recorded at different amounts—even when ending balances agree.

Why are deposits in transit and outstanding checks timing differences?

They normally clear on their own the following month; the cutoff bank statement lets the auditor confirm they cleared.

Cutoff bank statement

A bank statement covering 7–10 business days after year-end that is mailed directly by the bank to the auditors.

Auditing outstanding checks using cutoff statement

Trace listed outstanding checks to the cutoff statement. An unreasonably long delay before payment may mean the check was not mailed until after year-end; adjust by debiting Cash and crediting a liability.

Checks that cleared but were not listed as outstanding

A check dated on or before year-end that cleared the cutoff statement but was omitted from the outstanding list indicates cash was overstated on the reconciliation.

Deposits in transit and cutoff statement

Verify that deposits in transit appear as credits on the first business day(s) after year-end.

Float period

The days between depositing a transfer check in one bank and its clearing the bank on which it was drawn; temporarily, the money appears in both bank balances.

Kiting

Manipulating the float between bank accounts to conceal a shortage or meet short-term cash needs.

Kiting audit procedure

Prepare a schedule of bank transfers for a few days on either side of year-end, using bank dates from cutoff statements.

Kiting to meet short-term cash needs

Drawing against uncollected deposits. If recorded properly, it does not misstate cash, but it signals possible liquidity problems.

Financial investments in scope

Marketable stocks and bonds (most frequent and largest values), commercial paper, mortgages and trust deeds, cash surrender value of life insurance, and derivatives.

Derivatives

Financial instruments whose value is derived from other instruments, assets, or indexes; they range from simple commodity purchase commitments to complex rate/price relationships.

Why may auditing investments require specialized knowledge?

Auditors may need to understand service-organization controls, IT-heavy investment systems, complex accounting principles, fair-value methods, and risks associated with hedging derivatives.

Specialist in investment auditing

A specialist employed by the audit firm, a valuation firm, or the client may assist with complex investments.

Critical audit matter (CAM)

Very complex financial instruments are often identified as a critical audit matter in public-company audit reports.

Auditors' objectives for financial investments

Establish existence/occurrence, completeness, cutoff, rights, valuation, and presentation/disclosure; also verify interest and dividend income, accrued interest, and gains/losses on sales.

Valuation objective for investments

Valuation is a major audit objective for investments: determine whether cost, fair value, or the equity method is appropriate and whether unrealized appreciation/depreciation is properly recorded.

Investment presentation and disclosure

Check presentation and disclosure, including realized and unrealized gains and losses.

Why coordinate cash and securities audits?

Both are liquid assets and can be substituted without authorization—for example, securities may be sold to hide a cash shortage.

Financial investment audit pattern

A. Consider inherent risks. B. Understand controls. C. Assess risks. D. Test controls. E. Perform substantive procedures.

Tests of controls for investments

Vouch a sample of investment transactions or use data analytics; review investment committee reports; inspect internal auditors' reports; test management reviews of holdings and revenue versus budget; test controls over fair-value estimates.

Potential investment misstatements

Misstated values, such as unrecorded market changes or fictitious securities; unauthorized transactions, such as an employee converting securities; incomplete recording, such as missed embedded derivatives.

Investment audit risk drivers

Liquidity creates fraud risk; complex accounting creates valuation-misstatement risk; employees who speculate may hide losses; derivatives almost always raise risk, and some create significant risks requiring special consideration.

Debt securities: trading

Under FASB ASC 320, trading debt securities are reported at fair value; trading gains go to income.

Debt securities: available-for-sale (AFS)

Under FASB ASC 320, AFS debt securities are reported at fair value; gains/losses go to other comprehensive income (OCI), according to the slide.

Debt securities: held-to-maturity (HTM)

Under FASB ASC 320, held-to-maturity debt securities are reported at amortized cost.

Equity securities valuation

Equity securities are measured at fair value. A fair-value option exists for all investments discussed on the slide.

Derivatives valuation

Under ASC 815/825, derivatives are always measured at fair value.

Accounting for derivative gains/losses

Documented hedge intent determines where gains/losses go: an effective hedge offsets the hedged item or goes to OCI; an ineffective hedge or nonhedge goes to earnings.

Equity method

Applies when ownership is 20–50% and there is significant influence. Verify initial recording and recognize income using the investee's audited financial statements.

Impaired investments

Investments that are impaired are written down.

Evaluating broker quotes

Consider the broker's independence and whether the quote is binding.