auditing PRINCIPLES AND PRACTICES

1. CHAPTER TWO
AUDIT OF CASH AND
MARKETABLE SECURITIES

2. Introduction
• Cash and marketable securities are generally used to meet the
transaction needs of the firm and for contingency purposes.
– The primary concern should be with safety and liquidity
rather than the maximum profits.
Motives For Holding Cash
– Transaction Motive: To meet cash needs that arise from doing
business.
– Precautionary Motive: Having cash on hand for unexpected
purposes.
– Speculative Motive: To take advantage of potential profit-
making. To take advantage of potential profit-making
situations.
– Compensating Motive: To maintain a minimum balance of
cash at banks to compensate for providing services &loans.

3. Definition of cash
• Cash:- is medium of exchange that a bank accept at its face value.
– It includes coins, currency notes, cheques, bank drafts &
checks & demand deposits.
• In a broad sense, cash includes “near-cash assets” such as
marketable securities & time assets” such as time deposits with
banks.

4. • Marketable securities: are securities or debts that are to be sold
or redeemed within a year or below a year.
– These are financial instruments that can be easily converted to
cash such as;
• government (treasury ) note,
• common shares, or certificates of deposits,
• commercial paper,
• Federal funds,
• bank acceptance
• letter of credit and etc.

5. Definiton of Internal control
• Internal control consists of the policies and procedures
adopted within a business in order to:
– Optimize resources.
– prevent irregularities or frauds.
– Safeguard its assets.
– Maintain the accuracy and reliability of its accounting
records.
• Internal control over cash is imperative in order to
safeguard cash and assure the accuracy of the accounting
records for cash.

6. Internal control techniques in
General
• Segregation of duties and authorization of activities:
– The work of one employee should provide a reliable basis for
evaluating the work of another employee.
– Control is most effective when only one person is
responsible for a given task.
• Documentation procedures:
– documents should provide evidence that transactions and
events have occurred.
– The document must proof that the accuracy of the
transaction when it is needed.

7. • Safeguards to control access to or use of assets and records:
• Using mechanical or electronic controls relate primarily to
the safeguarding of assets
• Then, enhance the accuracy and reliability of the
accounting records.
• Independent verification:
• Eexternal verification indicates whether the company’s
financial statements fairly present its financial position
and results of operations in accordance with GAAP/IFRS.
• internal verification involves review, comparison, and
reconciliation of information from two sources.

8. A. INTERNAL CONTROL OVER CASH
RECEIPTS
It includes:
• Only designated personnel should be authorized to handle or
have access to cash receipts.
• As per their authorized position, responsible individual should:
1. receive cash and deposit is a safe place or in bank accounts
2. record cash receipt transactions.
3. have custody of cash
• Documents should include:
1. remittance invoices
2. cash register tapes
3. deposit slips

9. Cont’d----
• Access to storage areas should be limited to authorized personnel.
• Cash registers should be used in visible manner to customers.
• Daily cash counts and daily comparisons of total receipts should
be made.
• All personnel who handle cash receipts should be bonded and
required to take vacations.

10. B. INTERNAL CONTROL OVER CASH
DISBURSEMENTS
• There are two cash disbursements functions as follows;
– Paying liability
– Recording the cash disbursements
• Specifically, activities performed under cash disbursement
includes;
– Payments are made by cheque rather than by cash, except
for petty cash transactions.
– Only specified individuals and authorized should sign a
cheques but the duties of approving payment must be done
by different individuals (departments).

11. – The check must be pre-numbered cheques supported by an
approved document.
–Access of cheques should be restricted to authorized personnel
–Following payment, the approved invoice should be stamped
PAID.
– Blank or unused cheques should be stored in a safe.
– Using a petty cash fund to pay relatively small amounts with
their recording.

12. C. Bank Reconciliations as internal control
• Examine evidence of independent check of bank reconciliations
(e.g. a signature).
• Examine evidence of regular bank reconciliations (usually once
per month).
• Examine evidence of follow-up of outstanding items on bank
reconciliations.
• Pay particular attention to old outstanding reconciling items that
should be written back such as old, un-presented checks.

13. D. Control Over Petty Cash
– The level and location of cash floats should be laid down
formally by the management.
– All expenditure should require a voucher system signed by a
responsible official, not by the petty cashier.
– Vouchers should be produced before the check is signed for
reimbursement.
– A maximum amount should be placed on a petty cash
payment to distinguish it from normal purchase procedures.
– Periodically the petty cash should be reconciled by an
independent person.

14. Audit program for cash

15. Objectives for Cash Audit
• Cash typically has a small account balance, but auditors devote a
large proportion of total audit hours because:
– Liabilities, revenues, expenses and most other assets flow
through cash
– Most liquid asset so greater temptation for misappropriation
– High risk account
• Thus, in order to audit cash, follow the following steps.

16. 1. Obtain an understanding of internal control over cash.
2. Use the understanding of the client and its environment to
consider inherent risk, including fraud risks, related to cash
3. Assess the risks of material misstatement of cash and design
substantive procedures that:
a. Substantiate the existence of recorded cash and
occurrence of the related transactions
b. Establish the completeness of recorded cash.
 Shows there are no unrecorded assets or liabilities, transaction
or events.
c. Verify the cutoff and accuracy of cash transactions

17. d. Determine that the client has rights to recorded cash
e. Determine that the presentation and disclosure of cash,
including restricted funds, are appropriate.
f. Design and perform further audit procedures—tests of
controls.

18. Tests of control over cash
• Only designated personnel should be authorized to handle or
have access to cash receipts and disbursements.
• Test the accounting records and Reconciliation by re-
performance.
– Compare detail of cash receipts listings to cash receipts
journal, accounts receivable postings, and authenticated
deposit slips.
– Compare detail of a sample of recorded disbursements in cash
payments journal, accounts payable postings, purchase orders,
receiving reports, invoices, and paid checks.

19. Cont’d…
– Send standard confirmation forms to financial institutions to
verify amounts on deposit.
– Obtain a cutoffs:
• Bank statement cut-off containing transactions of at least
seven business days subsequent to balance sheet date.
– Count and list cash on hand.
– Verify the Analyze bank transfers for the last week of audit
year and the first week of following year.
– Investigate any checks representing large or unusual payments
to related parties.

21. Limitations of internal control over cash
• Weak internal control procedures would create opportunity for
fraud or thefts of cash.
• The most common defalcation techniques of cash are:
1. Kiting: Fraudulent cash scheme to overstate cash assets at year
end by showing the same cash in two different bank accounts.
– For example: A business has two bank accounts say in bank X
and Y. check is written to withdraw an account from bank -X
account balance, and deposited into bank- Y account. Because
of lag (delay) of time for clearance, is not reflected as
deduction (withdrawal) from bank X account soon. But, the
amount deposited in bank Y is immediately reflected, such
technique is practiced by casher to cover up cash shortage
which an auditor might uncover.

22. 2. Lapping: refers cheating by using A/ receivable that have been
paid and will be closed with unpaid receivables next and so on.
–It can be a way of skimming money by way of cash-retreat delay
the recording of cash receipts in both the near-term and longer
periods of time.
•This is usually practiced as temporary borrowing.
– For example: Galilo (borrower)stole cash and used by Customer
A to pay the loan, the funds received from Customer B was
used to pay the balance of receivables owned by the Customer
A and so on, this can be liken to digging a hole and cover the
hole.

23. 3. Writing off bad debts: accounts receivable could be written - off
as bad debts when actually customers’ remittance is pocketed.
4. Sales discount: cash can be abstracted from sales discount not
taken by customers.
N.B: This is when customers pay the full amount, only amount net
of discount are recorded to customers and the difference would
be pocketed by recording it to discount account.

24. Auditing programs for Marketable
securities

25. • Marketable securities are liquid assets in that they can easily and
quickly be converted into cash.
– Thus, they are held as a temporary investment and classified
as current assets.
• The securities are marketable securities if;
The firm can readily convert them into cash, and
The firm intends to do so when it needs cash.
• If either of the two tests for marketable securities do not apply,
then the securities are properly classified as investment in
securities (long-term investment securities).

26. Control Tests of Marketable securities
• Reviewing policies for authorization
– To purchase, sell, and manage such securities
• Inquiring of BoD about board’s oversight of process and
examining related documentation.
• Examining documentation of authorization
– For selected purchases and sales
• Reviewing minutes of board meetings
– For reference to investment policies and associated oversight.

27. Cont’d…
• Examining evidence of authorization controls
– For changes in classification of such securities
• Inquiring of management about its process for
– Establishing valuation and
– Reviewing related documentation
• Inquiring about process for reclassifications and review related
documentation

28. Substantive Tests of Marketable
securities
• Existence or occurrence: check securities exist at balance sheet
date.
• It is requesting for a schedule of securities and verifying their existence.
• Completeness: Securities balances include all securities
transactions taken place during the period.
• Take footing schedule of marketable securities and examining them.
• Rights and obligations: Company has title (right) to such
securities accounts as of balance sheet date.
 Examining selected documents to determine any restrictions

29. Inherent and Fraud Risks Existence Reasons
• Internal Control risks (theft) of securities may arise when:
– 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

30. Auditing in Practice - 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

31. Thank you !!!
END OF
CHAPTER TWO