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A U D I T I N G A RISK-BASED APPROACH TO CONDUCTING A QUALITY AUDIT 9 th Edition Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg Copyright.

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Presentation on theme: "A U D I T I N G A RISK-BASED APPROACH TO CONDUCTING A QUALITY AUDIT 9 th Edition Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg Copyright."— Presentation transcript:

1 A U D I T I N G A RISK-BASED APPROACH TO CONDUCTING A QUALITY AUDIT 9 th Edition Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg Copyright © 2014 South-Western/Cengage Learning CHAPTER 10 AUDITING CASH AND MARKETABLE SECURITIES

2 Copyright © 2014 South-Western/Cengage Learning 10-2 LEARNING OBJECTIVES 1. Identify the significant accounts, disclosures, and relevant assertions in auditing cash accounts 2. Identify and assess inherent risks of material misstatement in cash accounts 3. Identify and assess fraud risks of material misstatement in cash accounts 4. Identify and assess control risks of material misstatement in cash accounts

3 Copyright © 2014 South-Western/Cengage Learning 10-3 LEARNING OBJECTIVES 5. Describe how to use preliminary analytical procedures to identify possible material misstatements for cash accounts, disclosures, and assertions 6. Determine appropriate responses to identified risks of material misstatement for cash accounts, disclosures, and assertions 7. Determine appropriate tests of controls and consider the results of tests of controls for cash accounts, disclosures, and assertions

4 Copyright © 2014 South-Western/Cengage Learning 10-4 LEARNING OBJECTIVES 8. Determine and apply sufficient appropriate substantive audit procedures for testing cash accounts, disclosures, and assertions 9. Identify types of marketable securities, articulate the risks and controls typically associated with these accounts, and outline an audit approach for testing these accounts 10. Apply frameworks for professional decision making and ethical decision making to issues involving the audit of cash accounts, disclosures, and assertions

5 Copyright © 2014 South-Western/Cengage Learning 10-5 THE AUDIT OPINION FORMULATION PROCESS

6 Copyright © 2014 South-Western/Cengage Learning 10-6 PROFESSIONAL JUDGMENT IN CONTEXT - FRAUDULENT PETTY CASH TRANSACTIONS AT KOSS CORPORATION Former vice president of finance orchestrated a $31 million embezzlement Remediation actions Eliminating petty cash fund

7 Copyright © 2014 South-Western/Cengage Learning 10-7 PROFESSIONAL JUDGMENT IN CONTEXT - FRAUD AT PEREGRINE FINANCIAL Embezzlement of over $200 million from Peregrine Financial Group’s (PFG) brokerage clients over a 20- year period Bankruptcy filed immediately after implementation of change in online system Where bank statement information would be sent electronically directly to National Futures Association

8 Copyright © 2014 South-Western/Cengage Learning 10-8 PROFESSIONAL JUDGMENT IN CONTEXT - FRAUD AT KOSS CORPORATION AND PEREGRINE FINANCIAL Why is cash an inherently risky account? (LO 2, 3) What controls should be in place to help ensure that cash accounts are not misappropriated? (LO 4) What are the audit implications of poor controls over cash accounts? (LO 6) What types of audit procedures would auditors employ when auditing cash? (LO 7, 8)

9 IDENTIFY THE SIGNIFICANT ACCOUNTS, DISCLOSURES, AND RELEVANT ASSERTIONS IN AUDITING CASH ACCOUNTS LEARNING OBJECTIVE 1

10 Copyright © 2014 South-Western/Cengage Learning 10-10 MAJOR TYPES OF CASH ACCOUNTS General checking accounts Cash management accounts Imprest payroll accounts Petty cash accounts Marketable security accounts: A security that is readily marketable and held by a company as an investment

11 Copyright © 2014 South-Western/Cengage Learning 10-11 IMPREST PAYROLL ACCOUNTS Imprest bank account Normally carrying a zero balance Replenished when checks are to be written against the account Provides additional control over cash Payroll account - The most widely used imprest bank account Company makes a deposit equal to amount of payroll checks issued

12 Copyright © 2014 South-Western/Cengage Learning 10-12 BENEFITS OF CASH MANAGEMENT TECHNIQUES Speed the collection and deposit of cash Reduce the amount of paperwork Automate the cash management process

13 Copyright © 2014 South-Western/Cengage Learning 10-13 CASH MANAGEMENT TECHNIQUES Lockboxes Electronic Funds Transfers Cash Management Agreements with Financial Institutions Compensating Balances

14 Copyright © 2014 South-Western/Cengage Learning 10-14 LOCKBOXES Cash management arrangement with a bank whereby payments are sent directly to a post office box number accessible to client’s bank Bank opens cash remittances and directly deposits money in client’s account Advantages Company immediately earns interest on deposited funds Manual processing is shifted to bank Speeds up receipt of cash and allows organization to use cash to earn a return

15 Copyright © 2014 South-Western/Cengage Learning 10-15 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

16 IDENTIFY AND ASSESS INHERENT RISKS OF MATERIAL MISSTATEMENT IN CASH ACCOUNTS LEARNING OBJECTIVE 2

17 Copyright © 2014 South-Western/Cengage Learning 10-17 PERFORMING RISK ASSESSMENT PROCEDURES FOR CASH ACCOUNTS Information useful in assessing risk of material misstatement is obtained Inherent risks Financial statement level Account and assertion level Fraud risks Feedback from audit team brainstorming sessions Strengths and weaknesses in internal control Results from preliminary analytical procedures

18 Copyright © 2014 South-Western/Cengage Learning 10-18 REASONS FOR IDENTIFYING CASH AS HAVING HIGH INHERENT RISK Volume of activity Liquidity Automated systems Importance in meeting debt covenants Can be easily manipulated

19 Copyright © 2014 South-Western/Cengage Learning 10-19 INHERENT RISK ANALYSIS QUESTIONNAIRE: CASH Does company have significant cash flow problems in meeting its current obligations on a timely basis? Does company use cash budgeting techniques effectively? Does company use cash management services offered by its banker? What is their nature?

20 Copyright © 2014 South-Western/Cengage Learning 10-20 INHERENT RISK ANALYSIS QUESTIONNAIRE: CASH Has company made significant changes in its cash processing in the past year? Does company have loan or bond covenants that influence use of cash or maintenance of working-capital ratios? Is there any reason to suspect that management may desire to misstate the cash balance?

21 IDENTIFY AND ASSESS FRAUD RISKS OF MATERIAL MISSTATEMENT IN CASH ACCOUNTS LEARNING OBJECTIVE 3

22 Copyright © 2014 South-Western/Cengage Learning 10-22 TOPICS TO BE COVERED IN A BRAINSTORMING SESSION IncentivesOpportunities Rationalization

23 Copyright © 2014 South-Western/Cengage Learning 10-23 AUDITING IN PRACTICE - COMMON FRAUD SCHEMES RELATING TO CASH Frauds relating to cash receipts Inventory sold, but employee does not record the sale and steals the cash Employee receives a check and deposits it, but does not record the sale; then the employee writes a check out to himself and does not record the disbursement Employee collects a customer payment, steals cash, and writes off accounts receivable as uncollectible

24 Copyright © 2014 South-Western/Cengage Learning 10-24 AUDITING IN PRACTICE - COMMON FRAUD SCHEMES RELATING TO CASH Lapping: Employee steals a payment from one customer, and covers it up by using payments from another customer to disguise the theft Skimming: Type of fraud that occurs when an employee makes a sale but does not record it, and steals the cash

25 Copyright © 2014 South-Western/Cengage Learning 10-25 AUDITING IN PRACTICE - COMMON FRAUD SCHEMES RELATING TO CASH Frauds relating to cash payments Purchasing merchandise and recording sale at an unauthorized discounted amount Selling merchandise to a friend at a discounted price; friend returning merchandise for a refund at undiscounted price; splitting profits Employee stealing cash and concealing it by recording a fictitious discount Employee writing a check to a fictitious vendor and depositing the check into an account controlled by the employee

26 IDENTIFY AND ASSESS CONTROL RISKS OF MATERIAL MISSTATEMENT IN CASH ACCOUNTS LEARNING OBJECTIVE 4

27 Copyright © 2014 South-Western/Cengage Learning 10-27 COMMON CONTROLS OVER CASH Segregation of dutiesRestrictive endorsements of customer checks Independent bank reconciliations by employees who do not handle cash Computerized control totals and edit tests Authorization of transactions

28 Copyright © 2014 South-Western/Cengage Learning 10-28 COMMON CONTROLS OVER CASH Prenumbered cash receipt documentsTurnaround documentsPeriodic internal auditsCompetent, well-trained employees

29 Copyright © 2014 South-Western/Cengage Learning 10-29 AUDITING IN PRACTICE - THE PARMALAT FRAUD AND ITS MANY VICTIMS Evolved over a 10-year period Included invention of over $11 billion in fictitious cash in offshore front companies to offset liabilities at parent company In reality, cash was not accounted for and Parmalat had only about 500 million euros in cash Involved large number of individuals acting collusively in various ways

30 Copyright © 2014 South-Western/Cengage Learning 10-30 IMPLICATIONS OF WEAK CONTROLS RELATED TO COMPLETENESS Employee required to record a cash receipt Not performing the task Not reflecting the cash being received, a sale made, or reduced accounts receivable

31 Copyright © 2014 South-Western/Cengage Learning 10-31 AUDITING IN PRACTICE - SKIMMING AND THE COMPLETENESS ASSERTION When a transaction is not immediately recorded, completeness assertion is violated Applicable where customers pay cash directly to an employee

32 Copyright © 2014 South-Western/Cengage Learning 10-32 CONTROLS FOR PETTY CASH Limiting access by keeping funds in a locked box Requiring receipts for petty cash disbursements with: Date Amount received Purpose or use for funds Name of employee receiving funds Reconciling petty cash fund before replenishing it Keeping customer receipts separate from petty cash funds

33 Copyright © 2014 South-Western/Cengage Learning 10-33 CONTROLS FOR CASH MANAGEMENT TECHNIQUES Lockboxes Electronic funds transfers Cash management agreements with financial institutions

34 Copyright © 2014 South-Western/Cengage Learning 10-34 ASSESSING CONTROL RISK FOR CASH Controls minimize potential risks to cash accounts Requires the auditor to have an understanding of internal controls for: Integrated audits Financial statement only audits Understood by: A walkthrough of process Inquiry Observation Review of documentation

35 Copyright © 2014 South-Western/Cengage Learning 10-35 ASSESSING CONTROL RISK FOR CASH At account and assertion levels, considering: Entity-wide controls Transaction controls At entity-wide level, considering control environment Commitment to financial accounting competencies Independence of the board of directors Risk assessment Information and communication Monitoring controls

36 Copyright © 2014 South-Western/Cengage Learning 10-36 ASSESSING CONTROL RISK FOR CASH Integrated audit of cash involves evaluating: Design of internal controls Operation of internal controls Smaller organizations - Testing of operating effectiveness of controls is not a required part of the audit Larger organizations - Evaluating and testing of internal controls happen via an integrated audit

37 Copyright © 2014 South-Western/Cengage Learning 10-37 CONTROL RISK QUESTIONNAIRE - CASH Have service arrangements been reviewed on a current basis? Do management and board periodically review the process? Are cash transactions properly authorized? Are bank reconciliations performed on a timely basis? Does internal audit department conduct timely reviews of the process?

38 Copyright © 2014 South-Western/Cengage Learning 10-38 CONTROL RISK QUESTIONNAIRE - CASH Is the lockbox used to collect cash receipts?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?

39 Copyright © 2014 South-Western/Cengage Learning 10-39 DOCUMENTING CONTROLS Documenting auditor’s understanding of internal controls for: Integrated audits Financial statement only audits A questionnaire often used to guide auditors in documenting understanding of internal controls

40 Copyright © 2014 South-Western/Cengage Learning 10-40 EXHIBIT 10.3 - CONTROL ACTIVITIES QUESTIONNAIRE: CASH RECEIPTS

41 DESCRIBE HOW TO USE PRELIMINARY ANALYTICAL PROCEDURES TO IDENTIFY POSSIBLE MATERIAL MISSTATEMENTS FOR CASH ACCOUNTS, DISCLOSURES, AND ASSERTIONS LEARNING OBJECTIVE 5

42 Copyright © 2014 South-Western/Cengage Learning 10-42 PERFORMING PRELIMINARY ANALYTICAL PROCEDURES Helps identify areas of potential misstatements when planning the audit Cash is examined in relation to: Operational data Budgetary forecasts Requires awareness of importance of cash balances to debt covenants

43 Copyright © 2014 South-Western/Cengage Learning 10-43 PERFORMING PRELIMINARY ANALYTICAL PROCEDURES Relationships indicating heightened 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

44 Copyright © 2014 South-Western/Cengage Learning 10-44 USING TREND ANALYSIS OF ACCOUNT BALANCES AND RATIOS IN PRELIMINARY ANALYTICAL PROCEDURES FOR CASH ACCOUNTS Comparing monthly cash balances with past years and budgets Identifying unexpected spikes or lows in cash during the year Computing trends in interest returns on investments Analyzing cash balances and changes in relation to new or retiring debt obligations

45 Copyright © 2014 South-Western/Cengage Learning 10-45 USING TREND ANALYSIS OF ACCOUNT BALANCES AND RATIOS IN PRELIMINARY ANALYTICAL PROCEDURES FOR CASH ACCOUNTS Comparing cash ending account balances with those of preceding years Computing typical short-term liquidity ratiosComparing cash flow to sales and profitability

46 DETERMINE APPROPRIATE RESPONSES TO IDENTIFIED RISKS OF MATERIAL MISSTATEMENT FOR CASH ACCOUNTS, DISCLOSURES, AND ASSERTIONS LEARNING OBJECTIVE 6

47 Copyright © 2014 South-Western/Cengage Learning 10-47 RESPONDING TO IDENTIFIED RISKS OF MATERIAL MISSTATEMENT Audit procedures are proportional to assessed risks Areas of higher risk receive more audit attention and effort Developing audit approach that contains: Tests of controls (if applicable) Substantive procedures, including analytical procedures Audit programs are customized based on assessment of risk of material misstatement

48 Copyright © 2014 South-Western/Cengage Learning 10-48 EXHIBIT 10.5 - PANEL A: SUFFICIENCY OF EVIDENCE FOR EXISTENCE AND COMPLETENESS OF CASH

49 Copyright © 2014 South-Western/Cengage Learning 10-49 EXHIBIT 10.5 - PANEL B: APPROACHES TO OBTAINING AUDIT EVIDENCE FOR EXISTENCE AND COMPLETENESS OF CASH

50 DETERMINE APPROPRIATE TESTS OF CONTROLS AND CONSIDER THE RESULTS OF TESTS OF CONTROLS FOR CASH ACCOUNTS, DISCLOSURES, AND ASSERTIONS LEARNING OBJECTIVE 7

51 Copyright © 2014 South-Western/Cengage Learning 10-51 SELECTING CONTROLS TO TEST AND PERFORMING TESTS OF CONTROLS Auditors make decisions about: Which controls to test for formulating an opinion on entity’s internal controls Whether the level of control risk warrants reduction of substantive testing

52 Copyright © 2014 South-Western/Cengage Learning 10-52 SELECTING CONTROLS TO TEST AND PERFORMING TESTS OF CONTROLS Tests of transactions controls Inquiry of personnel performing the control Observation of control being performed Inspection of documentation confirming that control has been performed Reperformance of control by individual testing the control

53 Copyright © 2014 South-Western/Cengage Learning 10-53 CONSIDERING THE RESULTS OF TESTS OF CONTROLS Control deficiencies identified Assessing those deficiencies to determine their severity Modifying preliminary control risk assessment Documenting implications of control deficiencies No control deficiencies identified Determining that preliminary assessment of control risk as low is appropriate Determining the extent that controls can provide evidence on correctness of account balances Determining planned substantive audit procedures

54 DETERMINE AND APPLY SUFFICIENT APPROPRIATE SUBSTANTIVE AUDIT PROCEDURES FOR TESTING CASH ACCOUNTS, DISCLOSURES, AND ASSERTIONS LEARNING OBJECTIVE 8

55 Copyright © 2014 South-Western/Cengage Learning 10-55 AUDITING IN PRACTICE - WEAKNESSES IN SUBSTANTIVE PROCEDURES RELATED TO CASH Auditor needs to consider types of substantive procedures for cash that should be performed Make sure that engagement team performs those procedures PCAOB disciplinary proceedings against two audit firms provide insight on weaknesses in cash-related audit procedures

56 Copyright © 2014 South-Western/Cengage Learning 10-56 SUBSTANTIVE ANALYTICS FOR CASH ACCOUNTS Focusing on substantive tests of details Minimal substantive analytics to be performed include identifying significant: Fluctuations in cash balances Differences between budgeted and actual levels of cash

57 Copyright © 2014 South-Western/Cengage Learning 10-57 SUBSTANTIVE TESTS OF DETAILS FOR CASH ACCOUNTS Preparing independent bank reconciliations Obtaining bank confirmations and bank cutoff statements Preparing bank transfer schedules

58 Copyright © 2014 South-Western/Cengage Learning 10-58 PREPARING INDEPENDENT BANK RECONCILIATIONS Provides evidence for accuracy of year-end cash balance Process includes reconciling balance per bank statements with balance per books Auditor independently verifies the following items when testing client’s bank reconciliation Balance as per bank statement Deposits in transit Outstanding checks Other adjustments

59 Copyright © 2014 South-Western/Cengage Learning 10-59 EXHIBIT 10.7 - TESTS OF CLIENT’S BANK RECONCILIATION

60 Copyright © 2014 South-Western/Cengage Learning 10-60 BANK CONFIRMATION A standard confirmation sent to all banks with which the client had business during the year Used to obtain information about year-end cash balance and additional information about loans outstanding Seeks information on: Client’s deposit balances Existence of loans Due dates of loans

61 Copyright © 2014 South-Western/Cengage Learning 10-61 BANK CONFIRMATION Interest rates Dates through which interest has been paid Collateral An asset or a claim on an asset held by a borrower or an issuer of a debt instrument To serve as a guarantee for value of a loan or security If the borrower fails to pay interest or principal, collateral is available to lender to recover principal amount of loan

62 Copyright © 2014 South-Western/Cengage Learning 10-62 EXHIBIT 10.8 - STANDARD BANK CONFIRMATION: ACCOUNT BALANCES

63 Copyright © 2014 South-Western/Cengage Learning 10-63 AUDITING IN PRACTICE - CONFIRMATIONS WITH FINANCIAL INSTITUTIONS PCAOB-proposed Auditing Standard would require auditor to: Perform confirmation procedures for cash and other relationships with financial institutions

64 Copyright © 2014 South-Western/Cengage Learning 10-64 OBTAINING BANK CONFIRMATIONS – LOAN GUARANTEES These requirements are referred to as covenants A violation of covenants makes loans immediately due and payable Considering client‘s ability to continue to operate as a going concern In case of a long-term debt, reclassifying it as a current liability

65 Copyright © 2014 South-Western/Cengage Learning 10-65 EXHIBIT 10.9 - STANDARD BANK CONFIRMATION: LOAN GUARANTEES

66 Copyright © 2014 South-Western/Cengage Learning 10-66 OBTAINING YEAR-END CUTOFF INFORMATION AS PART OF BANK CONFIRMATION PROCESS Obtaining information on last checks issued in fiscal year Last check number Observing that all previous checks had been mailed Obtaining information on last cash receipts

67 Copyright © 2014 South-Western/Cengage Learning 10-67 CUTOFF BANK STATEMENTS A statement for a period of time determined by client and auditor Shorter than that of regular month-end statements Sent directly to auditor, who uses it to verify reconciling items on client’s year-end bank reconciliation

68 Copyright © 2014 South-Western/Cengage Learning 10-68 PREPARING BANK TRANSFER SCHEDULES Kiting: Fraudulent cash scheme to overstate cash assets at year end by showing the same cash in two different bank accounts Bank transfer schedule: Audit document listing all transfers between client bank accounts Starts shortly before year end and continues for a short period after year end Purpose - Assures that cash in transit is not recorded twice

69 Copyright © 2014 South-Western/Cengage Learning 10-69 FRAUD-RELATED SUBSTANTIVE PROCEDURES FOR CASH ACCOUNTS Confirming with financial institutions about individuals authorized to access cash accounts Scrutinizing checks that are payable to cash Scrutinizing checks with unusual vendor names Scrutinizing checks made out to employees outside of normal payroll processing system Comparing timing of deposits into bank accounts with timing of cash receipts Noting any unusual time lags

70 Copyright © 2014 South-Western/Cengage Learning 10-70 FRAUD-RELATED SUBSTANTIVE PROCEDURES FOR CASH ACCOUNTS Comparing time lags between: The date a check was issued for payment The date that it clears the bank Investigating voided checks and analyzing voided transactions

71 Copyright © 2014 South-Western/Cengage Learning 10-71 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

72 IDENTIFY TYPES OF MARKETABLE SECURITIES, ARTICULATE THE RISKS AND CONTROLS TYPICALLY ASSOCIATED WITH THESE ACCOUNTS, AND OUTLINE AN AUDIT APPROACH FOR TESTING THESE ACCOUNTS LEARNING OBJECTIVE 9

73 Copyright © 2014 South-Western/Cengage Learning 10-73 MARKETABLE SECURITIES Held as temporary investments Short-term cash management securities U.S. Treasury bills Certificates of deposit (CDs) Commercial paper Notes issued by major corporations at rates approximating prime lending rates with high credit rating Short-term hybrid-type securities Improve return on temporary investments

74 Copyright © 2014 South-Western/Cengage Learning 10-74 CLASSIFICATION OF INVESTMENTS IN SECURITIES Valued at amortized cost, subject to an impairment test Held-to-maturity securities Carried at fair market value Trading securities Carried at fair market value Available-for-sale securities

75 Copyright © 2014 South-Western/Cengage Learning 10-75 AUDITOR’S JUDGMENTAL CHALLENGE Corroborating management’s intent in classifying assets Gathering information about management’s trades in investments Importance of market value to management compensation Determining fair market value Easily determinable for regularly traded securities Financial institutions reluctant to mark fair values for thinly traded securities

76 Copyright © 2014 South-Western/Cengage Learning 10-76 RELEVANT FINANCIAL STATEMENT ASSERTIONS Securities exist at balance sheet date Existence or occurrence Securities balances include all securities transactions taken place during the period Completeness Company has title to such securities accounts as of balance sheet date Rights and obligations Recorded balances reflect true underlying economic value of those assets Valuation or allocation Properly classifying the securities on balance sheet and disclosing in notes to financial statements Presentation and disclosure

77 Copyright © 2014 South-Western/Cengage Learning 10-77 INHERENT AND FRAUD RISKS Risk of sudden market declines Manipulation of classification of securities Manipulation of valuation of fair market value

78 Copyright © 2014 South-Western/Cengage Learning 10-78 CONTROL RISKS Risk of 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

79 Copyright © 2014 South-Western/Cengage Learning 10-79 CONTROL RISKS 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

80 Copyright © 2014 South-Western/Cengage Learning 10-80 INHERENT RISK ANALYSIS QUESTIONNAIRE - MARKETABLE SECURITIES Is there a regular investment in marketable securities? Is there a change in classification of securities? If yes, what is the reason for the change? Is there a ready market for the securities?

81 Copyright © 2014 South-Western/Cengage Learning 10-81 CONTROL RISK ANALYSIS QUESTIONNAIRE - MARKETABLE SECURITIES Are the written policies and guidelines approved by the board? Is there a clear policy for classification of marketable securities? If classification has changed, are the amounts significant and reviewed by audit committee?

82 Copyright © 2014 South-Western/Cengage Learning 10-82 CONTROL RISK ANALYSIS QUESTIONNAIRE - MARKETABLE SECURITIES How is value of marketable securities estimated if a liquid market does not exist? Is there an effective segregation of duties? Is there a regular audit of the controls and review of recent reports?

83 Copyright © 2014 South-Western/Cengage Learning 10-83 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

84 Copyright © 2014 South-Western/Cengage Learning 10-84 ANALYTICAL PROCEDURES FOR MARKETABLE SECURITIES Developing expectations about level of amounts in ending balances Based on purchase or sales activity reported Developing expectations about relationship between balances in marketable securities accounts Reviewing changes in: Balances Risk composition Classification types of marketable securities

85 Copyright © 2014 South-Western/Cengage Learning 10-85 TESTS OF CONTROLS Reviewing policies for authorization To purchase, sell, and manage such securities Inquiring of board of directors 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

86 Copyright © 2014 South-Western/Cengage Learning 10-86 TESTS OF CONTROLS Examining evidence of authorization controls For changes in classification of such securities Inquiring of management about its process for Establishing valuation Reviewing related documentation Inquiring about process for reclassifications and review related documentation

87 Copyright © 2014 South-Western/Cengage Learning 10-87 TESTS OF CONTROLS Examining documentation for selected marketable securities transactions Reviewing reports of internal audit

88 Copyright © 2014 South-Western/Cengage Learning 10-88 ASSERTIONS AND RELATED SUBSTANTIVE TESTS OF DETAILS - MARKETABLE SECURITIES Requesting for a schedule of securities and verifying their existence Existence or occurrence Footing schedule of marketable securities and examining them Completeness Examining selected documents to determine any restrictions Rights and obligations Determining current market value Re-computing interest and proper recording of accrued interest Valuation or allocation Determining whether securities are properly classified Presentation and disclosure

89 Copyright © 2014 South-Western/Cengage Learning 10-89 EXHIBIT 10.15 - AUDIT WORKPAPER FOR TESTING MARKETABLE EQUITY SECURITIES

90 Copyright © 2014 South-Western/Cengage Learning 10-90 AUDITING IN PRACTICE - AUDIT PROCEDURES USED TO ADDRESS RISK RELATED TO COMMON FRAUD SCHEMES FOR INVESTMENTS Employing specialist to assist in fair value measurements Conducting background checks of employees having access to investment accounts Requiring original documents of securities Tracing: Dividend payments Interest payments Sales of securities

91 Copyright © 2014 South-Western/Cengage Learning 10-91 AUDITING IN PRACTICE - AUDIT PROCEDURES USED TO ADDRESS RISK RELATED TO COMMON FRAUD SCHEMES FOR INVESTMENTS Tracing purchases of securities to cash disbursements on the bank statement Reviewing any unusual journal entries in investment accounts

92 Copyright © 2014 South-Western/Cengage Learning 10-92 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

93 Copyright © 2014 South-Western/Cengage Learning 10-93 DOCUMENTATION RELATED TO SUBSTANTIVE PROCEDURES FOR MARKETABLE SECURITIES Reports of any outside valuation experts Documentation of calculation of potential impairments


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