Presentation on theme: "CHAPTER 18 AUDITING INVESTMENTS AND CASH BALANCES Spring 2007"— Presentation transcript:
1CHAPTER 18 AUDITING INVESTMENTS AND CASH BALANCES Spring 2007
2Overview of Investments Investing in marketable securities interfaces with 2 other cycles:1. Dividends and interest received on investments - revenue cycle.2. Purchases of securities - expenditure cycle.
3ST and LT Investments: Transactions and Accounts Income StatementDividend revenueInterest revenueRealized gains/losses on securitiesUnrealized gains/losses on trading securitiesEquity in equity investee’s N/SBalance SheetTrading SecuritiesAFS SecuritiesHTM SecuritiesCumm. Unrealized holding gains/losses on AFS securities (equity)Equity Investments
4Investments General Audit Strategy Assess Inherent RiskUse Knowledge of Business and Industry to Perform Analytic Procedures and Assess Analytic Procedures RiskAssess Control RiskEvidence of effectiveness gained while obtaining an understanding of internal controlsEvidence of effectiveness of management controlsEvidence of effectiveness from direct tests of programmed controlsDesign Appropriate Substantive Tests of DetailsRecall that within this general strategy, the relative emphasis placed on the different types of tests can change.Low IR, emphasis on APEmphasis on CR --Emphasis on Substantive testsThis is the same for all cycles!!!!!!
5Investments Initial Audit Procedures: IR factors Company policy on risk of investmentsVolume of investing transactions generally lowAccounting for investments can become complexProper classification of an investment may be contentious (i.e., AFS vs. Trading)How material are investments?Short term solvency of entityEffect of changes in market value (unrealized gain/loss)Effect of income from investments
6Investments Initial Audit Procedures Analytical ProceduresTremendous variation of investments even within an industry – dependent on what they are invested inAnalytical procedurescurrent-year and prior-year balancesactual results for the amount of investments and investment income with budgets or other documentation of management’s plansReturn on investment by category compared to other similar investment funds
8Investments Audit Objectives AssertionCompletenessExistence & OccurrenceValuationRights and ObligationsPresentation and DisclosureSpecific Audit ObjectiveCompletenessCutoff / TimelinessValidityValuation at Historical Cost / GAAPValuation at Net Realizable ValuePosting and SummarizationOwnershipClassificationDisclosure
9Investments: Understand Internal Controls Control environmentAssignment of authority & responsibility to company officerUse of appropriate 3rd partiesManagement Risk AssessmentHow management considers fluctuations in market valuesImpact of investments on cash flow requirementsActively manage risks associated with investments in accordance with objectives of board
10Investments: Understand Internal Controls Information SystemDocumentsStock certificatesBond certificatesBond indentureBroker’s adviceBroker’s statementF/S of equity investmentsFilesInvestment subsidiary ledgerGeneral journal (accrual of bond interest, revenue, market adjustments under FV method, and income earned under equity method)CRJ (record proceeds from sales, receipt of interest and dividends)Voucher and check registers (purchasing and paying for securities)
11Investments: Understand Internal Controls Authorize Investment TransactionPurchases in accordance w/ mgmt authorizationSales in accordance w/ mgmt authorizationReceive or deliver securitiesSecurities held by broker or physically secure locationPeriodic income subject to cash receipts controlsRecord transactionsAppropriate supporting documentation and segregation of dutiesMkt adjustments periodically analyzed and adjusted
12Investments: Understand Internal Controls Settle transactionsCash receipts from sales subject to normal cash receipts proceduresCash disbursements for purchases subject to normal cash disb proceduresIndependent reconciliation of brokers advice and stmts with investment subsidiary ledgersAssess investment performance and reportingMgmt periodically reviews performance and classification of investmentsPeriodic BOD review of investments and policies
13Investments: Determining Detection Risk Determine detection risk for each audit objective based on audit risk model after assessing:Inherent riskControl riskRisk that analytic procedures would fail to detect material misstatements.Need to combine assessments w/ those for cash disb and cash receipts
14Investments: Determining Detection Risk When assessing detection risk:It is difficult to design effective controls for fair value accounting adjustments andThe proper classification of investments often means that low acceptable levels of detection risk for tests of details are usually specified for the valuation or allocation and presentation and disclosure assertions.
15Investments: Standard Substantive Tests Initial proceduresAgree beginning balance to prior year workpapersReview activity in investment-related accounts for entries that are unusual in nature or amountTest client-prepared schedules of activity (rollforward) in all investments, for mathematical accuracy and agreement with the underlying accounting records.Determine that schedules and subsidiary investment ledgers agree with related GL control account balances.These schedules are the basis for add’l substantive tests.Analytical ProceduresRollforward:Beg Bal + purchases – sales + other adjustments = Ending BalTest each piece of it to get comfort.
16Investments: Standard Substantive Tests Test of Details of TransactionsGenerally effective when low volume of transactions.Standard substantive tests in this category are:1. Inspect and count securities on hand2. Confirm securities held by others3. Vouch the individual debits and credits in the various investment accounts (sample basis usually)Fair value method: Verify year-end market price of securitiesEquity method: DR to documentation of investor’s share of the investee’s earnings. CR to documentation of dividends received from investees or worksheets calculating periodic amortization of the excess of cost over underlying book value.4. Recalculate investment revenue earned
17Investments: Standard Substantive Tests Test of Details of Balances: Accounting EstimatesWhen auditing investments, the auditor must apply significant audit judgment with respect to evaluating:the proper classification of investments andTrading unrealized gain/loss => I/SAFS unrealized gain/loss => Equity2. the fair value of investments.
18Auditing Cash Balances Understanding auditing cash balancesRelationship of Cash Balances to Trans. Cycles (fig 18-4)Revenue cycles increases cashExpenditure cycle decreases cashPersonnel services cycle decreases cashProduction cycle doesn’t directly affect cashFinancing and investing cycles both increase and decrease cashCash balances may not be material, but the volume of transactions through the account almost always is – additionally, higher inherent risk of fraud
20Cash Initial Procedures Inherent RiskHigh volume of transactions poses risk particularly for existence and completeness.Nature of cash balances susceptible to theftRisks pertaining to the rights and obligations, valuation or allocation, and presentation and disclosure minimal due to the absence of complexities involving rights, accounting measurements, estimates, and disclosures.Analytical ProceduresOften can be less helpful except for comparisons of actual to budget
21Cash Balance Control Risk Cash receipts and disbursements:Routine transactions => good controls (normally) => assess control risk at a low level.
22Cash Balance Detection Risk Inherent risk is normally high due to the susceptibility of cash to misappropriation.
23Cash Balances: Standard Substantive Tests Initial proceduresAgree beginning balance to prior year workpapersReview the G/L for large or unusual transactions. Often this includes the use of GASAnalytical proceduresConsider reliability
24Cash Balances: Standard Substantive Tests Tests of Details of Transactions1. Performing cash cut-off tests2. Tracing bank transfersTest of Details of Balances1. counting cash on hand,2. confirming bank deposit and loan balances,3. confirming other arrangements with banks,4. scanning, reviewing, or preparing bank reconciliations, and5. obtaining and using bank cutoff statements.
25Cash Balances: Standard Substantive Tests How to audit bank reconciliationsBalance per bank+ Deposits in transit- Outstanding checks= Adjusted balance per bookUnadjusted balance per book+ Bank originated adjustments- Service charges
26Cash Balances: Fraud consideration Lapping to misappropriate cash receiptsTests to detect lapping are only performed when control risk for cash receipts transactions is moderate or high. There are 3 procedures that should detect lapping:1. confirm accounts receivable,2. make a surprise cash count, and3. compare details of cash receipts journal entries with the details of corresponding daily deposit slipsCash theft covered up by applying AR collections to unrelated accounts. Cash accountant should not also be AR accountant.