1. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-1

2. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-2 Part Five AUDITING BUSINESS PROCESSES

3. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-3 Chapter 16 CHAPTER 16 AUDITING CASH AND INVESTMENTS

4. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-4 CASH AND THE EFFECT OF OTHER BUSINESS PROCESSES Cash represents currency on hand and cash on deposit in bank accounts including certificates of deposit, time deposits, and savings accounts. Virtually all accounting transactions pass through the cash account as part of their "cradle-to-grave" cycle and thus cash is affected by the entity's other business processes. Figure 16-1 shows the effect that each major business process has on the cash account.

5. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-5 TYPES OF BANK ACCOUNTS General cash account Imprest accounts Branch accounts

6. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-6 SUBSTANTIVE TESTS OF TRANSACTIONS - CASH Table 16-1 contains examples of substantive tests of transactions for both cash receipts and cash disbursements. On most audits, the substantive tests of transactions for cash receipts and cash disbursements are conducted with the tests of controls for the revenue and purchasing processes, respectively.

7. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-7 ANALYTICAL PROCEDURES - CASH Because of its residual nature, cash does not have a predictable relationship with other financial statement accounts, thus the use of analytical procedures is limited. This limited use of analytical procedures is normally offset by (1) extensive tests of controls and/or substantive tests of transactions for cash receipts and cash disbursements or (2) extensive tests of the entity's bank reconciliations.

8. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-8 TESTS OF ACCOUNT BALANCES - CASH The reliability of the client's control procedures over cash receipts and cash disbursements affects the nature and extent of the auditor's substantive tests of cash balances. A major internal control procedure that directly affects the audit of cash is the completion of a monthly bank reconciliation by client personnel who are independent of handling and recording cash receipts and cash disbursements.

9. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-9 AUDIT OBJECTIVES - CASH Table 16-2 summarizes the audit objectives and tests of account balances for cash accounts. The major audit procedures for each cash account involve tests of the bank reconciliation.

10. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-10 AUDITING THE GENERAL CASH ACCOUNT The main source of evidence for the validity, completeness, mechanical accuracy, and valuation objectives is the audit work completed on the bank reconciliation. The following documents are obtained : A copy of the bank reconciliation. A standard bank confirmation. A cutoff bank statement. Review Exhibit 16-1.

11. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-11 FRAUD-RELATED AUDIT PROCEDURES Extended bank reconciliation procedures. Proof of cash (see Exhibit 16-3). Tests for kiting (see Exhibit 16-4).

12. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-12 AUDITING A PAYROLL OR BRANCH IMPREST ACCOUNT The audit of any imprest cash account such as payroll or a branch account follows the same basic audit steps discussed under the audit of the general cash account except the testing is less extensive.

13. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-13 AUDITING A PETTY CASH FUND Control procedures. Audit tests.

14. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-14 SAMPLE DISCLOSURE ITEMS FOR CASH Policy for defining cash and cash equivalents. Any restrictions on cash such as a sinking fund requirement for funds allocated by the entity's board of directors for special purposes. Contractual obligations to maintain compensating balances. Cash balances restricted by foreign exchange controls. Letters of credit.

15. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-15 INVESTMENTS Entities frequently invest their excess cash in securities of other entities (e.g., equity securities such as common and preferred stock, debt securities such as notes and bonds, and hybrid securities such as convertible bonds and stocks). The accounting for such instruments is affected by factors such as the percentage of the other entity owned, the degree of influence exercised over the entity, the classification of the investment as a current or noncurrent asset, and other factors.

16. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-16 CONTROL RISK ASSESSMENT - INVESTMENTS The auditor must have a reasonable understanding of internal control over investments so that the types of misstatements that may occur can be anticipated in order to plan the substantive tests. The main internal control objectives that are of concern to the auditor are validity, authorization, completeness, valuation and classification.

17. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-17 VALUING DEBT AND EQUITY SECURITIES FASB No. 115, "Accounting for Certain Investments in Debt and Equity Securities" classifies investments into three categories: Held-to-maturity securities that are reported at amortized cost. Trading securities that are reported at fair value, with unrealized gains and losses included in earnings. Available-for-sale that are reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity.

18. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-18 SEGREGATION OF DUTIES - INVESTMENTS The initiation function should be segregated from the final approval function. The valuation-monitoring function should be segregated from the acquisition function. Responsibility for maintaining the securities ledger should be separated from that of making entries in the general ledger. Responsibility for custody of the securities should be separated from that of accounting for the securities.

19. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-19 SUBSTANTIVE TESTS OF INVESTMENTS It is generally more efficient to follow a substantive strategy for auditing investments. Because of the nature of the audit work, substantive tests of transactions are seldom used as a source of evidence.

20. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-20 ANALYTICAL PROCEDURES - INVESTMENTS Comparison of the balances in the current year’s investment accounts with prior years' balances after consideration of the effects of current year operating and financing activities on cash and investments. Comparison of current-year interest and dividend income with reported income for prior years and with the expected return on investments.

21. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-21 SUBSTANTIVE TESTS OF INVESTMENTS Table 16-5 summarizes the tests of investment account balances for each audit objective.

22. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 16-22 Chapter 16 CHAPTER 16 AUDITING CASH AND INVESTMENTS