Auditing principals and procedures ( ACCT401)

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Question 1 Ch13

Question 2 & 3 Ch14

Question 4 Ch16

College of Administration and Finance Sciences
Assignment (2)
Deadline: Saturday 23/11/2024 @ 23:59
Course Name: Auditing principals and
procedures
Student’s Name:
Course Code: ACCT 401
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Semester: 1st
CRN:
Academic Year: 1446 H
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/15
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College of Administration and Finance Sciences
Assignment Question(s):
(Marks 15)
Q1. Identidy the first three steps that the auditor should follow while
observing the physical inventory count. (3 Points)
Answer:
Q2. What are factors considered in assessing control risk for intangible asset?
(5 Points)
Answer:
College of Administration and Finance Sciences
Q3.Identidy the three major types of transactions that occur in stockholders
equity. (3 Points)
Answer:
Q4. Identify audit procedures to test the bank reconciliation. (4 points)
Answer:
Chapter 13
Auditing the
Inventory
Management
Process
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO# 1
Overview of the Inventory
Management Process
Purchasing
process
• Purchase of
raw materials
• Payment of
manufacturing
overhead
Inventory
management
process
Human resource
management
process
Revenue
process
• Sale of
goods
• Assignment of
direct and indirect
labor costs
13-2
LO# 2
Types of Documents and Records
1. Production Schedule – Based on the expected demand for the
entity’s products.
2. Receiving Report – Records the receipt of goods from vendors.
3. Materials Requisition – Used to track materials during the
production process.
4. Inventory Master File – Contains all the important information
related to the entity’s inventory, including the perpetual inventory
records.
Production
Schedule
Inventory
Master
File
13-3
LO# 2
Types of Documents and Records
5. Production Data Information – Contains information about the
transfer of goods and related cost accumulation at each stage
of production.
6. Cost Accumulation and Variance Report – Material, labor, and
overhead costs are charged to inventory as part of the
manufacturing process. The variance report compares actual
costs to standard or budgeted costs.
7. Inventory Status Report – Shows the type and amount of
products on hand.
8. Shipping Order – Used to remove goods from the perpetual
inventory records.
Shipping
Order
13-4
LO# 3
The Major Functions
Functions in the Inventory Management Process
Inventory management
Raw materials stores
Manufacturing
Finished goods stores
Cost accounting
General ledger
Authorization of production activity and maintenance of
inventory at appropriate levels; issuance of purchase
requisitions to the purchasing department.
Custody of raw materials and issuance of raw materials to
manufacturing departments.
Production of goods.
Custody of finished goods and issuance of goods to the
shipping department.
Maintenance of the costs of manufacturing and inventory in
cost records.
Proper accumulation, classification, and summarization of
inventory and related costs in the general ledger.
13-5
LO# 4
Key Segregation of Duties
Segregation of Duties
The inventory management function
should be segregated from the costaccounting function.
The inventory stores function should
be segregated from the costaccounting function.
The cost-accounting function should
be segregated from the general
ledger function.
The responsibility for supervising
physical inventory should be
separated from the inventory
management and inventory stores
functions.
Possible Errors or Fraud
If the individual responsible for inventory management
also has access to the cost-accounting records,
production and inventory costs can be manipulated.
This may lead to an over- or understatement of
inventory and net income.
If one individual is responsible for both controlling and
accounting for inventory, unauthorized shipments can
be made or theft of goods can be covered up.
If one individual is responsible for the inventory
records and also for the general ledger, it is possible for
that individual to conceal unauthorized shipments. This
can result in the theft of goods, leading to an
overstatement of inventory.
If the individual responsible for production
management or inventory stores functions is also
responsible for the physical inventory, it is possible that
inventory records to the physical inventory, resulting in
an overstatement of inventory.
13-6
LO# 4
Key Segregation of Duties
Segregation of duties is a particularly important control
in the inventory management process because of the
potential for theft and fraud.
13-7
LO# 5
Inherent Risk Assessment
The auditor should consider industry-related factors
and operating and engagement characteristics
when assessing the possibility of a material
misstatement.
If industry competition is intense,
there may be problems with the
proper valuation of inventory.
Technology changes in certain
industries may also promote
material misstatement due to
obsolescence.
Products that are small and of
high value are more susceptible
to theft. The auditor must be
alert to related-party transactions
for acquiring raw materials and
selling finished products. Prior-year
misstatements are good indicators
of potential misstatements in the
current year.
13-8
LO# 6
Control Risk Assessment
Major steps in setting the control risk in the
inventory management process.
Understand and document the inventory
management process based on a reliance strategy.
Plan and perform tests of controls on inventory
transactions.
Set and document the control risk for the inventory
management process.
13-9
LO# 7
Control Activities and Tests of
Controls – Inventory Transactions
13-10
LO# 7
Control Activities and Tests of
Controls – Inventory Transactions
Occurrence of Inventory Transactions
The auditor’s main concern is that all recorded
inventory exists. The auditor should also be
concerned that goods may be stolen. Review and
observation are the main tests of controls used by
the auditor to test the control procedures.
13-11
LO# 7
Control Activities and Tests of
Controls – Inventory Transactions
Completeness of Inventory Transactions
The primary control procedure for completeness
relates to recording inventory that has been
received. Controls are closely related to the
purchasing process.
13-12
LO# 7
Control Activities and Tests of
Controls – Inventory Transactions
Authorization of Inventory Transactions
The auditor’s concern with authorization in the
inventory system is with unauthorized purchase or
production activity that may lead to excess levels of
certain types of finished goods.
13-13
LO# 7
Control Activities and Tests of
Controls – Inventory Transactions
Accuracy of Inventory Transactions
Inventory transactions that are not properly recorded
result in misstatements that directly affect the
amounts reported in the financial statements.
Inventory purchases must be recorded at the correct
price and actual quantity received. Inventory
shipped must be properly recorded in cost of goods
sold and the related revenue recognized.
13-14
LO# 7
Control Activities and Tests of
Controls – Inventory Transactions
Cutoff of Inventory Transactions
Inventory transactions recorded in the improper
period could affect a number of accounts, including
inventory, purchases, and cost of goods sold.
13-15
LO# 7
Control Activities and Tests of
Controls – Inventory Transactions
Classification of Inventory Transactions
The entity must have control procedures to ensure
that inventory is properly classified as raw materials,
work in process, or finished goods. By knowing
which manufacturing department holds the
inventory, the auditor is able to classify it by type.
13-16
LO# 8
Auditing Inventory
Assertions about Classes of Transactions and Events:
Occurrence . Inventory transactions and events are valid.
Completeness . All inventory transactions and events have been
recorded.
Authorization . All inventory transactions and events are properly
authorized.
Accuracy . Inventory transactions have been properly computed and
recorded.
Cutoff . Inventory receipts and shipments are recorded in the correct
accounting period.
Classification. Inventory is recorded in the proper accounts.
13-17
LO# 8
Auditing Inventory
Assertions about Account Balances at the Period End:
Existence. Inventory recorded on the books and records
actually exists.
Rights and obligations. The entity has the legal right to the
recorded inventory.
Completeness. All inventory is recorded.
Valuation and allocation. Inventory is properly recorded in
accordance with GAAP (e.g., lower of cost or market).
13-18
LO# 8
Auditing Inventory
Assertions about Presentation and Disclosure:
Occurrence and rights and obligations. All disclosed events,
transactions, and other matters relating to inventory have occurred and pertain
to the entity.
Completeness. All disclosures relating to inventory that should have been
included in the financial statements have been included.
Classification and understandability. Financial information relating to
inventory is appropriately presented and described, and disclosures are clearly
expressed.
Accuracy and valuation. Financial and other information relating to
inventory are disclosed fairly and in appropriate amounts.
13-19
LO# 9
Substantive Analytical
Procedures
Substantive Analytical Procedure
Possible Misstatement Detected
Compare raw material, finished goods, and total inventory
Obsolete, slow-moving, or excess inventory
turnover to previous years’ and industry averages.
Compare days outstanding in inventory to previous years’ Obsolete, slow-moving, or excess inventory
and industry average.
Compare gross profit percentage by product line with
Unrecorded or fictitious inventory
previous years’ and industry data.
Compare actual cost of goods sold to budgeted amounts. Over- or understated inventory
Compare current-year standard costs with prior years’ after
Over- or understated inventory
considering current conditions.
Compare actual manufacturing overhead costs with
Inclusion or exclusion of overhead costs
budgeted or standard overhead costs.
13-20
LO# 10
Auditing Standard Costs
Materials
Test the quantity and
type of materials
included in the product
and the price of the
materials.
Labor
Gather evidence about
the type and amount of
labor needed for
production and the labor
rate.
Overhead
Review the entity’s method of
overhead allocation for
reasonableness, compliance
with GAAP, and consistency.
13-21
LO# 11
Observing Physical Inventory
During the observation of the physical inventory
count, the auditor should do the following:
1. Ensure that no production is scheduled. If production is scheduled
proper controls must be established for movement between
departments in order to prevent double counting.
2. Ensure that there is no movement of goods during the inventory
count.
3. Make sure that the entity’s count teams are following the inventory
count instructions.
4. Ensure that inventory tags are issued sequentially to individual
departments.
13-22
LO# 11
Observing Physical Inventory
5. Perform test counts and record a sample of counts in the working
papers.
6. Obtain tag control information for testing the entity’s inventory
compilation.
7. Obtain cutoff information, including the number of the last shipping
and receiving documents issued.
8. Observe the condition of the inventory for items that may be obsolete,
slow moving, or carried in excess quantities.
9. Inquire about goods held on consignment for others or held on a “billand-hold” basis.
13-23
LO# 12
Tests of Details of Transactions
Substantive Tests of Transactions
Occurrence. Vouch a sample of inventory additions to receiving
reports and purchase requisitions.
Completeness. Trace a sample of receiving reports to the
inventory records.
Authorization. Test a sample of inventory shipments to ensure
there is an approved shipping ticket and customer sales.
Accuracy. Recompute the mathematical accuracy of a sample
of inventory transactions. Audit standard costs or other methods
used to price inventory.
Cutoff. Trace a sample of time cards before and after period end
to the appropriate weekly inventory report.
Classification. Examine a sample of inventory checks for
proper classification into expense accounts.
13-24
LO# 12
Tests of Details of Account
Balances
Test of Details of Account Balances
Existence. Observe count of physical inventory.
Rights and obligations. Verify that inventory held on
consignment for others or “bill-and-hold” goods are not included
in inventory.
Completeness. Trace test counts and tag control information to
the inventory compilation.
Valuation and allocation. Obtain a copy of the inventory
compilation and agree totals to general ledger. Test
mathematical accuracy of extensions and foot the inventory
compilation. Inquire of management concerning obsolete, slowmoving, or excess inventory. Review book-to-physical adjustment
for possible misstatements.
13-25
LO# 12
Tests of Details of Disclosures
Tests of Details of Disclosures
Occurrence and rights and obligations. Inquire of
management and review any loan agreements and board of directors’
minutes for any indication that inventory has been pledged or
assigned. Inquire of management about issues related to warranty
obligations.
Completeness. Complete financial reporting checklist to ensure
that all financial statement disclosures related to inventory are made.
Classification and understandability. Review inventory
compilation for proper classification among raw materials, work in
process, and finished goods. Read footnotes to ensure that required
disclosures are understandable.
Accuracy and valuation. Determine if the cost method is
accurately disclosed. Inquire of management about issues related to
LIFO liquidations. Read footnotes and other information to ensure that
the information is accurate and properly presented at the appropriate
amounts.
13-26
LO# 12
Tests of Details of Transactions,
Account Balances, and Disclosures
Possible causes of book-to-physical differences:
1. Inventory cutoff errors.
2. Unreported scrap or spoilage.
3. Pilferage or theft.
13-27
LO# 12
Tests of Details of Transactions,
Account Balances, and Disclosures
Examples of Disclosure Items:
1. Cost method (FIFO, LIFO, retail method).
2. Components of inventory.
3. Long-term purchase contracts.
4. Consigned inventory.
5. Purchases from related parties.
6. LIFO liquidations.
7. Pledged or assigned inventory.
8. Disclosure of unusual losses from write-downs
or losses on long-term purchase commitments.
9. Warranty obligations.
13-28
LO# 13
Evaluating the Audit Findings Inventory
At the conclusion of testing, the auditor should
aggregate all identified misstatements. The likely
misstatement is compared to the tolerable
misstatement allocated to the inventory account.
Likely misstatement < Tolerable misstatement The auditor may accept the inventory account as fairly presented. Likely misstatement > Tolerable misstatement
The auditor must conclude the inventory is not fairly presented.
13-29
End of Chapter 13
13-30
Chapter 14
Auditing the
Financing/Investing
Process: Prepaid
Expenses,
Intangible Assets,
and Property, Plant,
and Equipment
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO# 1
Auditing Prepaid Expenses
Other assets that provide economic benefit for
less than a year are classified as current
assets.
Prepaid expenses are a common other asset.
Examples include:
1. Prepaid insurance.
2. Prepaid rent.
3. Prepaid interest.
14-2
LO# 1
Inherent Risk Assessment –
Prepaid Expenses
The inherent risk associated with prepaid expenses
is generally assessed as low because the accounts
do not involve any complex or contentious
accounting issues.
14-3
LO# 1
Control Risk Assessment – Prepaid
Expenses
Because prepaid expenses are normally processed
through the purchasing process, control procedures
in purchasing should ensure that each item is
properly authorized and recorded.
14-4
LO# 2
Substantive Procedures – Prepaid
Insurance
Tests of Details of the Prepaid Insurance Account
Audit testing begins by obtaining a detailed
schedule of the prepaid insurance account.
Existence and
Completeness
Confirm policy with
insurance broker,
examine supporting
source documents.
Rights and
Obligations
Confirm policy
beneficiary with
the insurance broker.
Valuation
Determine unexpired
portion of policy and
insurance expense.
Classification
Determine propriety of distribution between
manufacturing overhead and SG&A expense.
14-5
LO#
1&2
Auditing Intangible Assets
Intangible assets are assets that provide economic
benefit for longer than a year, but lack physical
substance. The following list includes examples of
five general categories of intangible assets:
1. Marketing – trademark, brand name, and Internet
domain names.
2. Customer – customer lists, order backlogs, and
customer relationships.
3. Artistic – items protected by copyright.
4. Contract – licenses, franchises, and broadcast rights.
5. Technology – patented and unpatented technology.
14-6
LO#
1&2
Inherent Risk Assessment –
Intangible Assets
The inherent risk associated with intangible assets raises
serious risk considerations.
The accounting rules are complex and the transactions are
difficult to audit.
Accounting standards require different asset impairment
tests for different classes of intangible assets (FASB ASC
Topic 350).
With the judgment and complexity associated with
valuation and estimation of intangible assets, the auditor
would likely assess the inherent risk as high.
14-7
Control Risk Assessment –
Intangible Assets
LO#
1&2
In assessing control risk, the auditor considers factors such as:
1. The expertise and experience of those determining the fair value of the
assets.
2. Controls over the process used to determine fair value measurements,
including controls over data and segregation of duties between those
committing the entity to the purchase and those undertaking the valuation.
3. The extent to which the entity engages or employs valuation specialists.
4. The significant management assumptions used in determining fair value.
5. The integrity of change controls and security procedures for valuation
models and relevant information systems, including approval processes.
14-8
Substantive Procedures –
Intangible Assets
LO# 2
Tests of Details of Intangible Assets
Tests of details associated with valuation and impairment of intangible
assets are often necessary because the complexity and degree of
judgment increase the risk of material misstatement.
Some substantive evidence is required for all significant accounts, and, as
noted above, substantive analytical procedures are not likely to provide
sufficient, appropriate evidence for significant transactions involving
intangible assets.
Four assertions are normally considered for tests of details of intangible
assets:
1. Existence and completeness.
2. Valuation.
3. Rights and obligations.
4. Classification.
14-9
LO# 3
Auditing the Property Management
Process
Property, plant, and equipment usually represents a
material amount in the financial statements.
Recurring Engagement
New Engagement
The auditor is able to focus
on additions and retirements
in the current period because
amounts from prior periods have
been subject to audit procedures.
The auditor has to verify the
assets that make up the
beginning balance in property,
plant, and equipment.
14-10
LO# 4
Types of Transactions
Four types of PP&E transactions may occur:
1. Acquisition of capital assets for cash or
nonmonetary considerations.
2. Disposition of capital assets through sale,
exchange, retirement, or abandonment.
3. Depreciation of capital assets over their useful
economic life.
4. Leasing of capital assets.
14-11
Property Management Process
at EarthWear Clothiers
Physical Plant
IT Department
From
purchasing
process
PP&E
transaction
file
Specialized
PP&E
transactions
LO# 4
PP&E
master
file
PP&E
program
Input
General
ledger
master file
General
ledger
program
General
ledger
report
PP&E
transaction
report
Review for
proper
recording
Reconcile to
general ledger
Monthly
PP&E
subledger
14-12
LO# 5
Inherent Risk Assessment –
Property Management Process
There are three inherent risk factors that must be
considered by the auditor.
Complex
accounting
issues.
Difficult-to-audit
transactions.
Misstatements
detected in
prior audits.
14-13
Inherent Risk Assessment –
Property Management Process
LO# 5
Complex Accounting Issues
Lease accounting, self-constructed assets, and
interest capitalization are examples of some of the
complex accounting issues faced by auditors.
14-14
Inherent Risk Assessment –
Property Management Process
LO# 5
Difficult-to-Audit Transactions
When assets are purchased directly from a vendor,
the transaction is relatively easy to audit. However,
transactions involving donated assets, nonmonetary
exchanges, and self-constructed assets are more
difficult to audit.
14-15
Inherent Risk Assessment –
Property Management Process
LO# 5
Misstatements Detected in Prior Audits
If misstatements in prior audits have been
detected, the auditor should set inherent risk
higher than if few or no misstatements
have been found in the past.
14-16
Control Risk Assessment –
Property Management Process
LO# 6
Occurrence and Authorization
Control procedures for the occurrence and authorization
of property, plant, and equipment are normally part of the
purchasing process.
However, large capital asset transactions may be subject
to additional controls.
Companies should have an authorization table for
approving capital asset transactions.
Assets no longer in use.
14-17
LO# 6
Control Risk Assessment –
Property Management Process
Completeness
The detailed property, plant, and equipment
subsidiary ledger usually includes the following
information for each capital asset:
1. Description, location, and ID number.
2. Date of acquisition and installed cost.
3. Depreciation methods for book and tax purposes,
salvage value, and estimated useful life.
14-18
Control Risk Assessment –
Property Management Process
LO# 7
Key Segregation of Duties and Possible Errors
14-19
LO# 8
Substantive Analytical Procedures
– Property, Plant, and Equipment
The following substantive analytical procedures
can be used in the audit of PP&E:
1. Compare prior-year balances in PP&E and depreciation
expense with current-year balances.
2. Compute the ratio of depreciation expense to the related
PP&E accounts and compare to prior years’ ratios.
3. Compute the ratio of repairs and maintenance expense
to the related PP&E accounts and compare to prior
years’ ratios.
4. Compute the ratio of insurance expense to related PP&E
accounts and compare to prior years’ ratios.
5. Review capital budgets and compare the amounts spent
with amounts budgeted.
14-20
LO# 9
Tests of Details of Transactions and
Account Balances and Disclosures
Completeness and Accuracy
The auditor begins the process by obtaining a lead
schedule and detailed schedules of additions and
dispositions of assets.
These schedules are footed and agreed to the
general ledger.
The auditor can trace a sample of assets to the
property, plant, and equipment subsidiary ledger.
14-21
LO# 9
Tests of Details of Transactions and
Account Balances and Disclosures
Cutoff
Cutoff is normally part of the accounts payable and
accrued expenses work. Vendor’s invoices from a
few days before and after year-end are examined to
determine if the assets are recorded in the proper
accounting period.
14-22
LO# 9
Tests of Details of Transactions and
Account Balances and Disclosures
Classification
First, the auditor must determine that the capital
asset is recorded in the proper account.
Second, the repairs and maintenance account
should be reviewed to determine if any capital assets
have been incorrectly recorded in these accounts.
Finally, each material lease agreement should be
reviewed for proper classification as operating or
capital lease.
14-23
LO# 9
Tests of Details of Transactions and
Account Balances and Disclosures
Existence
A list of all major additions should be obtained and
each addition should be vouched to supporting
documentation. For major acquisitions, the auditor
may physically examine the capital asset. This is
often done during the inventory observation. Major
dispositions should be vouched to supporting
documentation.
14-24
LO# 9
Tests of Details of Transactions and
Account Balances and Disclosures
Rights and Obligations
In most cases, rights or ownership can be
determined by examining vendor’s invoices and
other supporting documents. In some cases, the
auditor may wish to confirm property deeds or title
documentation.
14-25
LO# 9
Tests of Details of Transactions and
Account Balances and Disclosures
Valuation and Allocation
Capital assets are valued at
acquisition cost plus any costs
necessary to make the asset
operational. The auditor tests
the recorded cost of major new
additions to PP&E.
The auditor may
recompute, either
manually or with the aid
of a computer, the proper
depreciation expense for
the period.
The auditor must test for permanent impairment of long-lived
assets. While GAAP requires the comparison of future cash
inflows to the asset’s carrying amount, this process can be
quite difficult. Auditors may look to other sources of
information to learn about impairments.
14-26
LO# 9
Tests of Details of Transactions and
Account Balances and Disclosures
Disclosure Issues
Examples of disclosure items:
1. Classes of capital assets and valuation bases.
2. Depreciation methods and useful lives for financial reporting and tax
purposes.
3. Nonoperating assets.
4. Construction or purchase commitments.
5. Liens and mortgages.
6. Acquisition or disposal of major operating facilities.
7. Capitalized and other lease arrangements.
14-27
LO# 10
Evaluating the Audit Findings
Property, Plant, and Equipment
The auditor aggregates the likely misstatements and
compares this amount to the tolerable misstatement.
If the aggregate misstatement is less than
the tolerable misstatement, the evidence indicates
that the PP&E accounts are not materially misstated.
If the aggregate misstatement is greater than the
tolerable misstatement, the auditor would either require
adjustment of the accounts or issue a qualified audit report.
14-28
End of Chapter 14
14-29
Chapter 16
Auditing the
Financing/Investing
Process: Cash and
Investments
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
LO# 1
Cash and Cash Equivalents
“Cash” reported in the financial statements
represents currency on hand and cash on deposit
in bank accounts, including certificates of deposit,
time deposits, and savings accounts.
“Cash equivalents” are frequently combined with
cash for presentation in the financial statements.
Definition: Short-term, highly liquid investments
that are readily convertible to cash or so near their
maturity that there is little risk of change in their
value.
Examples: Treasury bills and money market funds.
16-2
LO# 1
Cash and the Effect of Major Accounting
Transactions/Business Processes
16-3
LO# 2
Types of Bank Accounts
Types of Bank
Accounts
General Cash
Account
Imprest Cash
Accounts
Branch
Accounts
In order to optimize its cash flow, an entity implements
procedures for accelerating the collection of cash
receipts and delaying the payment of cash
disbursements, to the extent delay is appropriate.
16-4
LO# 2
The Effects of Controls
Controls for
Cash
Disbursements
Controls for
Cash Receipts
The reliability of the entity’s
controls over cash affects
the nature and extent of the
auditor’s tests of details.
Completion of
Monthly Bank
Reconciliation
16-5
Substantive Analytical
Procedures—Cash
LO# 3&4
Because of the residual nature of
the cash account, the auditor’s
use of substantive analytical
procedures for auditing cash is
limited to . . .
comparisons with
prior years’ cash
balances.
comparisons with
budgeted amounts.
This limited applicability of substantive analytical procedures is normally offset
by (1) extensive tests of controls and/or substantive tests of transactions for cash
receipts and disbursements or (2) extensive tests of the entity’s bank
reconciliations.
16-6
LO# 3&4
Substantive Tests of Details
of Transactions and Balances
16-7
LO# 3&4
Balance-Related Assertions
16-8
Auditing the General Cash
Account
Copy of Bank
Reconciliation
LO# 5
To audit a cash
account, the auditor
should obtain these
items.
Standard Bank
Confirmation
Cutoff Bank
Statement
16-9
LO# 5
Bank Reconciliation Working Paper
16-10
LO# 5
Standard Bank Confirmation Form
16-11
LO# 5
Cutoff Bank Statement
Date of Last
Bank
Reconciliation
7 to 10
Days
A cutoff bank statement normally covers the 7- to 10-day
period after the date on which the bank account is
reconciled.
For reconciliation purposes, any item should have cleared
the entity’s bank account during the 7- to 10-day period.
16-12
LO# 5
Tests of the Bank Reconciliation
The auditor typically uses the following audit procedures to
test the bank reconciliation:
1. Verify the mathematical accuracy and agree the balance per the books
to the general ledger.
2. Agree the bank balance on the reconciliation with the balance shown
on the standard bank confirmation.
3. Trace the deposits in transit on the bank reconciliation to the cutoff
bank statement.
4. Compare the outstanding checks on the bank reconciliation with the
canceled checks contained in the cutoff bank statement for proper
payee, amount, and endorsement.
5. Agree any charges included on the bank statement to the bank
reconciliation.
6. Agree the adjusted book balance to the cash account lead schedule.
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LO# 6
Fraud-Related Audit Procedures
Extended Bank
Reconciliation
Procedures
Proof of Cash
Tests for Kiting
16-14
LO# 6
Extended Bank Reconciliation Procedures
In some instances, the year-end bank reconciliation can
be used to cover cash defalcations. This is usually
accomplished by manipulating the reconciling items in
the bank reconciliation. For example, suppose an
employee was able to steal $5,000 from the entity. The
entity’s cash balance at the bank would then be $5,000
less than reported on the entity’s books. The employee
could “hide” the $5,000 shortage in the bank
reconciliation by including a fictitious deposit in transit.
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LO# 6
Proof of Cash
16-16
LO# 6
Tests for Kiting
16-17
Auditing a Payroll or Branch
Imprest Account
LO# 6
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.
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LO# 6
Auditing Petty Cash
Usually not
material.
Potential for
defalcation.
Seldom perform
substantive
tests.
Document
controls.
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LO# 6
Disclosure Issues for Cash
16-20
LO# 6
Disclosure Issues for Cash
16-21
LO# 6
Disclosure Issues for Cash
16-22
LO# 7
Auditing Investments
Common Stock
Preferred Stock
Debt Securities
Hybrid Securities
16-23
LO# 8
Control Risk Assessment—
Investments
Occurrence
and
Authorization
Here are some of the more
important assertions for
investments.
Completeness
Accuracy and
Classification
16-24
LO# 9
Segregation of Duties
16-25
LO# 10
Substantive Procedures for Testing
Investments
16-26
LO# 10
Tests of Details—Investments
Existence
Auditing Standards state that the auditor
should perform one of the following procedures
when gathering evidence for existence:
– Physical examination
– Confirmation with the issuer
– Confirmation with the custodian
– Confirmation of unsettled transactions with the
broker-dealer
– Confirmation with the counterparty
– Reading executed partnership or similar
agreements
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LO# 10
Tests of Details—Investments
Valuation and Allocation
The auditor must also determine if there
has been any “other than temporary” or
permanent decline in the value of an
investment security.
Auditing and accounting standards
provide guidance for determining
whether a decline in value below
amortized cost is other than temporary.
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LO# 10
Tests of Details—Investments
Valuation and Allocation
Here are some factors that may indicate a non-temporary impairment of
investment value:
– Fair value is significantly below cost
– Decline in fair value is attributable to specific adverse
conditions affecting a particular investment
– Decline in fair value is attributable to specific conditions,
such as conditions in an industry or in a geographic area
– Management does not possess both the intent and ability
to hold the investment long enough to allow for any
anticipated recovery in fair value
– The decline in fair value has existed for an extended period
– A debt security has been downgraded by a rating agency
– The financial condition of the issuer has deteriorated
– Dividends have been reduced or eliminated, or scheduled
interest payments on debt securities have not been made
Permanently Impaired = Write down to new carrying amount
16-29
LO# 10
Tests of Details—Investments
◆
◆
◆
Disclosure Assertions
Marketable securities need to be properly
classified as held-to-maturity, trading,
and available-for-sale.
Held-to-maturity securities and
individual available-for-sale securities
should be classified as current or noncurrent assets based on whether
management expects to convert them to
cash within 12 months.
All trading securities should be classified
as current assets.
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LO# 11
Advanced Module: Auditing Fair
Value Measurements
ASC Topic 820 Levels
❑ Level 1: Valuations based on quoted prices in
active markets for identical assets. Also known
as “marking to market.”
❑ Level 2: Valuations based on directly or
indirectly observable market data for similar
assets. Also known as “marking to matrix.”
❑ Level 3: Valuations based on management’s
best judgment and involve management’s
assumptions. Also known as “marking to
model.”
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LO# 11
Advanced Module: Auditing Fair
Value Measurements
❑ Obtain an understanding of how management
makes the fair value measurements.
❑ Consider whether specialized skills or
knowledge are required.
❑ Test the entity’s fair value measurements.
❑ Evaluate the reasonableness of the fair value
measurements.
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End of Chapter 16
16-33