Chapter-One

Audit of Cash and Marketable Securities

1.1 Sources and nature of cash - Cash normally includes general cash accounts,
payroll accounts, petty cash fund, saving accounts, marketable securities and other
cash equivalents such as money market funds, certificate deposit, saving certificates
and other similar types of deposits. Receipt and payment of cash is a significant part
of an independent financial statement audit. This is because these receipts and
payments affect almost all accounts relating to the income and expenditure and a
number of asset and liability accounts. On other hand, the liquid nature of cash
increases the risk of undetected fraud. The auditor has to recognize this factor in
developing appropriate audit program accordingly.
 
1.2. Auditors’ objectives of auditing cash
The auditor’s objectives in the audit of cash are to

1. Consider the internal control over cash transactions

2. Substantiate the existence of the recorded cash
3. Establish the completeness of the recorded cash
4. Determine that the client has the rights to the recorded cash
5. Establish the clerical accuracy of the cash schedules
6. Determine that the presentation and disclosure of cash, including restricted
funds (such as compensating balances and band sinking funds) are
appropriate

 
In auditing the cash transactions, the auditor has to be extremely careful with the
possibility of the overstatements of the cash payments and understatements of the
cash receipts. The auditor has to verify the ending balance of cash thoroughly as there
is a possibility of including fictitious checks in the cash on hand at the year-end. The
possible irregularities of the cash transactions are

a. Receipt of cash without proper recording

b. Payment may not have made with actual withdrawal
c. Duplicate payments
d. Overpayments or payments to fictitious persons
e. Payments for the personal expenditures of officers and related parties

 
1.3. Internal control over cash transactions
Most of the functions of the cash handling are the responsibility of the finance
department and these functions include handling and depositing of cash receipts,
signing of checks, investing idle cash and maintaining custody of cash, marketable
securities and other liquid assets. In achieving a good internal control over cash
transactions are the following
  Do not permit any one employee to handle a transaction from beginning to
end
 Separate cash handling from record keeping
 Centralize receiving of cash to the extent possible
 Record cash transactions on a timely basis
 Encourage customers to obtain receipts and observe cash register totals
 Deposit cash receipts daily
 Make all disbursements by check or electronic fund transfer with the exception
of small expenditures from petty cash
 An appropriate official should review the completed reconciliations promptly.
 Forecast expected cash receipts and disbursements and investigate variances
from forecasted amounts

 
Internal Control Over Cash Receipts
    1. Cash sales: Control over cash sales is important when two or more employees
participate in each transaction with the customer. Some organizations use a centrally
located cashier who receives cash from the customer along with a sales ticket
prepared by another employee. If the ticket or the sales checks are serially numbered
and all numbers accounted for, this separation of responsibility for the transaction is
an effective means of preventing fraud. In many establishments, the nature of
business is such that one employee must make over the counter sales, deliver the
merchandise, receive cash and record the transaction. In this situation dishonesty
may be discouraged by proper use of cash registers or electronic point of sale systems.
The protective features of the cash registers include

a. Visual display of the amount of the sale is in full view of the customer
b. A printed receipt, which the customer is urged to take with the merchandise
c. Accumulation of a locked in total of the day’s sales

 
    2. Electronic Point-of –Sale (POS) System: In many establishments, various
type of electronic cash registers, including on-line computer terminals are being used.
With these registers, an electronic     scanner is used to read the sales price and other
data from specially prepared product tags. The sales person need only pass the tag
over the scanner for the register to record the sale at the product’s price. Thus the risk
of a salesperson recording sales at erroneous prices is substantially reduced. Besides
providing strong control over cash sales, electronic registers often may be
programmed to perform numerous other control functions such as verification of the
status of the customers, update the accounts receivable and perpetual inventory
records, provide special printouts accumulating sales data by product line,
salesperson, department and type of sale etc.
 
    3. Collection from credit customers: For most of the establishments, a major
part of sales are made on credit and collection from these credit customers is a
tedious task. Most of the collections are received through mail. This poses a major
threat if one employee is allowed to receive, deposit, and record the credits to the
customer’s accounts. Hence a proper internal control system should be established
leaving no room for misappropriation.
    4. Lockbox Control over Cash Receipts: Business receiving a large volume of
cash through the mail often uses a lockbox system to strengthen the internal control
and hasten the depositing of cash receipts. The lockbox is actually a post office box
controlled by the company’s bank. The bank picks up mail at the post office box
several times a day, credits the company’s checking accounts for cash received and
send the remittance advices to the company. The internal control system of the
company is strengthened by the fact that the bank has no access to the company’s
accounting records.
 
Internal Control Over the Cash Disbursements
The cash disbursements of the company should be made by check, electronic fund
transfer and for minor items petty cash should be used.
 1. Payment by check: the principal advantage of requiring disbursement by check
is obtaining evidence or receipt from the payee in the form of an endorsement on the
check. The other advantages of using check for payment are

a. The centralization of disbursement authority in the hands of a few designated

officials who is authorized to sign the check
b. A permanent record of payments
c. Reduction in the amount of cash kept on hand

      In order to have a proper control of payments,

 The checks should be serially pre-numbered and all the numbers in the series
should be accounted for.
 Unissued prenumbered checks should be adequately safeguarded against theft
or misuse.
 Voided checks should be defaced to eliminate any possibility of further use and
filed in the regular sequence of paid checks.
 A computer or a check-protecting machine should print the amount on the
check.
 The check should be crossed before issue.
 The authorized official should sign the check only after reviewing the
supporting documents and put some identification to prevent them from being
produced a second time.
 The check should reach the official for signature after completing all
formalities except signature
 The check should not be returned to the accounting department who prepares
them after signature
 If a check signing machine is used, a key should be required to retrieve the
signed checks and facsimile signature plate should be removed from the
machine when the machine is not in use
  Frequent bank reconciliation statements should be prepared to have adequate
internal control over cash. The reconciliation should be prepared by a
employee who do not have a role in the cash transactions.

 2. Electronic fund transfer:  Electronic funds transfer system is that process
fund related transactions for customers as an alternative to paying by checks. The
funds are electronically transferred between companies’ bank accounts. This is done
through electronic data interchange, which allows the interchange of data from one
company’s computer to another. These systems have the advantage over paying by
check by reducing the paper work, processing costs and delays. But the disadvantage
is that it requires an extensive set of computer network controls relating to the system
access and data entry. It also requires backup controls for situations in which a
system breakdown occurs.
 3. Internal control for petty cash: internal control over payments from an
imprest petty cash fund is achieved at the time the fund is replenished to its fixed
balance rather than at the time of making the payments. The documents supporting
each payment will be reviewed for completeness and authenticity when the custodian
of the petty cash funds requests for replenishment of the fund. The petty cash
payments may not be material for the financial statement and hence the auditor may
test one or more replenishment transactions by examining petty cash vouchers.
 
1.4. Audit program for cash
The most appropriate procedures for a particular audit will be guided by the nature of
the internal controls in force and by other circumstances of the engagement. The
following is the audit program for the verification of cash transactions
A. Consider the internal control for cash transactions
1. Obtain an understanding of the internal control structure for cash
2. Assess control risk and design additional tests of controls for cash
3. Perform additional tests of controls for those controls which the auditors plan
to consider supporting their planned assessed levels of control risk such as:

a. Test the accounting records and reconciliations by performance

b. Compare the details of a sample of cash receipts listings to the cash receipts
journal, account receivable postings and authenticated deposit slips
c. Compare the details of a sample of recorded disbursements in the cash
payments journal to accounts payable postings, purchase orders, receiving
reports, invoices and paid checks.

4. Reassess control risk and modify substantive tests for cash

 
B. Perform substantive tests of cash transactions and balances
The objective of major substantive testing procedures of cash
transactions and balances are given in the following table.
 Primary Audit
Substantive Tests Objective to be
Addressed
5. Obtain analyses of cash balances and
Clerical accuracy
reconcile them to the general ledger
6. Send standard confirmation forms to
financial institutions to verify amounts on  
deposit.         
7. Obtain or prepare reconciliations of bank  
(financial institutions) accounts as of the
balance sheet date and consider needs to  
reconcile bank activity for   additional
months.      

8. Obtain cut-off bank statements  

containing transactions of at least seven Existence and right
days subsequent to balances sheet date.
9. Count and list cash on hand
 
10. Verify the client’s cut-off  of cash receipts
and cash disbursements       
 
11. Analyze bank transfer for last week of
Existence and right
audit year and first week of the following
year. Completeness
 
12. Investigate any check representing large
or unusual payments to related 
parties                  

13. Evaluate proper financial statements Presentation and

presentation and disclosure of cash. disclosure

 
 
The factor of materiality applies to audit work on cash as well as to other aspects of
the audit. Even if the cash balance shown in the financial statements is relatively
small, the auditor may have to devote a larger proportion of the total audit hours to
cash transactions. This is due to the amount of flow of cash into and out of the
business during the year is often great than for any other account. Several reasons
exist to explain the auditors’ traditional emphasis on cash transactions. Liabilities,
revenue, expenses and most other assets flow though the cash account i.e. most of
these items either arise or result in cash transactions. The examination of cash
transactions assists the auditors in the substantiation of many other items in the
financial statements.
Another reason contributing to extensive auditing of cash is that cash is the most
liquid of all assets and offers the greatest temptation for theft, embezzlement and
misappropriation. For liquid assets, the inherent risk is very high and auditors tend
to respond to high-risk situations with more intensive investigation. If the fraud in
cash transactions is material, then only the detection of fraud is relevant to the overall
fairness of the financial statements of the client. The auditor can avoid wasting audit
time on matters that are not material to the financial statements and that may better
be pursued by client personnel.

o Since cash generally has a high degree of inherent risk, more audit time is
devoted to the audit of the account than is indicated by its dollar amounts.
o Internal control over cash receipts should provide assurance that all cash
received is recorded promptly and accurately. Control over sales is strongest
when two or more employees participate in each transaction, or when a cash
register or an electronic point of sale system controls collections.
o When a cash receipt consists of checks received through the mail, the receipts
should be listed and controlled by personnel who do not maintain cash or
accounts receivables records. The control listing should be reconciled to the
entries in the cash receipts journal and deposit records from the financial
institutions.
o Internal control over cash disbursements is best achieved when all payments
are made by check or well- controlled electronic fund transfers, except for
payments of minor items from petty cash funds.
o Separation of the functions of presentation of the payments from that of
signing checks tends to prevent errors and fraud in cash disbursements.

 
1.5 Audit of Marketable securities
From the viewpoints of the auditors, the most important group of investments
consists of bonds and shares as they are found more frequently and usually are of
greater value than other kinds of investment holding. Commercial paper, mortgage
deeds, surrender value of the insurance policies are other type of investments. For the
business organization, the idle cash has to be utilized for some profitable purposes.
Management may also choose to maintain some investments in marketable securities
on a semi-permanent basis.  The length of time such investments are held may be
determined by current security yields and by the company’s income tax position, as
well as by its cash requirements.
  1.5.1. The Auditors’ objectives in Examination of marketable securities
The auditors’ objectives in the examination of marketable securities are to:

1. Consider internal control over marketable securities.

2. Determine the existence of recorded marketable securities and that the client
has rights to the securities.
3. Establish the completeness of recorded marketable securities.
4. Determine that the valuation of marketable securities is in accordance with the
cost market, or equity method of accounting, as appropriate.
5. Establish the clerical accuracy of schedules of marketable securities.
6. Determine that the presentation and disclosure of marketable securities,
including current/non-current classifications are appropriate.
In conjunction with their audit of marketable securities, the auditors will also verify
the related accounts of interest income and dividends, accrued interest revenue, and
grains and losses on the sale of securities.
The liquid nature of marketable securities makes the potential for irregularities high. 
Auditors must coordinate their cash and marketable securities audit procedures to
detect any possible irregularities involving unauthorized substation between the
accounts.  The overall audit approach is one of assessing control risk for securities,
inspecting certificates, confirming securities held by third parties such as banks, and
determining the appropriate valuation of the securities.
 
1.5.2. Internal Control for Marketable Securities:
The major elements of adequate internal control over marketable securities include
the following:

1. Separation of duties between the executive authorizing purchases and sales of

securities, the custodian of the securities, and the person maintaining the
record of investments.
2. Complete detailed records of all securities owned and the related revenue from
interest and dividends.
3. Registration of securities in the name of the company.
4. Periodic physical inspection of securities by an internal auditor or an official
having responsibilities for the authorization, custody or record keeping of
investments.

 
1.5.3. Audit Program for Securities
The following are the procedures typically performed by auditors to achieve the
objectives:
A. Consider internal control for securities

1. Obtain an understanding of internal control for securities.

2. Assess control risk and design additional tests of controls for securities.
3. Perform additional tests of controls for those controls the auditors plan to
consider to support their planned assessed levels of control risk such as:

             a) Trace several transactions for purchases and sales of securities through the
accounting systems.
             b) Inspect reports by internal auditors on their periodic inspection of
securities.
             c) Inspect monthly reports on securities owned, purchased, and sold and
amounts of revenue earned and budgeted.
     4. Reassess control risk and modify substantive tests for securities.
 
B. Perform substantive tests of securities transactions and year-end
balances.

1. Obtain or prepare analyses of the securities investment account and related

revenue accounts and reconcile to the general ledger.
2. Inspect securities on hand.
3. Obtain confirmation of securities held by others.
4. Vouch selected purchases and sales of securities during the year.
5. Verify the client’s cutoff of securities transactions.
6. Perform analytical procedures.
7. Make independent computations of revenue from securities
8. Determine the market values of securities at date of balance sheet.
9. Evaluate the method of accounting for securities.
10. Evaluate financial statement presentation and disclosure of securities.