Auditing Cash and Cash Equivalents

Transcription

1 Auditing Cash and Cash Equivalents I. Participant Supplemental Material 1 A. Exhibit 1: Cash Audit Procedures 1 B. Exhibit 2: Auditing Cash and Cash Equivalents 4 C. Exhibit 3: Cash Case Study 12 D. Exhibit 4: Cash Inquiry Case Study 18 E. Exhibit 5: Client Inquiry 21 F. Exhibit 6: Additional Information Obtained from CFO 23 G. Exhibit 7: Key Controls Related to Cash Disbursements 25 H. Exhibit 8: Key Controls Related to Cash Receipts 27 I. Technical Update Slide 15 Cash in Excess of FDIC Limits 28 i

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3 Auditing Cash and Cash Equivalents I. Participant Supplemental Material A. Exhibit 1: Cash Audit Procedures 1. Using the standard AICPA bank confirmation form, consider requesting confirmation as of the balance sheet date for each bank account. Trace the bank balance on the reconciliation to the bank confirmation received from the bank. This should include confirmation of material savings accounts, certificates of deposit, and compensating balance requirements, restrictions on withdrawal of funds. (Note: Accounts selected for confirmation should be based on professional judgment considering risk and materiality. If the client has only a few accounts, it may make sense to send confirmations for every account. If the client has numerous primary and secondary accounts, perhaps only the primary account(s) are confirmed. In some cases, all bank balances may simply be agreed to the original bank statements or on-line inquiry.) 2. Consider sending standard bank confirmations for accounts closed during the year if there is a risk of fraud or unrecorded debt. 3. Perform alternate procedures for confirmations not received. An example would include agreeing the balance per bank reconciliation to the client-received bank statement, bank cut-off statement received by the auditors, or other information accessible through on-line inquiry directly with the bank. 4. For accounts with a significant volume of transactions, consider requesting a cutoff bank statement for the subsequent period after the balance sheet date to be mailed directly to the auditors. Compare the beginning bank balance on the subsequent bank statement to the bank reconciliation. Investigate any difference. 5. Trace the reconciled book balance to the general ledger trail balance. 6. Consider testing the clerical accuracy of the reconciliation and detail supporting schedules. 7. Obtain the bank reconciliation and review the nature and extent of reconciling items for reasonableness for accounts with significant balances or volume of activity, and determine the necessity and extent of reconciling items testing based on professional judgment. Be alert for unusual reconciling items, even if not quantitatively material. 8. Consider tracing material deposits per the bank reconciliation to deposits in the subsequent period s/cutoff bank statement noting reasonableness of the time period between book and bank recording. 1

4 9. Consider inspecting selected canceled checks returned with the subsequent period s cutoff bank statement. Trace checks dated before the balance-sheet date above a specified scope to the list of outstanding checks. Be alert for large or unusual outstanding checks. Investigate any large or unusual outstanding checks that did not clear with the subsequent period s cutoff bank statement. 10. Inquire whether any checks drawn before year end were released after year end or are being held. Consider classification of any significant held checks to accounts payable. 11. Consider reviewing the client s schedule of material interbank transfers for a sufficient period before and after year end to determine that the deposit and disbursement side of each transfer is recorded in the proper period, and that incomplete transfers are properly recorded as reconciling items on the bank reconciliations. (Note: In the past, interbank transfer schedules were traditionally prepared for five days before and after year end to detect kiting. Kiting is where a company shows a deposit-intransit in one account, but does not show the deduction on the other account. Before the prevalence of electronic banking, it used to take several days for banks to process interbank transfers. So, this fraud scheme was possible. The purpose of the interbank test is to ensure all year-end transfers were recorded in each appropriate account before year-end, and all post year-end transfers were recorded in each appropriate account post year-end. Transfers not clearing the bank in the same accounting period should be shown as reconciling items on the bank reconciliations. Theoretically, interbank transfers should be tested through the bank reconciliation testing and a specific test is not necessary. If a deposit-in-transit is related to an interbank transfer, the auditor would simply ensure that there was an outstanding debit on the other account s bank reconciliation. However, if there are numerous bank accounts with significant activity at year end, then the risk of kiting may substantiate a specific test of this nature. This is particularly true if there is a specific identified risk of fraud with cash. The auditor should challenge the need for this test, as well as the length of time before and after year-end that makes sense based on the bank s typical timeline for processing interbank activity.) 12. Inquire whether amounts are designated for a special purpose. Cash restricted for special purposes should be segregated from cash available for general operations. If restricted cash offsets current liabilities, then it may be shown as a current asset. Otherwise, the amount is typically shown as a non-current asset. In some cases, restricted cash could have both a current and non-current portion. 13. Inquire about compensating balances (minimum balance requirements of loan agreements or debt service funds established by debt indentures) or other withdrawal restrictions. Compensating balance agreements should be disclosed if the agreement legally restricts the use of funds. 14. Inquire about related guarantees, endorsements, and/or letters of credit, including guarantee arrangements for related parties. 15. Determine proper classification of cash, cash equivalents, or other short-term investments. Items typically included as cash and cash equivalents include: non-interest-bearing cash on deposit with banks, interest-bearing time deposits, certificates of deposit, money market accounts, short-term investments with original maturities of three months or less, and repurchase agreements. Related footnote disclosures should be adequate to explain the nature of cash and cash equivalents. 2

5 16. Count material cash on hand. 17. Conclude whether procedures performed are adequate to respond to identified fraud risks. 18. Consider whether results of procedures indicate possible significant deficiencies or material weaknesses. 19. Conclude whether the results of procedures are sufficient to achieve audit objectives. 3

6 B. Exhibit 2: Auditing Cash and Cash Equivalents Instructions: Prepare the cash audit workpaper files for Ping s Pong Supply Company. Note any errors, concerns, adjustments, and/or recommendations. Enter any necessary adjustments on the cash lead sheet. Inherent Risk = Moderate Control Risk = High Performance Materiality = $5,000 Lucy Diamond, Controller, has represented that there are no restrictions imposed by external parties on the use of cash. 4

7 Ping s Pong Supply Company December 31, 20XX Page : 1 Prepared by: Reviewed by: STANDARD LEAD SCHEDULE: A Cash & Cash Equivalents Account Description WP Ref Prior Yr Adjusted 12/31/20XW Dr (Cr) Unadjusted 12/31/20XX Dr (Cr) AJE Ref # Amount Dr (Cr) Adjusted 12/31/20XX Dr (Cr) 100 Petty Cash Operating Cash 97, , , Payroll Cash - 3, , , Savings 73, , , TOTALS 174, , ,

8 Ping s Pong Supply Company 12/31/20XX Cash Operating Balance per bank statement as of 12/31/20XX $100, Deposits in transit 1, , Less outstanding checks: Number Amount Total o/s checks: 1, Less: Bank Charges 0.00 Total Other reconciling: 0.00 Balance per general ledger 100,

9 Ping s Pong Supply Company Cash Receipts Journal Date Description Debit General Debit Payroll Credit A/R Credit Other 12/23 Balance Forward 13, , , /24 Cash Sales /27 A/R Collections /27 Cash Sales /28 A/R Collections /28 Cash Sales /28 Payroll from General Acct. 5, , /29 A/R Collections /29 Cash Sales /30 A/R Collections /30 Cash Sales /31 A/R Collections /31 Cash Sales December Totals 19, , , , /3 A/R Collections /3 Cash Sales /4 Cash Sales /4 A/R Collections /5 Cash Sales /5 A/R Collections /6 Cash Sales /7 Cash Sales /7 A/R Collections Totals 5, , ,

10 Ping s Pong Supply Company Cash Disbursements Journal Date Check No. Description Payee G/L Account Credit General 12/23 Brought Forward 3, / Inventory China Imports / Inventory Plasaball / Inventory WhitePaint4U / Inventory Paddle Corp / Utilities State Power / Inventory Balls Direct / Inventory Just Nets / Utilities Trash B Gone / Office Supplies Supply Depot / Advertising Great Promos / Inventory Tippy s Tables /30 Payroll Bank Transfer DA Bank , Credit Payroll 12/ Paycheck Ringo Starr , / Paycheck Paul McCartney , / Paycheck John Lennon / Paycheck George Harrison / Paycheck Pete Best /31 December Totals 13, , / Rent Payment Prop Managers , / Inventory USA Balls / Inventory China Imports / Inventory Plasaball / Supplies Happy Hardware / Corporate Fees State Treasurer / Janitorial AAA Janitors / Capital Additions Comps R US / Janitorial Best Lawns

11 Da Bank P.O. Box Anytown, AS Cut-off Bank Statement Ping s Pong Supply Company 123 Anywhere Street Anytown, AS A/C # Checking Account Summary for 1-1 through XY Opening Balance Deposits Interest Withdrawals & Checks Service Charge Closing Balance 100, , , , DEPOSITS DATE AMOUNT DATE AMOUNT 3-Jan 1, Jan 1, Jan Jan 1, Jan Jan 1, CHECKS NUMBER AMOUNT ,

12 STANDARD FORM TO CONFIRM ACCOUNT BALANCE INFORMATION WITH FINANCIAL INSTITUTIONS Financial Institution s Name and Address Da Bank P.O. Box Anytown, AS Ping s Pong Supply Company CUSTOMER NAME We have provided to our accountants the following information as of the close of business on December 31, 20XX, regarding our deposit and loan balances. Please confirm the accuracy of the information, noting any exceptions to the information provided. If the balances have been left blank, please complete this form by furnishing the balance in the appropriate space below. Although we do not request nor expect you to conduct a comprehensive, detailed search of your records, if, during the process of completing this confirmation, additional information about other deposit and loan accounts we may have with you comes to your attention, please include such information below. Please use the enclosed envelope to return the form directly to our accountants. 1. At the close of business on the date listed above, our records indicated the following deposit balance(s): ACCOUNT NAME ACCOUNT NO. INTEREST RATE BALANCE Operating None 100, Savings % 84, Payroll None 3, We were directly liable to the financial institution for loans at the close of business on the date listed above as follows: ACCOUNT NO./ DESCRIPTION BALANCE* DATE DUE INTEREST RATE DATE THROUGH WHICH INTEREST IS PAID DESCRIPTION OF COLLATERAL Lucy Diamond (Customer s Authorized Signature) 12/27/20XX (Date) The information presented above by the customer is in agreement with our records. Although we have not conducted a comprehensive, detailed search of our records, no other deposit or loan accounts have come to our attention except as noted below. Penny Lane (Financial Institution Authorized Signature) Teller (Title) EXCEPTIONS AND/OR COMMENTS Please return this form directly to our accountants: Attn: Smart & Co., LLP Certified Public Accountants & Business Consultants *Ordinarily balances are intentionally left blank if 345 Anywhere Street they are not available at the time the form is prepared. Ping s Pong Anytown, Supply AS Company 12/31/20XX 10

13 Cash Payroll Balance per bank statement 3, Deposits in transit: 0.00 Less Outstanding Checks: Number Amount Number Amount , Total o/s checks 2, Balance per general ledger 1,

14 C. Exhibit 3: Cash Case Study Key Information: Client: Carr Parts Company Fiscal year end: December 31 Tolerable misstatement: $50,000 Planned scope for testing outstanding checks = 1/10 of tolerable misstatement Number of Employees = 25 Key Players: Justin Tyme -- Staff auditor with Smart & Co., LLP Iona Carr -- Owner/President Norma Lee -- CFO Otto Mobile -- Accounts payable manager Willy Makit -- Bookkeeping clerk 12

15 Carr Parts Company 12/31/20XX Cash Operating Balance per bank statement as of 12/31/20XX 50, Deposits in transit 34, , Less outstanding checks: Number Amount , , , , , Total o/s checks: 45, Less: Bank Charges Bank Error #6020 1, Total Other reconciling: 1, Balance per general ledger 38,

16 Carr Parts Company Anywhere Street 23-Dec 20XX Anytown, AS NON-NEGOTIABLE PAY TO THE ORDER OF Vroom Vroom Motors $ 3, Three thousand five hundred and 00/100 DOLLARS Da Bank, Anytown, AS MEMO Norma Lee Endorse Here: Vroom Vroom Motors 2-Jan 20XY Carr Parts Company Anywhere Street 23-Dec 20XX Anytown, AS NON-NEGOTIABLE Screws Loose Limited $ 7, PAY TO THE ORDER OF Seven thousand five hundred and 00/100 DOLLARS Da Bank, Anytown, AS MEMO Norma Lee Endorse Here: Screws Loose Limited 2-Jan 20XY 14

17 Carr Parts Company Anywhere Street 23-Dec 20XX Anytown, AS NON-NEGOTIABLE PAY TO THE ORDER OF Supply Depot $ Two hundred and fifty and 00/100 DOLLARS Da Bank, Anytown, AS MEMO Norma Lee Endorse Here: Supply Depot 2-Jan 20XY Carr Parts Company Anywhere Street 24-Dec 20XX Anytown, AS NON-NEGOTIABLE PAY TO THE ORDER OF WM Enterprises $ 10, Ten thousand seven hundred fifty and 00/100 DOLLARS Da Bank, Anytown, AS Iona Carr MEMO Endorse Here: Will Makit Enterprises 5-Jan 20XY 15

18 Carr Parts Company Anywhere Street 28-Dec 20XX Anytown, AS NON-NEGOTIABLE PAY TO THE ORDER OF Slick Sam Used Car Sales $ 20, Twenty thousand and 00/100 DOLLARS Da Bank, Anytown, AS Norma Lee MEMO Used Car Iona Carr Endorse Here: Slick Sam Used Car Sales 2-Jan 20XY Carr Parts Company Anywhere Street 2-Jan 20XY Anytown, AS NON-NEGOTIABLE PAY TO THE ORDER OF Iona Carr $ Five hundred and 00/100 DOLLARS Da Bank, Anytown, AS MEMO Norma Lee Expense Reimbursement Endorse Here: Iona Carr 7-Jan 20XY 16

19 Carr Parts Company 12/31/20XX Cash Payroll Balance per bank statement Deposits in transit: 0.00 Less Outstanding Checks: Number Amount Number Amount void Total o/s checks Balance per general ledger

20 D. Exhibit 4: Cash Inquiry Case Study Instructions: Read the following client inquiry scenario related to the Cash Case Study in Exhibit 3. Highlight significant audit evidence/issues and identify potential management letter comments. Be prepared to consider Do s and Don ts of interviewing techniques based on this given scenario. What would you do differently in this situation? Script Hi, Norma Lee! What s happening? (Standing in doorway with chewing gum and a wrinkled shirt.) (Looking frazzled and distracted.) Huh? Oh, hi, Justin Tyme. Did I miss seeing a meeting scheduled with you on my calendar? No, we didn t have anything scheduled, but I have a few quick questions about cash that I wanted to get out of the way. (Walking into the office and sitting down without being invited.) (Speaking sarcastically, while looking at watch). Well, why don t you have a seat? Thanks, Norma! I m trying to get out of here in time to catch a pick-up basketball game at the gym and then catch drinks with the fellas. This will just take a minute. (Sarcastically again.) Really? Literally, just a minute? Would I lie to you, my friend? Hey, I noticed that there s a $3,000 check on your operating account s outstanding check list that appears pretty old. Do you know what s up with that? No, not really. If you have a check number, I can get Otto Mobile, the accounts payable manager, to look it up for you. I recall there may be a check to one of our vendors that we re holding because of a dispute over what we owe. Nah, unfortunately I don t have the specific check details. I ll drop that by in the morning, but I can t promise what time because I don t know what time I ll get home tonight! (Laughing a little too loudly.) I also noticed there s a payroll check for $750 outstanding. Any idea what that s about? Yes. It s for a bookkeeping clerk, Willy Makit, who s on emergency extended personal leave. He left unexpectedly and didn t have a chance to collect his check. We re just holding onto it until we figure out how to properly handle the situation. Most of the employees have direct deposit, so we usually carry a zero balance right after payroll is processed. Oh. I hope everything is all right. I know that Otto thinks of him as a son. Hey, who are authorized check signers around here again? 18

21 Well, I sign all checks under $10,000. All checks over $10,000 require the signature of Iona Carr, the owner and President. Did you hold any other checks at year-end besides the one you just mentioned? Not that I recall. (Shuffling through a stack of loose papers.) Uhhmm do you have a bank reconciliation for your savings account? I seem to be missing it. We actually don t perform a formal reconciliation of the savings account, other than putting in the journal entry request to post the interest earned. I post these adjustments periodically. In fact, I post all the journal entries for cash reconciling items. Okay. I ll just create a bank reconciliation to put in our workpapers for me to document my testing for that account. I don t want to get a review note asking me to do it later. By the way, how often is the operating account reconciled? Otto reconciles it by the fifteenth of the following month. He gives the necessary journal entries to me to post. Cool. Who reviews the operating account reconciliation? Iona. Does she ever note anything unusual? Well, this month Otto noted an error in the bank s posting of check number The correct amount was $825, not $1,825 as the bank processed it. You will see $1,000 as a reconciling item in December. Oh! So, have you talked to the bank about what happened yet? (Sitting in silence for a few moments. Looking off in distance and not reacting.) (Shifting uncomfortably in seat.) So did you get a credit from the bank yet? (Still unresponsive.) But your bank account balances otherwise, right? (Shaking head like coming out of deep thought.) What? Oh, I m writing up a journal entry to post to correct the error. Wow! Good thing you caught that! (Looking sullen and distracted.) Yeah, good thing. 19

22 Hey, I read in last year s workpapers that petty cash is generally reconciled monthly with a reimbursement check. However, I didn t see any checks written in December or January to post the current activity. The receptionist maintains petty cash. I know I just signed a check in February for $250. What was the petty cash that was being reimbursed used for? Typically, it s for charitable contributions, postage, and office supplies. Cool. Maybe you can help me with this next one. I was testing some expenses at year-end, and I noted that this $10,750 invoice for WM Enterprises that was paid for with Check #6054 was not approved for payment. I m assuming this is probably an oversight. Was this invoice approval just missed? (Hands invoice to the client, wiping something off it.) Oops! Let me wipe that off! It looks like I got a little careless with my coffee late last night when I was working on this at home. Yeah. (Looking a little nervous.) Can you tell me more about this company? I notice it has a P.O. Box for an address. (In a very defensive and angry tone.) Look! What s this all about? I really don t have time to tell you about all of our vendors. Hey, relax! I just want to make sure that this invoice was properly approved. (Very assertively.) Trust me, it was! Great! I ll document it that way as an isolated exception. Are you aware of any accounts subject to withdrawal restrictions or designated for a special purpose? No. (Looking very annoyed and answering very curtly.) (Looking uncomfortable and uncertain about what to do.) Uhhmm I guess I ll be going now. See you tomorrow. (Rushing out quickly without saying thank you, shaking hands, or waiting for a response.) (Shakes head and puts head in hands.) 20

23 E. Exhibit 5: Client Inquiry A question is one of the most powerful tools available to auditors. The person who asks the questions controls the discussion. It takes a combination of focused inquiry and observation (in addition to other inspection and reperformance procedures) to complete an audit. Unfortunately, most staff learn on-thejob how to ask questions to elicit specific information. Inquiry Do s and Don ts There are many lessons learned from the above scenario that auditors should keep in mind when interviewing clients. 1. The auditor should have scheduled time to meet with client. 2. The auditor should have asked if the client had time to speak before entering room and sitting down. Be specific about how long the intrusion should last. If it takes longer than planned, stop and ask the client if it is okay to continue, or if you should reschedule. 3. Set the proper tone -- dress appropriately, smile, make eye contact, and shake hands. Don t chew gum. 4. Give the client an overview of the agenda for the meeting, including planned timing. This could be provided when scheduling the meeting to allow the client to prepare for the meeting and ensure that the proper people are in attendance. It allows the client to suggest topics to add to the agenda and allows you to alert the in-charge to client issues and concerns outside of your responsibilities. The agenda and timing should also be provided at the start of the interview to reinforce the purpose and duration of the meeting. This will keep the meeting on track. 5. Set the stage before getting into detailed questions. Newer staff will often jump directly into detailed questions without introducing the general area you are dealing with. This is helpful to direct your listener s mindset. For example: I am currently auditing cash and have a few questions regarding the purpose and function of your cash accounts. Could you please explain the nature of your 10 bank accounts? This is much better than just saying, Why do you have 10 bank accounts? 6. Be prepared with all information the client may need to follow up on your questions (e.g., check number). Do not believe that interpersonal skills alone can overcome a lack of preparation. Before asking the first question, spend time reviewing available documentation. Jot down the key areas you want to explore. Anticipate questions that the client may ask in response to your inquiries. 7. Let the interview flow naturally, progressing from easy to more complex questions. 8. Do not ask leading questions. Do not presume the answer. Exercise professional judgment. This is particularly important when fraud could be an issue. Perhaps the invoice with missing approval really should not have been paid. 21

24 9. Get comfortable with moments of silence. Do not help the client answer your question just to fill an uncomfortable communication void. Let the client respond. Do more listening than talking. 10. Do not presume every exception is an isolated exception. Approach exceptions with an appropriate level of professional skepticism. 11. Watch nonverbal behavior. It is easy to get caught up in what is being said and ignore how the person says it. Behaviorists claim that more than half of communication is nonverbal. Observe how someone reacts to easy questions and how behavior changes when questions get tougher. 12. If a client becomes defensive or frustrated with an inquiry, keep calm and handle the situation in a professional manner. People who are professional and courteous are usually very competent in their job. When they become defensive, it is usually a sign that they are not confident and comfortable with what they are doing. They might not know the answer when they should. They might be fearful of a fraud discovery. You may consider saying, I know you are terribly busy. Should I come back in an hour to finish? Consider the need to ask the in-charge to return to continue the discussion at a time the controller is available. 13. If the client answers your questions with terms you do not understand, tell the client that you are not familiar with that terminology, and ask them to help you understand. Take good notes and then ask the in-charge for a debriefing on the topic to ensure that you properly understood. In cases like this, be sure to let the client know at the conclusion of the meeting that you may have some follow-up questions. 14. Keep a key points list, but do not write your questions out in detail in advance. First, writing questions is limiting, as you are less likely to divert conversation away from your set list, and may overlook an important matter. Second, the person being interviewed may be tempted to peek ahead on your list or ask you to leave your list of questions behind, to be answered later. However, you need to have an idea of what you specifically want to ask the person. 15. Ask follow-up questions to ensure that you understand situations enough to explain to the incharge. Do not walk away believing that you do not have all the facts. Have a follow-up appointment if time does not allow you to feel this way. 16. Confirm key facts before you leave the interview. 17. Do not brag about going out for late-night social activities, especially during the work week. 18. Speak professionally and respectfully at all times. Use proper English instead of informal slang. 19. Keep client documents in good condition. Do not eat or drink while working with client documents. 20. Do not take original client documents out of the client s office without permission. 21. Always thank the client for his time and offer to shake hands whenever it seems appropriate. 22

25 F. Exhibit 6: Additional Information Obtained from CFO Subsequent to the meeting with the CFO, the staff auditor brought the fraud concerns to the in-charge s attention. The in-charge and audit manager scheduled an immediate meeting with the CFO. Upon further inquiry, the CFO finally admitted that Willy Makit, the accounts payable clerk, had fallen into drug addiction and had recently begun stealing money from the company. Willy s rationale was that he intended to pay the money back after he was able to pull himself out of his temporary debt. Willy knew the company was profitable, so he hoped that the money would not be missed for at least a month. Once the stealing of the $1,000 was perpetrated without detection, he felt bolder about creating the fake invoice for the $10,750. If it was not for the drug addiction, he would never dream of committing such a crime. How did he ever get in this situation? Otto Mobile, accounting manager, had initially covered for Willy because of his fondness for Willy, and Norma Lee had just found out a few weeks ago. Otto had confronted Willy, who agreed to enter a 30-day drug rehabilitation program immediately. Due to the extended nature of the rehabilitation program, Otto eventually had to tell Norma, to explain why Willy would be absent from work. After an internal fraud examination, it was discovered that Willy Makit created fraud in two instances: 1. Willy created a fake invoice and vendor for $10,750 and entered it into the system on December 24 when Norma Lee and Otto Mobile were at a continuing education class. Willy then forged a blank check to make a payment of $10,750 to pay the invoice. The bank cashed the check for $10,750 in January. The amount is listed as an outstanding check on the December operating account bank reconciliation. 2. Earlier in December, Willy had altered an expense reimbursement check written to him, to read $1,825 instead of $825. The bank cashed the check for $1,825. As a result, there was a $1,000 reconciling item on the December bank reconciliation for the operating account. The fraud was able to be perpetrated due to lack of internal controls in the following areas: Willy Makit had access to make changes in the vendor master file and to post cash disbursement transactions. Willy Makit had access to the blank check stock, which enabled him to forge a check. Iona Carr, owner, reviewed the bank reconciliations. She did not catch the fraudulent amounts, as she did not have the accounting background to recognize the significance of the unreconciled bank difference. Otto Mobile let his personal feelings stop him from reporting the fraud to management as soon as he started investigating the bank error and saw the unusual check in the cut-off statement. Norma Lee was embarrassed to admit that fraud had been perpetrated at her company. She knew she should review the bank reconciliations, but Iona Carr always wanted to do it, to feel more hands on at the company. In addition, Norma knew that the bank balance should have been about $12,000 higher than it was at year-end. Unfortunately, she was so busy closing the books that she did not get around to investigating the variance explanation until it was too late. Norma knew that the fraud was quantitatively immaterial, so she was hesitant to air the company s dirty laundry, especially to a new hire. She wanted to wait until she had more details and information about the scope of 23

26 the fraud before alerting the auditors, even though she knew she would eventually have to confess. Smart & Co., LLP gained comfort that the fraud was limited to these two instances, and an adjustment was made to the financial statements to reclassify the expense to Other Expenses. Willy Makit is awaiting prosecution upon completion of his drug treatment program. The company is uncertain about the recoverability of the amount and prefers to write off the $11,750. The $750 outstanding payroll check will remain on the books until it is legally decided whether the company can confiscate the funds. Due to relative immateriality quantifiably, the auditors agreed to this approach. See Fraud Memo discussion at GP-10. Note to Participants Traditional fraud is perpetrated only when three components of a fraud triangle are fulfilled. The first component is that the person committing fraud has the opportunity to commit fraud based on access to assets, improper segregation of duties, or other weaknesses in internal controls. The second component is that the person has an incentive or pressure to commit the fraud. Examples of external incentives or pressures include mounting personal debt, drug or alcohol addiction, divorce, and inability to attain desired lifestyle. Examples of internal incentives or pressures include incentive-based compensation, stock options, pressure to meet budgetary targets, and pressure to show revenue growth. The third component of the fraud triangle is the person s ability to rationalize the fraud or have an attitude that the fraud is acceptable. This can result from several rationalizations, including: It is owed to me, Everyone else is doing it, I intend to pay it back when I can, and No one is getting hurt. This occurrence will be reported as a material weakness to the audit committee (or equivalent). Material weaknesses are deficiencies, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material weakness of the entity s financial statements will not be prevented, or detected and corrected on a timely basis. Recommendations will be made to strengthen controls over cash disbursements. 24

27 G. Exhibit 7: Key Controls Related to Cash Disbursements When performing audit procedures in areas like cash, accounts payable, fixed assets, and expenses (areas typically assigned to new auditors), the auditor should be aware of desired internal controls related to cash disbursements. When gaining an understanding of controls through inquiry and observation, the auditor should ensure that the design of controls is appropriate to prevent and detect material fraud and error in accounts affected by cash disbursement transactions. In addition, the auditor will inspect and reperform procedures using supporting documentation for cash disbursement transactions. The auditor should look for unusual or improper transactions and bring them to the attention of the in-charge. Typical controls related to cash disbursements include the following. The controls shown in bold would have prevented or detected the two specific instances of fraud described in the previous scenario. Only small disbursements are made in cash. Using a zero-balance imprest account for payroll. All check signers and authorized wire transfer agents are from an appropriate level of management and are independent of the initiator/approver of purchases, check preparation, and accounts payable recordkeeping. Signature plates are kept secure. Blank check stock is kept secure, and sequencing of pre-numbered checks is periodically accounted for. Dual signatures are required for significant checks and wire transfers, and the bank enforces this policy. Once checks are signed, they are forwarded to someone other than the check preparer for mailing. There are appropriate controls over non-check disbursements (e.g., bank callback verifications, passwords for authorization, dual authorizations required for significant wire transfers, etc.) Stale, outstanding checks are followed-up by an appropriate party. Voided checks are canceled, retained, and periodically accounted for by an appropriate party. Cash disbursements are matched against supporting documentation for preparation and review. Supporting documentation is canceled and marked with the check number or wire transfer authorization number. Transactions are reviewed by an appropriate party for proper recording of account, amount, and period. There is an approved vendor list that the computer system automatically matches cash disbursement coding against, which cannot be altered by the person responsible for cash disbursement recordkeeping. Manual check processing is not allowed, and this policy is enforced by the bank. Cash disbursement activity is analytically reviewed for reasonableness and propriety by an appropriate level of management (e.g., compared to budget and/or prior period). Bank accounts are reconciled on a timely basis by someone independent of cash disbursements and cash receipts recordkeeping functions. Bank reconciliations are reviewed on a timely basis by an appropriate level of management, including support for significant or unusual reconciling items. 25

28 Bank statements (with enclosures) are received directly by the appropriate level of management and reviewed before routing to the person responsible for initial preparation of bank reconciliations. Using positive pay procedures with the bank. Positive pay occurs when the company prepares an electronic file of all checks (e.g., check number, amount, date, etc.) and transmits it to the bank. The bank compares all cashed checks to the file and notifies the company of any exceptions. The company must then notify the bank of acceptance or decline of payment. Checks exceeding a specified dollar limit can automatically be flagged as an exception until further approval for processing. 26

29 H. Exhibit 8: Key Controls Related to Cash Receipts The following is a listing of typical internal controls relating to cash receipts. These controls should be kept in mind when auditing cash, accounts receivable, or revenue financial statement accounts. The company uses a lockbox to process cash receipts, reduce access to cash, and improve timeliness of deposit. The mail is opened and daily deposits are prepared by someone independent of cash receipts bookkeeping. The list of daily deposits is reconciled to recordings to total credits to customer accounts receivable accounts (or other relevant financial statement accounts) by an appropriate party. Cash receipts are secured and deposited on a timely basis. Checks received are marked as For Deposit Only immediately upon receipt. Adjustments to cash accounts are approved by an appropriate level of management. Cash receipts are analytically reviewed by an appropriate level of management on a periodic basis (e.g., compared to budget and/or prior period). Transactions are reviewed by an appropriate party for proper recording of account, amount, and period. Bank accounts are reconciled on a timely basis by someone independent of cash disbursements and cash receipts recordkeeping functions. Bank reconciliations are reviewed on a timely basis by an appropriate level of management, including support for significant or unusual reconciling items. Bank statements (with enclosures) are received directly by the appropriate level of management and reviewed prior to routing to person responsible for initial preparation of bank reconciliations. Billing and shipping are independent of cash receipts bookkeeping. Customer complaints and billing questions are resolved on a timely basis by someone independent of accounts receivable and cash receipts bookkeeping. Recording of non-cash credits (e.g., credit memos, account write-offs) are independent of accounts receivable and cash receipts bookkeeping, and are authorized by an appropriate party. Aged accounts receivable are prepared and reviewed by an appropriate party. 27

30 I. Technical Update 1. Slide 15 Cash in Excess of FDIC Limits President Obama signed into law a variety of protections for bank customers, including a permanent increase in the basic federal deposit insurance limit from at least $100,000 to at least $250,000 per depositor. Under prior law, the basic federal deposit insurance limit was set to revert back to $100,000 on January 1,