Audit Tutorial 10

Question 1

(a) Internal control systems are designed, amongst, other things, to prevent error and misappropriation.

Describe the errors and misappropriation that may occur if the following are not properly controlled and
describe some internal controls that can be implemented to prevent the errors and misappropriation.

1) Receipts paid into the bank accounts

 Risk: Cash receipts are recorded but not deposited in the client’s bank account
 Internal control system
 Proper segregation of duties between cash receipts function and the account
receivable function. Example: Staff 1 in charged cash receipts and Staff 2 in
charged the accounts receivables functions
 Preparation of monthly bank reconciliation that are independently reviewed

2) Payments made out of the bank accounts

 Risk: Payments made out of bank accounts are not properly authorized
 Internal Control System
 Proper segregation of duties between an individual who approves a purchase
and an individual who have direct access to the cash disbursement for it
Example: The individuals in the accounts payable department who initiate
payment should not have access to the cheques after they are prepared
 Cheques should not be prepared unless all the original source documents
(purchase requisition, purchase order, receiving report and supplier’s invoice)
are attached to the payment voucher and approved.
Example: All the source documents such as purchase order, supplier DO and
purchase invoice→ chop “Paid” and with the “payment voucher no”

3) Interest and charges debited and credited to bank accounts

 Risks: Interest and charges debited and credited to the bank accounts being recorded in
the wrong financial statement account, wrong accounting period, wrong amount
 Internal control system
 Proper segregation of duties and supervision and authorization and approval,
i.e. different individual for key into the accounting system, review and approve.

(b) A book selling company has a head office and 25 shops, each of which holds cash at the balance
sheet date. There are no receivables. Accounting records are held at shops. Shops make returns to head
office and head office holds its own accounting records. Your firms have been the external auditor to the
company for many years and has offices near to the location of some but not all the shops.
List the audit objectives for the audit of cash and show how you would gain the audit evidence in
relation to those objectives at the year end.

Process flow

Daily Cash Risk Recorded in Risk

1
Risk 2 Banked In 3, 4,5
GL
Receipt Cash Book

1) Risk: Cash receipts being stolen/lost before recording

TOC: Enquiry→ Inquire of client personnel on daily cash receipts process and recording process
Observe and evaluate the process of segregation of duty between cash receipt and
recording in cash book
Physical inspection of document→ select a sample and trace from daily cash receipts and
reconcile with cash book

ICO: To validate the completeness of cash receipt transaction

2) Risk: Cash receipts recorded but not deposit

TOC: Observation→ To observe the segregation of duty procedures between recording function
and banked in function
Physical inspection of document→ Select a sample from cash book and trace to monthly
bank reconciliation to ensure no unexplained item exists
ICO: To validate the completeness of cash receipt transaction

3) Risk: Cash receipts are not properly posted to general ledger account
TOC: Physical inspection of document→ Select a sample and trace the bank deposit slips to
general ledger- Cash at bank
ICO: To validate the completeness/occurrence of cash receipts, i.e. to ensure proper posting and
Summarization

4) Risk: Cash receipts are recorded in the wrong accounting period

TOC: Physical inspection of documents→ Select a sample of bank deposit slips few days before
and few days after the financial year end and examine cash receipts and agree to the bank
deposit slips
ICO: To validate proper cut off, i.e. to ensure timeliness

5) Risk: Cash receipts recorded at the wrong amount

TOC: Physical inspection of document→ select a sample and trace the bank deposit slips and GL.
Physical inspection of document→ review and testing of bank reconciliation
ICO: To validate accuracy of the cash receipts
Question 2 (Case refer to Question Paper)

(a) Identify five information you would expect the bank of Anon to confirm in response to your
bank letter
 Full details of the bank balances (account name, account number etc) stating whether
the balances are maintained in RM or foreign currency
 Including “zero” balances
 Full titles and date of closure of all accounts closed during the year
 The separate amounts accepted accrued but not charged or credited at 30 June 20x5 of
interest and provisional charges (including commitment fees)
 In the case of bank overdraft and bank loan, the amount of agreed facilities and
repayment term (e.g- monthly/quarterly/fixed date)
 Restrictions imposed by bank→ Example: Whether the account is subject to any
restriction such as cannot borrow from other bank
 Assets held as Security/Collateral → Example: Pledge property
 For standing order, the amount and term of the agreed facilities

(b) Explain why it is important that you should send a bank letter to the bank of Anon. Your
explanation should include commentary on the extent to which you could rely on:
 Bank confirmation letter is a third-party representation where information is obtained
from an independent third party which is more reliable than bank statement provided
by the client’s management. The confirmation reply is addressed to the auditor directly
and therefore it would not be subject to the client’s manipulation
 In this regard, obtaining bank confirmation will enable the auditor to gather the most
reliable source of evidence relating to the client’s bank balances

(i) The company’s bank statements are presented by the company

 Bank statement is external documents which is more reliable than internal documents,
but the auditor would discount its reliability as the bank statements are sent to the
client and therefore might subject to the client manipulation
 Thus, bank confirmation is more reliable than bank statement because the confirmation
reply is addressed to the auditor directly

(ii) Verbal assurance from the managing director

 Oral evidence from internal parties is the least reliable source of evidence as there is
possibility that the managing director might suppress or manipulate the information
provided to the auditor
 Thus, bank confirmation is more reliable than verbal assurance from the managing
director because the confirmation reply is addressed to the auditor directly
(c) Explain the concern you would have and the action you would take if the managing director
refused to authorize disclosure of the information required in the bank letter
 The auditor’s concern would be unable to ascertain the existence and amount of
overdraft loans, the ownership and proper custody of the bank balances. There may a
risk that the bank balances are materially misstated
 The auditor should try to explain to the managing director the importance of confirming
the bank balance as a means of gathering appropriate audit evidence and a letter of
authority permitting the banks to disclose the information requested is necessary
 If the auditor still refused the letter authority, the auditor may consider withdraw from
the engagement or issue a modified opinion in the auditor report at the end of the audit

(d) Explain the meaning of the term “appropriate segregation of duties” as applied to cheque
payment system
 Segregation of duties→ different persons doing the different function
 Appropriate segregation of duties reduces the likelihood that unauthorized cheque
payments are made
 It is important that an individual who approves a purchase not have direct access to
cheque payment for it. Additionally, the individuals in the accounts payable department
who initiate payment should not have access to the cheques after they are prepared
 Cheques are forwarded directly to the cashier’s department for mailing
 Example: Recording purchase (staff 1) → Approve purchase (authorized
personnel) → Initial payment (staff 2) → Issue cheque (staff 3) → sign cheque
(authorized personnel) → Mailing (staff 4)

(e) Detail four control procedures that you would expect to find in the cheque payments system
 Proper segregation of duties→ an individual who approves a purchase not have direct
access to cheque payment
 Proper segregation of duties→ an individual in the accounts payable department who
initiate payment should not have access to the cheques after they are prepared
 Proper authorization and approval and information processing→ Cheques prepared only
after all the original source documents (PR, PO, GRN and supplier invoice) have been
independently approved and attached
 Proper arithmetical and accounting→ Accounting for numerical sequence of payment
vouchers and in the standard format
 Proper arithmetical and accounting→ Accounting for numerical sequence of cheque.
Any cancellation of cheque and returned cheque need to record and file precisely
 Proper information processing, i.e. monthly payable reconciliation, i.e. Supplier
statements independently reviewed and reconciled to the account payable records
  Proper information processing and supervision, i.e. Monthly bank reconciliation
prepared and reviewed by the superior

Question 3

(a) Outline 4 audit procedures other than bank confirmation that you would carry out in verifying
cash and bank balances
 Confirmation→ Obtain the cash and bank schedule/lead schedule- cash and bank
balances
 Check opening balances is agree to previous year’s audited financial statement
 To validate accuracy and completeness
 Confirmation→ Obtain the cash and bank schedule/lead schedule- cash and bank
balances
 Check closing balances is agree to trial balance/ statement of financial position
 To validate accuracy and completeness
 Re-performance, computation, physical inspection of documents confirmation→ bank
reconciliation
 Obtain bank reconciliation prepared by client
 Check balances in Trial Balance/ SFP agree to lead schedule- Cash and bank
balances
 Select long outstanding unpresented cheques→ trace to the following month
bank statement→ to ensure cleared
 Select long outstanding uncredited deposits→ ensure it appear in bank
statement prior to financial year end
 To validate accuracy, completeness and cut off
 Physical inspection of documents→ Review BOD minutes and loan agreement
 Any account is secured on assets
 Bank account subject to restriction
 Legal right to off set overdraft against positive bank balances
 To validate ownership, i.e. right and obligation
 Enquiry→ Discussion with management
 Reason for opening new account
 Reason for closure of account
 New credit facilities
 To validate completeness and accuracy
 Physical inspection of documents→ scrutinize/examine the cash book and bank
statement before and after Statement of Financial Position
 Examine the cash book and bank statement few days before and few days after
the financial year end
 Exceptional entries and transfer→ materially affect the balance
  To validate proper cut off
 Scanning→ Evaluate financial statement presentation
 Investigate unusual or large payment to related parties
 To validate understandability, i.e. proper presentation and disclosure

(b) If the auditor suspects that some type of fraud involving cash and bank has occurred, it may be
necessary to extend the normal cash and bank audit procedures
Briefly explain 3 extended audit procedures that auditor may use to detect fraudulent activities
in the cash and bank accounts
 Extended bank reconciliation procedures
 Auditor will extend the coverage period to investigate the outstanding cheques
and uncredited lodgements and have a detailed examination of the each of the
outstanding items
 Proof of cash
 Reconcile the receipts and payments in the cash book with bank statement for a
specific period to ensure all the transactions in the cash book and bank
statement agreed and no transactions have been omitted from the book
 Tests of kiting
 Test of kiting involves the preparation of an inter-bank transfer schedule to
ensure proper cut off for the cash transaction
 When cash has been stolen by an employee, it is possible to cover the cash
shortage by following a practice known as kitting
 This involves an employee covering the cash shortage by transferring money
from one bank account to another and recording the transaction improperly in
the entity’s book