DIRE DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING
Unit 1: Audit of Cash and Marketable Securities

Meaning of Cash

Cash represents currency on hand and cash on deposit in bank accounts including certificates of
deposit, time deposits, and savings accounts. Virtually (practically) all accounting transactions
pass through the cash account at some point.

Nature of Cash

Cash and bank balances are liquid assets and include 1.Notes and units, 2.Bank current
accounts and 3.Bank deposit accounts.

Because of their liquidity, these assets represent the most vulnerable of all the company’s assets.
On the other hand, they are the most easily verified, because they can be confirmed directly by
third parties or by physical counts.

Objectives for the Audit of Cash:

The auditors have five objectives in the audit of cash:

• Consider the inherent risks related to cash, including fraud risks
• Consider internal control over cash transactions
• Substantiate (verify) the existence of recorded cash
• Establish the completeness of recorded cash
• Determine that the presentation and disclosure of cash, including restricted funds, are
appropriate
The overall objective of the audit of cash is to determine that cash is fairly presented in
conformity with generally accepted accounting principles (GAAP).
1. Inherent Risk
Unless the client’s business is a retail business which involves significant amount of cash
balances daily, the cash balance is usually immaterial in most audits. From a good internal
control point of view, an Imprest petty cash fund is usually maintained. It is operated by
established a fixed amount of petty cash fund transferred from the business’s general cash in
bank account. Cash is more susceptible to theft; therefore, there is high inherent risk for the
existence, completeness, and accuracy objectives.
2. Internal Control
Control Objectives Description
1. Existence 1. Division of duties among custody, recording, authorization and
(Survive/continuation) replenishing (refill) petty cash fund.
2. Imprest petty cash fund system in existence to Control petty cash.
(accuracy, existence and completeness)
3. All disbursements should be authorized and claims are on
approved forms (occurrence).
4. Independent cash counts on a regular and surprise basis.

2. Completeness 1. Prenumbered petty cash vouchers should be used for withdrawing

cash from the fund and a limit should be placed on the size of
reimbursements.

Control activities for Cheque receipts

• Segregation of duties in the handling of cheque receipts and recording.
• Immediate preparation of incoming cheque listing and endorsement of incoming cheques.
• Timely deposit of cheques, preferably on a daily basis.
• Cash receipt journal vouchers prepared from cheque listing a pay-in slip and approved
by senior accounting staff before input into cash book.
• Periodic (regular) bank reconciliations prepared by an independent accounting staff
member.
• Independent review of bank reconciliation.

Internal Control Over Cash 

• Control Objectives
• Control Procedures
• Internal Control over Cash receipts
• Internal Control over Cash Disbursement

(a) Control Objectives

The central control objectives are that:
• All sums are received and subsequently accounted for.
• No payments are made which should not be made.
• All receipts and payments are promptly and accurately recorded.

(b) Control Procedures

• A detailed study of the operating routines of the individual business is necessary in
developing the most efficient control procedures. These universal rules for achieving
internal control over cash may be summarized as follows:
• Do not permit any one employee to handle transaction from beginning to end.
• Separate cash handling from record keeping.
 • Centralize receiving of cash as much as possible.
• Record cash receipts immediately.
• Encourage customers to obtain receipts and observe cash register totals.
• Deposit each day’s cash receipts intact (whole).
• Make all disbursements by cheques with the exception of small from petty cash.
• Have monthly bank Reconciliation prepared by employees not responsible for the
issuance or custody (protection) of cash. The completed reconciliation should be
reviewed promptly by an appropriate official.
• Forecast (estimate/anticipate) expected cash receipts and disbursements and investigate
variances from forecasted amounts.

(C) Internal control over cash receipts:

Cash receipts resulted from a variety of activities. For example, cash is received from revenue
transactions, short and long term borrowings, the issuance of stock, and the sale of marketable
securities, long term investments, and other assets. The scope of this section is limited to cash
receipts from cash sale and collection from customers on credit sales. The basic internal
controls over cash receipts include the following:

• Authority to collect cash should be clearly defined.

• Collections should be recorded when received.
• The collector’s cash receipts should be reconciled to the eventual banking.
• Receipts should be banked immediately.
• Each day’s receipts should be recorded promptly in the cashbook.
• Sales ledger account should have not access (admittance) to the cash.
• The processing of receipts from cash and credit sales involves the following cash receipts
functions:
- Receiving cash receipts.
- Depositing cash in bank.
- Recording the receipts.
Segregation of duties in performing these functions is an important internal control activity.

1. Receiving the cash receipt:

A major risk in processing cash receipts transactions is the possible theft of cash before and
after a record of cash is made. Thus, control procedures should provide reasonable assurance
that documentation establishing accountability (responsibility / liability) is created at the
moment cash is received and that the cash is subsequently safeguarded.
2. Depositing cash in bank:
Proper physical controls over cash require that all cash receipts be deposited intact
(Whole/together) daily. Intact means all receipts should be deposited; that is cash disbursements
should not be made out of un-deposited receipts.
3. Recording the receipts:
This function involves journalizing over the counter and mail receipts and posting mail receipts
to customer accounts. Controls should ensure that only valid receipts are entered and that all
actual receipts entered at the correct amount. To ensure that only valid transactions are entered,
physical access to the accounting records or computer terminals used in recording should be
restricted to authorized personnel.
D. Internal Control over Cash Disbursement:
There are two cash disbursements functions as follows:
- Paying the liability
- Recording the cash disbursements.
These functions should not be performed by the same department or individual. The basic
internal controls over cash disbursements include:
 Unused cheque should be held in a secure place.
 The person who prepares cheque should have no responsibility over purchase ledger or
sales ledger.
 Cheque should be signed only when evidence of a properly approved transaction is
available.
 These cheques should be evidenced by signing the supporting documents.
 Cheque signatories should be restricted to the minimum practical number.
 Two signatories at least should be required except perhaps for cheque of small amounts.
 Cheque should be crossed before being signed.
 Supporting documents should be cancelled as paid to prevent their use to support further
cheque payments.
 Cheque should preferably dispatch immediately.
Petty Cash
A petty cash account is often something as simple as a preset (fixed) amount of cash set aside in
a cash box for incidental expenses. It is used for small cash acquisition (attain/gain) that can be
paid more conveniently and quickly by cash than by cheque, or for the convenience of employees
in cashing personal or payroll cheque.
An Imprest cash account is set up on the same basis as an Imprest branch bank account, but the
expenditures are normally for much smaller amounts. Typical expenses include minor office
supplies, stamps, and employee meals. A petty cash account usually does not exceed a few
hundred dollars and is often reimbursed only once or twice each month.
Control over petty cash:
• The level and location of cash floats (drift) should be laid down formally.
• Cash should securely hold.
• There should be restricted access to the floats.
• All expenditure should require a voucher system signed by a responsible official, not the
petty cashier.
• Vouchers should be produced before the cheque is signed for reimbursement.
• A maximum amount should be placed on a petty cash payment to discourage normal
purchase procedures being by passed.
• Periodically the petty cash should be reconciled by an independent person.
Audit program for cash:
The following audit program indicates the general pattern of work performed by the auditors in
the verification of cash.
A. Consider internal control for cash.
1. Obtain an understanding of internal control for cash.
By understanding internal control over cash receipts and cash disbursements helps auditors to
observe whether there is appropriate segregation of duties and to enquire who performed
various functions throughout the year.
2. Assess control risk and design additional tests of controls for cash.
After obtaining an understanding of the client’s internal control for cash receipts and
disbursements, the auditors perform their initial assessment of control risk.
3. Perform additional tests of control for those controls, which the auditors plan to consider in
their assessment of control risk.
Tests directed toward the effectiveness of control help to evaluate the client’s internal control
and determine the extent to which the auditors are justified in reducing the assessed levels of
control risk for assertions about the cash account.
4. Reassess control risk and design substantive tests for cash.
When the auditors have completed the procedures described above, they should reassess control
risk and design substantive tests of cash transactions and balances.
The following are examples of typical tests of controls.
• Test the accounting records and Reconciliation by re-performance.
• Compare detail of cash receipts listings to cash receipts journal, accounts receivable
postings, and authenticated deposit slips.
• Compare detail of a sample of recorded disbursements in cash payments journal,
accounts payable postings, purchase orders, receiving reports, invoices, and paid
cheque.
B. Perform substantive tests of cash transaction and balances.
• Obtain analysis of cash balances and reconcile to the general ledger.
• Send standard confirmation forms to banks to verify amounts on deposit.
• Obtain or prepare reconciliation of bank accounts as of the balance sheet date and
consider the need to reconcile bank activity for additional months.
• Obtain a cutoff bank statement containing transactions of at least seven business days
subsequent to balance sheet date.
• Count and risk cash on hand.
• Verify the client’s cutoff of cash receipts and disbursements.
• Trace all bank transfers for last week of audit year and first week of following year.
• Evaluate proper financial statement presentation and disclosure of cash.

MARKETABLE SECURITIES
A marketable security is an easily traded investment that is readily converted into cash, usually
because there is a strong secondary market for the security. Such securities are typically traded
on a public exchange, where price quotes are readily available. The tradeoff for the high level of
liquidity is that the return on marketable securities is usually low.
Marketable securities are recorded as a current asset, since they have a maturity of less than one
year. This is of some importance when calculating the current ratio, since marketable securities
are included in the numerator of that calculation, and make a business look more liquid.
Definition:
Marketable securities are the financial instrument than can be easily bought and sold on a stock
exchange within a short period of time.
Financial instruments:
Financial instrument represents the legal obligation to pay or receive any monetary value.
Financial instruments are the assets than can be exchanged or traded. Some of the common
types of financial instruments are equity shares, preference shares, debts and derivates.
Marketable securities are part of financial instruments. All marketable securities are financial
instruments but all financial instruments are not marketable securities.
Classification of Marketable securities:
Marketable securities can be classified under two categories:
1. Marketable Equity Securities
2. Marketable Debt Securities
1. Marketable equity securities:
Marketable equity securities are equity instruments that are trade on stock exchanges. Common
type of equity securities are equity and preference shares. These instruments must be held for
trading purpose or should be available for sale. If these equity securities are acquired for
acquiring control, then these securities aren’t considered as marketable equity securities but,
instead, are classified as long term investment in the balance sheet.
2. Marketable Debt Securities
Marketable debt securities are those debt securities that are traded in bond market. Common
types of debt securities are U.S Government bonds, Commercial papers and etc. These
instruments must be held for trading purpose or should be available for sale.
Types of Marketable securities:
• Banker’s Acceptances
• Negotiable Bank Certificates of Deposit
• Commercial Paper
• Treasury Bills
1. Bankers Acceptances
A banker’s acceptance is a letter of credit (a bank’s promise to pay on a specific date) that has
been stamped as “accepted” (guaranteed) by another bank. In other words, a banker’s
acceptance is a bank draft (a promise of payment similar to a cheque) issued by a firm, payable
at some future date, and guaranteed for a fee by the bank that stamps it “accepted”.
The banker’s acceptances are particularly valuable in international trade transactions. The
advantage to the firm is that the draft is more likely to be accepted when purchasing goods
abroad because the foreign exporter knows that even if the company purchasing the good goes
bankrupt, the bank draft will still be paid off. The “accepted” drafts are often resold in
secondary market at a discount and so are similar in function to Treasury bills.
2. Negotiable Bank Certificates of Deposit
Certificates of Deposits (CDs) are debt instruments sold by banks and other depository
institutions. A Certificate of Deposits pays the depositor specified amount of interest during the
term of the certificate, plus the purchase price of the Certificate of Deposits at maturity.
Earlier, Certificate of Deposits were nonnegotiable that is they could not be sold to someone else
and could not be redeemed from the bank before maturity without paying a substantial penalty.
Now negotiable Certificate of Deposits is also in use in large denominations and can be resold in
the secondary market. This instrument is now issued by almost all the major commercial banks
and became extremely important sources of funds for commercial banks, corporations, money
market mutual funds, charitable institutions and government agencies.
3. Commercial Paper:
Commercial paper is a promise to pay back a higher specified amount at a designated time in
the immediate future say for example 30 days. Commercial paper is a short-term debt instrument
issued by large banks and well-known corporations. Growth of the commercial paper market,
now a day, has been substantial (considerable / significant).
4. Treasury Bills
The Treasury bills or T-Bills are short-term debt instruments issued by the Federal government
to finance for financial deficits. These are issued in 3 months, 6months, and 12 month
maturities. These instruments do not carry regular interest payments, but instead are sold at
discount. This means they are sold for an amount that is less than what the government promises
to pay at maturity, and the difference between the purchase price and the face value is the return
from buying the T-bill.
For instance, if one-year Treasury bill is purchased in May 2004 for ETB 9,700, in April 2005
(when it matures) the government would buy it from you for ETB10, 000.
Why invest in Marketable Securities:
Almost Every Company will invest the certain amount of funds in marketable securities. Broad
reasons for investing in marketable security as follows:
1. Substitute for hard cash – Marketable securities are great substitute for cash and bank
balances. Idle cash does not grow since no return is received by holding it. On the other hand,
bank balance offers only a meager return. Whereas, marketable securities not only offer
adequate return but also retains the benefits associated with holding money, since they are
highly liquid and easily transferable.
2. Repayment of short term liabilities: Every company has liabilities which are further
bifurcated into short term and long term liabilities. Long term liabilities are repaid over longer
time period, which generally is more than one year. Whereas short term liabilities are to be paid
within one year. Bonus expense, tax expense and etc. are some of the examples of the short term
liability.

Marketable securities are the best mode of payment of short term liabilities since they are highly
liquid and in the meantime also provide the company additional income in form of interests and
dividends.
3. Regulatory requirement: In order to raise funds and loans from financial institutions,
corporates have to follow certain guidelines and rules known as covenant which safeguards the
interest of lenders. These covenants are agreed upon by the borrower and lender and are
specified in every loan agreement. Covenants are often in form of ratios which the borrower has
to maintain throughout the loan period. These ratios mostly deal with liquidity and long term
solvency health of companies.
Maintenance of marketable securities helps in meeting out solvency ratios since most of the
marketable securities are considered as current assets. Hence higher the amount of marketable
securities, higher will be the current ratio and liquid ratio.
Test of control for marketable securities:

• Review policies for authorization to purchase, sell and manage marketable securities.
• Inquire of the board of directors about the board’s oversight of the marketable securities
process and examine related documentation.
• Examine documentation of authorization for selected purchases and sales of marketable
securities during the year
• Review the minutes of the board meetings for reference to investment policies and
associated oversight.
• Examine evidence of authorization controls for changes in classification of marketable
securities.
• Inquire of management about its process for establishing valuation of marketable
securities and review related documentation.
• Inquire of management about their process for reclassifications and review related
documentation
• Examine documentation for selected marketable securities transactions to determine
whether segregation of duties is maintained.
• Review reports of internal audit in relation to their activities involving monitoring of
marketable securities.

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