8.1 audit of cash and banks PDF

Preview

Summary

notes in accordance with acca...

Description

8.1 Audit of Cash and Bank Documents used and basic audit testing for cash and bank Documents used in the audit of Cash and Bank For Cash and Bank, auditors will normally use the following sources of information and documentation as part of their audit:  Listing of bank balance for each account  Detailed bank reconciliation for each account  List of cash balances  Nominal Ledger /trial balance

Basic audit testing   

Ensure that the detail adds up and ties to the statement of financial position. Analytical review comparison of balances with prior year Check foreign currency balances translated correctly in accordance ith IAS 21 using the year-end spot rate

Financial Statement Assertions

Bank confirmation letters The bank confirmation letter is a critical piece of audit evidence. It represents external third party evidence of bank balances, as with receivables confirmations the process for obtaining bank confirmations is important to ensure that the confirmation is reliable. A bank confirmation letter should be obtained for ALL client bank accounts

Bank confirmation process The process to be used for bank confirmations is as follows: The bank confirmation letter should be sent directly to the bank by the auditor on the headed notepaper of the auditor for all bank balances  The bank confirmation letter should refer to a letter of authority sent by the client to the bank authorising the Bank to disclose information to the auditor.  The letter of authority can be a standing letter or reissued every yea  The bank confirmation letter should be received by the bank at least one month before the clients’ year-end Responses to the bank letter should be received directly by the auditor. Auditors should check that the banks response covers all the information requested. 

Bank Reconciliations What is a bank reconciliation? A bank reconciliation is a critical accounting control and it's purpose is to ensure that the accounting balance for Bank is correct. It identifies and reconciles the differences between an external third party confirmation of the bank balance in the form of a bank statement (or bank confirmation letter) and the accounting balance for bank. It therefore ensures that all cash payments and receipts are correctly recorded in accounting records. Why might there be differences between the clients accounting records and the bank statements? Either because: 1) Transactions on the bank statement not picked up by the entity, e.g bank charges or a direct debit, these differences should be adjusted by the entity 2) Timing differences between the accounting records and the bank statements: Either 



Payments recorded in the accounting records not yet cleared through the bank. (for example if an entity pays a supplier by cheque on the last day of the year, this will correctly reduce the accounting balance for bank and cash, but will not impact the bank statement until it has been paid into a bank by the supplier and cleared (a process which can take a few days) ; or Receipts recorded in the accounting records not yet cleared through the bank. If an entity receives a cheque from a customer or cash this will immediately be recorded in the entities accounting records but will not impact the bank statement until it is paid into the bank and cleared (Generally this process should take no more than 5 days)

Timing differences are valid reconciling items

Example of a bank reconciliation

How to audit a bank reconciliation

Audit procedures on the bank reconciliation         

Ensure the bank reconciliation reconciles exactly ( any difference needs to be fully reconciled and cannot be ignored as immaterial) Check the maths of the bank reconciliation Agree bank balance to bank confirmation letter Agree accounts balance to the trial balance Check payments shown as outstanding to ensure they are recorded in the accounting records before year end Check payments shown as outstanding (unpresented) to the after date bank statements to ensure they clear within a reasonable time period Check receipts shown as outstanding to the after date bank statements (to ensure they clear within a reasonable time period Check receipts shown as outstanding to ensure they are recorded in the accounting records before year end Enquire into any still uncleared payments or receipts(propose adjustments if required)

Example Audit

Step 1- Check the bank reconciliation adds up Step 2 - Agree the Bank balance to the bank statement and note the dates that the outstanding receipts and payments clear the bank statement

Step 3 - Agree accounting balance to the accounting records and agree the date that the outstanding cash payments and receipts were posted to the accounting records

Cut-off Testing The cash and bank balance is often a sensitive balance in a set of financial statements with many Companies wishing to maximise the balance to improve the apparent liquidity of the business. This can lead to window dressing where a company can recognise receipts early to improve its bank balance or decrease an overdraft, or recognise payments early to improve liquidity ratios

. Alternatively balances can be improved by either delaying payments to suppliers or underpaying suppliers. Window dressing may:   

Improve appearance of liquidity or working capital management Meet covenants based on working capital targets Conceal timing-related abuses of incoming funds

AUDIT PROCEDURES TO TEST CASH AND BANK CUT-OFF To ensure that cash and bank transactions are recorded in the correct period auditors carry out the following tests:  Review of the reconciling items on the bank reconciliation to ensure they are recorded in the correct period  Review of cash and bank payments around year end for large and unusual items to ensure that they are recorded in the correct accounting period

Foreign currency and Cashbook review Review of Accounting records for large and unusual payments and receipts A standard audit test is to carry out a review of the accounting records (cashbook) for any large and unusual items, for example round sum payments and large amounts. This is a critical test for detecting potential fraud and also gaining audit evidence around for example Non-Current assets, prepayments, expenses etc. This test is increasingly being carried out by the use of audit software. With auditors capturing details of all payments and receipts for the year and setting parameters for individual payments and receipts to be investigated further and agreed to source documentation. Foreign Currency Balances If there are any bank balances denominated in a foreign currency then a standard audit test will be to ensure that the balances are retranslated correctly using the year end spot rate.

Audit procedures for Petty cash/cash on hand Audit Procedures on Cash balances (petty cash and cash balances kept in tills).

In many businesses the amount of petty cash or cash held in tills tends to be very small and immaterial. However for certain entities (e.g retail, pubs and bars, charities this may not be the case and audit of cash on hand becomes an important area. Substantive testing of Cash on hand    

Carefully audited if balances are material and susceptible to fraud ( hotels, restaurants, retail organisations). Auditors will be concerned that the cash exists, is complete, and belongs to the company (rights and obligations) and is stated at the correct value. Plan for locations to attend the cash count at year end (But do not warn client’s staff!) Obtain all reports/certificates on cash counts and compare with accounting records. Follow-up on banked cash receipts and reconcile with bank statements after cutoff date

During the cash count      

Check records & whether written up, make notes in records or copy if incomplete or in pencil. Count all balances together Count all negotiable securities at same time as cash Client staff must be present: if not auditor may be blamed for missing items Count & record & get client to sign they have received it back Keep copy for working papers

Bank and Cash Fraud/ Misstatement Because of the sensitivity of the cash and bank balance then it is a balance that is susceptible to fraud, it is worth considering how the perpetrators of fraud might cover up the theft of of cash and bank balances: 1) False debit By processing a fraudulent invoice into the accounts the perpetrator will allow cash/bank to be taken from a business whilst posting a fake debit, either to expenses or possibly purchases or an asset account. In this way the accounts will balance. Audit detection: The auditors may detect this by analytical review procedures e.g comparing actual expenditure with prior year and budget or through testing a sample of expenses back to invoice. 2) Omitted Credit By this method cash is taken from a business by income just not being recorded in the business in the first place. For example in businesses with alot of cash transactions e.g retail, hospitality Income is diverted/stolen before it is recorded in the accounting records Audit detection

The auditors may detect this through review of controls and or analytic review of income and gross margins 3) Forced balance Essentially missing bank or cash is hidden by creating a fake bank reconciliation where either the bank statement balance is misstated or false reconciling items are included in the bank reconciliation Audit detection Auditors should be able to detect forced balances by obtaining bank letters directly from the bank confirming balances rather than relying on bank statements that could be manipulated, by making sure that bank reconciliations reconcile exactly and by proper testing to ensure that all reconciling items on the bank reconciliation are valid.

Case studies of bank manipulations The following three case studies should be reviewed to examine the manipulation of cash balances. In two of the cases the auditors did not detect fraudulent balances by failing to directly obtain bank confirmation letters. The final Tesco example shows a combination of window dressing and aggressive accounting:

Parmalat “In December 2003 questions began to be asked about Parmalat, an Italian company specialising in long life milk. ….An immense black hole appeared in the company’s accounts after Parmalat struggled to make a EU 150m bond payment when the company was, according to the books, cash rich. However it was found that EU 3.9 bilion of the company’s funds, which were held in a Bank of America subsidiary (Bonlat) account in the Cayman Islands, did not exist. Letters from the Bank of America concerning Bonlat were found to have been forged. Parmalat was being audited by both Deloitte and Touche and Grant Thornton. The company has now admitted to £10 billion worth of debt.” (Solomon, 2013, Corporate Governance and Accountability 4ed, Wiley) Italian prosecutors reported that Grant Thornton relied on Parmalat’s internal mail system, rather than getting in direct contact with the Bank of America, to receive and accept a verification letter, allegedly from the Bank of America, confirming that Bonlat held EU 3.95 billion in cash and investments in an account at the bank. That document had been taken as basis for confirmation.

ZZZZ Best Carpet Cleaning In the 1980's, a small company founded by a high school student grew into the highly glamorized story of ZZZZ Best Carpet Cleaning. It highlighted how a single executive could circumvent the paper confirmation process to provide auditors the paper evidence needed to take a company public and bilk banks and investors out of $100 million. In later discussions, Mark Morze, the company's CFO, detailed how he used white out and a copy machine to create over 10,000 false documents including false bank statements.

To complete the confirmation fraud, Mark paid a friend $10,000 for the use of the friend's name and address as the contact information for the audit confirmations. ZZZZ Best's accountants sent the audit confirmations to the friend's address and received back official looking confirmations that "verified" ZZZZ Best's accounts. (confirmation.com) Tesco deliberately delayed payments to suppliers to boost sales performance, investigation finds Christine Tacon, head of the Groceries Code Adjudicator, demanded Tesco improve relations with suppliers Simon Neville Tuesday 26 January 2016 12:13 comments The supermarket also avoided dealing with suppliers it was in dispute with Tesco systematically and deliberately withheld money owed to suppliers without warning to boost its sales performance ahead of revealing its results to the stock market, the supermarket watchdog has found. The Groceries Code Adjudicator also said that the supermarket would encourage suppliers to give it extra cash in return for more control over where products appeared on shelves or to avoid losing out to rivals. Christine Tacon, the GCA head, demanded Tesco improve relations with suppliers, stop taking money from them without permission and speed up correcting the numerous errors that would occur on its payment systems. She also said all finance and buying teams must be trained in the findings of the investigation. The report is the first major publication into Tesco's internal workings since the company admitted it had overstated profits under the leadership of Phil Clarke. It paints a picture of a culture where staff were encouraged to boost margins at any cost and ignore pleas for payment. In one case Tacon found that Tesco had withheld a multi-million pound payment from one supplier for over two years. Several suppliers also made margin payments of £1 million to Tesco, regardless of whether more of their products had been sold. The report will now be passed onto the Serious Fraud Office who are conducting a criminal investigation into Tesco, which will look at whether the company lied to the stock market or any directors broke the law The findings are expected to also be used by investors who may want to sue Tesco for the collapse in share price since the revelations in September 2014.

Tacon revealed: “A Tesco list of methods for meeting the half-year target included 'Not paying back money owed'. ”The evidence I received revealed a number of examples of Tesco deliberately deferring payment of money in order to maintain its margin at key financial reporting periods. “I find that Tesco knowingly delayed paying money to suppliers in order to improve its own financial position. She added: ”In particular, requests for payments to meet margin targets appeared to be more prevalent at the end of trading periods. Some suppliers reported that what set Tesco apart from other retailers was the pressure it put on suppliers at the end of a financial quarter, halfyear or full-year.“ The supermarket also avoided dealing with suppliers it was in dispute with, and Tacon pointed out ”one of the key cultural factors“ which caused the delays was an apparent ”reluctance of some Tesco buyers to pro-actively engage in the resolution of payment disputes. There were times when Tesco did not appear to even attempt to resolve supplier concerns before unilaterally deducting money from suppliers.“ Bosses were in breach of the code on payment delays, but not on charging suppliers directly for prominent positioning on shelves However, she found that there were examples of indirect charging, which may require the code to be modified. The GCA only recently were granted the power to fine supermarkets, but not retrospectively, meaning Tesco avoided a fine. The report did find, however, that Tesco has subsequently improved its relations with suppliers, after chief executive Dave Lewis simplified the supply chain. Source Guardian Newspaper 26 January 2016

Summary The audit of bank and cash balances is often seen to be an area of higher inherent risk, the audit procedures for bank balances depend upon obtaining a bank confirmation letter and reperforming the bank reconciliation. If a client has a large amount of petty cash or cash in hand then attention also needs to be paid to verifying the amount of cash on hand if it is material. Key Tests    

Obtain bank confirmation letter for all bank accounts Reperform all year end-bank reconciliations (remember they must reconcile exactly) Ensure foreign currency balances are translated at the correct year-end rates Review cash payments and receipts throughout the year for any large or unusual items



Perform cut-off testing by checking a sample of cash payments and receipts recorded before and after year end to check they have been recorded in the correct period...