Exam 2 study guide ch6-10 PDF

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Chapter 6: Employee Fraud and the Audit of Cash6-1 Define and explain differences among several employee frauds that may occur at an audit client.Employee fraud (referred as misappropriation of assets): take money or property from an employer, employee fraud overview as false documents, lying, excee...

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Chapter 6: Employee Fraud and the Audit of Cash

6-1

Define and explain differences among several employee frauds that may occur at an audit client.

Employee fraud (referred as misappropriation of assets): take money or property from an employer, employee fraud overview as false documents, lying, exceeding authority, violating employer’s policy, illegal acts … Observation of person’s change as habit and lifestyle can reveal some red flags.  Sleeplessness  Drink too much  Take drug  Irritable easily  Can’t relax  Get defensive, argumentative  Can’t look other people in eye  Sweet excessively  Go to confession  Work standing up  Work alone  Work late frequently  Don’t take vacation Characteristic of fraudsters (referred as white color crime).  Has education beyond high school  Likely to be married  Member of mosque, temple, or church  Age between teens to over 60  An employment tenure from 1 to 20 years  Has no arrest record  Usually acts alone Common cash fraud techniques: Kiting: deliberate floating of fund between two or more bank accounts to cover the stolen from another account. The employee transfer money from one bank account to another account right before year-end. Lapping: using the receipt from one customer to cover the receivable for another customer. The employee uses the cash is received from one account applied to stolen account to cover up original theft. 6-2

Identify and explain the fraud triangle (AU-C 315, AS 2401)

Incentive/Pressure create a motive in fraud:  Buy a house  Pay bill  Pay for high lifestyle  Pay for drugs  …

Fraud without caught Issue: internal control either weak or non-existent

Nobody will get hurt

Everybody doing it Borrowing it and will give back later Company big enough to afford it

6-3 Technique used to prevent employee fraud Managing people and pressures in the workplace: Ex: counseling services, anonymous hotlines, some companies offer ethic officers … Internal control activities and employee monitoring: Segregation of duties and responsibilities for transaction authorization, record …. When completing fraud examination, auditors should learn to mark evidence, writing identification location … There are keys for auditors to be aware and notice exception  Transaction recorded at unusual times of day, month, year  Unusual number recorded (large or small)  Transaction for “round” dollar amounts  Cash shortage and overage  General ledger unbalance  Inventory shortage  Unexplained adjustment  Employees who can’t be found  Unusual check, deposit …  Common name or address for refund  Consist customer complain about account balance or missing shipment Tone at the top: Management establishes commitment to integrity and high ethical standards in the completion of all activities throughout the organization such as:  Accountability  Codes of conduct  Hiring and firing policies  Background check prior to hiring  Prosecution of fraudsters Other fraud detection procedure for cash:  Count liquid assets (e.g. petty cash) simultaneously  Carefully examine endorsements on canceled checks  Audit general journal entries  Use marked coins and currency  Measure receipt to deposit lag time  Examine documents such as bank statements for alteration  Covert surveillance 6-4

Relevant assertion and risk of material misstatement related to the cash balance

Cash is highly liquid, not easily identifiable as property There are different management reports, data, documents that are used by auditors for auditing cash. (Audit evidence used to test cash)  Cash receipts journal: consist all of the detailed entries for all receipts of cash by entity (debit to cash account) including cash deposit. Ex: revenues, receivables  receiving

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Cash disbursements journal (company’s checkbook): contain all detailed entries for check written during period being audited. Ex: inventory, operating expense, employee salaries  purchase & payment

6-5

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Bank reconciliations: is the primary document used to test cash balance in the financial meeting

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Canceled checks: if an amount of check is altered after it has cleared the bank, alternation should be note by comparing magnetic imprint of amount paid to amount written on check face.

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Bank statements: the number and dollar amount can be compared to detail data on the bank account. Internal control activities and relevant assertion related to cash

When evaluating the design of internal control related to cash, auditors must always consider whether the controls have been designed to mitigate the risk of misstatement for each relevant assertion identified for cash balance. Cash is highly liquid, easily transportable, and not easily identifiable, and therefore is a primary target for employee thieves.

Audit program including: Internal control over cash disbursements & receipts: Cash receipt and disbursement: key control activities  Voucher packet (purchase requisition, purchase order, receiving report, invoice) matched prior to cash disbursement authorization.  Deposit reconciled to amounts credited to accounts receivable ledger  Bank reconciliation

Substantive tests of cash:  Analytical procedures: tests of details and balance  Substantive analytical procedures: where auditor substantives an account or disclosure by developing an independent estimate of the amount and comparing the recorded balance to the estimate.

Audit of Cash: The first procedure in an audit of cash is to obtain bank reconciliation for each cash account and audit them in the following manner  Balance per bank Confirm (Standard Bank Confirmation) directly with bank Agree amount of Cutoff Bank Statement  Add deposits-in-transit Trace to cash receipts journal Vouch to cutoff bank statement  Subtract Outstanding Checks Vouch to cash disbursements journal Trace checks cleared from cutoff bank statement  Add/Subtract other Debit/Credit Memos Inspect bank credit/debit memo and audit for reasonableness. Examine relevant supporting documentation  Balance per books Foot the entire reconciliation for mathematical accuracy Trace the amount to the trial balance Confirmation of bank balances: bank confirms are most persuasive evidence of the existence of cash  Standard Bank Confirmation Inquiry Must be mailed under auditor’s own control. Used to confirm deposit balances and loan balances Also, can be used to request information about contingent liabilities and secured transactions. 

Electronic Confirmation Requests Many banks now only complete confirmation requests electronically (e.g., confirmations.com) Can improve the control of both delivery and receipt of the confirmation request Allowed by professional auditing standards

Which of the following control activities would best protect against the preparation of inaccurate cash disbursements? a. All checks must be signed by an officer designated by the board of directors. b. All signed checks must be reviewed and compared with supporting documentation by the treasurer before mailing. c. All checks must be sequentially numbered and accounted for by the internal auditors. d. All checks must be perforated or otherwise effectively canceled when they are returned with the bank statement. Which of the following control activities could prevent a paid disbursement voucher from being presented for payment a second time? a. Vouchers should be prepared by individuals who are responsible for signing disbursement checks. b. Disbursement vouchers should be approved by at least two management officials. c. The date on a disbursement voucher should be within a few days of the date the voucher is presented. d. The official signing the check should compare it with the voucher and should stamp “paid” on the voucher documents. An independent auditor has the responsibility to design the audit to provide reasonable assurance of detecting errors and fraud that might have a material effect on the financial statements. Which of the following, if material, is a fraud as defined in the auditing standards? a) Misappropriation of an asset or groups of assets. b) Clerical mistakes in the accounting data underlying the financial statements. c) Mistakes in the application of accounting principles. d) Misinterpretation of facts that existed when the financial statements were prepared. When auditing with “fraud awareness”, auditors should especially notice and follow up employee activities under which of these conditions? A. The company always estimates the inventory but never takes a complete physical count. B. The petty cash box is always locked in the desk of the custodian. C. Management has published a company code of ethics and sends frequent communication newsletters about it. D. The board of directors reviews and approves all investment transactions. Which of the following describes why a properly designed and executed audit may not detect a material misstatement in the financial statements resulting from fraud? a) An audit is designed to provide reasonable assurance of detecting material errors, but there is no similar responsibility concerning fraud. b) The factors considered in assessing control risk indicated an increased risk of intentional misstatements, but only a low risk of unintentional misstatements. c) The auditor did not consider factors influencing audit risk for account balances that have effects pervasive to the financial statements taken as a whole. d) Audit procedures that are effective for detecting unintentional misstatements may be ineffective for an intentional misstatement that is concealed through collusion. Fraud risk factors are events or conditions that indicate I. An incentive or pressure to perpetrate fraud. II. An opportunity to carry out fraud. III. An attitude or rationalization that justifies the fraudulent action. Which of the following statements is true? a) I is a fraud risk factor. b) I and II are fraud risk factors. c) II and III are fraud risk factors. d) None of these are fraud risk factors. e) All of these are fraud risk factors. Which of the following internal control procedures most likely would deter lapping of collections from customers? a) Independent internal verification of dates of entry in the cash receipts journal with dates of daily cash summaries b) Authorization of write-offs of uncollectible accounts by a supervisor independent of credit approval c) Segregation of duties between receiving cash and posting the accounts receivable ledger d) Supervisory comparison of the daily cash summary with the sum of the cash receipts journal entries

Chapter 7: Revenue and Collection Cycle 7-1

Revenue and collection cycle: typical activities

There are no such thing as typical revenue and collection cycle. Companies come in vary of shape and size, so the actual revenue generation can vary greatly among industries. We assume there are four basic activities: (1) Receiving and processing customer order: (2) Delivering goods and services (physical custody) (3) Account receivable recording: (4) Cash reconciliation:

Receiving and processing customer order:  Auditor should check customer actually exist, the order actually exists, and credit history for new customers (as sales authorization, credit files reports)  Customer orders, shipping documents, and invoices should be in prenumbered sequence, so the system can check and determine whether any transactions have not been recorded (completeness) or duplicated (occurrence)  If company sells its goods or services for something other than cash, it is important that someone authorize credit sales to ensure that the customer will be able to pay.

Delivering goods and services (physical custody): people who work for company and have authority to access to inventory.  If the sell items are huge such as tractors, we don’t have to worry about stolen in inventory, since if hard to carry. Otherwise, we should be careful on smaller items or easily carry as smart phones.  Bill on lading: the form that carrier sign to verify the goods are shipped.  Packing slip: describes the goods are shipped, and quantity of goods shipped, often included in shipping. Account receivable recording: auditors has examined all the accounts receivable to ensure that all are recorded.  Auditors review items in pending orders file for evidence of completeness of recorded sales and A/R  When a delivery is complete, the transaction is completed by filling a shipping record and preparing final invoice for the customer.  Sales invoice is the bill sent to the customer that indicates what amount customer owe  Customer master file: sample tested for current status and up to date credit limit information. Company review credit limit to ensure appropriate limit are placed on customers, and auditors will perform exception testing on credit checks.  Price list master file: pricing file should be compared to official price source for accuracy.  Sales detail file: should correspond with the issuance of invoices to customers and should including the shipping references and dates.  Pending order and back order master file: sales transactions that were initiated but are not yet recorded as sales are kept in pending order master file.  Cash receipt listing: contain all detail entries for cash deposit and credit to various account. These entries are important because they might signal the type of accounting error occur in cash receipt listing.  Customer statements: including statement of what has been billed, paid, and ending balance on monthly. Cash reconciliation: Trace – Start with source document and follow it to recording | Vouch – Start with recording and follow it to source documents SEC guidance 4 criteria of Revenue/Receivable: (1) Persuasive evidence that an arrangement exists (2) Delivery has occurred or services have been rendered (3) The seller's price to the buyer is fixed or determinable (4) Collectability is reasonably ensured The inherent risks in the revenue and collection cycle:  Improper Revenue Recognition Cut-off Bill and Hold Channel Stuffing and unauthorized shipments Premature revenue recognition Improper cutoff Improper percentage of completion Consignment sales  Returns and Allowances Side agreements  Collectability of Receivables Subjective estimate Effected by changing economic conditions Audit test to revenue:  Contract Reviews Occurrence, Valuation, Cut-off Review of Customer Order Review of Bill of Lading Sales Invoice- Agreed to Packing Slip and Price to Master List Returned Confirm or Customer Payment History  Sales Cut-off Tests

Cut-off Examine Sales before and after YE Review Credit Memos – Sales returned after YE Audit test to receivable:  Test A/R Aging Valuation Why might testing an A/R aging be more valuable than going on what the client says?  Assess collectability by reviewing Customers’ Credit Reports Valuation  Confirm/Inquire about Sold Receivables Rights & Obligations Restrictions Audit test uncollectible accounts:  Inspect customer files for collectability  Recalculate ALLOWANCE and BAD DEBT EXPENSE  Verify reasonableness of ALLOWANCE and BAD DEBT EXPENSE How?!?  Verify appropriateness of accounts written off Verify attempts to collect receivable Verify authorization is appropriate

7.46 Which of the following is the best reason for pre-numbering in numerical sequence documentation such as sales orders, shipping documents, and sales invoices? a. Enables company personnel to determine the accuracy of each document. b. Enables personnel to determine the proper period recording of sales revenue and receivables. c. Enables personnel to check the numerical sequence for missing documents and unrecorded transactions. d. Enables personnel to determine the validity of recorded transactions. 7.41 Which of the following responses to an A/R confirmation at 12/31 would cause the audit team the most concern? a. “This amount was paid on December 30.” b. “We received this shipment on January 2.” c. “These goods were returned for credit on November 15.” d. “The balance does not reflect our sales discount for paying by January 5.” 7.37 When auditing sales transaction, auditors vouch a sample of debit entries from the A/R ledger back to supporting sales invoices. The purpose of this audit procedure is to establish that: a. Sales invoices represent bona fide sales. b. All sales have been recorded. c. All sales invoices have been properly posted to customer accounts. d. Entries in the A/R ledger were properly invoiced. 7.44 Which of the following might be detected by auditors’ cutoff review and examination of sales journal entries for several days prior to the balance sheet date. a. Lapping year-end accounts receivable. b. Inflating sales for the year. c. Kiting bank balances. d. Misappropriating merchandise. Which of the following tests would most likely provide relevant evidence relating to sales recorded more than once? a) The auditor can review a numerically sorted list of sales transactions and look for duplicate numbers b) The auditor can check for proper cancellation of shipping documents

c) Examine the resolution of related receivables to see whether it was written-off or is still outstanding. d) Both a and c e) All of the above Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle? A. Fictitious transactions are recorded that cause an understatement of revenue and overstatement of receivables. B. The write-off of receivables by personnel who receive cash permits the misappropriation of cash. C. Merchandise received is not promptly reconciled to the outstanding purchase order file. D. Obsolete items included in inventory balances are rarely reduced to the lower of cost or market value. Which of the following best represents a key control for ensuring sales are properly authorized when assessing control risks for sales? A. Sales orders are sent to the credit department for approval. B. The use of an approved price list to determine unit selling price. C. The separation of duties between the billing department and the cash receipts approval department. D. Copies of approved sales orders sent to the shipping, billing, and accounting departments. If the business environment is experiencing a recession, the auditor most likely would focus increased attention on which of the following accounts? A. Purchase returns and allowances. B. Allowance for doubtful accounts. C. Common stock. D. Non-controlling interest of a subsidiary purchased during the year. What are the associated PCAOB Assertions? A. Accounts receivable represent all amounts due to the client company at the balance sheet date. Completeness 2 B. The client company has a legal right to all accounts receivable at the balance sheet date. Right & Obligation 4 C. Accounts receivable are stated at net realizable value. Valuation 3 D. Accounts receivable are properly described and presented in the financial statements. Presentation & Disclosure 5 For each of these assertions, select the audit procedure (labeled 1-6) that is best suited for the audit plan. 1. Analyze the relationship of accounts receivable and sales and compare with relationships from preceding periods. 2. Perform sales cutoff tests to obtain assurance that sales transactions and corresponding entries for inventories and cost of goods sold are recorded in the same and proper period. 3. Review the aged trial balance for significant past due accounts. 4. Review loan agreements for indications of whether accounts receivable have been factored or pledged. 5. Review the accounts receivable trial balance for amounts due from officers and employees. 6. Analyze unusual relationships between monthly accounts receivable and monthly accounts payable balances.

Chapter 8: Acquisition and Expenditure Cycle 8-1

Acquisition and expenditure cycle

Acquisition and expenditure cycle focus on 4 steps: Before purchase order, we need a purchase requisition from th...