CHAPTER 6 Employee Fraud and the Audit of Cash LEARNING O !

ECTI"E#
Review Checkpoints 1. Define and explain the differences amon several kinds of emplo!ee frauds that mi ht occur in an or ani"ation. #. %ist and explain some conditions that can lead to frauds. $. Describe wa!s and means for preventin emplo!ee frauds. &. Describe the controls over the receipt and disbursement of cash. '. Desi n and perform substantive audit procedures for the audit of cash. (. Discuss actual cash fraud cases and describe how the schemes were uncovered. ). Describe some extended procedures for detectin emplo!ee fraud schemes involvin cash. 1, #, $ Exercises, Problems, and Simulations

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#OL$TION# FOR RE"IE% CHEC&POINT#

(.1 Emplo!ee fraud is the use of fraudulent means to take mone! or other propert! from an emplo!er. 3t consists of three phases6 718 the fraudulent act, 7#8 the conversion of the mone! or propert! to the fraudster9s use and 7$8 the coverup. Embe""lement is a t!pe of fraud involvin emplo!ees or nonemplo!ees wron full! takin mone! or propert! entrusted to their care, custod!, and control, often accompanied b! false accountin entries and other forms of l!in and coverup. %arcen! is simple theft of an emplo!ers propert! that is not entrusted to an emplo!ee9s care, custod! or control. Defalcation is another name for emplo!ee fraud and embe""lement. (.# (.$ :raud perpetrators look like other people, hence the difficult! in spottin them easil!. 2owever, the! sometimes exhibit behavioral red fla s of odd habits. 718 7#8 7$8 3f the emplo!ees cannot be found, ma!be the! do not exist. .he names are odd. 4ll the first and last names be in with the same letter. 3f Eloise 0arfunkle is a compan! emplo!ee, somehow she cashed a check pa!able to a supplier. /a!be she is related to the supplier, or ma!be she intercepted the check before it reached the supplier. Somebod! is workin on holida!s; .hese dates are normal workda!s off for most businesses6 <ew =ear9s Da!, /emorial da!, 3ndependence da!, %abor da!, .hanks ivin da!, Christmas da!. 7>ould students have been able to identif! holida!s like memorial da! and labor da! if the other more obvious ones had not been listed?8

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E ocentric /otivations /! father was wealth!, and 3 need to be wealth! too. /! friends admire cars, and 3 need to have an expensive one. 3deolo ical motivations6 .he compan! sells tobacco and alcohol, and doesn9t deserve to make a profit. 3 can award the overnment housin rants to best use without the 2@D red tape. 7Austif!in diversion of funds in overnment housin pro rams.8 Economic /otivations Pa! colle e tuition Pa! hospital bills for a parent with cancer Pa! amblin debts Pa! for dru s Pa! alimon! and child support Pa! for hi h life st!le 7homes, cars, boats8 :inance business or stock speculation losses Report ood financial results

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Conditions related directl! to emplo!ee fraud6 <obod! counts the inventor!, so losses are not known .he pett! cash box is often left unattended Supervisors set a bad example b! takin supplies home @pper mana ement considered a written statement of ethics but decided not to publish one 4nother emplo!ee was cau ht and fired, but not prosecuted .he finance vice1president has investment authorit! without an! review :reBuent emer enc! Cobs leave a lot of excess material Cust la!in around Rationali"ations6 3 need it more than the other person 7Robin 2ood theor!8 39m borrowin the mone! and will pa! it back <obod! will et hurt .he compan! is bi enou h to afford it 4 successful ima e is the name of the ame Ever!bod! is doin it .he fraud diamond proposed in a text box includes capabilit! as a forth item necessar! for committin a fraud. Some ma! ar ue that if a control weakness exists, but !ou do not have the skills and knowled e to take advanta e of the weakness then an opportunit! does not present itself. Dthers would ar ue that these are separate issues and the opportunit! exists whether the potential fraudster has the capabilit! or not and, therefore, capabilit! is a reBuirement that must be present to produce fraud.

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:raud1Prevention /ana ement St!le Democratic, open1door mana ement .rust the emplo!ees and ive them power in their Cobs 3nstall controls that don9t make work difficult %et people desi n and mana e their Cobs and work Decentrali"e authorit! /ana e with foresi ht /easure performance on lon 1run basis 2ave multiple measures of performance /ake rewards positive and enerous 0ive constructive positive and ne ative feedback Create a cooperative workplace Eoss9 exemplar! behavior and decisions /ake back round checks on new emplo!ees Prosecute fraudsters

St!le %eadin to :raud 4utocratic mana ement Drient mana ement to low trust and power 3nstall ti ht, bureaucratic controls 3nsist ever!thin be documented with a rule for ever!thin Centrali"e authorit! in top mana ement /ana e b! crisis /easure performance on a short1term basis /ake profits the onl! criterion for success /ake rewards punitive, stin ! and political 0ive feedback that is alwa!s critical and ne ative Create a hi hl! hostile, competitive workplace Eoss9 Buestionable behavior and decisions Ee lax about back round checks :ire fraudsters without prosecution

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.he basic seBuence of activities and accountin in a revenue and collection c!cle is6 1. #. $. &. '. Receivin and processin customer orders. Enterin data in an order s!stem and obtainin a credit check. Deliverin oods and services to customers. 4uthori"in release from storekeepin to shippin to customer. Enterin shippin information in the accountin s!stem Eillin customers, producin sales invoices. 4ccountin for customer trade accounts receivable. Collectin cash and depositin it in the bank. 4ccountin for cash receipts. Reconcilin bank statements.

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3t mi ht be easier Cust to send the cash to the accounts receivable accountants, but 718 that would dela! the bank deposit and the compan! would lose interest income, and 7#8 a dishonest accountant could steal cash while still ivin the customer credit 7to forestall complaints8. .he accountant could cover the theft b! makin false debit entries to such accounts as allowance for doubt accounts 7account write1offs8 or discounts and allowances expense. .he term Flappin F refers to an emplo!ee9s stealin the cash receipts of a compan! and then coverin the amount with a followin da!9s pa!ment received for another customer9s account. 4 Flappin F operation is possible when a sin le emplo!ee has access to both cash and accounts receivable records. .he auditor is alerted to the possibilit! of a Flappin F operation when duties are not properl! separated. Surprise confirmation is the primar! means which an auditor can use to uncover such activit!. 4lso, details of deposit slips and cash remittance reports can be compared to detect discrepancies.

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Duplicate pa!ment based on the same supportin documents can be prevented b! stampin or impressin FpaidF on the voucher and supportin documents, or b! perforatin 7mutilatin 8 the documents so the! cannot be reprocessed unintentionall!. Compare the amount written on the check with the bank9s ma netic imprint of the amount paid b! the bank. .here are several clues that the bank statement has been altered6

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.he statement does not add up to the G),$)&.+$ balance shown. .he font of the H)Is do not match. .he low balance is G#,$)&.+$ 7the correct balance8 and no transactions occurred after this point. .here is a space for a ap in the check seBuence, but no HJJIKs as with the other aps. .he statement reports #( checks, but onl! #' are listed.

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.he cutoff bank statement is a bank statement sent b! the bank directl! to the auditor, and it is usuall! for a 1' or #, da! period followin the reconciliation date. .he basic use of the statement b! the auditor is to determine whether outstandin checks were actuall! mailed before the reconciliation date and outstandin deposits in transit were actuall! received in a timel! manner b! the bank.

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(.1(

Check kitin is the practice of buildin up apparent balances in one or more bank accounts based on uncollected 7float8 checks drawn a ainst similar accounts in other banks. Litin involves depositin mone! from one bank account to another, usin a hot check. Litin is the deliberate floatin of funds between two or more bank accounts. E! this method, a bank customer utili"es the time reBuired for checks to clear to obtain an unauthori"ed loan without an! interest char e. 4uditors can detect si ns of kitin b! observin in the bank statements6 :reBuent deposits and checks in same amounts :reBuent deposits and checks in round amounts :reBuent deposits with checks written on the same 7other8 banks Short time la between deposits and withdrawals :reBuent 4./ account balance inBuiries /an! lar e deposits made on .hursda! or :rida! to take advanta e of the weekend %ar e periodic balances in individual accounts with no apparent business explanation %ow avera e balance compared to hi h level of deposits /an! checks made pa!able to other banks Eank willin ness to pa! a ainst uncollected funds FCashF withdrawals with deposit checks drawn on another bank Checks drawn on forei n banks with lax bankin laws and re ulations

3f these cash transfers are recorded in the books, a compan! will show the ne ative balances that result from checks drawn on insufficient funds. 2owever, perpetrators ma! tr! to hide the kitin b! not recordin the deposits and checks. Such maneuvers ma! be detectable in a bank reconciliation audit. 4 schedule of interbank transfers can be constructed from the canceled checks and cleared deposits in the bank statements. .his schedule shows each check amount, the name of the pa!in bank 7with the book recordin date and the check clearin date8, the name of the receivin bank 7with the book deposit date and the bank clearin date8. .he purpose of this schedule is to see that both sides of the transfer transaction are recorded in the same period 7and in the proper period8. (.1) 4 schedule of interbank transfers shows improper cash transfer transactions when the auditors find 7a8 no recordin of transfers shown in the bank statement, and 7#8 dates of bank and eneral led er recordin that are out of order. 4 Fproof of cashF can reveal unrecorded cash deposit and cash pa!ment transactions when the attempt to reconcile the deposits and pa!ments reported b! the bank to the deposits and pa!ments recorded in the eneral led er reBuires consideration of unrecorded amounts. 3nspection of the bank statement and comparison to the eneral led er 7books8 will uncover the problem, provided the documents have not been destro!ed. .he former pett! cash custodian apparentl! had more expenditures than the new one. /a!be the former one was runnin false expense claims.

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<o separation of these duties and responsibilities6 718 transaction authori"ation, 7#8 recordkeepin , 7$8 custod! of, or access to, assets, and 7&8 reconciliation of actual assets to the accountin records. 4 supervisor ma! not take approval responsibilities seriousl! and fail to perform them 7like the supervisor of the pett! cash custodian in the text case8. .i ht control ma! be too expensive and simpl! not performed 7like the lack of observation of the laundr! mone! collectors in the text case8. .he pa!roll emplo!ee who has responsibilit! for preparin personnel files for new hires, approval of wa es, verification of time cards, and distribution of pa!roll checks can FhireF fictitious emplo!ees, fake their records, and order checks throu h the pa!roll s!stem. /ana ers can override controls and order people to ship bricks 7as in the text case8 or manipulate records to create false numbers from a position of accountin authorit! 7inventor! falsification text case8.

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Extended procedures are audit procedures performed onl! when 7external8 auditors think somethin deserves ima inative investi ation in the circumstances . @suall! the! are more complicated and expensive than FnormalF audit procedures, and the! usuall! su est a suspicion of somethin fraudulent oin on. .he text contains brief explanations of several Fextended procedures,F but these ma! seem FnormalF for fraud examiners. .wo endorsements ma! indicate that the pa!ee of the check is not the part! that received the benefit of the check pa!ment. .he pa!ee ma! fictitious. <et worth anal!sis is used when fraud has been discovered or stron l! suspected, and the information to calculate a suspect9s net worth can be obtained 7e. . asset and liabilit! records, bank accounts8. .he method is to calculate the suspect9s net worth 7known assets 1 known liabilities8 at the be innin and end of a period 7months or !ears8, then tr! to account for the difference as 718 known income less livin expenses, and 7#8 unidentified difference. .he unidentified difference ma! be the best available approximation of the amount of a theft. Expenditure anal!sis is similar to net worth anal!sis, except the data is the suspect9s spendin for all purposes compared to known income. 3f spendin exceeds le itimate and explainable income, the difference ma! be the amount of a theft.

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#OL$TION# FOR '$LTIPLE(CHOICE )$E#TION#

(.#& a. b. c. d. Correct 3ncorrect 3ncorrect 3ncorrect Risk is hi h when the compan! alwa!s estimates the inventor! but never take a complete ph!sical count. Risk is low when the pett! cash box is alwa!s locked in the desk of the custodian. Risk is lower when mana ement has published a compan! code of ethics and sends freBuent communication newsletters about it. Risk is lower when the board of directors reviews and approves all investment transactions.

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a. b. c. d.

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4irti ht control s!stems of checks and supervision is not the best lon 1run wa! to stop fraud. <ame an Fethics officerF who is responsible for receivin and actin upon fraud tips is not the best lon 1run wa! to stop fraud. Place dedicated FhotlineF telephones on walls around the workplace with direct communication to the compan! ethics officer is not the best lon 1run wa! to stop fraud. Practice mana ement Fof the people and for the peopleF to help them share personal and professional problems is the best lon 1run wa! to stop fraud. /an! frauds are motivated b! emplo!ees who have problems due to debt, addictions, or famil! problems. Establishin an emplo!ee assistance pro ram addresses these issues and ma! reduce the motivation to commit fraud for some emplo!ees. 4 fidelit! bond reduces the risk to the emplo!er for theft since this is a form of insurance. 3t also provides a back round check on emplo!ees. <either of these issues addresses emplo!ee motivation. Reconciliations are methods of detectin problems that have occurred. >hile these are ood controls and ma! reduce the opportunities for emplo!ees to steal, reconciliations to not address emplo!ee motivation to commit fraud. 4udits ma! detect fraud and even provide a deterrence for fraud. 4udits do not address the emplo!ees motivation to commit fraud. 4n appointment of a chief ethics officer would increase the effectiveness of the code of ethics. 4 hot line that allowed emplo!ees to report ethical violations would increase the effectiveness of the code of ethics.. .he violation of the code of ethics b! senior mana ement would reduce the effectiveness of the code of ethics since the tone at the top would provide a messa e to emplo!ees that the code of ethics was not important. .he postin of the code of ethics and an! other means of presentin the code of ethics to emplo!ees in a prominent manner would increase the effectiveness of the code of ethics.. <umerous cash refunds have been made to different people at the same post office box address is an indicator of cash refund fraud. 3nternal auditor cannot locate several credit memos to support reductions of customers9 balances is an indicator of returned oods fraud. Eank reconciliation has no outstandin checks or deposits older than 1' da!s is a si n of a ood bank reconciliation, a fraud detection techniBue. .hree people were absent the da! the auditors handed out the pa!checks and have not picked them up four weeks later is an indicator of padded pa!roll fraud. Dverstatin sales revenue and overstatin customer accounts receivable balances is a wa! to misstate financial statements for mana ement fraud. Dverstatin sales revenue and overstatin bad debt expense does not misstate income or assets but will hide an emplo!ee embe""lement. @nderstatin interest expense and understatin accrued interest pa!able is a wa! to misstate financial statements for mana ement fraud. Dmit the disclosure information about related part! sales to the president9s relatives at below1market prices is a wa! to misstate financial statements for mana ement fraud.

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a. b. c.

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d.

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3nventor! should be counted on a re ular basis, therefore, the fraud would be detected. Expense accounts are often ood places to hide fraud since accounts are closed at the end of the !ear. >a e expense accounts ma! be compared to bud et and ma! be reviewed b! department mana ers that mi ht detect the fraud. Expense accounts are often ood places to hide fraud since accounts are closed at the end of the !ear. Consultin expense is a particularl! ood place to hide a fraud since no actual product is provided which ma! be counted or compared to the expense. Propert! tax expenses would likel! be compared to the propert! tax bill and an! discrepancies investi ated. .he inventor! warehouse mana er can steal inventor! and manipulate the records. Cashier prepared the bank deposit, endorsed the checks with a compan! stamp, and took the cash and checks to the bank for deposit 7no other bookkeepin duties8. .he cashier mi ht steal currenc!, but needs access to the records to cover up a theft of customer pa!ments. 4ccounts receivable clerk received a list of pa!ments received b! the cashier so he could make entries in the customers9 accounts receivable subsidiar! accounts. 0ood arran ement because the bookkeeper does not have access to cash. :inancial vice president received checks made out to suppliers and the supportin invoices, si ned the checks, and put them in the mail to the pa!ees. :raud would be harder because financial MP would also need to be able to create fictitious vendors and invoices. .he cashier would have both custod! of cash and record keepin responsibilit!, hence could steal mone! and fix the records without interference b! an!one else. Litin involves a mismatchin of dates of recordin around !ear1end, and the schedule of bank transfers is desi ned to show all the relevant dates so the auditor can see that the entries are in the proper periods. Effective control of cash reBuires that receipts be recorded promptl!. :or mail receipts, a listin of remittance advices b! an emplo!ee not performin incompatible functions is a standard control procedure. 3f the customer does not return the remittance advice, one should be prepared at the time the mail is opened. 3f remittance advices are not used, a listin of receipts should still be made when the mail is opened. 4 check returned for insufficient funds would make the balance per bank different than the balance per books and would need to be a reconcilin item. 3t would not chan e an! of the information that was provided to the assistant controller. 3f the cash received was split into two or more deposits the deposits would not match the remittances or the pa!ments recorded. Controls over unauthori"ed access into accounts receivable stren thens the control indicated in the Buestion since information on the pa!ment report would be more reliable. 2avin someone else reconcile the accounts pa!able process adds an additional person to the control process.

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c.

Correct

.he individuals with record1keepin responsibilit! should have custod! of cash. 2ence, the! should use either the remittance advices or a listin of the remittances to make entries o the cash and accounts receivable control account and to the subsidiar! accounts receivable records. 3ndeed, havin different people make entries in the control account and in the subsidiar! records is an effective control. <ot recordin sales on account in the books of ori inal entr! is the most effective wa! to conceal a subseBuent theft of cash receipts. .he accounts will be incomplete but balanced, and procedures applied to the accountin records will not detect the defalcation. .he definition of embe""lement involves propert! that is entrusted to the emplo!eeKs control 7as in 7d8. .his statement refers to larcen!. .his statement is similar to the definition of mana ement fraud. .his statement is similar to mere error in accountin .his statement is the textbook and criminolo ical definition of embe""lement. 4 final review b! the treasurer can catch mistakes made in prior processin .

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.he overstatement of cash would be of most concern. Cash is overstated b! claimin that the or ani"ation has more cash then it does.
3t is possible that a firm could borrow mone! to include in a cash count and, therefore, not have the ri hts to the cash. 2owever, such a scheme is of lesser concern then if the compan! claimed cash that did not exist. Since the value of cash is easil! discernable this is usuall! not an issue 3mproper cash presentation is of lower risk then the existence of cash .

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a.
b. c. d.

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Since the sources and use of cash can var! reatl! from !ear to !ear, balances in prior !ear are of little use.
/ana ement inBuir! would provide poor information for use in performin anal!tical procedures. Eud ets provided b! mana ement provide the best estimates b! mana ement for the sources and use of cash. >here cash receipts or cash expenditures var! form the bud et b! a material amount, a hi her level of risk ma! be assessed. :ailure to collect accounts receivable ma! indicate a problem with cash sources but would onl! be one part of an estimate of cash. Cancellation 7FpaidF8 of vouchers prevent their use a second time.

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d.

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#OL$TION# TO PRO LE'#* E+ERCI#E# AN, #I'$LATION#

(.&$ Tests of Controls over Cash Disbursements Note to Instructor: Procedure N# below is desi ned to indicate that work on one sample of cash disbursements can produce evidence related to several obCectives. .he tasks numbered #a throu h #l all relate to the N# sample items. AUDIT PROGRAM OF T !T OF CONTRO"! AUDIT PROC DUR ! Internal Control Ob#ective Test of Controls Proce$ure 1. Dbserve who has custod! of si ned checks for evidence of se re ation of duties from persons havin cash disbursement or accounts pa!able record1keepin responsibilities and from persons who have cash disbursement authori"ation responsibilities. Malidit! DbCective #. Select a sample of cash disbursements recorded durin the period, Recorded disbursements are valid and and documented111 representin pa!ment #a. Compare to the cancelled check. for oods and services received. #b. Examine for authori"ed si nature and proper endorsement matchin pa!ee name. #c. Compare recorded amount and check amount. #d. Compare recorded pa!ee name and name on check. $. Scan the recorded cash disbursements for lar e or unusual amounts and perform the same work on these items as in the N# sample. 4uthori"ation DbCective Cash disbursements are authori"ed accordin to compan! polic!. 4ccurac! DbCective Cash disbursement dollar amounts are calculated and recorded accuratel!. Classification DbCective Cash disbursements are properl! classified in the accounts. 4ccountin DbCective Cash disbursements accountin is complete1properl! summari"ed and posted in the eneral led er. Proper Period DbCective Cash disbursements are recorded in the proper period. #e. #f. # . #h. #i. Examine supportin documents for a proper authori"in si nature or initials approvin the amount for pa!ment. .race authori"in si nature to list of authori"ed approvers. .race vendor9s name to approved vendor list. Recalculate amounts shown on supportin vendor9s invoices and compare to check amount. Recalculate cash discount, if an!.

&. Dbtain a chart of accounts and the accountin manual pertainin to classification polic!. #C. :or each disbursement, determine whether the debit entr! is classified accuratel!. '. :oot selected summaries 7dail!, monthl!8 of cash disbursements. (. .race these totals to the eneral led er debit and credit entries. ). :oot the eneral led er cash account. *. Dbserve cash disbursement procedures and inBuire to find out whether checks are held for time before mailin . #k. Compare date on check to date of recorded disbursement. #l. Compare dates to pa!ee9s bank clearance date for an! apparent len th! dela! that indicate that checks are held before mailin .

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Internal Control %uestionnaire for &oo' &u()&ac' Cash Fun$ Universit( &oo's* Incor+orate$ R ,O",ING CA!- FUND INT RNA" CONTRO" %U !TIONNAIR 1. #. $. &. '. (. ). *. +. Ouestion 3s responsibilit! for the fund vested in one person? 3s ph!sical access to the fund denied to all others? 3s the custodian independent of other emplo!ees who handle cash? 3s the custodian bonded? 3s the custodian denied access to other cash funds? 4re receipts unalterable? 4re receipts prenumbered? 3s the inte rit! of the prenumbered seBuence periodicall! accounted for? Does the seller si n receipts? =es <o

1,. 4re receipts attached to reimbursement vouchers? 11. 4re vouchers that are submitted for reimbursement approved b! someone other than the custodian? 1#. 4re reimbursement vouchers and attachments 7receipts8 cancelled after reimbursement? 1$. 3s the fund used exclusivel! for the acBuisition of books? 1&. 3s the fund periodicall! counted and reconciled b! someone other than the custodian? 1'. 3s the fund maintained on an imprest basis? 1(. 3s the si"e of the fund appropriate for the purpose intended?

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Au$it !imulation: Test of Controls over Cash Recei+ts Dther 4udit Procedures Source of debit entries in eneral led er cash account, other than from cash receipts Cournal, should be investi ated and supportin documents examined. 4 surprise examination of cash receipts should be performed. Prior to the accounts receivable clerk obtainin the cash receipts, the auditor should make a list of them without the clerk9s knowled e. .he undeposited mail receipts should then be controlled after completion of their preparation for deposit and postin s have been made to the subsidiar! accounts receivable led er. .he deposit slip should be compared to the remittances for accurac! and totaled. 3ndividual items on the deposit slip should be compared to postin s to the subsidiar! accounts receivable led er. .he auditor should then supervise the mailin of the deposit to the bank. .he auditor should ask 0ut"ler to ask the bank to send the statement containin this deposit directl! to the auditor. Postin s from the deposit slips should be traced to the subsidiar! accounts receivable led er. 4lso, entries in the subsidiar! accounts led er should be traced to deposit slips. 1. Reason for Dther 4udit Procedures Since the auditor, usin standard procedures, onl! examined the cash receipts Cournal, he must investi ate the occurrence of all other sources of cash receipts that are not recorded in these Cournals. Since there are no initial controls over cash receipts established prior to the time the accounts receivable clerk obtains the cash, a surprise examination is the onl! method of determinin if cash receipts are bein recorded and deposited correctl!.

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Since there is no separation of duties between cash receipts and accounts receivable, the accounts receivable clerk ma! have been careless in performin her postin duties. .his procedure ma! also disclose whether the accounts receivable clerk ma! have been lappin the accounts. See <o. $ above.

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Review the subsidiar! accounts receivable led er and confirm accounts that have abnormal transaction activit! 7consistentl! late pa!ments.8 3f 0ut"ler allows customers to take discounts, the amount of such discounts and the discount period should be checked.

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Dates and amounts of dail! deposits per bank statement should be compared with entries in the cash receipts Cournal. 4 proof1of1cash workin paper should be prepared which reconciles total cash receipts with credits per bank statement. :or those periods for which the above audit procedures were not performed and for a period after the balance sheet date, scan the cash receipts Cournal and bank statements for unusual items.

(.

Since there is no separation of duties between cash receipts and accounts receivables the account receivable clerk ma! have appropriated discounts which could have been but were not taken or ma! have been careless in checkin the appropriateness of discounts taken. Since there are no initial controls over cash receipts established prior to the time the accounts receivable clerk obtains the cash, she ma! have become careless about prompt deposit of the dail! receipts. Since internal control over cash receipts is weak, the auditor should perform this overall check to help substantiate that he has investi ated all material items durin his detail tests. Since internal control over cash receipts is weak, the auditor should perform this review to help substantiate that he has investi ated all material items not covered durin his other tests. - .he /c0raw12ill Companies, 3nc., #,,) (11#

).

).

*.

*.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

(.&(

stablishin. a Returne$ Goo$s !(stem a. b. Emplo!ees can falsif! returned oods 7no oods were actuall! returned8 and take the cash from the re ister as if it was provided to a customer. Procedures that ma! prevent this t!pe of fraud include6 1. #. 2avin one emplo!ee authori"e the return and have the customer brin the authori"ation of a cash re ister to obtain the mone!. /ana ement authori"ation for all returns.

Procedures that mi ht detect this fraud include6 1. #. c. (.&) 4nal!tical procedures. Comparin returns per emplo!ee or returns per shift. Contactin customers to ascertain the reason for returns. .his ma! also act as a fraud prevention if emplo!ees know that mana ement ma! follow1up with customers.

4nal!tical procedures mi ht detect an increase in returns. 4lso, since returned oods should o back to inventor!, inventor! shorta e ma! indicate that oods returned were not enuine.

Proce$ures for Au$itin. a Client/s &an' Reconciliation a. 3dentification of procedures6 4. Ealance per bank6 Procedures & and + E. Deposits in transit6 Procedures 1, ), *, +, and 1, C. Dutstandin checks6 Procedures #, ), *, +, and 1, D. Customer note collected b! the bank6 Procedure ' E. Error6 Check N1#*#, written on Sept #(6 Procedures ' and + :. Ealance per books6 Procedure $ .he total of outstandin checks is G1$,&',, not G11,&',. Someone has manipulated the bank reconciliation to match the eneral led er balance, which is overstated G#,,,, 7provided the eneral led er balance is G#,,&,,.8

b.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (11$

(.&*

Proof of Cash Month of 0ul( &alance 0une 12 Eank statement amounts Deposits in transit Dctober $1 December $1 Dutstandin checks Dctober $1 December $1 @nrecorded deposit @nrecorded disbursement 0eneral led er amounts. G$++,#1, G(',,1*) G$'',,,1 *(,*++ De+osits G*$',*&( 7*(,*++8 '1,#&, 7&#,(+,8 )$,$&, 71',,,,,8 71',,,,,8 G'(',$+) Pa(ments G(*&,)&) &alance 0ul( 13 G',(,1,,

'1,#&,

7&#,(+,8

7)$,$&,8 71',,,,,8 1',,,,, G&*&,,,,

.he compan! did not record deposits and disbursements in eBual amounts of G1',,,,, 7necessar! to make the bank and eneral led er deposits and disbursements reconcile8.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (11&

(.&+

Au$it !imulation: Interban' Transfers <ote to 3nstructors6 Check N1)++ 7G1,,,,, pa!able to Citi"en <ational Eank8 drawn on the 1st <ational Eank account was not recorded in EverRead!9s cash disbursements Cournal. .his is the reason it is not in the schedule of interbank transfers in Exhibit *.'*11. .he auditors obtained the initial information from the cash receipts and cash disbursements Cournals, and N1)++ was not in them. a. Complete the Schedule of 3nterbank .ransfers 7workin paper C1'8 b! enterin the new information. EP23E3. (.&+11 Schedule of 3nterbank .ransfers C1' EMERRE4D= CDRPDR4.3D< SC2ED@%E D: 3<.ERE4<L .R4<S:ERS Prepared QQQQQQQQQQ December $1, #,,P Date QQQQQQQQQQQ ReviewedQQQQQQQQQQQ Date QQQQQQQQQQQ Disbursin. Account Check <o. Eank 4mount Date per Eooks Date per Eank Receivin. Account Eank Date per Eooks Date per Eank ##1Dec #$1Dec #&1Dec #*1Dec $,1Dec $,1Dec $11Dec ,&1Aan ,'1Aan ,)1Aan ,*1Aan ,*1Aan

###, Chase 11,,,, #*1Dec Citi"en &,', Citi"en 1,,,,, #+1Dec 1st <at9l 1&1) 1st <at9l 1,,&($ #&1Dec #&1Dec 1st <at pa!roll &,'1 Citi"en 1#,,,, $11Dec Chase ###1 Chase 1',,,, ,'1Aan Citi"en &,'# Citi"en 1#,,,, ,'1Aan 1st <at9l 1(,1 1st <at9l 11,'+$ $11Dec $11Dec 1st <at pa!roll &,'$ Citi"en 1&,,,, ,)1Aan Chase 1)++ 1st <at9l 1,,,,, ,*1Aan Citi"en #### Chase 1#,,,, 1#1Aan Citi"en &,'& Citi"en #,,,,, 1$1Aan 1st <at9l 1+*# 1st <at9l +,+)1 ,*1Aan ,*1Aan 1st <at pa!roll 111111111111111111111111111111111111111 .raced from cash disbursements Cournal. Check properl! listed as outstandin on bank reconciliation. Mouched to check cleared in bank statement. .raced from cash receipts Cournal. Mouched deposit cleared in bank statement.

#&1Dec

$11Dec

,*1Aan

<ote6 >e scanned the cash disbursements and cash receipts Cournals for checks to and deposits from other bank accounts. :ound none other than those noted in this work paper. b. >hat is the actual cash balance for the four bank accounts combined, considerin onl! the amounts iven in this case information, as of December $1, 7before an! of the December $1 pa!roll checks are cashed b! emplo!ees8? 4s of Aanuar! *, 7before an! of the Aanuar! * pa!roll checks are cashed b! emplo!ees8? 72int6 Prepare a schedule of bank and actual balances like the one illustrated in Chapter * to explain check kitin .8

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (11'

(.&+

Au$it !imulation: Interban' Transfers 4Continue$5

3nterbank .ransfers Subtractions in the FbankF column indicate checks cleared and paid b! the banks. Chase Eank Citi"en Eank 1st <ational 1st <at9l Pa!roll Combined 1111111111 1111111111 11111111111111111111111 1111111111 111111111111 1111111111 111111111111 1111111111 111111111111 11 11 1 11 11 1 11 11 11 11 Date Check Eank718 4ctual7# Eank718 4ctual7#8 Eank718 4ctual7#8 Eank718 4ctual7#8 Eank718 4ctual7#8 8 11111111111111111 111111111 1111111111 1111111111 11111111111111111111111 1111111111 111111111111 1111111111 111111111111 1111111111 111111111111 111 1 11 11 1 11 11 11 11 11 11 11 Dec ## 7.ue8 ###, 711,,,,8 11,,,, 11,,,, Dec #$ 7>ed8 &,', 71,,,,,8 1,,,,, 1,,,,, Dec #& 7.hu8 1&1) 7+,&($8 7+,&($8 +,&($ +,&($ Pa!roll checks cashed 7+,&($8 7+,&($8 Dec #* 7/on8 &,'1 1#,,,, 1#,,,, 71#,,,,8 Dec #* 7/on8 ###,711,,,,8 Dec #+ 7.ue8 &,', 71,,,,,8 Dec $, 7>ed8 ###1 71',,,,8 1',,,, 1',,,, Dec $, 7>ed8 &,'# 71#,,,,8 1#,,,, 1#,,,, Dec $1 7.hu8 1(,1 711,'+$8 711,'+$8 11,'+$ 11,'+$ Dec $1 7.hu8 &,'1 71#,,,,8 1111111111 1111111111 11111111111111111111111 1111111111 111111111111 1111111111 111111111111 1111111111 111111111111 1 1 1 1 1 1 1 1 1 7a8 Ealances 1,,,, 71&,,,,8 &,,,, 7*,,,,8 +&& +&& 11,'+$ 11,'+$ 1),'$) 7+,&($8 1111111111 1111111111 11111111111111111111111 1111111111 111111111111 1111111111 111111111111 1111111111 111111111111 1 1 1 1 1 1 1 1 1 Pa!roll checks cashed 711,'+$8 711,'+$8 Aan & 7/on8 &,'$ 1&,,,, 1&,,,, 71&,,,,8 Aan ' 7.ue8 1)++ 1,,,,, 1,,,,, 71,,,,,8 Aan ' 7.ue8 &,'# 71#,,,,8 Aan ' 7.ue8 ###171',,,,8 Aan ) 7.hu8 #### 71#,,,,8 1#,,,, 1#,,,, Aan ) 7.hu8 &,'$ 71&,,,,8 Aan * 7:ri8 &,'& 7#,,,,,8 #,,,,, #,,,,, Aan * 7:ri8 1)++ 71,,,,,8 Aan * 7:ri8 1+*# 7+,+)18 7+,+)18 +,+)1 +,+)1 1111111111 1111111111 11111111111111111111111 1111111111 111111111111 1111111111 111111111111 1111111111 111111111111 1 1 1 1 1 1 1 1 1 7b8 Ealances , 71#,,,,8 , 7#,,,,,8 +)$ +)$ +,+)1 +,+)1 1,,+&& 7#1,,'(8 1111111111 1111111111 11111111111111111111111 1111111111 111111111111 1111111111 111111111111 1111111111 111111111111 1 1 1 1 1 1 1 1 1 Pa!roll checks 7+,+)18 7+,+)18 cashed Aan 1# 7.ue8 ####71#,,,,8 Aan 1$ 7>ed8 &,'& 7#,,,,,8 1111111111 1111111111 111111111111111111111111111111111 111111111111 1111111111 1111111111111111111111 111111111111 1 1 1 1 1 1 Ealances 71#,,,,8 71#,,,,8 7#,,,,,8 7#,,,,,8 +)$ +)$ , , 7$1,,#)8 7$1,,#)8 RRRRRR RRRRRR RRRRRR RRRRRRR RRRRRR RRRRRRR RRRRRR RRRRRRR RRRRRR RRRRRRR 718 FEankF means the bank9s records of deposits received and checks paid 7cleared8. 7#8 F4ctualF means the amounts the eneral led er would have shown had the transfers been recorded. McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e - .he /c0raw12ill Companies, 3nc., #,,) (11(

(.',

Mani+ulate$ &an' Reconciliation =es, somethin is wron , and it takes a careful e!e to detect it. .he bank statement has been altered. Cleared check N ##$$ for G',,,, has been erased, and the bank balance has been chan ed from G#,$)&.+$ to G),$)&.+$. .he bank balance is actuall! G',,,, lower than the reconciliation shows. Since the problem sa!s6 Fall checks entered in Caulco9s cash disbursements Cournal throu h :ebruar! #+ have either cleared the bank or are listed as outstandin checks in the :ebruar! bank reconciliation,F the conclusion is that this G',,,, check was not recorded. Students can find the alteration several wa!s. 718 .he! can notice the check 7;8 and find that it is not on the bank statement, even thou h it is dated and cleared in :ebruar!, 7#8 the! can add the checks listed in the :ebruar! bank statement and find that the total is G',*$*.#+, not the G1,,*$*.#+ shown on the bank statement, and the number of checks 7#'8 does not match the bank statement 7#(8, 7$8 the! can add the previous balance to the deposit and subtract the withdrawals to find a balance of G#,$)&.+$ instead of the altered G),$)&.+$, and 7&8 the! can notice the skip in the numerical seBuence not noted b! the bank9s double asterisk 7JJ8 used to indicate a skip 7this is the place the paid check was erased8. 4lso, the Flow bank balanceF fi ure of G#,$)&.+$ ives it awa!. C4@%CD, 3<C. Eank Reconciliation 7Corrected8 :ebruar! #* Ealance per bank .................................................................................................... Deposit in transit .................................................................................................... Dutstandin Checks6 <umber Date ##$+ ##&, :eb #( :eb #+ .otal Dutstandin Reconciled balance 0eneral led er balance :eb #* Cash overstatement, Check N##$$ not recorded Pa!ee 4lpha Suppl! %.C. Stateman 4mount ',,.,, #'&.$) 7)'&.$)8 G #,)1*.#' G ),)1*.#' G ',,,,.,,

G #,$)&.+$ 1,,+).(+

(.'1

Investi.atin. a frau$ 3f the compan! is local, visit the location to determine if the compan! exists. Dbtain the checks used to pa! the vendor to determine the bank used b! the vendor 7information should be on the back of the check8. /atch the vendor invoices to receivin reports to determine if product was received. /atch the invoices to purchase orders and purchase reBuisition to determine if purchase orders exist and that material was reBuested. 3f purchase orders or reBuisitions come from the same person, check the bank used b! that person 7from the direct deposit information or the back of their pa!check8 to see if it is the same bank as the vendor 7or ma!be even the same account8. Check the count! court house for information on the business. Dther procedures ma! also be valid.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (11)

(.'#

Au$it !imulation: Purchasin. Frau$ a. 3t is likel! that a purchasin a ent has created a shell compan! 7L.4. Supplies8 and is awardin bids to the shell compan!. Dnce the bid is award, someone purchases the necessar! materials and sends them to Ei Euilders at a marked up price. >e mi ht obtain information about the bank account used b! L.4. Suppliers. .his information would be available on the back of the checks we used to pa! L. 4. Suppliers. >e ma! wish to do an anal!sis of the business we do with L.4. Supplier. .he receipt and recordin of bids ma! be se re ated from the purchasin function. 3n addition, a reBuirement that all bids be attached to the purchase order ma! provide senior mana ement in purchasin opportunit! to see that the lowest bids is the bid bein accepted. .he bidders should have to be on the approved vendor list and an inspection of the vendor facilit! b! someone outside of purchasin should be reBuired for addin a compan! to the list.

b.

c.

(.'$

The Perfect Crime6 .he in enious scheme was a perfect crime for a lon time. Dnl! the reed of the embe""ler finall! tipped off the mana ers, who commissioned a special investi ation to learn wh! expenses were hi h, profits low, and cash flow small. Drdinar! ever!da! control activities for detection6 1. Someone else takin over the embe""ler9s duties at vacation time mi ht have been less willin or able to di out the documentation to support pa!ment of Fpast dueF amounts, thus leadin to suspicion and ma!be discover!. .he embe""ler avoided the problem b! clearin all the vendor pa!ments a month before his re ular vacation. .he treasurer mi ht have been more dili ent about rememberin earlier pa!ments of amounts later submitted as Fpast due,F but she had other more important assi nments. 73n fact, the documents were Cust scanned and the checks were si ned with a mechanical si nature plate.8 Someone in char e of investi atin bud et variances 7when the! occurred8 mi ht have been more in tune with Fthinkin like a crook,F but several people in several departments were not that careful. .he variances were not ver! lar e after the first two !ears 7althou h some lar er ones be an to show toward the end when the embe""ler ot reed!.8

#.

$.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (11*

(.'$

The Perfect Crime6 4Continue$5 Extensive detection efforts6 .he embe""ler was cau ht because he was too reed!11adverse cash flow alerted the business owner, and an investi ation started. 1. #. $. &. .he investi ator spent a lon time reviewin the expense accounts and stud!in documentation. 2e noticed fairl! freBuent pa!ments of Fpast dueF balances. 3n the course of repeated interviews with the compan! president, he learned about the compan!9s polic! of pa!in bills on time to obtain trade discounts. .he president was surprised to learn of the numerous incidents of past due bills. /ore searchin b! the investi ator led to notice of five FBuarterl! pa!mentsF in an expense account for the rental of a photocop! machine. .his was the first obvious si n of a duplicate pa!ment. .he investi ator asked the bank to send copies of the checks for the five pa!ments. Dne proved to be pa!able to the embe""ler. .his discover! led to reBuests for access to all the compan!9s canceled checks, and the investi ator then was able to find numerous checks pa!able to the embe""ler. .he ph!sical differences in the compan!9s own checks and the embe""ler9s private stock were small, but the! were noticeable. Char es were filed. .he district attorne! subpoenaed the embe""ler9s bank account records, and the bo us checks were matched with deposits.

'.

(.'&

!elect ffective 7ten$e$ Proce$ures .hese procedures are offered without explanation of the information that mi ht be discovered. :or each one, a confirmation of the suspicion mi ht arise. Dne definite instance is enou h to Custif! proceedin with an investi ation 7real fraud examination8, but failure to find confirmin evidence can mean 718 nothin wron is oin on, or 7#8 the crook is too clever for the auditor. 4ll of these procedures should be conducted with care not to impu n falsel! the inte rit! of the people under investi ation. a. Count the pett! cash fund on :rida! mornin in the presence of the supervisor and custodian of the fund. .hen, perform a second surprise count :rida! afternoon before the custodian leaves work for the da!. 4sk the local Eetter Eusiness Eureau for reports on the ei ht new vendors. 4sk the local Chamber of Commerce if the! are members. %ook them up in the telephone book. .elephone them, askin about business hours, product availabilit!, and other matters. but not in a wa! to arouse suspicion of investi ation. Misit the business location 7telephone book address8 to browse. 0o to the local tax assessor1collector office files to look up the owner of the propert! where the businesses are located. 3f an! of the new vendors are professional people, look them up in state licensin a enc! directories 7e. . CP4s, attorne!s, doctors8. 0o to the state secretar! of state office and look up the corporate charter to see if the purchasin a ent is shown as an incorporator, officer, or director 7if a lar e compan!, !ou can use the Standard S Poor9s Re ister of Corporations, Directors, and Executives8 . %ook them up in the state or count! Fassumed nameF files for real names. >rite a check to each business, and use the canceled check to identif! the businesses9 banksT then et one of the purchasin a ent9s canceled pa!roll checks to see whether the! all bank at the same place. 7.his is circumstantial evidence that needs more work, but it would be an unlikel! coincidence in most cases if all of them had accounts at the same bank.8 4void approachin the chief purchasin a ent with inBuiries about the new vendor approval process because !ou mi ht alert the person to the investi ation.

b.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (11+

(.'&

!elect ffective 7ten$e$ Proce$ures 4Continue$5 c. Select the people who have Buit and determine their termination dates. 3n the pa!roll records, find the identification of their last pa!checks 7check number8, then find the canceled checks and examine the endorsement, lookin for two endorsements, one of which mi ht be the pa!roll supervisor. Contact the terminated emplo!ees on the pretext of an exit conversation, and inBuire whether the! received all their pa!checks, bein sure to identif! the last period or severance pa! provision for them. 4dd the customers9 subsidiar! accounts and compare to the eneral led er control account. 3f clerks are ivin customers proper credit in their subsidiar! accounts but not depositin the mone! and enablin the accountin s!stem to credit the control account, the! ma! be out of balance. 3f !ou can identif! suspicious accounts, ask the customers to ive !ou ori inals or copies of their canceled checks so !ou can examine the endorsements to see whether the! appear to have been ne otiated b! a compan! emplo!ee. @se the cash receipts Cournal date and the deposit date at the bank to see whether there is a pattern of dela! that could indicate the cashier is holdin the deposits. %ast resort is a surprise cash count at the cashier9s desk to see whether cash on hand is actuall! on hand. NGAG M NT 3: 7+en$iture Anal(sis

d.

e.

(.''

FOR N!IC ACCOUNTING A!!URANC

:DRE<S3C 4CCD@<.3<0 CD<S@%.3<0 E<040E/E<. 1 Lnown Expenditures6 2ouse pa!ments /ercedes pa!ments <issan /axima pa!ments 4udio and video eBuipment 2ousehold expenses .otal estimated expenditures Lnown Sources6 Ee innin bank balance .ake1home pa! 1# U G#,+', Endin bank balance .otal known sources Expenditures financed b! unknown sources G $,&(# $',&,, 7#,,',8 G $(,*1# G $$,*#, 1# U G 1,$)) 1# U G #,$(1 down V monthl! 1# U G+,, G 1(,'#& #*,$$# +,&&& ','$# 1,,*,, G),,($#

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (1#,

(.'(

FOR N!IC ACCOUNTING A!!URANC

NGAG M NT 8: Net 9orth Anal(sis

:DRE<S3C 4CCD@<.3<0 CD<S@%.3<0 E<040E/E<. # ND : AR ON 4SSE.S6 Residence Stocks and Eonds 4utomobiles Certificate of Deposit Cash .otal 4ssets %34E3%3.3ES6 /ort a e Ealance 4uto %oan .otal %iabilities <et >orth Chan e in <et >orth .D.4% EPPE<SESJ 3ncrease in <et >orth V Expenses L<D>< 3<CD/E :@<DS :RD/ @<L<D>< SD@RCES J 3ncludes some principal pa!ments on debts. G 1,,,,,, $,,,,, #,,,,, ',,,,, (,,,, G #,(,,,, +,,,,, 1,,,,, G 1,,,,,, G 1,(,,,, ND : AR T9O G 1,,,,,, $,,,,, #,,,,, ',,,,, 1#,,,, G #1#,,,, ',,,,, 1,1 G ',,,,, G 1(#,,,, G '(,,,, $,,*,, G *(,*,, &,,,,, G &(,*,, ND : AR T-R G 1,,,,,, &#,,,, &,,,,, ',,,,, 1&,,,, G #&(,,,, 1,1 1,1 1,1 G #&(,,,, G *&,,,, #*,,,, G 11#,,,, &#,,,, G ),,,,,

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (1#1

(.')

m+lo(ee mbe;;lement via Cash Recei+ts an$ Pa(ment of Personal 7+enses DbCective6 Dbtain evidence to determine whether expenses paid from the extra bank account were for le itimate school business. 4uditors cannot i nore informants9 tales. Control6 Cash disbursements should be authori"ed b! responsible officers of the or ani"ation to be for valid business purposes. 3t is not unusual for a business mana er to have the authori"ation responsibilit!. .i ht control would call for disbursement review 7at time of check si nature8 b! another responsible person 7superintendent8, and this control was not alwa!s observed. Cash receipts should be listed b! the person initiall! in control 7cafeteria mana er8, deposited b! another person 7business mana er8, and a responsible person 7superintendent, internal auditor, external auditor8 should compare the initial control record to the deposit to note an! differences. .est of Controls6 :orewarned b! the informant, the auditors could make inBuir!6 FDoes the school district have a fund for which individual disbursements are not approved b! the school board?F and FDoes the business mana er have responsibilit! for this fund?F 4nswers to both Buestions directed to the superintendent would be F!es,F and the auditors can then concentrate initial attention on the particular account records. .he next Buestion is6 FDoes the cafeteria mana er make a record of the dail! receipts?F 4nswer b! the superintendent6 F3 don9t know, ask her.F %uckil!, it turned out that the cafeteria mana er, without direct instructions, made notes on a calendar of the amount of mone! sent forward to the business mana er for deposit. Procedure6 Compare the amounts from the cafeteria mana er9s calendar to the deposits in the account. 4udit of Ealance6 .he FbalancesF bein audited are the expense accounts that received the debits from the extra bank account. 2owever, it is efficient to o to the bank account records as a startin point for the investi ation. Dbtain the bank statements and supportin documents for cash disbursements. Stud! them for evidence of 718 improperl! authori"ed pa!ments, 7#8 pa!ments of personal expenses on the school district9s M3S4 account, and 7$8 pa!ments to unauthori"ed persons or to FcashF for unauthori"ed purposes. Discover! Summar!6 4fter findin pa!ments to 4merican Express and M3S4, auditors asked the superintendent about the credit card used b! the school and learned that the school used onl! M3S4. 3nBuir! at 4merican Express revealed the business mana er as the owner of the account number found on receipts in the supportin documents. 74ctuall!, b! this time the business mana er had confessed, but identification of the account mi ht have been harder.8 Stud! of the items and dates on the M3S4 char e slips showed items 7e. . hosier!8 not used at the school and dates that did not match business periods. Review of the checks identified the son as pa!ee on some. Durin this review, the auditors found checks dated out of numerical seBuence and a missin block in the most current month. .his was a si n of havin blank checks si ned, so the superintendent was asked, and he admitted doin so. .he missin block was in the business mana er9s a desk drawer, alread! si ned. Comparin the cafeteria mana er9s notes of cash receipts showed shorta es in numerous deposits. .he business mana er admitted takin the cash.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (1##

(.'*

<a+lan CPA 7am !imulation: Au$it ob#ectives for cash C 4 E .he confirmation of cash balances at !ear1end will provide assurance that cash on the balance sheet is owned b! 2arrison. Cut1off procedures will provide assurance that all cash amounts owned b! 2arrison at !ear1end appear on the balance sheet. 4n anal!sis of the relationships between cash and investments will provide assurance that cash balances are properl! described and presented in the financial statements. Reviewin the minutes of the meetin s of the board of directors will provide assurance that 2arrison has authori"ed all lon 1term debt at the balance sheet date. Examinin lease a reements for potential capitali"ation will provide assurance that all lon 1term debt at the balance sheet date is identified and recorded. .estin the reasonableness of interest expense and accrued interest pa!able will provide assurance that lon 1term debt at the balance sheet date is properl! classified. Reviewin debt a reements for interest rates, restrictive covenants and assets that have been pled ed will provide assurance that lon 1term debt is properl! presented in the financial statements and related restrictions, re ulations, uarantees, interest rates, pled ed assets and commitments are adeBuatel! disclosed.

2 E 3

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (1#$

(.'+

<a+lan CPA 7am !imulation: &an' Reconciliation 1. 4 .he amount stated on the bank statement should be traced and a reed to the balance provided on the bank confirmation 7the bank confirmation should be received directl! from the financial institution8. Deposits in transit that are listed on the bank reconciliation should be re1 totaled b! PS/ to confirm %akelandKs calculation. .he deposits in transit should be traced and a reed to the cash receipt records for the !ear bein audited 7=ear #8 since the amounts are alread! included in calculatin the December $1, =ear # cash balance but are not included on the December $1, =ear # bank statement balance. .he deposits in transit should also be traced to the cut1off bank statement 7presumabl! received sometime in Aanuar!, =ear $8 from the bank to confirm that the amounts were subseBuentl! received. .he outstandin checks listed on the bank reconciliation should be re1totaled b! PS/ to confirm %akelandKs calculation. .he outstandin checks should be traced and a reed to the cash disbursement records for the !ear bein audited 7=ear #8 since the amounts are not included 7thus, have been deducted8 in calculatin the December $1, =ear # cash balance but are included 7thus, have not been deducted8 in the December $1, =ear # bank statement balance. :inall!, the outstandin checks should be traced to the cut1 off bank statement to confirm that the amounts were subseBuentl! disbursed. .he erroneous bank deposit should be traced and a reed to the bank cut1off statement to ensure that the amount was subseBuentl! corrected b! the bank. .he balance of G')$,#', should be traced and a reed to %akelandKs trial balance or eneral led er. 4dditionall!, the balance should be recomputed b! PS/ to confirm the accurac! of %akelandKs total.

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C1012

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McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (1#&

(.(,

<a+lan CPA 7am !imulation: &an' Confirmation 1. #. :alse :alse .he confirmed bank balance 7cash basis8 should be traced and a reed to the balance per bank on the reconciliation, <D. the eneral led er 7accrual basis8. .he difference of G#',,,,, if left unresolved, could result in a material overstatement of liabilities 7recall that the overall financial statement materialit! is onl! G#,,,,,8. Such a material overstatement of liabilities would result in the overall financial statements bein materiall! misstated, which would not allow for a clean audit opinion. .herefore, further work is reBuired b! PS/ to resolve the apparent balance discrepanc!. Eank confirmations are enerall! not reBuired to be used when performin a proof of cash. <ote, PS/ would onl! perform a proof of cash if there is a material internal control weakness for cash at %akeland. 4 reconfirmation of the line of credit balance of G1',,,,, is necessar! to ensure that there was no error on the part of the bank in the ori inal confirmation process. .he restricted cash relatin to real estate taxes on the propert! under construction must be disclosed separatel! in the notes to the financial statements.

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<a+lan CPA 7am !imulation: &an' Transfer !che$ule 1. .rue Disbursement amounts included on a bank transfer schedule should be traced to the clientKs cash disbursement records to determine if the amount was appropriatel! included or excluded from the records. Disbursements on the bank transfer schedule should be correctl! included or excluded dependin on the date when the particular item cleared the bank. 4ll of the information is reBuired to prepare a complete bank transfer schedule. Check N1## is a not a deposit in transit at December $1, =ear # since it was not disbursed until the followin !ear, =ear $. .he procedure helps to detect the overstatement of cash due to kitin .

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:alse .rue :alse .rue

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (1#'

(.(#

<a+lan CPA 7am !imulation: 9ea'nesses in Cash Recei+ts .o6 Partner, PS/ :rom6 /ana er, PS/ SubCect6 Reportable Conditions, Si nificant Deficiencies, and /aterial >eaknesses 4 reportable condition is a si nificant deficienc! in the desi n or function of internal control that could adversel! affect the or ani"ationKs abilit! to record, process, summari"e, and report financial data. !i.nificant $eficiencies are defined as conditions that could adversel! affect the or ani"ationKs abilit! to initiate, record, process, and report financial data in the financial statements. .he deficienc! would provide a more than remote possibilit! of a misstatement that is more than inconsequential would not be prevented or detected. Examples include6 4bsence of appropriate se re ation of duties. 4bsence of appropriate reviews and approvals of transactions. Evidence of failure of control procedures. Evidence of intentional mana ement override of control procedures b! persons in authorit! to the detriment of control obCectives 4 material =ea'ness in internal control is defined as a condition that results in more than a remote likelihood of a material misstatement of the financial statements. Eefore Sarbanes Dxle!, 4@ $#' reBuired us to communicate reportable conditions to the audit committee throu h a report, either orall! 7with the discussion documented in the workin papers8 or in a written letter to the audit committee. 3n the report, we were not reBuired to identif! whether a reportable condition was actuall! a material weakness. <ow, because %akeland is a public compan!, we are reBuired to follow the Sarbanes1Dxle! act, which reBuires us to identif! si nificant deficiencies and material weakness and report them in writin to the audit committee.

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<a+lan CPA 7am !imulation: !A! >> Re?uirements 74@ sec. 11,, par. #86 .he auditor has a responsibilit! to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Eecause of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected. .he auditor has no responsibilit! to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused b! errors or fraud, that are not material to the financial statements are detected.

McGraw-Hill/Irwin 4uditin and 4ssurance Services, %ouwers et al., #5e

- .he /c0raw12ill Companies, 3nc., #,,) (1#(