ATC F8 materials FF8 AA (Int)Session25 j08

OVERVIEW

Objective

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To determine areas of risk in the audit of loans, bank and cash.

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To obtain appropriate audit evidence including bank reports for audit purposes.

RISKS SOURCES OF

EVIDENCE SYSTEM CASH

¾ Control objectives ¾ Internal control

examples

C A P E R

¾ “Ideas list” ¾ Examples

BANK REPORTS FOR AUDIT

PURPOSES ¾ Standard letter

¾ BBA

¾ Authority to disclose ¾ Loans

¾ Bank and cash _PROCEDURES

¾ Loans

¾ Bank reconciliation

¾ Form

1

SOURCES OF EVIDENCE

Example 1

Complete the following ideas list for bank and cash balances.

1.1 “Ideas list”

1.2 Examples

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Accounting systems ⇒

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Documentation ⇒

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Tangible assets ⇒

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Management and employees ⇒

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Customers and suppliers ⇒

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Other third parties ⇒

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Analytical procedures ⇒

2

CASH SYSTEM

2.1

Control objectives

To ensure that . . .

. . . payments are only requested for valid business expenses.

. . . payments are accurate and take advantage of credit terms.

. . . cash/cheques are not misappropriated.

. . . management has

accurate/timely info concerning cash position..

Request for payment Stage 1

Payment authorisation Stage 2

Payment made

Stage 3 Receipt

2.2

Internal control examples

2.2.1

Request for payment

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Standardised cheque requisitions

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Supporting documentation (e.g. invoice)

2.2.2

Payment authorization

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Departmental/buyer approval

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Agreement to suppliers’ statement

2.2.3

Payment made/Receipts

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Safe custody of cheque books

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Invoices/requisitions stamped “PAID”

2.2.4

Recording

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Segregation of duties

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Monthly bank reconciliations

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Supervision/independent review

3

RISKS

3.1

Loans

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Loans may be obtained without authorisation/in contravention of existing agreements.

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Loans may become repayable on demand due to breaches of agreements.

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Secured, unsecured and inter-company loans may not be separately disclosed.

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Loan interest may not be accrued.

3.2

Bank and cash

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Most liquid assets may be exposed to misappropriation.

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Secured assets may not be separately disclosed.

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Cheques raised in bulk at y/e may be subsequently cancelled or their despatch unacceptably delayed.

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Cash receipts may be stolen and difficult to trace.

4

AUDIT PROCEDURES

4.1

Loans

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Examine the loan agreement noting: ‰ term of the loan;

‰ rate of interest (fixed or variable); ‰ security given;

‰ repayment terms.

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Obtain schedules of the loan(s), reconciling opening balances, movements in year and closing balances.

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Confirm redemptions during the year by reference to: ‰ authority (e.g. board minutes);

‰ paid cheques and cash book entries;

‰ the calculation of any discount or premium; ‰ accrued interest paid;

‰ deletions in the register of holders of loans.

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Verify any fresh loans/debentures issued by reference to: ‰ trust deed;

‰ receipt of monies in cash book and general ledger; ‰ entries in register.

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Obtain direct confirmation from lenders.

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Agree reconciliation of opening and closing balances, statement of financial position figures and comparatives.

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Scrutinise statutory books (if any) and confirm that they are correct regarding: ‰ changes in assets;

‰ directors’ interests in debentures.

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Re-compute interest charge and interest accrual calculations.

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Agree disclosure of long-term liabilities in accordance with financial reporting framework. For example:

4.2

Bank reconciliation

4.2.1

Purpose

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To check the completeness and accuracy of cash book postings by “reconciling” the balance per the cash book to the balance per the bank statement (prepared by an independent, third party – the bank).

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At any time, the bank statement balance should equal that in the cash book, albeit “in reverse”. However, the cash book balance invariably does not agree with the bank statement. This is caused principally by timing differences (see below).

4.2.2

Bank statement balance

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Entity’s perspective

‰ Dr balance in cash book is an asset

‰ Cr balance in cash book means “overdrawn” (i.e. a liability)

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Bank’s perspective

‰ “Cr” balance on bank statement means customer is a creditor (i.e. bank owes customer)

‰ “Dr” means customer owes the bank (i.e. is overdrawn)

4.2.3

Reasons for differences

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Unpresented cheques (i.e. cheques drawn by the business)

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Outstanding lodgements (i.e.

receipts “lodged” with the bank)

Timing differences

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Bank interest/charges

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Standing orders (“SOs”)/

direct debits (“DDs”)

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Credit transfers

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Dishonoured (“bounced”) cheques

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Bank errors

Items on bank statement not in cash book

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Cash book errors

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cast errors

Commentary

Cheques

A cheque is a “money order” drawn (i.e. written out) by a payer to settle an amount due to the payee. The payee presents the cheque to a clearing bank to have the money transferred to the payee’s account. If the payer does not have sufficient funds to cover the payment then the cheque is returned to the payer as “dishonoured” and the transfer to the payee is reversed. The payer’s liability is not discharged and the payee must ask for payment again. There are many other reasons why a cheque might be dishonoured e.g. if:

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it is post-dated (i.e. drawn for payment at a late) or out of date (usually

after 6 months)

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there is a discrepancy between the amounts written (in narrative and numerically)

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the account has been closed or cannot be traced

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the payer has put a “stop” on the cheque.

The bank usually charges the payer a service cost for handling such cheques.

Direct debit

An authority given by a payer to a third party (the payee) to debit the payer’s account on a specific date (or nearest banking day thereto). This authority can be:

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for a fixed amount per month (e.g. a loan repayment) or

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variable (e.g. payment of a telephone bill where the amount is only known at the end of the billing period).

Standing order

Instructions given by a payer to their Bank to pay a fixed amount on

predefined dates to a third party (who has no power to request payment from the bank).

4.2.4

Reconciliation procedure

Step 1 Correct/amend cash book – requires double entries. Step 2 Adjust bank statement balance for

4.2.5

Proforma

XYZ Bank reconciliation as at . . .

Cash a/c

$ $

Opening balance b/f x Adjustments

eg dishonoured cheque x Adjustments

eg interest received _{__} x Balance c/f _{__} x

x x

__ __

Bank reconciliation statement

$ $

Balance per bank statement x

Add: Uncleared lodgements _{__} x

x __

x

Less: Unpresented cheques _{__} x

(x)

+/– Bank errors _{__} x

Balance per corrected cash account _{__} x

The fact that these do not agree suggests something has occurred which needs reconciling These should now agree. This balance ⇒ balance sheet Step 1 Adjust CB for all errors, timing differences or omissions ⇒ up-to-date balance. Step 2 Reconcile adjusted balance to bank statement, noting cheques in transit, bank errors, etc.

4.2.6

Summary of audit procedures

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Confirm balance per the bank statement (e.g. to the bank report for audit purposes) and agree cash book balance to the general ledger.

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Check the reconciliation casts (i.e. adds up).

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Agree uncleared (“outstanding”) lodgements and unpresented cheques to entries on the bank statement dated after the end of the reporting period.

5

BANK REPORTS FOR AUDIT PURPOSES

Commentary

Also called “bank (confirmation) letter”.

Role as Audit evidence:

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existence and amount of liabilities;

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existence, amount, ownership and custody of assets.

5.1

Standard letter

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Facilitates extraction of information

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Smoothes the processing of requests

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Answers received highlight particular areas for further work.

5.2

British Bankers Association (BBA)

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BBA membership includes banks around the world (e.g. Amex, Moscow Narodny, Zivnostenska).

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Instead of the bank confirmation request letter containing an exhaustive list of all the possible information which could possibly be required, the auditor simply ticks () for a

“Standard request” and/or supplementary information.

5.3

Authority to disclose information

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May be

‰ ongoing “standing” authority ‰ separate authority for each request.

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Addressed to the bank.

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Names all group entities.

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“I/We authorise [Bank] including all branches [and subsidiaries] to provide to our auditor [Accountants] any information that they may request from you regarding all and any of our accounts and dealings with you.”

5.4

Form

Send letter on own paper ↓

Send to every bank the client has dealt with during year → (Branch where client has main business arrangement)

No contractual

relationship →

Names of entities

covered by →

request

BANK CONFIRMATION REQUEST LETTER

XYZ and Co 17 Kendall Drive

11 December 2006 The Manager,

... (Bank) ... (Branch)

Dear Sirs

In accordance with the agreed practice for provision of information to auditors, please forward information on our mutual client(s) as detailed below on behalf of the bank, its branches and subsidiaries. This request and your response will not create any contractual or other duty with us.

Companies (or other business entities)

[Parent Company Subsidiary 1 Subsidiary 2]

FOR THE YEAR ENDED 31 DECEMBER 2006

← to reach bank at least 2 weeks before y/e

← Use standard

request letter

Attach a separate ← listing if

necessary

← “Audit

Information required Tick confirmation date”

Standard

Trade finance ← Banks may

Derivative and commodity trading charge clients a

Custodian arrangements premium for

Other information (see attached) supplementary

Explicit → authority to disclose from client

The Authority to Disclose Information signed by your customer is attached/ already held by you (delete as appropriate). Please advise up if this Authority is insufficient for you to provide full disclosure of the information requested.

The contact name is [xx] Telephone [xxxx xxx xxxx]

Yours faithfully

XXX Accountants

info

← Request to be advised

5.5

Standard request

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Balances on a/cs (including loans, joint a/cs and trade name a/cs)

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Facilities – loans/overdrafts/guarantees etc (including term, repayment, review date, limit, etc).

5.6

Supplementary information

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Trade finance – including letters of credit, acceptances, bills, bonds, guarantees and indemnities (and security thereon).

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Derivatives and commodity trading – including foreign exchange contracts, forward rate agreements, financial futures, swap arrangements and option contracts (and security thereon).

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Custodian arrangements – the nature and quantity of any assets held but not charged (e.g. title deeds held for safe-keeping rather than securing a mortgage).

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Other information – copy bank statements/paying-in slips, returned paid cheques, “stopped” cheques.

5.7

Disclaimers

“Our response is given solely for the purposes of the audit and creates no responsibility to the auditors.”

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Does not significantly impair the value of information given as audit evidence.

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Therefore entitled to rely, unless clearly wrong, suspicious, inconsistent, etc.

FOCUS

You should now be able to:

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identify risks and appropriate sources of evidence;

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suggest cash control objectives and recommend internal control procedures;

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describe methods used to collect audit evidence to verify loans, bank and cash

(including the bank reconciliation);

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state the standard information requested in a bank confirmation request letter;

EXAMPLE SOLUTION

Solution 1 — “Ideas list”

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Accounting systems ⇒ Cash system, cash book(s), “imprest” for petty cash

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Documentation ⇒ Cheque requisitions

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Tangible assets ⇒ Physical cash (count it)

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Management and employees ⇒ Board minutes (authorising cheque signatories), cashier

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Customers and suppliers ⇒ Possibly DD or SO mandates for expenses (e.g. insurance premiums)

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Other third parties ⇒ Bank statements, report for audit purposes (= “confirmation letter”)

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Analytical procedures ⇒ “Proof in total” – interest