Solution manual auditing and services 2e by louwers chap006

Chapter 06 - Employee Fraud and the Audit of Cash

CHAPTER 6
Employee Fraud and the Audit of Cash
LEARNING OBJECTIVES
Review
Checkpoints

Exercises, Problems,
and Simulations

1. Define and explain the differences among several
kinds of employee frauds that might occur in an
organization.

1, 2, 3

2. List and explain some conditions that can lead to
frauds.

4, 5, 6, 7

3. Describe ways and means for preventing employee
frauds.

8

46

4. Describe the controls over the receipt and
disbursement of cash.

9, 10, 11, 12

43, 44, 45

5. Design and perform substantive audit procedures for
the audit of cash.

13, 14, 15, 16, 17, 18

47, 48, 49, 50, 57,
59, 60, 61

6. Discuss actual cash fraud cases and describe how
the schemes were uncovered.

19, 20

53, 55, 56, 58

7. Describe some extended procedures for detecting
employee fraud schemes involving cash.

21, 22, 23

51, 52, 54

6-1

Chapter 06 - Employee Fraud and the Audit of Cash

SOLUTIONS FOR REVIEW CHECKPOINTS
6.1

Employee fraud is the use of fraudulent means to take money or other property from an employer.
It consists of three phases: (1) the fraudulent act, (2) the conversion of the money or property to
the fraudster’s use and (3) the cover up.
Embezzlement is a type of fraud involving employees or nonemployees wrongfully taking money
or property entrusted to their care, custody, and control, often accompanied by false accounting
entries and other forms of lying and cover up.
Larceny is simple theft of an employer’s property that is not entrusted to an employee’s care,
custody or control.
Defalcation is another name for employee fraud and embezzlement.

6.2

Fraud perpetrators look like other people, hence the difficulty in spotting them easily. However,
they sometimes exhibit behavioral red flags of odd habits.

6.3

(1)
(2)
(3)

1.4

If the employees cannot be identified, maybe they do not exist. The names are odd. All
the first and last names begin with the same letter.

If Eloise Garfunkle is a company employee, somehow she cashed a check payable to a
supplier. Maybe she is related to the supplier, or maybe she intercepted the check before
it reached the supplier.
Somebody is working on holidays! These dates are normal workdays off for most
businesses: New Year’s Day, Memorial day, Independence day, Labor day, Thanksgiving
day, and Christmas day. (Would students have been able to identify holidays like
memorial day and labor day if the other more obvious ones had not been listed?)

Egocentric Motivations



My father was wealthy, and I need to be wealthy too.
My friends admire cars, and I need to have an expensive one.

Ideological motivations



The company sells tobacco and alcohol, and doesn’t deserve to make a profit.
I can award the government housing grants to best use without the HUD red tape.
(Justifying diversion of funds in government housing programs.)

Economic Motivations










Pay college tuition
Pay hospital bills for a parent with cancer
Pay gambling debts
Pay for drugs
Pay alimony and child support
Pay for high life style (homes, cars, boats)
Finance business or stock speculation losses
Report good financial results

6-2


Chapter 06 - Employee Fraud and the Audit of Cash
6.5

Conditions related directly to employee fraud:

Nobody counts the inventory, so losses are not known

The petty cash box is often left unattended

Supervisors set a bad example by taking supplies home

Upper management considered a written statement of ethics but decided not to publish
one

Another employee was caught and fired, but not prosecuted


The finance vice-president has investment authority without any review

Frequent emergency jobs leave a lot of excess material just laying around

6.6

Rationalizations:

I need it more than the other person (Robin Hood theory)

I’m borrowing the money and will pay it back

Nobody will get hurt

The company is big enough to afford it

A successful image is the name of the game

Everybody is doing it

6.7

Some auditors look at capability as a forth item necessary for committing a fraud. They argue that
if a control weakness exists, but you do not have the skills and knowledge to take advantage of the
weakness then an opportunity does not present itself. Others would argue that these are separate
issues and the opportunity exists whether the potential fraudster has the capability or not and,
therefore, capability is a requirement that must be present to produce fraud.

6.8

Fraud-Prevention Management Style
Democratic, open-door management

Style Leading to Fraud
Autocratic management

Trust the employees and give them power in
their jobs

Orient management to low trust and power

Install controls that don’t make work difficult

Install tight, bureaucratic controls

Let people design and manage their jobs and
work

Insist everything be documented with a rule for
everything
Centralize authority in top management

Decentralize authority

Manage by crisis

Manage with foresight

Measure performance on a short-term basis

Measure performance on long-run basis
Have multiple measures of performance

Make profits the only criterion for success
Make rewards punitive, stingy and political

Make rewards positive and generous
Give constructive positive and negative
feedback
Create a cooperative workplace

Give feedback that is always critical and negative
Create a highly hostile, competitive workplace

6-3


Chapter 06 - Employee Fraud and the Audit of Cash

Boss’ exemplary behavior and decisions
Make background checks on new employees
6.9

Boss’ questionable behavior and decisions
Be lax about background checks

Prosecute fraudsters
Fire fraudsters without prosecution
The basic sequence of activities and accounting in a revenue and collection cycle is:

1.

Receiving and processing customer orders. Entering data in an order system and
obtaining a credit check.

2.

Delivering goods and services to customers. Authorizing release from storekeeping to
shipping to customer. Entering shipping information in the accounting system

3.

Billing customers, producing sales invoices. Accounting for customer trade accounts
receivable.

4.

Collecting cash and depositing it in the bank. Accounting for cash receipts.

5.

Reconciling bank statements.

6.10

It might be easier just to send the cash to the accounts receivable accountants, but (1) that would
delay the bank deposit and the company would lose interest income, and (2) a dishonest
accountant could steal cash while still giving the customer credit (to forestall complaints). The
accounting department is a recordkeeping function and having cash would violate the separation
of duties control because the accounting department would also have custody of assets (checks and

cash). The accountant could cover the theft by making false debit entries to such accounts as
allowance for doubt accounts (account write-offs) or discounts and allowances expense.

6.11

The term “lapping” refers to an employee’s stealing the cash receipts of a company and then
covering the amount with a following day’s payment received for another customer’s account. A
“lapping” operation is possible when a single employee has access to both cash and accounts
receivable records.
The auditor is alerted to the possibility of a “lapping” operation when duties are not properly
separated. Surprise confirmation is the primary means which an auditor can use to uncover such
activity. Also, details of deposit slips and cash remittance reports can be compared to detect
discrepancies.

6.12

All vendors should be required to be on an approved vendor list. Vendors are placed on this list
with approval from multiple departments (e.g. purchasing, engineering, and quality control). In
addition, payments should not be made without a complete voucher package including a purchase
order and receiving report. Since fictitious vendors do not supply product or service, such a fraud
would require collusion between purchasing and receiving.

6.13

Compare the amount written on the check with the bank’s magnetic imprint of the amount paid by
the bank.

6-4

Chapter 06 - Employee Fraud and the Audit of Cash

6.14

There are several clues that the bank statement has been altered:






The statement does not add up to the $7,374.93 balance shown.
The font of the “7”s do not match.
The low balance is $2,374.93 (the correct balance) and no transactions occurred after this
point.
There is a space for a gap in the check sequence, but no “**”‘s as with the other gaps.
The statement reports 26 checks, but only 25 are listed.

6.15

The cutoff bank statement is a bank statement sent by the bank directly to the auditor, and it is
usually for a 15 or 20 day period following the reconciliation date. The basic use of the statement
by the auditor is to determine whether outstanding checks were actually mailed before the
reconciliation date and outstanding deposits in transit were actually received in a timely manner by
the bank.

6.16

Check kiting is the practice of building up apparent balances in one or more bank accounts based
on uncollected (float) checks drawn against similar accounts in other banks. Kiting involves

depositing money from one bank account to another, using a hot check. Kiting is the deliberate
floating of funds between two or more bank accounts. By this method, a bank customer utilizes
the time required for checks to clear to obtain an unauthorized loan without any interest charge.
Auditors can detect signs of kiting by observing in the bank statements:













Frequent deposits and checks in same amounts
Frequent deposits and checks in round amounts
Frequent deposits with checks written on the same (other) banks
Short time lag between deposits and withdrawals
Frequent ATM account balance inquiries
Many large deposits made on Thursday or Friday to take advantage of the weekend
Large periodic balances in individual accounts with no apparent business explanation
Low average balance compared to high level of deposits
Many checks made payable to other banks
Bank willingness to pay against uncollected funds
“Cash” withdrawals with deposit checks drawn on another bank
Checks drawn on foreign banks with lax banking laws and regulations

If these cash transfers are recorded in the books, a company will show the negative balances that
result from checks drawn on insufficient funds. However, perpetrators may try to hide the kiting
by not recording the deposits and checks. Such maneuvers may be detectable in a bank
reconciliation audit.
A schedule of interbank transfers can be constructed from the canceled checks and cleared
deposits in the bank statements. This schedule shows each check amount, the name of the paying
bank (with the book recording date and the check clearing date), the name of the receiving bank
(with the book deposit date and the bank clearing date). The purpose of this schedule is to see that
both sides of the transfer transaction are recorded in the same period (and in the proper period).
6.17

A schedule of interbank transfers shows improper cash transfer transactions when the auditors find
(a) no recording of transfers shown in the bank statement, and (2) dates of bank and general ledger
recording that are out of order.

6-5


Chapter 06 - Employee Fraud and the Audit of Cash
6.18
A “proof of cash” can reveal unrecorded cash deposit and cash payment transactions when the
attempt to reconcile the deposits and payments reported by the bank to the deposits and payments recorded
in the general ledger requires consideration of unrecorded amounts. Inspection of the bank statement and
comparison to the general ledger (books) will uncover the problem, provided the documents have not been
destroyed.
6.19

The former petty cash custodian apparently had more expenditures than the new one. Maybe the
former one was running false expense claims.

6.20

No separation of the duties and responsibilities for (1) transaction authorization, (2)
recordkeeping, (3) custody of, or access to, assets, and (4) reconciliation of actual assets to the
accounting records.
A supervisor may not take approval responsibilities seriously and fail to perform them (like the
supervisor of the petty cash custodian in the text case).
Tight control may be too expensive and simply not performed (like the lack of observation of the
laundry money collectors in the text case).
The payroll employee who has responsibility for preparing personnel files for new hires, approval
of wages, verification of time cards, and distribution of payroll checks can “hire” fictitious
employees, fake their records, and order checks through the payroll system.
Managers can override controls and order people to ship bricks (as in the text case) or manipulate
records to create false numbers from a position of accounting authority (inventory falsification text
case).

6.21

Extended procedures are audit procedures performed only when (external) auditors think
something deserves imaginative investigation in the circumstances . Usually they are more
complicated and expensive than “normal” audit procedures, and they usually suggest a suspicion
of something fraudulent going on. The text contains brief explanations of several “extended
procedures,” but these may seem “normal” for fraud examiners.

6.22

Two endorsements may indicate that the payee of the check is not the party that received the
benefit of the check payment. The payee may be fictitious.

6.23

Net worth analysis is used when fraud has been discovered or strongly suspected, and the
information to calculate a suspect’s net worth can be obtained (e.g. asset and liability records, bank
accounts). The method is to calculate the suspect’s net worth (known assets - known liabilities) at
the beginning and end of a period (months or years), then try to account for the difference as (1)
known income less living expenses, and (2) unidentified difference. The unidentified difference
may be the best available approximation of the amount of a theft.
Expenditure analysis is similar to net worth analysis, except the data is the suspect’s spending for
all purposes compared to known income. If spending exceeds legitimate and explainable income,
the difference may be the amount of a theft.

6-6


Chapter 06 - Employee Fraud and the Audit of Cash

SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS
6.24

6.25

a.

Correct

b.

Incorrect

c.

Incorrect

d.

Incorrect

a.

Incorrect

b.

Incorrect

c.

Incorrect

d.

Correct

Risk is high when the company always estimates the inventory but
never take a complete physical count.
Risk is low when the petty cash box is always locked in the desk of the
custodian.
Risk is lower when management has published a company code of
ethics and sends frequent communication newsletters about it.
Risk is lower when the board of directors reviews and approves all

investment transactions.
Airtight control systems of checks and supervision is not the best
long-run way to stop fraud.
Name an “ethics officer” who is responsible for receiving and acting
upon fraud tips is not the best long-run way to stop fraud.
Place dedicated “hotline” telephones on walls around the workplace
with direct communication to the company ethics officer is not the best
long-run way to stop fraud.
Practice management “of the people and for the people” to help them
share personal and professional problems is the best long-run way to
stop fraud.

6-7


Chapter 06 - Employee Fraud and the Audit of Cash

6.26

6.27

6.28

6.29

a.

Correct

b.

Incorrect

c.

Incorrect

d.

Incorrect

a.

Incorrect

b.

Incorrect

c.

Correct

d.

Incorrect

a.

Incorrect

b.

Incorrect

c.

Correct

d.

Incorrect

a.

Incorrect

b.

Correct

c.

Incorrect

d.

Incorrect

Many frauds are motivated by employees who have problems due to

debt, addictions, or family problems. Establishing an employee
assistance program addresses these issues and may reduce the
motivation to commit fraud for some employees.
A fidelity bond reduces the risk to the employer for theft since this is a
form of insurance. It also provides a background check on employees.
Neither of these issues addresses employee motivation.
Reconciliations are methods of detecting problems that have occurred.
While these are good controls and may reduce the opportunities for
employees to steal, reconciliations to not address employee motivation
to commit fraud.
Audits may detect fraud and even provide a deterrence for fraud.
Audits do not address the employees motivation to commit fraud.
An appointment of a chief ethics officer would increase the
effectiveness of the code of ethics.
A hot line that allowed employees to report ethical violations would
increase the effectiveness of the code of ethics..
The violation of the code of ethics by senior management would reduce
the effectiveness of the code of ethics since the tone at the top would
provide a message to employees that the code of ethics was not
important.
The posting of the code of ethics and any other means of presenting the
code of ethics to employees in a prominent manner would increase the
effectiveness of the code of ethics..
Numerous cash refunds have been made to different people at the same
post office box address is an indicator of cash refund fraud.
Internal auditor cannot locate several credit memos to support
reductions of customers’ balances is an indicator of returned goods
fraud.
Bank reconciliation has no outstanding checks or deposits older than 15
days is a sign of a good bank reconciliation, a fraud detection

technique.
Three people were absent the day the auditors handed out the
paychecks and have not picked them up four weeks later is an indicator
of padded payroll fraud.
Overstating sales revenue and overstating customer accounts receivable
balances is a way to misstate financial statements for management
fraud.
Overstating sales revenue and overstating bad debt expense does not
misstate income or assets but will hide an employee embezzlement.
Understating interest expense and understating accrued interest payable
is a way to misstate financial statements for management fraud.
Omit the disclosure information about related party sales to the
president’s relatives at below-market prices is a way to misstate
financial statements for management fraud.

6-8


Chapter 06 - Employee Fraud and the Audit of Cash
6.30
a.
Incorrect
would be detected.
b.
Incorrect

Inventory should be counted on a regular basis, therefore, the fraud
Expense accounts are often good places to hide fraud since accounts are
closed at the end of the year. Wage expense accounts may be compared
to budget and may be reviewed by department managers that might

detect the fraud.
Expense accounts are often good places to hide fraud since accounts are
closed at the end of the year. Consulting expense is a particularly good
place to hide a fraud since no actual product is provided which may be
counted or compared to the expense.
Property tax expenses would likely be compared to the property tax bill
and any discrepancies investigated.

c.

Correct

d.

Incorrect

a.

Correct

b.

Incorrect

c.

Incorrect

d.

Incorrect

6.32

c.

Correct

The cashier would have both custody of cash and record keeping
responsibility, hence could steal money and fix the records without
interference by anyone else.

6.33

c.

Correct

Kiting involves a mismatching of dates of recording around year-end,
and the schedule of bank transfers is designed to show all the relevant
dates so the auditor can see that the entries are in the proper periods.

6.34

b.

Correct

Effective control of cash requires that receipts be recorded promptly.
For mail receipts, a listing of remittance advices by an employee not

performing incompatible functions is a standard control procedure. If
the customer does not return the remittance advice, one should be
prepared at the time the mail is opened. If remittance advices are not
used, a listing of receipts should still be made when the mail is opened.

6.35

a.

Incorrect

b.

Correct

c.

Incorrect

d.

Incorrect

A check returned for insufficient funds would make the balance per
bank different than the balance per books and would need to be a
reconciling item. It would not change any of the information that was
provided to the assistant controller.
If the cash received was split into two or more deposits the deposits
would not match the remittances or the payments recorded.
Controls over unauthorized access into accounts receivable strengthens

the control indicated in the question since information on the payment
report would be more reliable.
Having someone else reconcile the accounts payable process adds an
additional person to the control process.

6.31

The inventory warehouse manager can steal inventory and manipulate
the records.
Cashier prepared the bank deposit, endorsed the checks with a company
stamp, and took the cash and checks to the bank for deposit (no other
bookkeeping duties). The cashier might steal currency, but needs access
to the records to cover up a theft of customer payments.
Accounts receivable clerk received a list of payments received by the
cashier so he could make entries in the customers’ accounts receivable
subsidiary accounts. Good arrangement because the bookkeeper does
not have access to cash.
Financial vice president received checks made out to suppliers and the
supporting invoices, signed the checks, and put them in the mail to the
payees. Fraud would be harder because financial VP would also need to
be able to create fictitious vendors and invoices.

6-9


Chapter 06 - Employee Fraud and the Audit of Cash

6.36

c.

Correct

The individuals with record-keeping responsibility should have custody
of cash. Hence, they should use either the remittance advices or a
listing of the remittances to make entries o the cash and accounts
receivable control account and to the subsidiary accounts receivable
records. Indeed, having different people make entries in the control
account and in the subsidiary records is an effective control.

6.37

a.

Correct

Not recording sales on account in the books of original entry is the
most effective way to conceal a subsequent theft of cash receipts. The
accounts will be incomplete but balanced, and procedures applied to the
accounting records will not detect the defalcation.

6.38

a.

Incorrect

b.
c.
d.

Incorrect
Incorrect
Correct

The definition of embezzlement involves property that is entrusted to
the employee’s control (as in (d)). This statement refers to larceny.
This statement is similar to the definition of management fraud.
This statement is similar to a mere error in accounting
This statement is the textbook and criminological definition of
embezzlement.

6.39

b.

Correct

A final review by the treasurer can catch mistakes made in prior
processing.

6.40

a.

Correct

b.

Incorrect

c.
d.

Incorrect
Incorrect

The overstatement of cash would be of most concern. Cash is
overstated by claiming that the organization has more cash then it does.
It is possible that a firm could borrow money to include in a cash count
and, therefore, not have the rights to the cash. However, such a scheme
is of lesser concern then if the company claimed cash that did not exist.
Since the value of cash is easily discernable this is usually not an issue
Improper cash presentation is of lower risk then the existence of cash.

a.

Incorrect

b.

Incorrect

c.

Correct

d.

Incorrect

d.

Correct

6.41

6.42

Since the sources and use of cash can vary greatly from year to year,
balances in prior year are of little use.
Management inquiry would provide poor information for use in
performing analytical procedures.
Budgets provided by management provide the best estimates by
management for the sources and use of cash. Where cash receipts or
cash expenditures vary form the budget by a material amount, a higher
level of risk may be assessed.
Failure to collect accounts receivable may indicate a problem with cash
sources but would only be one part of an estimate of cash.
Cancellation (“paid”) of vouchers prevent their use a second time.

6-10


Chapter 06 - Employee Fraud and the Audit of Cash

SOLUTIONS TO PROBLEMS, EXERCISES AND SIMULATIONS
6.43

Tests of Controls over Cash Disbursements

NOTE TO INSTRUCTOR: Procedure #2 below is designed to indicate that work on one sample
of cash disbursements can produce evidence related to several objectives. The tasks numbered 2a
through 2l all relate to the #2 sample items.

AUDIT PROGRAM OF TEST OF CONTROLS AUDIT
PROCEDURES
Management Assertion

Test of Controls Procedure
1. Observe who has custody of signed checks for evidence of
segregation of duties from persons having cash disbursement or
accounts payable record-keeping responsibilities and from persons
who have cash disbursement authorization responsibilities.

Occurrence assertion
Recorded disbursements
are valid and
documented--representing payment for
goods and services
received.

2. Select a sample of cash disbursements recorded during the period,
and
2a.
2b.
2c.
2d.

Compare to the cancelled check.
Examine for authorized signature and proper endorsement

matching payee name.
Compare recorded amount and check amount.
Compare recorded payee name and name on check.

3. Scan the recorded cash disbursements for large or unusual amounts
and perform the same work on these items as in the #2 sample.
Occurrence assertion
Cash disbursements are
authorized according to
company policy.

2e.

Accuracy assertion
Cash disbursement dollar
amounts are calculated
and recorded accurately.

2h.

2f.
2g.

2i.

Examine supporting documents for a proper authorizing
signature or initials approving the amount for payment.
Trace authorizing signature to list of authorized approvers.
Trace vendor’s name to approved vendor list.
Recalculate amounts shown on supporting vendor’s invoices

and compare to check amount.
Recalculate cash discount, if any.

Classification assertion
Cash disbursements are
properly classified in the
accounts.

4. Obtain a chart of accounts and the accounting manual pertaining to
classification policy.
2j.
For each disbursement, determine whether the debit entry is
classified accurately.

Completeness assertion
Cash disbursements
accounting is completeproperly summarized and
posted in the general
ledger.

5. Foot selected summaries (daily, monthly) of cash disbursements.
6. Trace these totals to the general ledger debit and credit entries.
7. Foot the general ledger cash account.

6-11


Chapter 06 - Employee Fraud and the Audit of Cash

Cutoff assertion

Cash disbursements are
recorded in the proper
period.

6.44

8. Observe cash disbursement procedures and inquire to find out
whether checks are held for time before mailing.
2k. Compare date on check to date of recorded disbursement.
2l.
Compare dates to payee’s bank clearance date for any apparent
lengthy delay that indicate that checks are held before mailing.
Internal Control Questionnaire for Book Buy-Back Cash Fund
University Books, Incorporated
REVOLVING CASH FUND
INTERNAL CONTROL QUESTIONNAIRE
1.

Question
Is responsibility for the fund vested in one person?

2.

Is physical access to the fund denied to all others?

3.

Is the custodian independent of other employees who handle cash?

4.

Is the custodian bonded?

5.

Is the custodian denied access to other cash funds?

6.

Are receipts unalterable?

7.

Are receipts prenumbered?

8.

Is the integrity of the prenumbered sequence periodically accounted
for?
Does the seller sign receipts?

9.

10. Are receipts attached to reimbursement vouchers?
11. Are vouchers that are submitted for reimbursement approved by
someone other than the custodian?
12. Are reimbursement vouchers and attachments (receipts) cancelled after
reimbursement?
13. Is the fund used exclusively for the acquisition of books?
14. Is the fund periodically counted and reconciled by someone other than

the custodian?
15. Is the fund maintained on an imprest basis?
16. Is the size of the fund appropriate for the purpose intended?

6-12

Yes

No


Chapter 06 - Employee Fraud and the Audit of Cash
6.45

Audit Simulation: Test of Controls over Cash Receipts
Other Audit Procedures

Reason for Other Audit Procedures

1.

Source of debit entries in general ledger cash
account, other than from cash receipts journal,
should be investigated and supporting documents
examined.

1.

Since the auditor, using standard procedures, only
examined the cash receipts journal, he must

investigate the occurrence of all other sources of
cash receipts that are not recorded in these journals.

2.

A surprise examination of cash receipts should be
performed. Prior to the accounts receivable clerk
obtaining the cash receipts, the auditor should
make a list of them without the clerk’s knowledge.
The undeposited mail receipts should then be
controlled after completion of their preparation for
deposit and postings have been made to the
subsidiary accounts receivable ledger. The deposit
slip should be compared to the remittances for
accuracy and totaled. Individual items on the
deposit slip should be compared to postings to the
subsidiary accounts receivable ledger. The auditor
should then supervise the mailing of the deposit to
the bank. The auditor should ask Gutzler to ask the
bank to send the statement containing this deposit
directly to the auditor.

2.

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
only method of determining if cash receipts are
being recorded and deposited correctly.

3.

Postings from the deposit slips should be traced to
the subsidiary accounts receivable ledger. Also,
entries in the subsidiary accounts ledger should be
traced to deposit slips.

3.

Since there is no separation of duties between cash
receipts and accounts receivable, the accounts
receivable clerk may have been careless in
performing her posting duties. This procedure may
also disclose whether the accounts receivable clerk
may have been lapping the accounts.

4.

Review the subsidiary accounts receivable ledger
and confirm accounts that have abnormal
transaction activity (consistently late payments.)/

4.

See No. 3 above.

5.

If Gutzler allows customers to take discounts, the
amount of such discounts and the discount period

should be checked.

5.

6.

Dates and amounts of daily deposits per bank
statement should be compared with entries in the
cash receipts journal.

6.

Since there is no separation of duties between cash
receipts and accounts receivables the account
receivable clerk may have appropriated discounts
which could have been but were not taken or may
have been careless in checking 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 may have become
careless about prompt deposit of the daily receipts.

7.

A proof-of-cash working paper should be prepared
which reconciles total cash receipts with credits per
bank statement.

7.

6-13

Since internal control over cash receipts is weak, the
auditor should perform this overall check to help
substantiate that he has investigated all material
items during his detail tests.


Chapter 06 - Employee Fraud and the Audit of Cash
6.45

Audit Simulation: Test of Controls over Cash Receipts (Continued)
8.

6.46

For those periods for which the above audit
procedures were not performed and for a period
after the balance sheet date, scan the cash receipts
journal and bank statements for unusual items.

8.

Since internal control over cash receipts is weak, the
auditor should perform this review to help
substantiate that he has investigated all material
items not covered during his other tests.

Establishing a Returned Goods System

a.

Employees can falsify returned goods (no goods were actually returned) and take the cash
from the register as if it was provided to a customer.

b.

Procedures that may prevent this type of fraud include:
1.

Having one employee authorize the return and have the customer bring the
authorization of a cash register to obtain the money.

2.

Management authorization for all returns.

Procedures that might detect this fraud include:

c.

6.47

1.

Analytical procedures. Comparing returns per employee or returns per shift.

2.

Contacting customers to ascertain the reason for returns. This may also act as a

fraud prevention if employees know that management may follow-up with
customers.

Analytical procedures might detect an increase in returns. Also, since returned goods
should go back to inventory, inventory shortage may indicate that goods returned were
not genuine.

Procedures for Auditing a Client’s Bank Reconciliation
a.

Identification of procedures:
A.
B.
C.
D.
E.
F.

b.

Balance per bank: Procedures 4 and 9
Deposits in transit: Procedures 1, 7, 8, 9, and 10
Outstanding checks: Procedures 2, 7, 8, 9, and 10
Customer note collected by the bank: Procedure 5
Error: Check #1282, written on Sept 26: Procedures 5 and 9
Balance per books: Procedure 3

The total of outstanding checks is $13,480, not $11,450. Someone has manipulated the
bank reconciliation to match the general ledger balance, which is overstated $2,000
(provided the general ledger balance is $20,400.)

6-14


Chapter 06 - Employee Fraud and the Audit of Cash
6.48

Proof of Cash
Month of July
Balance
June 30

Deposits

Payments

Balance
July 31

$355,001

$835,846

$684,747

$506,100

Deposits in transit
October 31
December 31

86,899

(86,899)
51,240

Outstanding checks
October 31
December 31

(42,690)

Bank statement amounts

Unrecorded deposit

51,240
(42,690)
73,340

(150,000)

Unrecorded disbursement
General ledger amounts.

$399,210

$650,187

(73,340)

(150,000)

(150,000)

150,000

$565,397

$484,000

The company did not record deposits and disbursements in equal amounts of $150,000 (necessary
to make the bank and general ledger deposits and disbursements reconcile).
6.49

Audit Simulation: Interbank Transfers
NOTE TO INSTRUCTOR: Check #1799 ($10,000 payable to Citizen National Bank) drawn on
the 1st National Bank account was not recorded in EverReady’s cash disbursements journal. This
is the reason it is not shown in the schedule of interbank transfers in Exhibit 6.49-1. The auditors
obtained the initial information from the cash receipts and cash disbursements journals, and
#1799 was not in them.
a.

Complete the Schedule of Interbank Transfers (working paper C-5) by entering the new
information.
EXHIBIT 6.49-1
Schedule of Interbank Transfers

C-5

EVERREADY CORPORATION

SCHEDULE OF INTERBANK TRANSFERS
Prepared __________
December 31, 200X
Date
___________
Reviewed___________
Date
___________
Disbursing Account

Check
No.

Bank

Amount

2220
4050

Chase
Citizen

11,000
10,000

Receiving Account
Date per
Books

6-15

Date per
Bank

Bank

28-Dec
29-Dec

Citizen
1st Nat’l

Date per
Books

Date per
Bank
22-Dec
23-Dec


Chapter 06 - Employee Fraud and the Audit of Cash

1417
1st Nat’l 10,463
4051
Citizen
12,000
2221

Chase
15,000
4052
Citizen
12,000
1601
1st Nat’l 11,593√
4053
Citizen
14,000
1799
1st Nat’l 10,000
2222
Chase
12,000
4054
Citizen
20,000
1982
1st Nat’l
9,971√
---------------------------------------

24-Dec

31-Dec b

08-Jan

24-Dec m

31-Dec
05-Jan
05-Jan
31-Dec m
07-Jan
08-Jan
12-Jan
13-Jan
08-Jan m

1st Nat payroll
Chase
Citizen
1st Nat’l
1st Nat payroll
Chase
Citizen
Citizen
1st Nat’l
1st Nat payroll

√

Traced from cash disbursements journal.

b

Check properly listed as outstanding on bank reconciliation.

m

Vouched to check cleared in bank statement.

t

Traced from cash receipts journal.

n

Vouched deposit cleared in bank statement.

24-Dec t

31-Dec t

08-Jan t

24-Dec n
28-Dec
30-Dec
30-Dec
31-Dec n
04-Jan
05-Jan
07-Jan
08-Jan
08-Jan n

Note: We scanned the cash disbursements and cash receipts journals for checks to and deposits
from other bank accounts. Found none other than those noted in this work paper.

b.

6.49

What is the actual cash balance for the four bank accounts combined, considering only
the amounts given in this case information, as of December 31, (before any of the
December 31 payroll checks are cashed by employees)? As of January 8, (before any of
the January 8 payroll checks are cashed by employees)? (Hint: Prepare a schedule of
bank and actual balances like the one illustrated in Chapter 6 to explain check kiting.)

Audit Simulation: Interbank Transfers (Continued)

Interbank Transfers
Subtractions in the “bank” column indicate checks cleared and paid by the banks.
Chase Bank
Citizen Bank
1st National
1st Nat’l Payroll
Combined
---------- ---------- ----------------------- ---------- ------------ ---------- ------------ ---------- -------------------Date
Check Bank(1) Actual(2 Bank(1) Actual(2) Bank(1) Actual(2) Bank(1) Actual(2) Bank(1) Actual(2)
)
----------------- --------- ---------- ---------- ----------------------- ---------- ------------ ---------- ------------ ---------- ----------------------Dec 22 (Tue)
2220
(11,000) 11,000 11,000
Dec 23 (Wed) 4050
(10,000) 10,000 10,000
Dec 24 (Thu)
1417
(9,463) (9,463) 9,463

9,463
Payroll checks cashed
(9,463) (9,463)
Dec 28 (Mon) 4051 12,000 12,000
(12,000)
Dec 28 (Mon) 2220(11,000)
Dec 29 (Tue)
4050
(10,000)
Dec 30 (Wed) 2221
(15,000) 15,000 15,000
Dec 30 (Wed) 4052
(12,000) 12,000 12,000

6-16


Chapter 06 - Employee Fraud and the Audit of Cash

Dec 31 (Thu)
Dec 31 (Thu)

1601
(11,593) (11,593) 11,593 11,593
4051
(12,000)
---------- ---------- ----------------------- ---------- ------------ ---------- ------------ ---------- -----------(a) Balances
1,000 (14,000) 4,000 (8,000)
944
944

11,593 11,593 17,537 (9,463)
---------- ---------- ----------------------- ---------- ------------ ---------- ------------ ---------- -----------Payroll checks cashed
(11,593) (11,593)
Jan 4 (Mon)
4053 14,000 14,000
(14,000)
Jan 5 (Tue)
1799
10,000 10,000
(10,000)
Jan 5 (Tue)
4052
(12,000)
Jan 5 (Tue)
2221(15,000)
Jan 7 (Thu)
2222
(12,000) 12,000 12,000
Jan 7 (Thu)
4053
(14,000)
Jan 8 (Fri)
4054
(20,000) 20,000 20,000
Jan 8 (Fri)
1799
(10,000)
Jan 8 (Fri)
1982
(9,971) (9,971) 9,971

9,971
---------- ---------- ----------------------- ---------- ------------ ---------- ------------ ---------- -----------(b) Balances
0
(12,000)
0
(20,000) 973
973
9,971
9,971 10,944 (21,056)
---------- ---------- ----------------------- ---------- ------------ ---------- ------------ ---------- -----------Payroll checks
(9,971) (9,971)
cashed
Jan 12 (Tue)
2222(12,000)
Jan 13 (Wed)
4054
(20,000)
---------- ---------- --------------------------------- ------------ ---------- ---------------------- -----------Balances
(12,000) (12,000) (20,000) (20,000) 973
973
0
0
(31,027) (31,027)
====== ====== ====== ============= ======= ====== ============= =======
(1) “Bank” means the bank’s records of deposits received and checks paid (cleared).
(2) “Actual” means the amounts the general ledger would have shown had the transfers been recorded.
6.50

Manipulated Bank Reconciliation
Yes, something is wrong, and it takes a careful eye to detect it. The bank statement has been

altered. Cleared check # 2233 for $5,000 has been erased, and the bank balance has been changed
from $2,374.93 to $7,374.93. The bank balance is actually $5,000 lower than the reconciliation
shows. Since the problem says: “all checks entered in Caulco’s cash disbursements journal through
February 29 have either cleared the bank or are listed as outstanding checks in the February bank
reconciliation,” the conclusion is that this $5,000 check was not recorded.
Students can find the alteration several ways. (1) They can notice the check (!) and find that it is
not on the bank statement, even though it is dated and cleared in February, (2) they can add the
checks listed in the February bank statement and find that the total is $5,838.29, not the
$10,838.29 shown on the bank statement, and the number of checks (25) does not match the bank
statement (26), (3) they can add the previous balance to the deposit and subtract the withdrawals to
find a balance of $2,374.93 instead of the altered $7,374.93, and (4) they can notice the skip in the
numerical sequence not noted by the bank’s double asterisk (**) used to indicate a skip (this is the
place the paid check was erased). Also, the “low bank balance” figure of $2,374.93 gives it away.

6-17


Chapter 06 - Employee Fraud and the Audit of Cash

CAULCO, INC.
Bank Reconciliation (Corrected)
February 28
Balance per bank ................................................................................................

$ 2,374.93

Deposit in transit ................................................................................................

1,097.69

Outstanding Checks:
Number
Date

Payee

2239
2240

Alpha Supply
L.C. Statement

Feb 26
Feb 29
Total Outstanding

6.51

Amount
500.00
254.37

(754.37)

Reconciled balance
General ledger balance Feb 28

$ 2,718.25
$ 7,718.25

Cash overstatement, Check #2233 not recorded

$ 5,000.00

Investigating a Fraud
If the company is local, visit the location to determine if the company exists. Obtain the checks
used to pay the vendor to determine the bank used by the vendor (information should be on the
back of the check). Match the vendor invoices to receiving reports to determine if product was
received. Match the invoices to purchase orders and purchase requisition to determine if purchase
orders exist and that material was requested. If purchase orders or requisitions come from the
same person, check the bank used by that person (from the direct deposit information or the back
of their paycheck) to see if it is the same bank as the vendor (or maybe even the same account).
Check the county court house for information on the business.
Other procedures may also be valid.

6.52

Audit Simulation: Fraud in Purchasing
a.

It is likely that a purchasing agent has created a shell company (K.A. Supplies) and is
awarding bids to the shell company. Once the bid is award, someone purchases the
necessary materials and sends them to Big Builders at a marked up price.

b.

We might obtain information about the bank account used by K.A. Suppliers. This
information would be available on the back of the checks we used to pay K. A. Suppliers.
We may wish to do an analysis of the business we do with K.A. Supplier.

c.

The receipt and recording of bids may be segregated from the purchasing function. In
addition, a requirement that all bids be attached to the purchase order may provide senior
management in purchasing opportunity to see that the lowest bids is the bid being
accepted. The bidders should have to be on the approved vendor list and an inspection of
the vendor facility by someone outside of purchasing should be required for adding a
company to the list.

6-18


Chapter 06 - Employee Fraud and the Audit of Cash

6.53

The Perfect Crime?
The ingenious scheme was a perfect crime for a long time. Only the greed of the embezzler finally
tipped off the managers, who commissioned a special investigation to learn why expenses were
high, profits low, and cash flow small.
Ordinary everyday control activities for detection:

6.53

1.

Someone else taking over the embezzler’s duties at vacation time might have been less
willing or able to dig out the documentation to support payment of “past due” amounts,
thus leading to suspicion and maybe discovery. The embezzler avoided the problem by
clearing all the vendor payments a month before his regular vacation.

2.

The treasurer might have been more diligent about remembering earlier payments of
amounts later submitted as “past due,” but she had other more important assignments. (In
fact, the documents were just scanned and the checks were signed with a mechanical
signature plate).

3.

Someone in charge of investigating budget variances (when they occurred) might have
been more in tune with “thinking like a crook,” but several people in several departments
were not that careful. The variances were not very large after the first two years (although
some larger ones began to show toward the end when the embezzler got greedy).

The Perfect Crime? (Continued)
Extensive detection efforts:
The embezzler was caught because he was too greedy--adverse cash flow alerted the business
owner, and an investigation started.
1.

The investigator spent a long time reviewing the expense accounts and studying
documentation. He noticed fairly frequent payments of “past due” balances.

2.

In the course of repeated interviews with the company president, he learned about the
company’s policy of paying bills on time to obtain trade discounts. The president was
surprised to learn of the numerous incidents of past due bills.

3.

More searching by the investigator led to notice of five “quarterly payments” in an
expense account for the rental of a photocopy machine. This was the first obvious sign of
a duplicate payment.

4.

The investigator asked the bank to send copies of the checks for the five payments. One
proved to be payable to the embezzler. This discovery led to requests for access to all the
company’s canceled checks, and the investigator then was able to find numerous checks
payable to the embezzler. The physical differences in the company’s own checks and the
embezzler’s private stock were small, but they were noticeable.

5.

Charges were filed. The district attorney subpoenaed the embezzler’s bank account
records, and the bogus checks were matched with deposits.

6-19


Chapter 06 - Employee Fraud and the Audit of Cash

6.54

Select Effective Extended Procedures
These procedures are offered without explanation of the information that might be discovered. For
each one, a confirmation of the suspicion might arise. One definite instance is enough to justify
proceeding with an investigation (real fraud examination), but failure to find confirming evidence

can mean (1) nothing wrong is going on, or (2) the crook is too clever for the auditor. All of these
procedures should be conducted with care not to impugn falsely the integrity of the people under
investigation.

6.54

a.

Count the petty cash fund on Friday morning in the presence of the supervisor and
custodian of the fund. Then, perform a second surprise count Friday afternoon before the
custodian leaves work for the day.

b.

Ask the local Better Business Bureau for reports on the eight new vendors. Ask the local
Chamber of Commerce if they are members. Look them up in the telephone book.
Telephone them, asking about business hours, product availability, and other matters. but
not in a way to arouse suspicion of investigation. Visit the business location (telephone
book address) to browse. Go to the local tax assessor-collector office files to look up the
owner of the property where the businesses are located. If any of the new vendors are
professional people, look them up in state licensing agency directories (e.g. CPAs,
attorneys, doctors). Go to the state secretary of state office and look up the corporate
charter to see if the purchasing agent is shown as an incorporator, officer, or director (if a
large company, you can use the Standard & Poor’s Register of Corporations, Directors,
and Executives). Look them up in the state or county “assumed name” files for real
names. Write a check to each business, and use the canceled check to identify the
businesses’ banks; then get one of the purchasing agent’s canceled payroll checks to see
whether they all bank at the same place. (This is circumstantial evidence that needs more
work, but it would be an unlikely coincidence in most cases if all of them had accounts at
the same bank.) Avoid approaching the chief purchasing agent with inquiries about the

new vendor approval process because you might alert the person to the investigation.

Select Effective Extended Procedures (Continued)
c.

Select the people who have quit and determine their termination dates. In the payroll
records, find the identification of their last paychecks (check number), then find the
canceled checks and examine the endorsement, looking for two endorsements, one of
which might be the payroll supervisor. Contact the terminated employees on the pretext
of an exit conversation, and inquire whether they received all their paychecks, being sure
to identify the last period or severance pay provision for them.

d.

Add the customers’ subsidiary accounts and compare to the general ledger control
account. If clerks are giving customers proper credit in their subsidiary accounts but not
depositing the money and enabling the accounting system to credit the control account,
they may be out of balance. If you can identify suspicious accounts, ask the customers to
give you originals or copies of their canceled checks so you can examine the
endorsements to see whether they appear to have been negotiated by a company
employee.

e.

Use the cash receipts journal date and the deposit date at the bank to see whether there is
a pattern of delay that could indicate the cashier is holding the deposits. Last resort is a
surprise cash count at the cashier’s desk to see whether cash on hand is actually on hand.

6-20

Chapter 06 - Employee Fraud and the Audit of Cash

6.55

Forensic Accounting: Assurance Engagement 1: Expenditure Analysis
FORENSIC ACCOUNTING CONSULTING ENGAGEMENT 1
Known Expenditures:
House payments
Mercedes payments
Nissan Maxima payments
Audio and video equipment
Household expenses

12 @ $ 1,377
12 @ $ 2,361
down + monthly
12 @ $900

Total estimated expenditures

$70,632

Known Sources:
Beginning bank balance
Take-home pay 12 @ $2,950
Ending bank balance
Total known sources

$ 3,462

35,400
(2,050)
$ 36,812

Expenditures financed by unknown sources
6.56

$ 16,524
28,332
9,444
5,532
10,800

$ 33,820

Forensic Accounting: Assurance Engagement 2: Net Worth Analysis
FORENSIC ACCOUNTING CONSULTING ENGAGEMENT 2
END YEAR ONE

END YEAR TWO

END YEAR THREE

ASSETS:
Residence
Stocks and Bonds
Automobiles
Certificate of Deposit
Cash

$ 100,000
30,000
20,000
50,000
6,000

$ 100,000
30,000
20,000
50,000
12,000

$ 100,000
42,000
40,000
50,000
14,000

Total Assets

$ 206,000

$ 212,000

$ 246,000

90,000
10,000

50,000

-0-

-0-0-

Total Liabilities

$ 100,000

$ 50,000

-0-

Net Worth

$ 106,000

$ 162,000

$ 246,000

Change in Net Worth
TOTAL EXPENSES*

$ 56,000
30,800

$ 84,000
28,000

Increase in Net Worth + Expenses

$ 86,800

$ 112,000

40,000

42,000

$ 46,800

$ 70,000

LIABILITIES:
Mortgage Balance
Auto Loan

KNOWN INCOME
FUNDS FROM UNKNOWN SOURCES

6-21


Chapter 06 - Employee Fraud and the Audit of Cash

* Includes some principal payments on debts.
6.57

Mini-Case: Cash Confirmations
NOTE TO INSTRUCTOR: For this assignment, question 1 from this Mini-Case is applicable.

1.

6.58

Auditors should take the following steps:


Standard bank confirmation requests should be signed by a client officer. Banks
usually will not release information without client permission.



Auditors should be very careful that the bank’s address is reliable and not
subject to alteration by the client in such a way as to misdirect the confirmation.



The request should seek information the recipient can supply, like the amount of
a balance.



The accounting firm should control and mail the confirmations, not provide
them to client personnel for mailing. Auditing standards requires direct
communication.



Responses should be returned directly to the accounting firm, not to the client.

Employee Embezzlement via Cash Receipts and Payment of Personal Expenses
Objective:
Obtain evidence to determine whether expenses paid from the extra bank account were for
legitimate school business. Auditors cannot ignore informants’ tales.
Control:
Cash disbursements should be authorized by responsible officers of the organization to be for valid
business purposes. It is not unusual for a business manager to have the authorization responsibility.
Tight control would call for disbursement review (at time of check signature) by another
responsible person (superintendent), and this control was not always observed. Cash receipts
should be listed by the person initially in control (cafeteria manager), deposited by another person
(business manager), and a responsible person (superintendent, internal auditor, external auditor)
should compare the initial control record to the deposit to note any differences.
Test of Controls:
Forewarned by the informant, the auditors could make inquiry: “Does the school district have a
fund for which individual disbursements are not approved by the school board?” and “Does the
business manager have responsibility for this fund?” Answers to both questions directed to the
superintendent would be “yes,” and the auditors can then concentrate initial attention on the
particular account records.
The next question is: “Does the cafeteria manager make a record of the daily receipts?” Answer
by the superintendent: “I don’t know, ask her.” Luckily, it turned out that the cafeteria manager,
without direct instructions, made notes on a calendar of the amount of money sent forward to the
business manager for deposit. Procedure: Compare the amounts from the cafeteria manager’s
calendar to the deposits in the account.

6-22


Chapter 06 - Employee Fraud and the Audit of Cash

Audit of Balance:

The “balances” being audited are the expense accounts that received the debits from the extra bank
account. However, it is efficient to go to the bank account records as a starting point for the
investigation. Obtain the bank statements and supporting documents for cash disbursements. Study
them for evidence of (1) improperly authorized payments, (2) payments of personal expenses on
the school district’s VISA account, and (3) payments to unauthorized persons or to “cash” for
unauthorized purposes.
Discovery Summary:
After finding payments to American Express and VISA, auditors asked the superintendent about
the credit card used by the school and learned that the school used only VISA. Inquiry at American
Express revealed the business manager as the owner of the account number found on receipts in
the supporting documents. (Actually, by this time the business manager had confessed, but
identification of the account might have been harder.) Study of the items and dates on the VISA
charge slips showed items (e.g. hosiery) not used at the school and dates that did not match
business periods. Review of the checks identified the son as payee on some of the checks.
During this review, the auditors found checks dated out of numerical sequence and a missing block
in the most current month. This was a sign of having blank checks signed, so the superintendent
was asked, and he admitted doing so. The missing block was in the business manager’s desk
drawer, already signed. Comparing the cafeteria manager’s notes of cash receipts showed
shortages in numerous deposits. The business manager admitted taking the cash.
6.59

Kaplan CPA Exam Simulation: Audit Objectives for Cash
C

The confirmation of cash balances at year-end will provide assurance that cash
on the balance sheet is owned by Harrison.

A

Cut-off procedures will provide assurance that all cash amounts owned by

Harrison at year-end appear on the balance sheet.

B

An analysis of the relationships between cash and investments will provide
assurance that cash balances are properly described and presented in the
financial statements.

H

Reviewing the minutes of the meetings of the board of directors will provide
assurance that Harrison has authorized all long-term debt at the balance sheet
date.

E

Examining lease agreements for potential capitalization will provide assurance
that all long-term debt at the balance sheet date is identified and recorded.

I

Testing the reasonableness of interest expense and accrued interest payable
will provide assurance that long-term debt at the balance sheet date is
properly classified.

6-23


Chapter 06 - Employee Fraud and the Audit of Cash

F

6.60

Reviewing debt agreements for interest rates, restrictive covenants and assets
that have been pledged will provide assurance that long-term debt is properly
presented in the financial statements and related restrictions, regulations,
guarantees, interest rates, pledged assets and commitments are adequately
disclosed.

Kaplan CPA Exam Simulation: Audit of Cash
a.

Bank Reconciliation
1.

A

The amount stated on the bank statement should be
traced and agreed to the balance provided on the
bank confirmation (the bank confirmation should be
received directly from the financial institution).

2.

C-E-H

Deposits in transit that are listed on the bank
reconciliation should be re-totaled by P&M to
confirm Lakeland’s calculation. The deposits in

transit should be traced and agreed to the cash
receipt records for the year being audited (Year 2)
since the amounts are already included in
calculating the December 31, Year 2 cash balance
but are not included on the December 31, Year 2
bank statement balance. The deposits in transit
should also be traced to the cut-off bank statement
(presumably received sometime in January, Year 3)
from the bank to confirm that the amounts were
subsequently received.

3.

C-G-H

The outstanding checks listed on the bank
reconciliation should be re-totaled by P&M to
confirm Lakeland’s calculation. The outstanding
checks should be traced and agreed to the cash
disbursement records for the year being audited
(Year 2) since the amounts are not included (thus,
have been deducted) in calculating the December
31, Year 2 cash balance but are included (thus, have
not been deducted) in the December 31, Year 2 bank
statement balance. Finally, the outstanding checks
should be traced to the cut-off bank statement to
confirm that the amounts were subsequently
disbursed.

4.

H

The erroneous bank deposit should be traced and
agreed to the bank cut-off statement to ensure that
the amount was subsequently corrected by the bank.

5.

B-C

The balance of $573,250 should be traced and
agreed to Lakeland’s trial balance or general ledger.
Additionally, the balance should be recomputed by
P&M to confirm the accuracy of Lakeland’s total.

6-24


Chapter 06 - Employee Fraud and the Audit of Cash

6.60

Kaplan CPA Exam Simulation: Audit of Cash (continued)
b.

Bank Confirmation 1
1.

False

Confirmations should be sent to the banks where
Lakeland’s accounts have been closed to ensure that
negative cash balances (i.e., overdrafts) have not been
hidden.

2.

True

Materiality is not considered because although the
ending cash balance may often be immaterial in terms
of quantitative financial statement impact, the cash
transactions that collectively determine the ending
balance are usually not immaterial.

3.

True

P&M would usually provide the account information
on the standard bank confirmation request form and
ask for balance corroboration (i.e., bank fills in the
appropriate amount(s) in the space(s) provided).

4.

False

When a bank confirmation has not been received, it is

necessary for P&M to send a second request to the
financial institution to document the attempt at
performing the primary procedures prior to
performing alternate procedures.

5.

False

Bank confirmations are not useful in detecting a kiting
scheme since they do not show the subsequent cash
activity necessary to ensure that the bank transfers
were recorded correctly.

6.

False

Bank confirmations are designed to substantiate
evidence primarily for the existence assertion. Bank
confirmations are not designed to discover or provide
assurance about the accounts not listed on the form
and, therefore, do not provide evidence to support the
completeness assertion. It is important to note that it
might not be possible for P&M to send confirmations
to all of the possible banks if Lakeland manages not to
disclose them. Therefore, there is the possibility that
not all cash balances nor bank indebtedness are being
reported.

7.

False

Sending a standard confirmation to Lakeland’s banks
will not provide evidence of any secured transactions
since a standard bank confirmation does not
specifically request this information.

8.

False

For privacy and confidentiality reasons, banks are not
required to search their records for bank balances or
loans beyond those listed by P&M on the standard
bank confirmation form.

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