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a) Internal control systems are designed, amongst other things, to prevent error and misappropriation. Required: Describe the errors and misappropriations that may occur if the following are not properly...

a) Internal control systems are designed, amongst other things, to prevent error and
misappropriation.
Required:
Describe the errors and misappropriations that may occur if the following are not
properly controlled:
(i) Receipts paid into bank accounts;
(ii) Payments made out of bank accounts;
(iii) Interest and charges debited and credited to bank account
(b) A book-selling company has a head office and 25 shops, each of which holds cash
(banknotes, coins, and credit card vouchers) at the balance sheet date. There are
no receivables. Accounting records are held at shops. Shops make returns to head
office and head office holds its own accounting records. Your firm has been the
external auditor to the company for many years and has offices near to the
location of some but not all of the shops.
Required:
List the audit objectives for the audit of cash and state how you would gain the audit
evidence in relation to those objectives at the year-end.

c) The external auditors of companies often write to companies’ bankers asking for
details of bank balances and other matters at the year-end.
Required:
Explain why auditors write to companies’ bankers and list the matters you would
expect banks to confirm.

Answers

a) Errors and misappropriations – cash
(i) Receipts
?
>Money paid into the bank may be stolen. If cash is not properly controlled it is
possible to falsify documentation in relation to receivables, and to pay company?
receipts into private bank accounts. This is sometimes known as ‘teeming and
lading’.
>Money paid into the bank may be incorrectly accounted for, either by the bank or
by the company, if there are no controls to check the accuracy of the company’s
records or the bank statements. This could mean that the internal records and the
financial statements are incorrect.
(ii) Payments
>Money paid out of the bank may be paid to incorrect suppliers, or may be paid for
incorrect amounts resulting in operational difficulties with cash and supplier
management;
>Money paid out of bank accounts may also be misappropriated by payments for
goods and services that are not received, or simply by payments into private bank
accounts if there are no controls to prevent this.
(iii) Interest and charges
Banks make errors in calculating interest and charges. If the company does not
check these, it may lose money and the amounts appearing in the financial
statements may be incorrect. This is particularly important for companies that
hold high levels of cash.

(b) Principal audit objectives of cash audit and related audit evidence
Audit objectives are dealt with in ISA 500 ‘Audit Evidence’
(i) Existence: to ensure that the cash actually exists at a given date. The related
evidence will include cash counts. Cash counts need not necessarily be conducted
at each location (unless the amounts are material), the firm might consider
conducting counts on a rotational basis, year on year. The decision as to which
sites to visit might be determined on the basis of materiality and analytical
procedures. Cash balances should be reconciled to records held at the shop and
records held at head office. Any shortfalls in cash, or ‘IOUs’ should be thoroughly
investigated.
(ii)
Completeness: to ensure that there is no unrecorded cash. This means
reconciling cash balances to records held at the shop and records held at head
office, as above, ensuring that proper sales cut-off has been achieved.(iii) Rights and obligations: to ensure that the company has a right to the cash.
This means checking to ensure that credit card vouchers are correctly made
payable to the company, and not to third parties.
(iv) Occurrence: to ensure that the cash belongs to the company at the year-end
date. This means checking to ensure that no credit card vouchers are post-dated.
(v) Measurement: to ensure that amounts are correctly recorded in the proper
period. This means ensuring that cut-off is correct and consistent between the
records held at shops, the returns to head office, and the records held at head
office.
(vi) Presentation and disclosure: to ensure that the cash balance and related income
statement entries are correctly disclosed in the financial statements in accordance
with legislation and accounting standards.

(c) Why auditors seek bank confirmations – matters confirmed
This matter is noted in ISA 505 ‘External Confirmations’.
Auditors seek bank confirmations in order to provide third party, written evidence
in relation to the balance sheet disclosure of cash, liabilities and related items.
The matters typically confirmed by the bank include:
(i) Details of all bank balances, overdrafts and loans held at all branches.
(ii) The charges or restrictions over any such accounts.
(iii) The terms and repayment conditions of loans and overdrafts.
(iv) Any right of set-off between accounts in credit and other balances.
(v) Any securities held by the bank (such as fixed assets charged as security).
(vi) Any relationships with other banks the bank is aware of.

johnson mwenjera answered the question on August 4, 2018 at 11:33

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a) Internal control systems are designed, amongst other things, to prevent error and misappropriation. Required: Describe the errors and misappropriations that may occur if the following are not properly...

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