12-46 (Overview and Objectives of Audit Procedures) The following represents a critical review of the documentation of a new auditor for the cash and marketable securities audit areas. Several deficiencies are noted; they resulted in significant errors not being initially identified.
For each item listed as follows:
a. Identify the audit procedure that would have detected the error.
b. Identify the basic financial assertion tested by the audit procedure.
Documentation Deficiencies and Financial Statement Misstatements
1. The client was in violation of important loan covenant agreements.
2. The client was engaged in a sophisticated kiting scheme involving transfers through five geographically disbursed branch offices.
3. The December cash register was held open until January 8.All receipts through that date were recorded as December sales and cash receipts.The receipts, however, were deposited daily.
4. Cash disbursements for December were written, but the checks were not mailed until January 10 because of a severe cash flow problem.
5. The client's bank reconciliation included an incorrect amount as balance per the bank.
6. Approximately 25 percent of the cash receipts for December 26 and December 28 were recorded twice.
7. The client's bank reconciliation covered up a clever fraud by the controller by incorrectly footing the outstanding checks and including fictitious checks as outstanding.
The financial assertions in quotes are not original but taken from various audit reports. These may be found in hard copies or in reports on the Internet.
The client was in violation of important loan covenant agreements:
The audit procedure would have been to go through every loan covenant agreement and match it with the client position. In that case the client's violation would have been detected the very first time the audit was conducted after a violation was made and this would have been mentioned in the audit report. This is clearly a case where substantive testing was required.
The basic financial assertion being tested is that "The client has not violated any important loan covenant agreement".
The client was involved in a sophisticated kiting scheme involving transfer through five geographically disbursed branch offices.
The audit procedure that would have detected the error would have been to recalculate or estimate the revenues of the client based on total sales and know margins of profit. Any comparison of the total revenue as reported in the income statement and the total of sales journal would have shown that non-existent revenue has emerged in the final accounts. The other procedure that could have exposed kiting would have been the matching of the cashbook balance and its reconciliation with the reported balances in the final accounts.
The basic financial assertion ...
This posting gives the audit procedure that would have detected the error for each item. Then it identifies the financial assertion.