Question

Reliable Communications Ltd (Reliable Communications) is a large company involved in providing various telecommunication products. Reliable Communications has created a number of subsidiaries to concentrate on specific aspects of its activities. While Reliable Communications and its subsidiaries each have an individual bank, all of the main banking activities of the group are undertaken through the bank account of Reliable Communications. Sarah Parker, the senior banking clerk of Reliable Communications, maintains and monitors all of the accounts. Your preliminary discussions with Sarah indicate the following:

• Subsidiary bank accounts are used for depositing the proceeds fo the technology operations.
• All expenses of the group are paid by Reliable Communications. These expenses include the costs of the technology operations.
• Each of the subsidiaries reimburse Reliable Communications for costs associated with its activities together with a management fee. Reimbursement occurs on a quarterly basis and is completed via a direct transfer between the bank accounts. The transfer is authorised by the financial controller of Reliable Communications and the CEO of the relevant subsidiary.
• Sarah prepares a schedule of transfers each quarter and reconciles each of the bank accounts monthly.

1. Explain which assertions are most likely to be assessed as high risk for material misstatement for the cash balances of Reliable Communications and its subsidiaries.
2. Identify three audit procedures that may be used to test whether these risks will result in a material misstatement and indicate the assertion addressed.

Answer 1

Answers:

(a) High-risk assertions

• Rights and obligations: Owing to the transfer arrangement there might be some concern as· to who has ownership of the funds within the bank accounts of Reliable Communications and its subsidiaries.
• Existence: The complex transfer arrangements for cash may be accounted for twice (i.e. once in the transferee account as an outstanding deposit, and once in the transferor account, not shown as withdrawn until the next day, as money that they have custody of). This can lead to an overstatement of the bank balance through this practice, which is known as kiting.
• Cut-off: Owing to movement of funds around year end, cut-off is likely to be of concern.

(b) Procedures to test whether these risks will result in a material misstatement:

• Rights and obligations: Review the terms of the transfer arrangement to determine at which point the funds are considered to be ‘owned’ by the transferee/transferor.
• Existence: Review the bank reconciliation and ensure all outstanding deposits are received within a reasonable period after year end.
• Cut-off: Review the transfer schedule, together with bank statements and bank reconciliations, to ensure that all transfers between bank accounts are accounted for in the same period for the transferor and the transferee.