Expert Answers

You have been assigned to audit the “investments” account of one of your firm’s older clients, the D Company. During the prior year, your client received more than $1 million from the sale of all its stock in a subsidiary. The proceeds from this sale were promptly invested in time certificates of deposit (CDs) having various maturities. More than one year has elapsed since the sale of the stock, and your client continues to invest the funds in CDs. Investment decisions are made by the company treasurer, who also is responsible for custody of the CDs. During the current year, D’s treasurer obtained $100,000 from the surrender of a CD at maturity and invested the proceeds in another six-month certificate having an interest rate of 10 percent. This transaction was recorded on the books of the company as being for a CD bearing an interest rate of 8 percent. At the end of the six months, the treasurer redeemed this CD for its $105,000 maturity value. On the books of the company, the transaction was recorded as having been for $104,000, and the treasurer deposited that amount in the company’s bank account prior to reinvesting the proceeds in another security.
Required
a. What internal controls could have prevented or permitted detection of the treasurer’s action?
b. What are the substantive tests that would detect the irregularity.