Chapter two

Auditing Cash

Cash is the only account

Learning Objectives:
After studying this chapter, students should be able to: that is included in several
cycles. It is a part of
 Evaluate internal control over cash according to acceptable
procedures. every cycle except
 Audit cash audit cash receipts applying the standard audit procedures
for cash receipts. inventory and
 Audit cash payments according to the standard audit procedures for
cash payments. warehousing therefore
 Audit cash on hand and in bank according to the standard cash audit
procedures for cash on hand and in bank. the audit of cash balance
depends heavily on the
results of the tests in
other cycles.

Cash is important primarily because of the potential for fraud but also because there may be
errors.
In the audit of cash, it is important to distinguish between verifying the client’s reconciliation of
the balance on the bank statement to the balance in the general ledger. Verifying whether
recorded cash in the general ledger correctly reflects all cash transactions that took place during
the year. This is because there are some misstatements ultimately results in the improper
payment of the failure to receive cash, but none will normally be discovered as a part of the audit
of the bank reconciliation; such as

Failure to bill a customer

Billing a customers at lower price
A defalcation of cash, before they are recorded
Duplicate payment of a vendor’s invoice
Payment for row material that were not received
Payment to an employee for more hours than he or she worked

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 Payment of interest to a related party for an amount in excess of the going rate.

Types of Cash Accounts

1.The general cash account
Is the focal point of cash because all cash receipts and disbursements flow through this account.
The disbursements for the acquisition and payment cycle are normally paid from this account,
and the receipt of cash in the sales and collection cycle are deposited in this account in addition,
the deposits and disbursements for all other cash accounts are normally made through the general
account.
2.Imprest payroll Account
Is established for such things as making payroll payments to employees or separate cash receipts
and disbursements accounts for branch banking.
In an imprest account a fixed balance, is maintained in a separate account and this amount should
always be shown as a balance.
The use of imprest payroll account can improve internal control and reduce the time needed to
reconcile bank accounts.
3.Branch Bank Account
For a company operating in multiple locations, it is often desirable to have a separate bank
balance at each location.
Branch bank accounts are useful for building public relations in local communities and
permitting the centralization of operations at the branch level.
4.Imprest Petty cash fund
Is actually not a bank account, but it is sufficiently similar to cash or deposit to merit inclusion.
A petty cash account is often something as simple as a present amount of cash set aside in a
strong box for incidental expenses.
It is used for small cash acquisitions that can be paid more conveniently & quickly by cash than
by check, or for the convenience of employees in cashing personal or payroll checks
An imprest cash account is set up on the same basis as an imprest branch bank account, but the
expenditures are normally for a much smaller amount
Typical expenses include minor office supplies, stamps, and small contributions to local
charities.

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A petty cash account usually does not exceed a few hundred dollars and may not be reimbursed
more than once or twice each month.
Cash Equivalent
Highly liquid cash equivalents are excess cash accounted during certain parts of the operating
cycle that are invested in short-term and needed in a reasonable near future
Examples: - time deposits, certificates of deposit and money market funds
Cash equivalent, which can be highly material, are included.

Included in the financial statements as a part of the cash account only if they are short-term
investments that are readily convertible to known amounts of cash either a short time and there is
insignificant risk of a change of value form interest rate changes.
Marketable securities and long – term interest bearing investments are not cash equivalents.
A) Audit of the General cash account
In testing the year-end balance in the general cash account, the auditor must accumulate
sufficient evidence to evaluate whether cash, as stated on the balance sheet, is fairly stated and
properly disclosed in accordance with six of the nine balance-related audit objectives used for
tests of details of balances. Rights to general cash, its classification on the balance sheet, and the
realizable value of cash are not a problem.
Methodology for auditing-year-end-cash

Set tolerable misstatement and assess Phase I

inherent risk for cash in bank

Phase I

Assess control risk for cash in bank

Phase I

Design and perform tests of control &

substantive tests of transactions for
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 Phase II

Phase II

Deign and perform analytical

procedures for cash in bank balance
Phase III

Design tests of details of cash in bank Audit procedures

Phase III
balance to satisfy balance related audit Sample size
objectives.
Items to select
Phase III
Timing

Cycle affected include sales & collection, acquisition & payment, payroll
Personnel and capital acquisition and repayment.
Set Tolerable Misstatement & Assess Inherent Risk (Phase1)
Because cash is more susceptible to theft other than assets, there is a high inherent risk
for the existence, completeness, and accuracy objections, and after there is a potential for
a misstatement of cash. Therefore these objectives should be the focus of in auditing
cash balances.
Assess control risk (Phase 1)
Internal controls over year-end cash balance in the general account can be divided into two
categories
Control over the transaction cycles affecting the recording of cash receipts and
disbursements.

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 Independent bank reconciliation.
Major controls over transactions cycle affecting cash receipts and payments include:
 Segregation of duties between the check signing and accounts payable functions
 Signing of check only by proper authorized person
 Use of pre-numbered check printed on special paper
 Adequate control over blank and void check.
 Careful review of supporting documentation by the check signers before checks are
signed
 Adequate internal verifications
Generally if controls affecting cash related transactions are adequate, it is possible to
reduce control risk and therefore the audit tests for the year-end-bank reconciliation
Careful bank reconciliation by competent client personnel includes:
 Compare cancelled check with cash disbursements records for date, payee, and
amount.
 Examine cancelled checks for signature endorsement, and cancellation.
 Compare deposits in the bank with recorded cash receipts for date, customer, and
amount
 Account for the numerical sequence of checks, and investigate missing ones.
 Reconcile all items causing a difference between the bank and the bank balance and
verify their property.
 Reconcile total debits on the bank statement with the totals in the cash disbursement
record.
 Reconcile total credits on the bank statement with the totals in the cash receipts
records.
 Review month –end inter banks transactions for propriety and proper recording
 Follow up on outstanding checks & stop payment notice.

Design and perform tests of controls and substantive tests of transactions

(Phase II)

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As a cash balance is affected by all other cycles except inventory and warehousing, an extremely
large number of transactions affected cash, appropriate tests of control and substantive tests of
transactions should be maintained.
Design and perform analytical procedures (phase II)
Since in many organizations, the year-end bank reconciliation is extensively audited, using
analytical procedures to test the reasonableness of the cash balance will be less important than it
is for most other audit areas.
Design tests of details of cash balance (phase III)
A detail test of cash balance i.e. test of the component parts that are used in the computation of
the ending balance of cash should properly designed and tested.
Fraud – Oriented Procedures
Are procedures in the audit of year-end cash to determine the possibility of a material fraud exist
when there are inadequate internal controls, especially the improper segregation of duties
between the handling of cash and the recording of cash transactions in the accounting records
Fraud oriented procedures include:
1. Extended tests of the bank reconciliation

 It is performed when the auditor believes that the year-end bank reconciliation is
intentionally misstated.
 The purpose of this procedure is to verify whether all transactions included in the
journal for the last month of the year were correctly included in or excluded from the
bank reconciliation and to verify whether all items in the bank reconciliation were
correctly included.
2. Proof of cash
Is a four-column working paper prepared by the auditor to reconcile the bank’s record of the
client’s beginning balance cash deposit, cleared checks and ending balance for the period, with
the client’s records.

The auditor uses a proof of cash to determine whether the following were done.
 All recorded cash receipts were deposited

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  All deposit in the bank were recorded in the accounting records
 All recorded cash disbursements were paid by the bank
 All amounts that were paid by the bank were recorded
A proof of cash includes the following.
 A reconciliation of the balance on the bank statement with the general ledger balance
at the beginning of the proof-of-cash period.
 A reconciliation of cash receipts deposited per the bank with the cash receipt journal
for a given period
 A reconciliation of cancelled checks clearing the bank with the cash disbursements
journal for a given period
 A reconciliation of the balance on the bank statement with the general ledger balance
at the end of the proof of-cash period.
3. Test of Inter bank transactions
 This procedure is helpful in preventing embezzlements that may occur when the
client to has accounts in more than one bank
 Embezzlers occasional cover a defalcation of cash by transferring money form one
bank to another and improperly record the transaction, such practice is known as
kiting.
 A useful approach to test for kiting, as well as for errors in recording inter bank
transfers, is to list all inter-bank transfers made a few days before and after the
balance sheet date and to trace each to the accounting records for proper recording.

The following should be done on the audit of inter bank transfers:

 The accuracy of the information on the inter-bank transfer schedule should be
verified.
 The inter-bank transfer must be recorded in both the receiving and disbursing banks
 The date of the recording of the disbursements and receipts for each transfer must be
in the same fiscal year.
 Disbursements on the inter-bank transfer schedule should be correctly included in or
excluded from year-end bank reconciliation as outstanding check.

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  Receipt on the inter-bank transfer schedule should be correctly included in or
excluded from year-end bank reconciliation as deposits in transit.

B)Audit of the Imprest payroll Bank account

 It is a bank account to which the exact amount of payroll for the pay period is
transferred by check from the employer’s general cash account.
 The audit includes a reconciliation like those described in the general cash account to
reconcile outstanding checks.
C) Audit of Imprest Petty cash
Imprest petty cash fund is a fund of cash maintained within the company for small cash
acquisitions or to cash employees’ checks; the fund’s fixed balance is comparatively small and is
periodically reimbursed / replenished.

Internal control over petty cash include

 The use of imprest funds that is the responsibility of one individual.

 Not to mingle /mix petty cash with other receipts
 Keep the fund separate from all other activities
 There should be limits on the amount of any expenditure from petty cash, as well as
on the total amount of the fund.
 The typical expenditure that can be made from petty cash transactions should be well
defined by company policy.
 Appropriate official should approach a disbursement from a petty cash fund.
 Use pre-numbered petty cash form.

Audit tests for petty cash include:

 Determining the client’s procedures for handling the fund

 Understand the client’s internal control over petty cash
 Examine the documentation of few transactions

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There are two important procedures to be performed whenever an auditor decides to test petty
cash:
1. To count the petty cash balance
2. To carry out detailed tests of one or two reimbursement transaction in such a case the
primary procedures should include finding of petty cash vouchers supporting the amount
of the reimbursement, accounting for a sequence of petty cash vouchers, examining the
petty cash vouchers for authorization and cancellation, and examining the attached
documentation for reasonableness.
The typical supporting documentation includes
 Cash register tapes
 Invoices, and
 Receipts.
-Petty cash test can ordinarily be performed at any time during the year, but as a mater of
convenience they are typically done on an interim date.
How to Properly Perform Bank Reconciliations

1. Begin with recording the balance from your books and the bank balance that is shown on the
monthly statement you receive. ( Books: , Bank: )
2. On the bank side, subtract any outstanding checks that you see recorded on your books that
have not yet been received by the bank.
3. Also on the bank side of your paper, you then need to add into that balance any deposits that
are showing on your books, but not on your bank statement.
4. Now on your books side subtract any kind of bank fee that is being charged to you.(don’t
forget to record the bank fee in your books)
5. Give correction for any errors either by subtracting or adding to a bank or book balance based
on their statements.
6. Deduct NFS from book balance.
7. You should then have an adjusted bank balance as well as an adjusted book balance, they
should now equal.

Happy Reading!!

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