Chapter 7
Chapter 7
Objectives
1. Describe the nature of cash and identify the major types of cash accounts maintained by
business entities.
2. Design and perform audit tests of the general cash account.
3. Recognize when to extend audit tests of the general cash account totes further for
material fraud.
4. Design and perform audit tests of the impress payroll bank account.
5. Design and perform audit tests of impress petty cash.
Cash balances include cash on hand and cash at bank. Cash on hand includes un deposited
receipts, impress payroll and petty cash. While cash at bank includes cash held in current and
saving accounts, which is available on demand. Unlike any other account balances, cash may be
either an asset or a liability. The latter arises where the bank with which the entity holds an
account allows the entity to write checks in excess of the balance in account up to an agreed limit
known as overdraft. It is important to understand the different types of cash accounts because
the auditing approach to each cash account varies. The following are the major types of cash
accounts:
General cash account: it is the focal point of cash for most organizations because virtually 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 receipts of cash in the sales and
collection cycle are deposited in this account. In addition, deposits and disbursements for all
other cash accounts are normally made through the general cash account.
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establish a separate impress bank account for such things as making payroll payments to
employees or separate cash receipts and disbursements for branch banking. In an impress payroll
account, a fixed balance, such as 2,000, is maintained in a separate bank account.
Immediately before each pay period, one check or electronic transfer is drawn on the general
cash account to deposit the total amount of the net payroll in to the payroll account. After all
payroll checks have cleared the impress payroll accounts, the bank account should have 2,000
balances. The only deposits in to the account are for weekly and semiannually payroll, and the
only disbursements are paychecks to employees. For companies with many employees, the use
of an impress payroll account can improve internal control and reduce the time needed to
reconcile bank accounts.
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.
In some companies, the deposits and disbursements for each branch are made to a separate bank
account, and the excess cash is periodically electronically transferred to the main office general
bank account. The branch account in this instance is much like a general account, but at the
branch level.
Impress petty cash fund: an impress petty cash fund is actually not a bank account, but it is
sufficiently similar to cash on deposit to merit inclusion. A petty cash account is often something
as simple as a preset 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 and quickly by cash than by
check, for the convenience of employees in cashing personal or payroll checks. An impress cash
account is set up on the same basis as an impress bank account, but the expenditures are
normally for a much smaller amount. Typically, expenses include minor office supplies, stamps,
and small contributions to local charities. 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 equivalents: excess cash accumulated during certain parts of the operating cycle that will
be needed in the reasonably near future is often invested in short-term, liquid cash equivalents.
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Examples include time deposits, certificate of deposit, and money market funds. Cash
equivalents, which can be highly material, are 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 within a short time and there is a significant risk of a change of value from
interest rate changes, marketable securities and longer-term interest-bearing investments are not
cash equivalents.
4. Cash schedules are mathematically correct and agree with general ledger accounts
(clerical accuracy).
5. The presentation and disclosure of cash, including restricted funds (such as compensating
balance and bond sinking funds) is adequate.
As is the case with other assets, auditors are especially concerned with the likelihood of
overstatement of cash account; therefore, the validity (existence & rights) of the recorded amount
of cash is of utmost important. However, exceptions exist to the general rule that auditors are
primarily concerned with overstatements of cash (another asset). For example, the management
of a privately held company may be motivated to understate assets (including cash) to minimize
income taxes. In addition, a client may maintain bank accounts not recorded on the books for
purposes such as making illegal bribes. Thus, auditors must consider whether all amounts of cash
are recorded (the completeness objective). We have not included a” valuation” objective for
cash. Valuation of cash is less a concern than for other assets because no allowance need be
considered to arrive at a realizable value.
General cash account is considered significant in almost all audits, even when the ending balance
is immaterial, because the amount of cash flowing in to and out of the cash account is often
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larger than that of any other account in the financial statements. Furthermore, the susceptibility
of cash to defalcation is greater than for other assets because most other assets must be converted
cash to make them usable (liquidity of cash).
In the audit of cash, an important distinction should be made between verifying the client’s
reconciliation of the balance on the bank statement to the balance in the general ledger and
verifying whether recorded cash in the general ledger correctly reflects all cash transactions that
took place during the year. It is relatively easy to verify the client’s reconciliation of the balance
in the bank account to the general, but a significant part of the total audit of a company involves
verifying whether cash transactions are properly recorded. For example, each of the following
misstatements ultimately results in the improper payment of or the failure to receive cash, but
none will normally be discovered as a part of the audit of the bank reconciliation:
If these misstatements are to be uncovered in the audit, their discovery must come about through
the tests of controls and substantive test of transaction. The first three misstatements could be
discovered as part of the audit of the sales and collection cycle, the next three in the audit of the
acquisition and payment cycle, and the last two in the tests of the payroll and personal cycle and
the capital acquisition and payment cycle, respectively.
Entirely different types of misstatements are normally discovered as a part of the tests of bank
reconciliation. For example,
Failure to include a check that has not cleared the bank on the outstanding checklist,
even though it has been recorded in the cash disbursement journal.
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Cash received by the client subsequent to the balance sheet date but records as cash
receipts in the current year.
Deposits recorded as cash receipts near the end of the year, deposited in the bank in the
same month, and included in the bank reconciliation as a deposit in transit.
Payments on notes payable debited directly to the bank balance by the bank but not
entered in the client’s records
Deposits received by the bank on behalf of the company from credit card agencies and
other vendors making payments electronically, but not recorded in the client’s records.
For most companies, there is only one cash account. Notice however, that all cycles, except
inventory and warehousing, affect cash in the bank.
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 of six of the nine balance-related audit objectives used for all
tests of details of balances shown in the table below. Rights to general cash, its classification on
the balance sheet and the realizable value of cash are not a problem.
Completeness: recorded cash balances include the effects of all transactions that have occurred.
Detail-tie-in: cash balances as stated on the balance sheet foot correctly and agrees with the
general ledger.
Cutoff: cash receipts and cash disbursement transactions are recorded in the proper period.
Presentation and disclosure: cash balances are properly presented and disclosed in the balance
sheet. Lines of credit, loan guaranties and other restriction on cash balances are appropriately
disclosed.
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The methodology for auditing year-end cash is essentially the same as that for all other balance
sheet accounts as listed below.
Methodologies for designing tests of details of balances for cash in the bank are:
Set tolerable misstatement and assess inherent risk for cash in bank (phase I)
Design and perform tests of controls and substantive tests of transactions for several
cycles (phase II)
Design and perform analytical procedures for cash in bank balance (phase III)
Design tests of details of cash in bank balance to satisfy balance related audit objectives
(phase III)
Identify Client Business Risks affecting Cash (phase I): most companies are unlikely to
have significant client business risks affecting cash balances. However, client business risk
may arise from in appropriate cash management policies or handling of funds held in trust for
others. Therefore, the auditor should understand the risks from the client’s investment
policies and strategies, a well as management controls that mitigate these risks.
Set Tolerable Misstatement and Assess Inherent Risk (phase I): for many entities, cash
balances represent only a very small portion of assets. However, the amount of cash flowing
through the accounts over a period of time is usually greater than for any other account in the
financial statements. More ever, cash is vital to the survival of the business as a going
concern. The inability of an entity to pay its debts as they fall due because of a shortage of
cash can render a company insolvent, despite the profitability of its operations. Cash,
therefore, has a materiality that is greater, relative to its balance, than any other account
balance.
The high volume of transactions contributes to a significant level of inherent risk for cash
balance assertions (objectives), particularly: existence, completeness and accuracy. In
addition, the nature of cash balances makes them susceptible to theft as numerous kinds of
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fraudulent schemes involving cash have borne out. Therefore, existence, completeness and
accuracy are usually the focus in auditing cash balances. In contrast to debtors or stocks,
however, the risks pertaining to the rights and obligations, valuation, presentation and
disclosure and other assertions for cash are minimal due to the absence of complexities
involving these assertions.
Assess Control Risk (phase I): internal controls over year-end cash balances in the general
account can be divided in to two categories :(1) controls over the transaction cycles affecting
the recording of cash receipts and disbursements and (2) independent bank reconciliations.
Internal control over cash transactions: most of functions relating to cash handling are the
responsibility of the finance department, under the direction of the treasurer. These functions
include handling and depositing cash receipts; signing checks; investing idle cash; and
maintaining custody of cash, marketable securities, and other negotiable assets. In addition,
the finance department must forecast cash requirements and make both short-term and long-
term financing arrangements.
Ideally, the functions of the finance department and the accounting department should be
integrated in a manner that provides assurance that:
All cash that should have been received was in fact received, recorded accurately,
and deposited promptly.
Cash disbursements have been made only for authorized purposes and have been
properly recorded.
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1. Do not permit any one employee to handle a transaction from beginning to end.
2. Separate cash handling from record keeping
3. Centralize receiving of cash as much as possible.
4. Record cash receipts immediately.
5. Encourage customers to obtain receipts and observe cash register totals.
6. Deposit each day’s cash receipts intact.
7. Make all disbursements by check, with the exception n of small expenditures from
petty cash.
8. Have monthly bank reconciliation prepared by employees not responsible for the
issuance of checks or custody of cash. An appropriate official should review the
completed reconciliation promptly.
Several good reasons exist for the rule that each day’s cash receipts should be deposited intact.
Daily deposits mean that less cash will be on hand to invite “borrowing”; moreover, the deposit
of each day’s cash receipts as a unit tends to prevent the substituting of latter cash receipts to
cover a shortage. Any delay in depositing customers’ checks increases the risk that the checks
will be uncollectible. Furthermore, undeposited receipts represent idle cash, which is not a
revenue-producing asset.
Internal control over payments from an impress petty cash fund is achieved at the time the fund
is replenished to its fixed balance, rather than at the time of giving out small amounts of cash.
When the custodian of a petty cash fund requests replenishment of the fund, the documents
supporting cash disbursements should be reviewed for completeness and validity and perforated
to prevent reuse. Audit tests of petty cash emphasize transactions rather than the year-end
balance. The auditors may test one or more replenishment transactions by examining petty cash
vouchers and verifying their numerical sequence.
Independent bank reconciliation: a monthly bank reconciliation of the general bank account on
a timely basis by someone independent of the handling or recording of cash receipts and
disbursements is an essential control over the cash balance. If a business defers preparing bank
reconciliations for long periods, the value of the control is reduced and may affect the auditor’s
assessment of control risk for cash. The reconciliation is important to ensure that the books
reflect the same cash balance as the actual amount of cash in the bank considering reconciling
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items, but even more important, the independent reconciliation provides a unique opportunity for
an internal verification of cash receipts and disbursements transactions.
Design and perform Tests of Controls and Substantive Tests of Transactions (phase II)
1. Tests of Controls:
Tests directed towards the effectiveness of controls help to evaluate the client’s internal control
structure and determine the extent to which the auditors are justified in relying up on the client’s
controls to restrict control risk for the cash account. The following are examples of typical tests.
The purpose of proving footings and postings of cash records is to verify the mechanical
accuracy of the journals and ledgers. In computer-based system, journal and ledger entries are
created simultaneously from the same source documents. The auditors might choose to use a test
data approach to test controls over the postings of ledgers. The accuracy of footings may be
proved with the auditors’ generalized audit software.
In a manual system, information on source documents is entered first in a journal; at a later date,
the information is summarized and posted from journals to ledgers. Therefore, in a manual
system, the auditors must manually determine that journals are accurately footed and the data
properly posted to the ledgers.
The auditors also should trace the monthly postings of column totals from the cash receipts
journal to the cash account and to the controlling account for accounts receivable. Similar
verification may be made for the totals posted from the cash payments journal to cash account
and to accounts payable account in the general ledger. If the testing of postings and footings
discloses sloppy accounting work, with numerous errors and corrections, indistinct figures, and
ambiguous totals, the scope of the auditor’s work should be increased, for these are often hall-
marks of fraudulent manipulation of the records.
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II. Compare detail of cash receipts listings to cash receipts journal, accounts
receivable postings, and authenticated deposit slips.
Satisfactory internal control over cash receipts demands that each day’s collections should be
deposited intact no later than the next banking day. This practice will minimize the opportunity
for employees handling cash to “borrow” from the funds in their custody and will facilitate
comparison by the auditors of the cash receipt s journal with the deposits per the bank.
To provide assurance that cash receipts have been deposited intact, the auditors should compare
the detail of the original cash receipts listings (mailroom listings and register tapes) to the detail
of the daily deposit tickets. The detail of cash receipts refers to a listing of the amount of each
individual check and the total amount of currency comprising the day’s receipts. In making a
comparison of receipts and deposits, the auditors must emphasize the detail of cash receipts
rather than relying up on daily or periodic totals. Agreement of total receipts and deposits for a
period gives no assurance that worthless checks have not been substituted for currency or that
shortages occurring early in the period have not been made by subsequent deposits.
How to prevent and detect lapping: some of the safeguards against lapping include
independent comparison of recorded cash receipts with funds actually deposited,
separation of incoming receipts from subsidiary accounts receivable remittance advices,
comparison of the details of bank deposits and the details of remittance credits, provision
of timely statements, and confirmation of customer balances. One of the best methods to
guard against lapping is use of a “lock box” system. In this system, customers send their
payments directly to the bank, which prevents company employees from having access to
payments received. Another best method to detect lapping is to compare the dollar
amounts and dates on the bank deposit slips with customer remittance credits recorded in
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the accounts receivable ledger. Any lapping not using exact replacement dates and
amounts would be detected.
b. Kiting: kitting occurs when a check drawn on one bank is deposited in another bank
and no record is made of the disbursement in the balance of the first bank. Kitting
may be used to cover a cash shortage or to pad a company’s cash position.
How to detect kiting: to detect kiting effectively, the cash deposits in transit at the end
of a period and the paid checks returned with the bank statement of the next period must
be examined. This is accomplished by preparing a bank transfer schedule. A bank
transfer schedule comprises the dates checks are drawn (on the disbursing bank account)
to the dates checks are deposited (in the receiving bank account). Kiting is indicated
when the date stamped by receiving bank on the rear of the returned (paid) check
precedes the date on which the disbursement was recorded.
Satisfactory internal control over cash disbursements requires that controls exist to
provide assurance that disbursements are properly authorized. Testing cash disbursements
involves tracing selected items back through the cash payments journal to original source
documents, including vouchers, purchase orders, receiving reports, invoice, and paid
checks. While examining these documents, the auditors have an opportunity to test many
of the controls over cash disbursements. For example, they will notice whether all paid
vouchers and supporting documents have been perforated or cancelled. Also, they will
determine whether agreement exists among the supporting documents and note the
presence of all required authorization signatures. The auditors also may review the file of
paid checks to test the client’s procedures for accounting for the numerical sequence of
checks.
Cash discounts on purchases may be tested if the auditors are concerned that the company
may be losing money by failing to take advantage of the discounts or that purchase
discounts may have been fraudulently manipulated by employees. Numerous case
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histories of fraud relating to cash disbursements have involved the drawing checks for the
gross amount of an invoice paid within the discount period. The dishonest employees was
then in a position to request a refund from the creditor, to substitute the refund check for
currency, and to abstract cash in this amount without any further manipulation of the
records. When testing disbursements, the auditors will investigate and obtain
explanations for any payments made within the discount period on which discounts have
not been taken.
2. Substantive Tests:
The following table shows substantive tests of cash transactions and balances and the
primary audit objectives.
The balance sheet figure for cash should include all cash received up on the final day of the year
and none received subsequently. In other words, an accurate cutoff of cash receipts (and of
disbursements) at year-end is essential to a proper statement of cash on the balance sheet. If the
auditors can arrange to be present at the client’s office at the close of business on the last day of
the fiscal year, the will be able to verify the cutoff by counting the undeposited cash receipts.
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It will then be impossible for the client to include in the records any cash received after this
cutoff point without the auditor is being aware of such actions.
All customers’ checks included in cash receipt journal before the auditors’ cash count. The
auditors should compare these checks, both as to name and amount, with the cash journal entries
to indicate a likelihood of lapping or other fraudulent activity.
Of course, auditors cannot visit every client’s place of business on the last day of the fiscal year,
nor is their presence at this time is essential to a satisfactory verification of cash. As an
alternative to a count on the balance sheet date, auditors can verify the cutoff of cash receipts by
determining that deposits in transit as shown on the year-end bank reconciliation appear as
credits on the bank statement on the first business day of the New Year. Failure to make
immediate deposit of the closing day’s cash receipts would suggest that cash received at a later
time might have been included in the deposit, thus overstating the cash balance at the balance
sheet date.
To ensure an accurate cutoff of cash disbursements, the auditors should determine the serial
number of the last check written on each bank account on the balance sheet date and should
inquire whether all checks up to this number have been placed in the mail. Some companies, in
an effort to improve the current ratio, will prepare checks payable to creditors and enter these
checks as cash disbursements on the last day of the fiscal year, although there is no intention of
mailing the checks until several days or weeks later. When the auditors make a note of the
number of the last check issued for the period, they are in a position to detect at once any
additional checks that the client might later issue and seek to show as disbursements of the year
under audit.
In general, a proper cut-off of cash receipts and cash payments at the end of the year is essential
to the proper statement of cash at the balance sheet date. Two cash cut-off tests are performed:
Cash receipts cut-off test. The cash receipt cut-off test is designed to obtain reasonable
assurance that cash receipts are recorded in the accounting period in which received. If the
auditors are present at the year-end date, they can observe that all collections received prior to
the close of business are included in cash on hand or in deposit in transit, and are credited to
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debtors. An alternative to personal observation is to review supporting documentation such as the
daily cash summary and validated deposit slip for the last day of the year.
Cash payments cut-off test. The usual method of verifying payments cut-off is by examining the
date of presentation of checks outstanding as at balance sheet date. This test is normally
performed as part of the test of the bank reconciliation and the use of the subsequent period’s
bank statement, and is described below.
Any large or unusual checks payable to directors, officers, employees, affiliated companies, or
cash should be carefully reviewed by the auditors to determine whether the transactions (a) were
properly authorized and recorded and (b) are adequately disclosed in the financial statements. If
checks have been issued payable to cash, the auditors should determine who received these
payments and why this form of check was used.
To provide assurance that cash disbursements to related parties were authorized transactions and
were properly recorded, the auditors should determine that each such transaction has been
charged to the proper account, is supported by adequate vouchers or other records, and was
specifically approved in advance by an offer other than the one receiving the funds.
To determine that such transactions are adequately disclosed, the auditors must obtain evidence
concerning the relationship between the parties, the substance of each transaction upon the
financial statements. Disclosure of related party transactions should include the nature of the
relationships, a description of the transactions, and the dollar amounts involved.
The auditors will prepare or obtain a schedule that lists all of the client’s cash accounts. For cash
in bank accounts, this schedule will typically list the bank, the account number, account type,
and the year-end balance per books. The auditors will trace and reconcile all accounts to the
general ledger as necessary.
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One of the objectives of the auditors’ work on cash is to substantiate the validity of the amount
of cash shown on the balance sheet. A direct approach to this objective is to confirm amounts on
deposit, count the cash on hand, and obtain or prepare reconciliations between bank statements
and the accounting records.
Generally, information identifying the accounts, loans and other transactions are typed on the
standard bank confirmation to assist bank officials in confirming the information. Thus, the
confirmation primarily corroborates the validity of recorded information. However, the
confirmation may also lead to the discovery of additional accounts, loans, or other transactions.
An important element of the confirmation letter is the request for disclosure of all indebtedness
of the client to the bank. This request thus serves to bring to light any unrecorded liabilities to
banks, as well as to confirm the existence of assets. Auditors should normally send confirmation
letters to all banks in which the client has had deposits during the year, even though a deposit
account may have been closed out during the period. It is entirely possible that a bank loan will
continue after the closing of the deposit account. The same line of reasoning leads to the
conclusion that confirmation letters are necessary even when the auditors obtain the bank
statements and paid checks directly from the bank. Since every client maintains one or more
bank accounts, the independent auditors will use bank confirmation requests on every audit
engagement.
Obtain or prepare reconciliations of bank accounts as of the balance sheet date and
consider need to reconcile bank activity for additional months.
Determination of a company’s cash position at the close of the period requires a reconciliation of
the balance per the bank statement at the date with the balance per the company’s accounting
records. Even though the auditors may not be able to begin their fieldwork for some time after
the close of the year, they will prepare a bank reconciliation as of the balance sheet date or
review the one prepared by the client.
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If the client before the arrival of the auditors has made the year-end reconciliation, there is no
need for duplicating the work. However, the auditors should examine the reconciliation in detail
to satisfy themselves that it has been properly prepared. That is the reason for testing the bank
reconciliation are to determine whether client personnel have carefully prepared the bank
reconciliation and to verify whether the client’s recorded bank balance is the same amount as the
actual cash in the bank except for deposits in transit, outstanding checks, and other reconciling
items. Inspection of a reconciliation prepared by the client will include verifying the arithmetical
accuracy, tracing balances to the bank statement and ledger account, and investigating the
reconciling items. The importance of a careful review of the client’s reconciliations is indicated
by the fact that a cash shortage may be concealed merely by omitting a check from the
outstanding checklist or by purposely making an error in addition on the reconciliation.
There are many satisfactory forms of bank reconciliations. The form most frequently used by
auditors begins with balance per bank and ends with unadjusted balance per the accounting
records. The format permits the auditors to post adjusting entries affecting cash directly to the
bank reconciliation working paper, so that the final adjusted balance can be cross-referenced to
the cash-grouping sheet or to the working trial balance.
The mechanics of balancing the ledger account with the bank statement by no means completes
the auditors’ verification of cash on deposit. The authenticity of the individual items making up
the reconciliation must be established by reference to their respective sources.
Then auditors should investigate any checks outstanding for a year or more. If checks are
permitted to remain outstanding for long periods, internal control over cash disbursement is
weakened. Employees who become aware that certain checks have long been outstanding and
may never be presented have an opportunity to conceal a cash shortage merely by omitting the
old outstanding check from the bank reconciliation. Such omissions will serve to increase the
apparent balance of cash on deposit and may thus induce an employee to abstract a
corresponding amount of cash on hand. Payroll and dividend checks are the types most
commonly misplaced or lost. It is good practice for the client to eliminate long-outstanding
checks of this nature by an entry debiting cash account and crediting unclaimed wages or another
special liability account. This will reduce the work required in bank reconciliations, as well as
lessen the opportunity for irregularities.
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When internal control over recording of cash receipts and disbursements is considered weak, the
auditors may use additional reconciliation procedures such as preparing a proof of cash, which
allows a more detailed study of the cash transactions occurring within a specified period.
Comparing the closing bank balance with the balance confirmed by the bank;
Verify the validity of deposits in transit and outstanding checks by,
Tracing entries in the bank statement for the last month of the fiscal year to the
cash book or bank reconciliation at the beginning of the month, marking them off
in the process,
Identifying deposits and checks recorded in the cash book for the last month of
the fiscal year, or in the reconciliation at the beginning of that month not marked
as appearing on the bank statement, and tracing them to the closing
reconciliation,
Clearing the bank reconciliation to ensure that all applicable outstanding deposits
and outstanding checks are marked as having been traced from the cashbook and
that none are fictitious.
Establishing the mathematical accuracy of the reconciliation;
Vouching other reconciling items such as bank charges to supporting documentation;
Investigating old items such as checks outstanding for a long period of time and
unusual items;
Tracing outstanding checks and deposits in transit to the subsequent period’s bank
statement.
When the entity does not prepare a bank reconciliation or when control risk over entity prepared
reconciliation is high (such as where it is prepared by the cashier), the auditors may prepare the
bank reconciliation. When the auditors suspect possible material misstatements, the auditors may
obtain the year-end bank statement directly from the use in preparing the bank reconciliation and
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not relay on the copy of the bank statement held by the entity. This procedure will prevent the
entity form altering the data to cover any misstatements.
Testing of preparing bank reconciliation establishes the correct cash at bank balance at the
balance sheet date. Thus, it is a primary source of evidence for the valuation assertion. This test
also provides evidence for the existence, completeness, and rights and obligations assertions.
A cutoff bank statement is a partial-period (7 to 10 days) bank statement and the related
canceled checks, duplicate deposit slips, and other documents included in bank statements,
mailed by the bank directly to the CPA firm’s office. The purpose of the cutoff bank statement is
to verify the reconciling items on the client’s year-end bank reconciliation with evidence that is
inaccessible to the client. To fulfill this purpose, the auditor requests the client to have the bank
directly to the auditor the statement for 7 to 10 days subsequent to the balance sheet date. It
allows the auditors to examine firsthand the check listed as outstanding and the details of
deposits in transit on the company’s reconciliation.
With respect to checks that were shown as outstanding at year-end, the auditors should determine
the dates on which these checks were paid by the bank. By noting the dates of payment of these
checks, the auditors can determine whether the time intervals between the dates of the check and
the time of payment by the bank were unreasonably long. Unreasonable delay in the presentation
of these checks for payment constitutes a strong implication that the check were not mailed by
the client until sometime after the close of the year. The appropriate adjusting entry in such cases
consists of a debit to cash and a credit to a liability account.
In studying the cutoff bank statement, the auditors will also watch for any paid checks issued, or
clearing a bank, on or before the balance sheet date but not listed as outstanding on the client’s
year-end bank reconciliation. Thus, the cutoff bank statement provides assurance that the amount
of cash shown on the balance sheet was not overstated by omission of one or more checks from
the list of checks outstanding.
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Many auditors verify the subsequent period bank statement if a cutoff statement is not received
directly from the bank. The purpose of this verification is to test whether the client’s employees
have omitted, added, or altered any of the documents accompanying the statement. It is
obviously a test for intentional misstatements. The auditor performs the verification in the month
subsequent to the balance sheet date by (1) footing all the cancelled checks, debit memos,
deposits, and credit memos ;(2) checking to see that the bank statement balances when the footed
totals are used; and (3) reviewing the items included in the footings to make sure that they were
cancelled by the bank in the proper period and do not include any erasures or alterations.
Cash on hand ordinarily consists of undeposited cash receipts, petty cash funds, and change
funds. The petty cash funds and change funds may be counted at any time before or after the
balance sheet date; many auditors prefer to make a surprise count of these funds. If the client’s
internal audit staff regularly performs surprise counts of petty cash and change funds, the CPAs
may review the internal auditors’ working papers for these counts and conclude that it is
unnecessary to include a count of petty cash and change funds among the procedures of the
annual independent audit. If undeposited cash receipts and any other cash on hand constitute a
material factor, a count at the balance sheet date is desirable; otherwise, the auditors may verify
the deposit in transit at year-end by referring to the date of deposit shown on the cutoff bank
statement.
This test is often omitted as the amount of cash on hand is rarely material. If it is performed, the
following procedures are appropriate:
Control all cash held by the entity until all funds have been counted which is designed
to prevent transfers by entity personnel of counted funds to uncounted funds.
Insist that the custodian of the cash be present throughout the count because having
the custodian present and requiring his or her signature on return of the funds
minimizes the possibility, in the event of shortage, of the custodian claiming that all
cash was intact when released to the auditors for counting.
List each item making up the balance.
Obtain a signed receipt from the custodian on return of the funds.
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Ascertain that all undeposited checks are payable to the order of the entity, either
directly or through endorsement.
Trace each item listed to the subsequent bank deposit to test the possibility of a
teeming and lading fraud.
The count of cash on hand is of special importance in the audit of banks and other financial
institutions. Whenever auditors make a cash count, they should insist that the custodian of the
funds be present throughout the count. At the completion of the count, the auditors should
obtain from the custodian a signed and dated acknowledgment that the funds were counted in the
custodian’s presence and were returned intact by the auditors. Such procedures avoid the
possibility of an employee trying to explain a cash shortage by claiming that the funds were
intact when turned over to the auditors.
A first step in the verification of cash on hand is to establish control over all negotiable assets,
such as cash funds, securities and other investments, notes receivable, and warehouse receipts.
Unless all negotiable assets are verified at one time, an opportunity exists for dishonest officer or
employee to conceal a shortage by transferring it from one asset category to another.
Trace all bank transfers for the last week of audit year and first week of the
following year.
The purpose of tracing bank transfers is to disclose overstatements of cash balances resulting
from kiting. Many businesses maintain checking accounts with a number of banks and often find
it necessary to transfer funds from one bank to another. When a check drawn on one bank is
deposited in another, several days usually pass before the check clears the bank on which it is
drawn. During this period, the amount of the check is included in the balance on deposit at both
banks. Kiting refers to manipulations that utilize such temporarily overstated bank balances to
conceal a cash shortage or meet short-term cash needs.
Auditors can detect manipulation of this type by preparing a schedule of bank transfers for a few
days before and after the balance sheet date. The working paper lists all bank transfers and shows
the dates that the receipt and disbursement of cash were recorded in the cash journals and on the
bank statements.
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The balance sheet figure for cash should include only those amounts that are available for use in
current operations. Most users of the balance sheet are not interested in the breakdown of cash by
various bank accounts or in the distinction between cash on hand and on deposit. Consequently,
all cash on hand and in banks that is available for general use is presented as a single amount on
the balance sheet. Change funds and petty cash funds, although somewhat lacking in the general
availability test, are usually not material in amount and are included in the balance sheet figure
for cash.
A bank deposit that is restricted in use (for example, cash deposited with a trustee for payments
on long-term debt) should not be included in cash. Agreements to maintain compensating
balances should be disclosed. The auditors must also make sure that the caption, cash or cash
and equivalents, on the client’s balance sheet corresponds to that used in the statement of cash
flows.
Window dressing: refers to actions taken shortly before the balance sheet date to improve the
cash position or in other ways to create an improved financial picture of the company. For
example, if the cash receipts journal is held open for a few days after the close of the year, the
balance sheet figure for cash is improperly increased to include cash collections actually received
after the balance sheet date.
Another approach to window dressing is found when a corporate officer who has borrowed
money from the corporation repays the loan just before the end of the year and then promptly
obtains the loan again after the balance sheet has been prepared. This second example is not an
outright misrepresentation of the cash position (as in the case of holding the cash receipts journal
open), but nevertheless creates misleading financial statements that fail to portray the underlying
economic position and operations of the company.
Not all forms of window dressing require action by the auditors. Many companies make tiring
efforts at year-end to achieve an improved financial picture by speeding up shipments to
customers, by pressing for collection of receivables, and sometimes by paying liabilities down to
an unusually low level. Such efforts to improve the financial picture to be reported are not
improper. Before giving approval to the balance sheet presentation of cash, the auditors must
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exercise their personal judgment to determine whether the client has engaged in window dressing
of a nature that causes the financial statements to be misleading.
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