3

MODULE
AUD 4

Cash Cycle AUD 4

1 Fraud Risk Related to the Cash Cycle

Cash is an area with high fraud risk, especially when the system of internal control is weak.
Lapping and kiting are two common cash fraud schemes.

1.1 Lapping
The theft of cash is often concealed by failing to account for cash receipts. The most common
of these methods is known as lapping. Lapping occurs when an employee withholds funds
received by a customer for personal use and fails to apply these receipts of cash or checks to
the customer's receivable balance. The unrecorded receipt is covered by applying a subsequent
receipt to the previously unrecorded account.
Safeguards against lapping include the following:
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.
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. A statement is then sent by the bank to the company so the
cash can be applied in the general ledger to the outstanding receivable balance.

1.2 Kiting
Kiting 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 until after year-end. Kiting may
be used to cover a cash shortage or to pad a company's cash position. Kiting results in an
intentional overstatement of cash in the financial statements as the cash is simultaneously
reflected in two different bank accounts.
To detect kiting effectively, a bank transfer schedule should be prepared. For any bank‑to‑bank
transfers that occur near year-end, the disbursement date on the check and in the ledger for the
disbursing account should precede the receipt date noted by the bank and in the ledger for the
receiving account.
To ensure that kiting has not occurred, evidence should exist that all deposits in transit and
outstanding checks listed on the bank reconciliation at year-end cleared in the next period. This
information can be confirmed by using a bank cutoff statement.

© Becker Professional Education Corporation. All rights reserved. Module 3 A4–21

3 Cash Cycle AUD 4

2 Controls Related to the Cash Cycle

Segregation of duties is a key control over cash. Proper segregation of duties demands that close
consideration be given to check-writing authority. Separation of cash handling, record keeping,
and reconciliation of bank statements should exist, as well as separation of petty cash activities.
A strong system of internal control for cash would also include the use of a voucher system for
cash disbursements.

3 Performing Specific Procedures to Obtain Evidence:

The Cash Cycle

3.1 Auditing the Cash Balance

Completeness, Valuation and Allocation, Existence: The primary audit procedures
performed to test the completeness, valuation and allocation, and existence of the ending
cash balance are the bank confirmation and the audit of the year-end bank reconciliation.
y Bank Confirmation: STANDARD FORM TO CONFIRM ACCOUNT
The standard bank BALANCE INFORMATION WITH FINANCIAL INSTITUTIONS
confirmation should be ORIGINAL
sent to all banks with To be mailed to accountant CUSTOMER NAME

which the client has We have provided to our accountants the following information as of

[ ] the close of business on , 20 , regarding our

done business during Financial

Institution's
deposit and loan balances. Please confirm the accuracy of the information,
noting any exceptions to the information provided. If the balances have
been left blank, please complete this form by furnishing the balance in the

the year, regardless Name and appropriate space below.* Although we do not request nor expect you to
conduct a comprehensive, detailed search of your records, if during the
Address
[ ] process of completing this confirmation additional information about other

of whether there is deposit and loan accounts we may have with you comes to your attention,
please include such information below. Please use the enclosed envelope to
return the form directly to our accountants.

a year‑end balance 1. At the close of business on the date listed above, our records indicated the following deposit balance(s):

to confirm. This is ACCOUNT NAME ACCOUNT NO. INTEREST RATE BALANCE*

done because the

bank confirmation, in
addition to verifying 2. We were directly liable to the financial institution for loans at the close of business on the date listed above as follows:

year-end balances, ACCOUNT NO. /

DESCRIPTION BALANCE* DATE DUE INTEREST RATE
DATE THROUGH WHICH
INTEREST IS PAID DESCRIPTION OF COLLATERAL

also provides evidence

about actual loans,
contingent liabilities,
discounted notes, (Customer's Authorized Signature) (Date)

pledged collateral, and The information presented above by the customer is in agreement with our records. Although we have not conducted a comprehensive, detailed search
of our records, no other deposit or loan accounts have come to our attention except as noted below.
guarantee or security
agreements. A sample (Financial Institution Authorized Signature) (Date)

bank confirmation is (Title)

shown here. EXCEPTIONS AND/OR COMMENTS

Please return this form directly to our accountants:

[ ]

[ ]
* Ordinarily, balances are intentionally left blank if they are not available at the time the form is prepared.

Approved 1990 by American Bankers Association, American Institute of Certified Public Accountants, and Bank Administration D 451 5951
Institute. Additional forms available from: AICPA – Order Department, P.O. Box 1003, NY, NY 10108-1003

A4–22 Module 3 Cash Cycle

© Becker Professional Education Corporation. All rights reserved.
AUD 4 3 Cash Cycle

y Bank Reconciliation: The year-end bank reconciliation for every account should be
tested by:
1. Footing the bank reconciliation and the list of outstanding checks.
2. Agreeing the balance per the books on the year-end bank reconciliation to the
general ledger.
3. Agreeing the balance per the bank on the year-end bank reconciliation to the
balance per the bank confirmation.
4. Agreeing deposits in transit and outstanding checks to the cutoff bank statement.
The cutoff bank statement is obtained by the auditor from the bank and covers the
first 10 to 15 days of the period after year-end. Reconciling items should generally
clear during the 10‑ to 15‑day period. Any item that does not clear should be
investigated by the auditor and resolved with the client if necessary.

3.2 Auditing Cash Receipts and Cash Disbursements

The following tests of details are generally performed as dual-purpose tests.
Completeness: For cash receipts, the auditor should trace a sample of remittance advices
to the cash receipts journal and deposit slips. For cash disbursements, the auditor should
trace a sample of canceled checks to the cash disbursements journal.
Cutoff: The auditor should verify the cutoff of cash receipts and cash disbursements
shortly before and after year-end for recording in the proper period. The auditor should
also compare the dates for recording a sample of cash receipts with the dates the cash was
deposited in the bank, and the dates for recording a sample of checks with the dates the
checks cleared the bank, noting any significant delays.
Valuation, Allocation, and Accuracy: For cash receipts, from a sample of daily deposits,
the auditor should foot the remittance advices and entries on the deposit slip and agree to
the cash receipts journal and bank statement. For cash disbursements, from a sample of
voucher packages, the auditor should agree the purchase order, receiving report, invoice,
cancelled check, and disbursement journal.
Existence and Occurrence: For cash receipts, the auditor should vouch a sample of entries
in the cash receipts journal to remittance advices, deposit slips, and the bank statement.
For cash disbursements, the auditor should vouch a sample of entries from the cash
disbursements journal to canceled checks, the voucher package, and the bank statement.
Understandability of Presentation and Classification: The auditor should examine a
sample of remittance advices and canceled checks for recording in the proper account.

3.3 Auditing Presentation and Disclosure

Completeness: The auditor should ensure that all required disclosures related to cash
have been included in the notes to the financial statements. Required disclosures related to
cash include:
y Policy defining cash and cash equivalents.
y Restrictions on cash, including sinking fund requirements.
y Compensating balance requirements.

© Becker Professional Education Corporation. All rights reserved. Module 3 A4–23

3 Cash Cycle AUD 4

Valuation, Allocation, and Accuracy: The auditor should read the footnotes and other
information related to cash to determine whether the information is accurate and
presented at the appropriate amounts.
Rights and Obligations, and Occurrence: The auditor should compare disclosures to other
audit evidence to ensure that all disclosed information related to cash has occurred.
Understandability of Presentation and Classification: The auditor should read all cash-
related disclosures to ensure that they are understandable.

A4–24 Module 3 Cash Cycle

© Becker Professional Education Corporation. All rights reserved.