Chapter 16: Audit of Cash and Cash Equivalents

Overview of Cash Accounts

A significant part of the total audit of a company involves verifying whether cash transactions are properly recorded by considering cash transactions in each cycle.

Inherent Risk Factors and Determining Significant Risks

Cash itself is an inherently risky asset, and errors in processing cash or cash fraud could affect any cycle.

When assessing IR, the auditor should assess if the client has any cash flow problems in meeting its current obligations or if there are any particular debt covenants operating on the cash balance.

Materiality

The cash balance itself is usually immaterial; however, the cash transactions affecting the balance are almost always extremely material. Therefore, often there is a potential for a material misstatement of cash.

Key Controls Risks

Most important is the independent bank reconciliations

Internal controls over cash receipts and disbursements are key is assessing control risk

When super users or people have incompatible functions granted to them using computer systems could lead to control risk being assessed as high.

Electronic Cash Transactions

These systems help reduce control risk; however still face the risk of incorrect transfers or theft by unauthorized transfers still exists.

Controls to ensure that only authorized amounts are set up for payments and that all automatic withdrawals are recorded in the accounts in the period made.

Petty cash is verified primarily because of the potential fraud and clients' expectation of suit review even when amounts are immaterial.

Key Internal Controls

Controls over the YE cash balance are divided into two categories:

Controls over the transaction cycles affecting the recording of cash receipts and distributions

Independent bank reconciliation

Additionally, a monthly review of the reconciliation done by an employee of the company after the bank rec is completed.

Design Substantive Tests

The tests typically resolve around the following misstatements

Not all cash accounts are on the GL

Cash is misstated due to errors in the Bank Rec

Cash is misstated due to improper cutoff.

Substantive Analytical Procedures

In many audits, YE bank rec is verified on a 100% basis.

Typically done by comparing the ending balance with deposits in transit, outstanding cheques and other reconciling items with the PY reconciliation.

Test of Details: Bank Rec

Verify that the bank rec is mathematically correct

Trace the balance on the cutoff statement to the balance per bank on the bank rec.

Trace cheques included with the cutoff bank statement to the list of outstanding cheques on the bank rec and cash disbursements journal

Investigate all significant cheque payments included on the outstanding cheque list that have not cleared the bank on the cutoff statement.

Trace deposits to the subsequent bank statement

Account for other items such as bank service charges, bank errors and corrections and unrecorded note transitions benefited or credited directly to the bank account by the bank.

Test of Details: Bank Rec (controls over Debt card cash receipts)

When performing the bank rec, the debit card total should agree with the amounts automatically deposited into the bank statement.

This should be handled by a person independent of the POS function.

Design Fraud Procedures for Cash

A major consideration in the audit of the general cash account is the possibility of fraud.

The auditors must extend their tests when there are inadequate controls, especially the improper segregation of duties between handling cash and recording or the lack of an independently prepared bank rec.

Extended tests of the Bank Rec.

Done when the auditor suspects that the bank rec is intentionally misstated.

It is done to verify whether all transactions included in the journals for the last month of the year were correctly included or excluded from the bank rec, and to verify whether all the times in the bank rec were recorded correctly.

Proof of Cash

Is a forum column working paper used to reconcile the bank records of the clients' beginning balance, cash deposits, cleared cheques and ending balance for the period with the clients' records.

Done when the client has an internal control weakness in cash

What is the proof of cash used to determine?

if the following has occurred.

All record cash receipts were deposited

All deposits in the bank were recorded in the accounting records.

All recoded cash disbursements were paid by the bank

All amounts that were paid by the bank were recoded

Interbank transfers (kiting)

Transferring money from one bank to another and improperly recording the transaction so that the amount is recoded as an asset in those accounts, which overstates cash.

Embezzlers occasionally cover a deflation by a practice known as kiting

The day before the balance sheet date, a cheque is drawn on one bank account and immediately deposited in a second account for credit before the end of the accounting period. The embezzler makes sure that it does not clear the first bank until after the period ends

Test of Interbank transfers (kiting)

all the bank transfers made a few days before and after the balance sheet date should be traced to the accounting record for proper recording. In addition, the transfer deposited in the bank year or included in deposits not yet credited can be traced to the cash receipts or payments journal to ensure they have been recorded in the journal in the appropriate period.