Audit of Cash Balances

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 Types of Cash Accounts
Major Types of Cash Accounts or Balances and Their Purpose
Type of Cash Account or Balance
General cash account – the primary bank account for most
organizations; virtually all cash receipts and disbursements flow through
this account at some time.
Imprest payroll account – a bank account to which the exact amount
of payroll for the pay period is transferred from the general cash
account. A fixed balance, such as $1,000 may also be kept in the
account.
Branch bank account – a separate bank account maintained at a local
bank by a branch of a company. Can be either a general account or an
imprest type account. Usage depends upon what is authorized by head
office.
Imprest petty cash fund – a fund of cash maintained within the
company for small cash payments; its fixed balance is comparatively
small, and it is periodically reimbursed.
Cash equivalents – short-term, highly liquid investments (such as term
deposits) that have a known value and an insignificant risk of change n
value (Section 1540.06, IAS 7.6). Where bank overdrafts are in normal
use (i.e., a fluctuating bank balance), the bank overdraft would also be
considered a cash equivalent, even though it is a liability rather than an
asset.
Purpose of Cash Account
• Used to make payments (for expenses and capital assets) and to
record cash received from operations (such as cash sales and
accounts receivable).
• Small companies who have only one account have this type of
account.
• Used to pay employees, and may also be used to pay employee
remittances to Canada Revenue Agency.
• Helps improves control over cash and reduce time to reconcile bank
accounts.
• Provides for more rapid deposits and/or payments at the local level.
• Builds business relationships with local banks.
• Used for small cash purposes that can be paid more conveniently and
quickly by cash other than cheque (e.g., office supplies)
• Used to manage fluctuating cash balances so that cash is available
for short-term operating needs.
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 The Relationship Between Cash in the Bank and
Transaction Cycles

• It is relatively easy to verify the client’s reconciliation of the balance in the bank
account to the general ledger

• What will not be discovered as a part of the audit of the bank reconciliation? See some
examples in the table below.

Example of Major Risk of Error or Fraud in the Cash Cycle

Risk of Error Risk of Misappropriation of Assets,
Other Fraud, or Illegal Acts
Cash received could be posted in the Payments in cash (rather than by cheque)
incorrect period could be stolen rather than recorded
Cash received could be recorded at the Payments could be made to a fictitious
wrong amount supplier for goods not received
Suppliers could be paid twice for their Management steals cash by authorizing
services personal payments (e.g., home renovations)
as business expenses
Employees could be paid using the wrong Blank cheques are stolen and signatures
wage rate. forged to steal funds, or bank accounts are
hacked into and cash stolen
Risks of Inadequate Disclosure or
Incorrect Presentation of Financial
Information, including Fraudulent
Financial reporting
Funds received as debt financing could be
recorded as revenue
Cash received from related parties could be
recorded as cash received from general
operations
Payments to associated companies or
companies controlled by the company are
not disclosed
Cash equivalents are incorrectly classified
as marketable securities

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Major Risk of Fraud or Error
Example of Major Risk of Error or Fraud in the Cash Cycle
Risk of Error
Cash received could be posted in the
incorrect period
Cash received could be recorded at the
wrong amount
Suppliers could be paid twice for their
services
Employees could be paid using the wrong
wage rate.
Risk of Misappropriation of Assets,
Other Fraud, or Illegal Acts
Payments in cash (rather than by cheque)
could be stolen rather than recorded
Payments could be made to a fictitious
supplier for goods not received
Management steals cash by authorizing
personal payments (e.g., home renovations)
as business expenses
Blank cheques are stolen and signatures
forged to steal funds, or bank accounts are
hacked into and cash stolen
Risks of Inadequate Disclosure or
Incorrect Presentation of Financial
Information, including Fraudulent
Financial reporting
Funds received as debt financing could be
recorded as revenue
Cash received from related parties could be
recorded as cash received from general
operations
Payments to associated companies or
companies controlled by the company are
not disclosed
Cash equivalents are incorrectly classified
as marketable securities
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 Bank Reconciliation Misstatements

Some types of misstatements normally discovered as part of

the tests of a bank reconciliation include:
Failure to include on the outstanding cheque

Cash received by the client after year end

Deposits made and recorded as cash receipts near the end of

the year

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Audit Process for Cash in Bank

Set performance materiality,

and assess audit risk and
inherent risk and fraud risk for
cash in bank.

By assertion:

Assess control risk for cash in

bank.

Identify assertions where

substantive testing is
insufficient, risk of material
misstatement, and
significance.

Design and perform tests of

controls for several cycles

Design and perform analytical

procedures as substantive
tests for cash in bank balance

Design tests of Audit procedures

details of cash in
bank balance to Sample size
satisfy balance-
Items to select
related audit
objectives Timing

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 Assessing Inherent Risk and Fraud Risk

• There is high inherent risk

• When assessing inherent risk what should auditor

consider?

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 Materiality Considerations

• The cash balance is immaterial on most audits

• Thus often potential for material misstatement of cash.

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 Understanding Internal Control and Assessing
Control Risk

Internal control effectiveness over cash balances

The most important internal control

Internal controls over cash receipts and disbursements

Individuals who are super users or have incompatible

functions granted to them using computer systems

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 Thus Key Controls over Cash

Internal controls over the year-end cash balances in the

general account can be divided into two categories:

Another common control for many companies

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 Analytical Procedures

In most, if not all, audits, the year-end bank reconciliation is

verified on a 100 percent basis.
Testing the reasonableness of the cash balance is therefore
less important than for most other audit areas.

Similarly, auditors normally compare the ending balance in

cash

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 Tests of Details Related to Cash Account

Substantive Test of Details for Cash Balance

Balance Sheet
Company XYZ. Inc.
Cash $1,000,000

Cash Account Subledger (in CAD)

Bank account (CAD) #1 $100,000

Bank account (CAD) #2 250,000
Bank account (EURO) #3 150,000
Bank account (USD) #4 500,000
Cash Balance $1,000,000

Existence
The auditor needs to verify that the stated cash balance exists in each account.
Key risk associated with assets is that they are overstated (they don’t exist).
Valuation/Accuracy
The auditor needs to verify that the cash balance in each account has been valued correctly,
using the foreign exchange rate.
For example Account #3 has been translated by management from euros to Canadian dollars.
The auditor is concerned if management used the correct foreign exchange rate.

Audit Procedures Audit Procedures

To verify the existence of cash the auditor can:
• Mail a bank confirmation and directly confirm with company’s XYZ bank(s) the cash balance
that exists in each account as of the financial reporting date. Vouch the balance per bank
confirmation with the balance in the cash account.
• Alternatively, obtain and review the bank statement for each account, and vouch the ending
balance per bank statement with the balance in the cash account. Keep in mind however that
bank statements are documents that are in the possession of management and therefore there is a
risk that they could be altered.
To verify the valuation of cash the auditor can:
• Obtain and review documentation supporting the exchange rate that management used to
convert the cash balance from EURO and USD currency into CAD currency at the financial
reporting date . Vouch the exchange rate used by management with reliable external sources.
Such as the bank of Canada website.
To verify the accuracy of the foreign exchange calculation performed by management, the
auditor would reperform the calculation by multiplying the euro and American dollar cash
balance by the exchange rate to ensure it was done accurately.

Directly confirming cash balances for each account with a bank provides the auditor with the Note that the risk of the cash balance being incomplete (completeness assertion) is low. It is
strongest level of evidence (third-party independent confirmation). unlikely management would be inclined to understate their cash balance (an asset). Keep in
mind that the auditor would be most concerned with the valuation of cash balance in foreign
currency accounts (Account #3, 4).

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 Bank Confirmations

Standard bank confirmation form—a form approved by

the CPA Canada and Canadian Bankers Association the

It is typical for the bank to confirm loan information and bank

balances on the same form.

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The standard bank confirmation form is
used to confirm deposit and loan
balances.

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 Bank Cutoff Statement

Auditors use cutoff bank statement to ensure the transactions

were recorded in the proper accounting period.

Shows transactions that hit your audit client's bank statement

for the 7- to 10-day period after the end of the financial
period.

Trace all these cheques and deposits on the cutoff statement

to the client's bank reconciliation

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 Tests of the Bank Reconciliation

1) Verify that the client’s bank reconciliation is

2) Trace the balance on the cutoff statement to

3) Trace cheques included with the cutoff bank statement to the list of outstanding cheques
on the bank reconciliation and
4) Investigate all significant cheques or payments included on the outstanding cheque list
that
5) Trace deposits in transit (outstanding deposits) to
6) Account for other reconciling items on the bank statement and bank reconciliation. These
include such items as

These reconciling items should be carefully investigated to ensure they have been treated properly
by the client.

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 Extended Tests of the Bank Reconciliation

When the auditor believes that the year-end bank

reconciliation may be intentionally misstated

Want to verify whether all transactions included in the

journals 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.

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 Fraud-Oriented Procedures

A major consideration in the audit of the general cash account

is the possibility of fraud.
The auditors must extend their year-end audit procedures to
test more extensively for the possibility of material fraud
This can be due to

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 Proof of Cash

Auditors can prepare a proof of cash when the client has material internal
control weaknesses in cash.
Proof of cash is a four-column working paper used to reconcile the
bank’s records of the client’s beginning balance, cash deposits, cleared
cheques, and ending balance for the period with the client’s records.
Used to determine whether the following occurred:

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 Alpha Bravo Company Prepared by GHY Dated 8/7/1X
Proof of Cash Reviewed by
For the Month of June 201X

5-31-1X Receipts Disbursements 6-30-1X

Balance per bank $11,800 b $18,300 b $21,200 b $8,900 b
Deposits in transit
May 31 500 (500) b
June 30 600 b 600 b
Outstanding cheques
May 31 (800) (800) j
June 30 400 (400)
NSF cheques (100) j (100) j
Cash balance $11,500 $18,300 r $20,700 d $9,100

Balance per books $11,320 L $18,200 L $21,710 L $8,810 L

Bank service charge
May (20) b (20) b
June 10 (10) b
Bank collection
May 200 b (200)
June 300 300 b
Cash balance $11,500 $18,300 r $20,700 d $9,100
^ ^ ^ ^

^ Footed d Traced to cash disbursements journal

b Traced to bank statement L Traced to general ledger
r Traced to cash receipts journal j Customer’s NSF cheque redeposited on July 8 and cleared Cash 20
 Tests of Interbank Transfers (Kiting)

Kiting refers to transferring money from one bank to another

An example:
Sally opens checking accounts at Bank A and Bank B. Initially, she deposits $500
in Bank A and $0 in Bank B.
She then writes a $10,000 check on her account at Bank A and deposits it in Bank
B. Unaware that Sally has insufficient funds in her account at Bank A, Bank B
immediately gives her credit on her account.
During the three business days it takes Bank B to clear the check on her account at
Bank A, Sally writes a $10,000 check on her account at Bank B and deposits it in
Bank A to cover her first $10,000 check. Bank A immediately gives her credit on
her account, and Bank B clears Sally's first $10,000 check.
Sally continues writing bad checks between her accounts. By doing so, she
illegally obtains a $10,000 interest-free loan
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 Tests of Interbank Transfers (Kiting)

To test for kiting, as well as for unintentional errors in

recording bank transfers

Similarly, transfers deposited in the bank near the end of the

year or included in deposits not yet credited

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 Other Audit Issues Related to Cash

Many organizations receive cash or make cash payments

electronically.
More sophisticated or larger businesses could use

EFTs and EDIs have the potential to improve internal

controls, since there is no cash handling by employees.

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 Controls Over Debit Card Cash Receipts

Most debit card transactions are processed accurately as most

organizations keep track of payment methods automatically
using their point-of-sale (POS) systems.
Remember that daily sales are broken down into

When performing the bank reconciliation,

This reconciliation should be handled by a person

independent of the POS function.
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 Controls Over Electronic Payments

The organization under audit should have controls to ensure

The extent of audit work conducted on the bank reconciliation

depends on the assessed quality of internal controls.

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 Petty Cash

Petty cash is verified primarily because of the potential for fraud and the client’s
expectation of an audit review even when the amount is immaterial.

The emphasis in verifying petty cash should be on

An important part of testing petty cash is first determining the client’s procedures
for handling the fund

When testing petty cash, the two most common procedures are

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 Problem DC 11-5, Page 612
The Patrick Company had poor internal control over its cash transactions. Facts about its cash position at November 30 were as
follows:
The cash books showed a balance of $18,901.62, which included undeposited receipts. A credit of $100 on the bank statement did not appear
on the books of the company. The balance according to the statement was $15,550.
When you receive the cutoff bank statement on December 10, the following cancelled cheques were enclosed: No. 6500 for $116.25, No.
7126 for $150.00, No. 7815 for $253.25, No. 8621 for $190.71, No. 8623 for $206.80, and No. 8632 for $145.28. The only deposit was in
the amount of $3,794.41 on December 7.
The cashier handles all incoming cash and makes the bank deposits personally. He also reconciles the monthly bank statement. His
November 30 reconciliation is shown below.

Balance, per books, November 30 $18,901.62

Add: Outstanding Cheques
8621 190.71
8623 206.80
8632 145.28 442.79
Less: Undeposited receipts 3,794.41
Balance per bank, November 30 15,550.00
Deduct: Unrecorded credit 100.00
True cash, November 30 $15,450.00

Required:
1. You suspect that the cashier has stolen some money. Prepare a schedule showing your estimate of the loss
2. How did the cashier attempt to conceal the theft?
3. Based only on the information above, name two specific features of internal control that are missing.
4. If the cashier’s October 31 reconciliation is known to be in order and you start your audit on December, what
specific auditing procedures could you perform to discover the theft? Cash 27
 Problem 17-22, Page 541
The following are fraud and other irregularities that might be found in the client’s year-end cash balance.
(Assume the balance sheet date is June 30.)
1.A cheque was omitted from the outstanding cheque list on the June 30 bank reconciliation. It cleared the
bank July 7.
2.A cheque was omitted from the outstanding cheque list on the bank reconciliation. It cleared the bank
September 6.
3.Cash receipts collected on accounts receivable from July 2 to July 5 were included as June 29 and June
30 cash receipts.
4.A loan from the bank on June 26 was credited directly to the client’s bank account. The loan was not
entered in the books as of June 30.
5.A cheque that was dated June 26 and disbursed in June was not recorded in the cash disbursements
journal, but it was included as an outstanding cheque on June 30.
6.A bank transfer recorded in the accounting records on July 2 was included as a deposit in transit on June
30.
7.The outstanding cheques on the June 30 bank reconciliation were underfooted by $2000.

REQUIRED
a)Assuming that each of these misstatements was intentional, state the most likely motivation of the
person responsible.
b)What control could be instituted for each intentional misstatement to reduce the likelihood of errors.
c)List an audit procedure that could be used to discover each misstatement.

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