Audit of Cash Balances

Audit of Cash Balances

Cash is considered as the current assets of the company. It is

the liquid form of a short-term asset.

Every business needs to maintain a certain amount of cash to

use in settlement of its current liabilities.

In addition, some firms sell goods and services primarily in

cash, so they may have significant cash balances on hand
from cash receipts.

These cash balances may be aggregated into a number of

bank accounts, including the following:
 TYPES OF CASH ACCOUNTS
1. Checking account. This is important for most organizations because it is actually the
receipt and disbursement of cash through this account at a time. This is the general
account into which customer payments flow, and from which payables payments are
disbursed

2. Branch account. A company may operate a separate bank account for each of its
branch locations, which is intended to take in and disburse funds related to local
operations.

3. Imprest Payroll account. This account receives funding for each successive payroll,
which is drawn down as employees cash their paychecks.

4. Imprest Petty cash. This account is maintained internally (it is not a bank account),
and contains a small amount of cash for incidental cash purchases.

5. Savings account. A client may have a separate bank account that is only used for
earning interest on excess funds.
Cont…

When a client’s cash balance is stated on its balance

sheet, the line is frequently listed as “cash and cash
equivalents.” A cash equivalent is a highly liquid
investment having a maturity of three months or less.
Examples of cash equivalents:
a. Treasury bill
b. Short-term time deposit
c. Money market
d. Commercial paper
E. Certificate of Deposit(CD)
Cont…
 The audit of cash is considered an important part of
an audit mainly due to two reasons:

(a) Almost all business transactions will be ultimately

settled through the cash accounts, the audit of cash
accounts also assists in the verification of other asset
and liability accounts as well as revenue and expenses.

(b) Cash is the highly liquid asset in a company and it

is an area of high inherent risk since there is
a relatively high risk of misappropriation.
Cont…
In short, the baseline case for a client’s cash
accounts indicates a relatively high level of
auditing effort, especially when the client’s cash
controls are weak.
 Auditor Objectives
When developing an audit program for cash, the
auditor must consider his objectives in this area.
They are as follows:

1. To discern the internal controls over cash

being used by the client.
2. To consider the inherent risks associated
with cash.
3. To gauge the risk of material misstatement.
Cont…
Based on these objectives, the auditor must develop
an audit program that contains adequate tests of the
client’s substantive procedures and controls that are
targeted at the following:

Completeness of records. Verify that the cash stated

in the client’s records has been fully recorded.

Cutoff. Prove that the transactions triggering the

recordation of cash are recorded in the correct
period.
Cont…
Disclosure. Corroborate that the information
about cash in the client’s financial statements is
properly presented and fully disclosed.

Existence. Affirm the existence of cash and that

the related transactions occurred.

Rights. Verify that the client has the legal right

to the cash it is recognizing.
 Auditing Activities
Inherent Risk Assessment The auditor should use his knowledge of the
client to consider inherent risks related to cash.

Inherent risk is the risk posed by an error or omission in a financial

statement due to a factor other than a failure of control.
It is the probability of loss based on the nature of an organization's
business, without any changes to the existing environment.

Material Misstatement Assessment As noted earlier, one of the

objectives of the auditor is to gauge the risk of material misstatement.

This assessment is largely based on tests of the client’s controls over its
cash.
Cont…
Several possible misstatements are as follows:

 Timing error. An accountant may record a cash receipt or cash expenditure in

the wrong period. This mistake can arise when the accounting staff does not pay
attention to the proper cutoff of transactions at the end of a reporting period.
 Window dressing. A client may attempt to adjust its ending cash balance
upward, in order to make the business look more solvent than is really the case.

For example, corporate insiders who have borrowed money from the firm
could repay the funds just prior to year-end and then take out loans again
immediately thereafter.

Or, the accounting staff could have an improper period-end cutoff by

continuing to record subsequent cash receipts within the period being
audited.
 Cash In The Bank And Transaction Cycles

In a cash audit, a distinction must be made between verifying

the client's reconciliation of the checking account balance
with the general ledger balance and verifying whether the
cash recorded in the general ledger correctly reflects all cash
transactions carried out during the year.

The following errors will result in incorrect payments or cash

receipts, and are not disclosed as part of the audit of bank
reconciliations:
1. Billing error to customer
2. Billing customers at a lower price than the company policy
dictates.
3. Embezzlement of cash by withholding cash receipts from
customers before they are recorded
 Internal Controls over cash Used by the Client

As noted earlier in the Auditor Objectives section, the auditor needs to gain an
understanding of the client’s controls over its cash.

Safeguarding Assets: Protect the organization’s cash on hand by placing them

in a locked cabinet or drawer with limited access (or better yet a drop safe).

Segregation of Duties: Authorizing a transaction, the recording of a transaction

and maintaining custody of the related assets should all be handled by
different personnel.

Accountability: Ensure all cash transactions have been authorized, have been
properly accounted for, and have been documented properly.
Record cash in cash register.

Reconciliations: It is important to reconcile all bank accounts monthly to

ensure all transactions are being recorded accurately and completely.
.
Cont…

Record cash in cash register

Record cash on pre-numbered receipts: In situations where

relatively small quantities of cash are anticipated, it may not be
cost-effective to operate a cash register.

If so, record cash received on pre-numbered receipts, and be

sure to use the receipts consecutively.

Give receipt to customer: If a customer is paying with cash,

cashiers should give customers a copy of the receipt.

If the cash is recorded in a cash register, the amount printed on

the receipt will match the amount punched into the register
Cont…
Deposit daily

Match cash receipts journal to bank receipt: When

funds are deposited at the bank, the bank clerk
hands over a receipt for the amount deposited.

Require a monthly petty cash funding review:

There should not be so much cash in the petty cash
box that it represents a serious temptation for
someone to steal it.
 Fraud Issues
Skimming (No Recordation) One of the easier
frauds for an employee to perpetrate is to
remove a portion of any incoming cash before it
can be recorded in a company’s books.

Discounted Sales (Partial Recordation) An

employee can instead record a sale in the
accounting system in order to log the inventory
outflow, but also records a discount against the
sale and steals the amount of the discount.
Cont…
Modification of Receipts (Altered Recordation) If
an employee is responsible for all aspects of the
cash receipts process, it is not especially difficult
for the person to extract incoming cash and then
alter the receipts documentation to cover up or
obscure the amount of the theft.

For example, a few receipts could be selectively

damaged, making it impossible for anyone else to
reconcile the receipts to the amount actually
deposited.
Cont…
Lapping is a fraudulent accounting techniques that occurs
when an employee alters the financial records to hide
cash stolen from the company.

It occurs when an employee steals cash by taking a

payment from one customer and then hides the theft by
diverting cash from another customer to offset the
receivable from the first customer

Basically, the employee will take subsequent cash

received and apply it to an accounts receivable to cover
the theft.
 Substantive Procedures
Substantive procedures are intended to create
evidence that an auditor assembles to support
the assertion that there are no material
misstatements in regard to the completeness,
validity, and accuracy of the financial records of
a client.

substantive procedures are performed in order

to detect whether there are any material
misstatements in accounting transactions.
Cont…
The following are all considered to be
substantive procedures for cash.
1. Obtain balance detail. Obtain cash balance
information for each cash account and
reconcile these balances back to the general
ledger.
2. Confirm balances. Send confirmation forms
to the financial institutions with which the
client does business, asking for verification of
account balances.
Cont…
3. Reconcile accounts. Either review bank reconciliations prepared by the
client or directly prepare the reconciliations.

4. Examine cutoff. Obtain a cutoff bank statement that itemizes transactions

subsequent to the balance sheet date, and verify that the client has properly
cut off the recordation of cash receipts and cash disbursements.

5. Count cash. Verify the amount of cash on hand.

6. Examine Account transfer. A client may have several bank accounts, and
regularly shifts funds among them.

For example, it could move cash from its general checking account to its
payroll account in order to have sufficient funds on hand for an upcoming
issuance of payroll checks to employees.
Cont…

7. Conduct analytical procedures. Compare the client’s cash totals to its

operational information to see if there are any disparities worth
discussing.

The following analytical procedures can be applied to cash:

 Compare the ending cash balance in each account to the balance in the
prior year
 Compare the aggregate amount of deposits in transit to the same amount in
the prior year
 Compare the aggregate amount of outstanding checks to the same amount
in the prior year
 Compare the ending cash balance to the ending cash balances in prior
months of the same year

8. Review presentation. Review the client’s presentation of information

in its financial statements related to cash, including disclosures in the
accompanying footnotes.
Detection risk is the possibility that auditors are unable to detect a noticeable error
in accounts.
Control risk, which is the risk that the client's controls will not prevent or detect a
material misstatement;
Inherent risk is the risk of a material misstatement in a company’s financial
statements without considering internal controls. Inherent risk is the risk posed by
an error or omission in a financial statement due to a factor other than a failure of
control
• Complex accounting or calculations.
• Accounting personnel's knowledge and experience.
• Need for judgment.
• Difficulty in creating disclosures.
• Size and volume of accounts balance or transactions.
• Susceptibility to obsolescence.
• Prior year period adjustments.