Audit of Cash Balances

Major Types of Cash Accounts or Balances and Their Purpose Type of Cash Account or Balance Purpose of Cash Account General cash account – the primary bank account for most organizations; virtually all cash receipts and disbursements flow through this account at some time. 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. 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. 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. 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. Provides for more rapid deposits and/or payments at the local level. Builds business relationships with local banks. 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. Used for small cash purposes that can be paid more conveniently and quickly by cash other than cheque (e.g., office supplies) 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. Used to manage fluctuating cash balances so that cash is available for short-term operating needs.

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

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

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

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

Assessing Inherent Risk and Fraud Risk There is high inherent risk When assessing inherent risk what should auditor consider?

Materiality Considerations The cash balance is immaterial on most audits Thus often potential for material misstatement of cash.

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

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

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

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) Bank account (EURO) Bank account (USD) Cash Balance #1 #2 #3 #4 $100,000 250,000 150,000 500,000 $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 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. Directly confirming cash balances for each account with a bank provides the auditor with the strongest level of evidence (third-party independent confirmation). 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. Note that the risk of the cash balance being incomplete (completeness assertion) is low. It is 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).

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.

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

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

Tests of the Bank Reconciliation Verify that the client’s bank reconciliation is Trace the balance on the cutoff statement to Trace cheques included with the cutoff bank statement to the list of outstanding cheques on the bank reconciliation and Investigate all significant cheques or payments included on the outstanding cheque list that Trace deposits in transit (outstanding deposits) to 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.

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.

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

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:

Alpha Bravo Company Proof of Cash For the Month of June 201X Prepared by GHY Dated 8/7/1X Reviewed by 5-31-1X Receipts Disbursements 6-30-1X Balance per bank $11,800 b $18,300 $21,200 $8,900 Deposits in transit May 31 500 (500) June 30 600 Outstanding cheques (800) j 400 (400) NSF cheques (100) Cash balance $11,500 r $20,700 d $9,100 Balance per books $11,320 L $18,200 $21,710 $8,810 Bank service charge May (20) June 10 (10) Bank collection 200 (200) 300 ^ ^ 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

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

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

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.

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.

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.

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

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: You suspect that the cashier has stolen some money. Prepare a schedule showing your estimate of the loss How did the cashier attempt to conceal the theft? Based only on the information above, name two specific features of internal control that are missing. 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?

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.) A cheque was omitted from the outstanding cheque list on the June 30 bank reconciliation. It cleared the bank July 7. A cheque was omitted from the outstanding cheque list on the bank reconciliation. It cleared the bank September 6. Cash receipts collected on accounts receivable from July 2 to July 5 were included as June 29 and June 30 cash receipts. 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. 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. A bank transfer recorded in the accounting records on July 2 was included as a deposit in transit on June 30. The outstanding cheques on the June 30 bank reconciliation were underfooted by $2000. REQUIRED Assuming that each of these misstatements was intentional, state the most likely motivation of the person responsible. What control could be instituted for each intentional misstatement to reduce the likelihood of errors. List an audit procedure that could be used to discover each misstatement.