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TABLE OF CONTENTS 1
Introduction
Review of Accounting Principles / Question 1
Review of Accounting Principles / Question 2
Review of Accounting Principles / Question 3
Audit Objectives
The Audit Risk Model
Accounting System for Cash Transactions
Accounting System for Cash Transactions / Example
Accounting System for Cash Transactions / Conclusions
Accounting System for Cash Transactions / What Next?
Quick Review 1 of 3
Quick Review 2 of 3
Quick Review 3 of 3
Substantive Audit Tests
Substantive Audit Tests / Frequently Asked Questions
Substantive Audit Tests / Preliminary Steps
Bank Confirmations
Bank Confirmations / Frequently Asked Questions
Deposits in Transit
Outstanding Checks
Quick Review 1 of 3
Quick Review 2 of 3
Quick Review 3 of 3
Other Tests in the Cash Area
Traps to Avoid
More Traps to Avoid
Quick Review 1 of 4
Quick Review 2 of 4
Quick Review 3 of 4
Quick Review 4 of 4
Case Study
Questions to Consider and Lessons Learned
Glossary
Course Objectives:
At the end of this course, you will be able to:
· Match audit procedures typically performed in the cash area to stated audit objectives.
· Effectively review the accounting system and controls over cash transactions and identify weaknesses and possible
solutions.
· Properly test client's bank reconciliations and perform other substantive tests in the cash area.
· Avoid common audit inefficiencies and oversights.
Please note: This study guide is provided as a convenience for note taking and review purposes. It does not present
1
complete or comprehensive information on each topic. For more information, you should refer to the course materials
and technical standards.
Auditing Cash Study Guide
AUDIT OBJECTIVES
The audit objectives stated in your firm's audit manual may be slightly different.
· Cash exists.
· The client owns the rights to the cash reported on its financial statements.
· Cash balances reflect a proper cutoff of cash receipts and disbursements.
· Cash balances properly reflect all cash and cash items on hand, in transit, or on deposit with third parties.
· Cash balances are properly classified in the financial statements and all relevant disclosures are complete and understandable.
Your audit procedures have a purpose. Before you do any audit procedure, you should have a clear understanding of its objective.
Those objectives are directly related to the financial statement assertions (.existence or occurrence., completeness, rights and
obligations, valuation or allocation, presentation and disclosure.) you are trying to test.
THE AUDIT RISK MODEL
This is the audit risk model equation. In some audit methodologies, the combination of inherent risk and control risk is referred to
as the risk of material misstatement, and the risk assessment is performed on this combination. In this course, we have separated
the assessment of inherent risk and control risk to highlight the two decisions.
Inherent Risk X Control Risk X Detection Risk = Audit Risk
The first component of the equation is inherent risk. Inherent risk is the risk that errors exist in the accounting system regardless of
internal controls. Therefore, it must come before both control risk and detection risk.
The second component of the equation is control risk. If an error exists in the accounting system (inherent risk), the next risk is
that the client’s internal control fails to detect the error.
The third component of the equation is detection risk. Auditors must first consider inherent and control risk before they can design
the right mix of procedures to address detection risk.
Remember that auditing is a riskdriven process, and your consideration of audit procedures is the last thing you do, only after you
have assessed all three of these components of risk. These three components are multiplied together because there is an inverse
relationship between the components of the audit risk model. For example, if the combined inherent and control risk assessment is
low, then you may reduce the evidence gathered from your substantive procedures and accept a higher level of detection risk.
Here is some further information on the audit risk model.
Inherent Risk
There are two key features of the audit risk model. The model is linear.
· First, you consider inherent and control risk, or the combined “risk of material misstatement”; then, you choose your
substantive audit procedures.
· Second, there is an inverse relationship between the elements. If inherent and control risk are assessed at the maximum, then
detection risk must be reduced to an acceptable level.
The first element in the audit risk model is inherent risk. Inherent risk is the susceptibility of an assertion to a material
misstatement, assuming that there are no related controls. Accounting for cash usually is not that complex, and cash balances
typically are small in relation to the overall balance sheet. However, cash accounts usually reflect a great number of transactions,
and cash is highly susceptible to the risk of material misstatement caused by fraud. In assessing inherent risk related to cash
accounts and cash receipts and disbursements, you will have to exercise considerable judgment.
Auditing Cash Study Guide
Control Risk
Most likely, you will assess control risk at the maximum in the cash area just as a matter of audit efficiency. However, assessing
control risk at the maximum does not mean you can ignore internal control completely.
On all audits, you must obtain an understanding of internal control to properly assess the risk of material misstatement. This means
that, for significant audit areas, you should understand the accounting system, which requires you to understand:
· How transactions are initiated.
· The records, supporting documents, computer media, and specific accounts in the financial statements involved in the
processing and reporting of transactions.
· The accounting processing involved from the initiation of a transaction to its inclusion in the financial statements, including
how the computer is used to process data.
· The financial reporting process used to prepare the entity's financial statements, including significant accounting estimates and
disclosures.
Additionally, as a client service matter, you’ll want to determine if the client has designed "basic" controls in this area.
“Basic" controls (this term is not in the official audit literature) are the minimum controls the client should have in place to operate
its business. If these controls are not in place, you probably should make a management letter comment. If the client is "really" out
of control, you might ask whether the entity is even auditable.
Auditing Cash Study Guide
ACCOUNTING SYSTEM FOR CASH TRANSACTIONS
This chart lists the general items you need to know about a client's accounting system related to cash.
For cash disbursements, a check register is
the main accounting record. The client
also should keep copies of vendor invoices
to support the disbursements.
Each bank account should have its own
general ledger account.
How the accounting There are many ways in which the The primary control over the cash accounts is the
information is information might be processed. The most bank reconciliation. Bank reconciliations should be
processed, from the common is to have the cash receipts and performed timely by someone who does not have the
initiation of a disbursements totaled and those totals authority to write checks.
transaction to its posted once a month to the general ledger.
inclusion in the
financial
statements.
ACCOUNTING SYSTEM FOR CASH TRANSACTIONS / EXAMPLE
Usually, you will gain your understanding of the accounting system by sitting down with the client and talking to them for a few
minutes and asking to see some of the documents and records they describe.
The questions that you might ask could be your own or they may come from your audit manual.
Auditing Cash Study Guide
ACCOUNTING SYSTEM FOR CASH TRANSACTIONS / WHAT NEXT?
It's one thing to gather and evaluate information. But the more important question is: "So what?" What should you do with it?
Management Letter Comments
In general, once you gather information about the client's accounting system and internal control, you should first determine
whether the design and implementation of the client’s system achieves the management’s control objectives. If it does not,
you should determine how the inability to achieve those control objectives affects the design of your further audit procedures.
Audit Planning
The third thing you should do is determine how the information you just learned will affect other areas of the audit.
The manual checks have implications for other parts of the audit. This "system" of giving the ownermanager the ability to write
checks outside of the accounting system raises the issue of completeness. The only way the company’s accounting staff (and by
implication, the accounting system) knows if a manual check has been written is if the owner/manager tells them, or when the
check clears the bank. What if the owner manager wrote a manual check, forgot to tell the staff, and then the check didn't clear the
bank right away? In that situation, the accounting system would fail to capture a transaction.
When planning the audit, you should be sure to take this into account. For example, the search for unrecorded liabilities should be
sure to include any manual checks written subsequent to yearend. Additionally, by definition, manual checks are used for
unusual, nonrecurring transactions, the types of transactions that sometimes require closer scrutiny. You might want to look
through the check register for any large manual checks, just to make sure the underlying transactions were properly accounted for.
Auditing Cash Study Guide
SUBSTANTIVE AUDIT TESTS
Common Audit Procedures
The primary test in the cash area is the test of the client's bank reconciliations. By testing the bank reconciliations you will gather
audit evidence to support the objectives that:
· Cash exists.
· Cash balances reflect a proper cutoff of cash receipts and disbursements.
· Cash balances properly reflect all cash and cash items on hand, in transit, or on deposit with third parties.
Of course, these aren't all your audit objectives, so other procedures will need to be performed. But testing the bank reconciliation
will be your key procedure.
Coordinating With the Client
Before you begin your substantive tests of cash, you'll need to coordinate your efforts with the client. Here's what you need from
the client in order to do your work:
· A complete listing of all cash accounts.
· Bank reconciliations as of the balance sheet date for each account.
· Yearend bank statements.
· Bank statements, including canceled checks, subsequent to yearend.
In addition, you'll need to ask the client to prepare the standard bank confirmations that you will send out to the banks.
SUBSTANTIVE AUDIT TESTS / FREQUENTLY ASKED QUESTIONS
Here are two frequently asked questions dealing with the planning for the audit of cash.
Queston: What if the client does not get canceled checks returned with its bank statements?
Question: When should I get a bank cutoff statement?
Answer: A bank cutoff statement is an interim bank statement that is sent directly to the auditors. Unless you are performing your
fieldwork prior to the date the bank statements normally are received, or unless you suspect the client is tampering with the bank
statements, you will not need to obtain a bank cutoff statement.
Auditing Cash Study Guide
SUBSTANTIVE AUDIT TESTS / PRELIMINARY STEPS
Before actually testing the bank reconciliations, you need to do a little preliminary work, namely
· Test the mathematical accuracy of the bank reconciliations
· Scan the reconciliations and look for amounts that have been "plugged in" to make the reconciliation foot. Captions such
as "other,” “net," and "unknown" are sure giveaways.
· Compare the "amount per the general ledger" to the actual general ledger
Tip: Client’s Bank Reconciliations: During the planning phase of the audit, scan the client's bank reconciliations and ask a few
questions to make sure the client understands how to properly prepare bank reconciliations so that they include all the information
you need to test. You might be surprised at how many small business audits are slowed down because the client does not prepare
proper reconciliations.
A bank reconciliation consists of four main parts:
· The bank balance per the bank.
· Deposits in transit.
· Outstanding checks.
· The balance per the general ledger.
Testing a bank reconciliation basically involves obtaining audit evidence to support the validity of each of these components.
Testing the balance per bank is relatively straightforward. Your primary procedure is to send a standard bank confirmation to the
bank.
BANK CONFIRMATIONS
The bank confirmation has to be signed by the client. They are the ones requesting information from the bank; it is their bank
account.
If a client has more than one bank account with a given financial institution, there's no need to prepare separate confirmations for
each account. Just list all account names and numbers on one form as
.
Be sure to make copies of all confirmations before you send them. If you have to send second requests, this will make your job a
lot easier.
Auditing Cash Study Guide
BANK CONFIRMATIONS / FREQUENTLY ASKED QUESTIONS
Here are some frequently asked questions dealing with the bank confirmation process.
Question: I'm trying to finish the work in this area and get it to the senior for review, but the bank confirms haven't come back.
What should I do?
Answer: Tie the “balance per bank” to the bank statement and make a checkmark on your workpaper. This does not relieve you of
your responsibility to obtain a confirmation. If you send a confirmation request to the bank, call the bank and ask them to send
back the confirmation. Send a second request. Get the workpapers to your senior for review, knowing that the confirmation is on
the way.
Question: The bank confirmation came back and the balance that the bank confirmed does not agree to the bank reconciliation. Is
this an audit difference?
Answer: It is not uncommon for a bank to fill out the confirmation incorrectly. Remember that you are asking for a balance as of
the balance sheet date (usually December thirtyone). Sometimes, the person filling out the confirmation prepares the information
as of the day he or she receives it. Call the person who signed the confirmation. Explain what you are looking for and make
arrangements to obtain a corrected confirmation.
Question: I received a faxed confirmation reply from the bank. Is this okay?
Answer Faxed confirmation replies are usually okay. If it is a thermal printer, make sure you take a photocopy because thermal
paper fades over time. If this is a highrisk area or if you suspect the client may have tampered with the bank statement or
otherwise committed fraud in this area, then you should request a signed original of the fax to be sent directly to you.
Question: I received the bank confirmation and the balances look okay, but the bank failed to confirm a loan that I know the client
has with this bank. Is the bank confirmation still valid?
Answer: It is not unusual for the bank to overlook the loan information asked for in the confirmation. The confirmation of the
bank balances is still valid. Chances are you will be sending a separate confirmation for the loan payable.
DEPOSITS IN TRANSIT
Once you have tied down the balance per the bank, you're ready to move on to the next section of the bank reconciliation, deposits
in transit. To determine the validity of a deposit in transit, compare the validated deposit ticket to the bank statement subsequent to
yearend. Look at the bank statement and verify that the amount was deposited in the account shortly after yearend. Make sure
that the time period between the date the client made the deposit and the date the deposit was credited appears reasonable.
Question: Do I always have to test all deposits in transit
Answer: No. Only test the ones that seem significant. Don’t bother with minor items. If you have trouble deciding whether an item
is significant enough to warrant testing, ask your supervisor.
Auditing Cash Study Guide
OUTSTANDING CHECKS
To determine if an item listed as an outstanding check is valid, you should obtain the canceled check from a bank statement
subsequent to yearend. Look at the date of the check and the date the check actually cleared the bank. This comparison will tell
you that the check was properly listed as outstanding at the balance sheet date.
You also should trace "backwards" from the canceled checks to the clientprepared listing of outstanding checks. Starting with the
stack of canceled checks, select a few that are dated prior to yearend, and make sure that these have been included on the list of
outstanding checks. This test will give you some comfort that the outstanding check list is complete.
When performing your test work, it is best to look at an actual canceled check and not just trace the item to the bank statement.
Turn the check over and see if it was endorsed by the payee. Checks that are endorsed by a person other than the payee may
indicate fraud.
Answer: Absolutely not. As with deposits in transit, you should only test the outstanding checks that seem significant. Don’t
bother with minor items. The audit program indicates the scope of outstanding checks to test.
Question: What about checks written on the last day of the year?
Answer: You probably should. Always be sure to scan the list of outstanding checks and look for old items. Ask the client about
checks that have been outstanding for more than a few months. In some instances, stop payments have been put on those checks or
other circumstances may indicate that the item will never clear, and an adjustment is necessary to restore cash balances.
Should I assume that these were "held checks?" Never assume anything. There’s a possibility that these checks were held at year
end, but before you propose an audit difference that assumes they were, you’d best talk to the client.
OTHER TESTS IN THE CASH AREA
Cash Restrictions and Other Disclosure Items
Testing the bank reconciliations will not tell you whether the client has compensating balance arrangements or other restrictions on
cash balances that require financial statement disclosure. To gather evidence for this audit objective you should:
· Ask the client if they have any restrictions on their cash balances.
· Review the bank confirmations or loan confirmations and look for evidence that the bank has placed restrictions on certain
cash balances.
· Look for evidence of restrictions in the minutes.
Interbank Transfers
Typically you will perform procedures to make sure there was a good cutoff at yearend for all cash activity between bank
accounts. A poor cutoff of interbank transfers could result in cash being overstated.
To make sure the client has a good cutoff you should:
· Look through the cash receipts and disbursements ledger for each bank account and identify interbank deposits and transfers
for the five days before and five days after yearend.
· Check to see that transfers between accounts were recorded in the same period. See that all transfers before the balance sheet
date were recorded in each ledger before yearend, and all those after yearend were recorded in each ledger after yearend,
· For transfers that did not clear the bank in the same period as the transaction was initiated, check to make sure that these items
are properly reflected in the bank reconciliations.
Auditing Cash Study Guide
TRAPS TO AVOID
It’s easy to get caught overauditing the cash area. Here are some suggestions for performing a more efficient audit of cash.
Audit Test Suggestion for Improved Efficiency
Bank Reconciliations Don’t beat the reconciliations to death. Only look at significant items.
SeldomUsed Accounts Don’t spend a lot of time testing immaterial or little used cash accounts.
No need for elaborate workpapers, when a simple test and brief memo will do. For example, you
Documentation normally don’t need an interbank transfer schedule or a proof of cash.
Vouching Transactions No need to vouch transactions during the year if ending balances are confirmed. For example, if a
company invests funds in CDs that automatically roll over, there’s no need to test the rollovers when
the ending balances will be confirmed at yearend.
MORE TRAPS TO AVOID
More transactions may flow through the cash account than any other, so it’s important that you take care not to overlook important
tests.
Audit Test Tips for Improved Effectiveness
Testing Outstanding Checks Test the completeness of the outstanding check list by tracing canceled checks dated before year
end that cleared after yearend to the canceled check list. Going the other way (from list to
canceled check) does not test completeness.
Bank Reconciliations Investigate reconciling items listed as “other, net” or some other caption that is clearly a “plug.”
Financial Statement Disclosures Consider and investigate the possibility of restricted cash or other disclosure items.
Held Checks Be on the lookout for held checks and bank overdrafts
Auditing Cash Study Guide
QUESTIONS TO CONSIDER AND LESSONS LEARNED
The purpose of this course was to provide you with guidance and practice in auditing cash.
QUESTIONS TO CONSIDER
· Have you taken the proper steps to work with the client to obtain all the records, schedules, and other information that you
need to do your job?
· Are you prepared to keep your eyes open for signs of possible problems such as unusual or unexplained reconciling items on
the bank statement?
· Have you considered items such as restricted cash balances that require disclosure or the possibility that the client has written
but not distributed certain checks as of the balance sheet date?
LESSONS LEARNED
· Testing the bank reconciliation is the primary test of cash. Make sure you thoroughly test each component of the
reconciliation.
· Even if you assess control risk at the maximum, spend the time to understand the accounting system and related controls in
this area. You may be able to generate valuable management letter comments.
GLOSSARY
Analytical Procedures. Substantive tests of financial information which examine relationships among data as a means of
obtaining evidence. Such procedures include: (1) comparison of financial information with information of comparable prior
periods; (2) comparison of financial information with anticipated results, for example, forecasts; (3) study of relationships between
elements of financial information that should conform to predictable patterns based on the entity's experience; (4) comparison of
financial information with industry norms.
Cash. Currency on hand, bank balances, negotiable money orders, and checks.
Control Risk. Measure of risk that errors exceeding a tolerable amount will not be prevented or detected by an entity's internal
controls.
Detection Risk. Risk that the auditor will not detect a material misstatement.
Disclosure. Process of divulging accounting information so that the content of financial statements is understood.
Inherent Risk. The susceptibility of an assertion to a material misstatement, assuming that there are no related controls.