Chapter 23

Audit of Cash Balances

This is one chapter we always cover. For one reason, it ties the various
transaction cycles together. Secondly, students will frequently do work in this area
early in their professional careers. Students are told that there will be reasonably
heavy testing of their knowledge of bank reconciliations and proofs of cash on the
next exam.
The following are the major subjects covered in this session:

 Chapter opening vignette

 Cash in the bank and transaction cycles
 Types of cash accounts
 Effect of proper segregation of duties and an independent bank
reconciliation
 Definitions
 Audit of the general cash account
 Cutoff tests
 Summary of audit tests for the general cash account
 Proof of cash
 Audit of an imprest account – payroll

Chapter Opening Vignette – “Society Expects a Lot from Auditors”

Like the vignette at the beginning of Chapter 10, this vignette illustrates a large
defalcation. In this case, the auditors apparently complied with auditing standards,
but missed the fraud. The technical issue that was the focus of the resulting trial
was whether the auditors should have done more testing of internal control.
This case provides a basis for a discussion of a substantive procedures
approach versus an internal control reliance audit approach on small clients. It
provides an opportunity to highlight the importance of obtaining an understanding of
internal control in every audit, which involves assessing the design and
implementation of controls. A heavy focus on substantive testing is less likely to
uncover a defalcation than an internal control reliance approach where more tests of
controls and substantive tests of transactions are performed.
The vignette also illustrates the typical litigation format for accountants’
malpractice suits where two auditing "experts" contradict each other and the jury is
left to sort out who is more believable. This can lead to a discussion about whether
lay jury members can be expected to understand technical accounting and auditing
concepts and issues.
In this case, it was quite clear that the jury made a misinformed decision.
Whether the defendant firm would appeal is essentially an economic decision. In this
case, it was decided not to appeal.

23-1
Cash in the Bank and Transaction Cycles (page 734)

Studying the relationship of cash to the various transaction cycles is an

essential part of the course, because it helps students integrate material learned in
other chapters. We spend a few minutes on Figure 23-1 (page 735), making sure
that students understand these interrelationships.

(See Figure 23-1)

At this point, Review Question 23-2 helps students see the link of testing in
the various transaction cycles to the testing of the year end cash balances.

Types of Cash Accounts (page 736)

It is useful to summarize the types of cash accounts discussed in the beginning

of the chapter to make sure that students understand the difference between each
one and how they tie into the general cash account. T-23-1 provides a good
summary of the types of cash accounts.

(See T-23-1)

Effect of Proper Segregation of Duties and an Independent Bank

Reconciliation

The importance of these two controls over cash accounts deserves emphasis.
At this point, we refer students to the bank reconciliation in Figure 23-3 (page 740)
and talk about the types of misstatements that would and would not be uncovered by
an independent bank reconciliation.

(See Figure 23-3)

The questions on T-23-2 help clarify this from a control and an audit point of
view.

(See T-23-2)

Definitions (pages 741 and 746)

Before going into detail about the audit of cash in the bank, it is desirable to
define certain terms. For the first two, we state their purpose. In the case of kiting,
we explain what it is, and how it can be detected.

 Cutoff bank statement (page 741)

 Proof of cash (page 746)
 Kiting (page 746)

Problem 23-23 is a useful one to make sure that students know the procedures
to uncover kiting.

23-2
Audit of the General Cash Account (page 737)

First we discuss the methodology for designing tests of details of balances , with
emphasis on risk and materiality of the cash receipts and cash disbursements
transactions. Next we ask students to identify the starting point for auditing cash
(client's year-end bank reconciliation), and why it is the starting point. Students are
then asked to refer to Figure 23-3 (page 740) and are asked to identify all
procedures that would normally be performed on a client-prepared bank
reconciliation. We also discuss a standard bank confirmation, using Figure 23-4
(page 742).

(See Figures 23-3 and 23-4)

The following questions and problems are then used:

 23-5 - Bank confirmation compared to accounts receivable confirmation

 23-18 - Multiple choice questions
 23-21 - Objectives of various audit procedures

Problems 23-22 and 23-24 give students practice in preparing a bank

reconciliation.

Cutoff Tests (see Table 23-1, page 741, for detailed cutoff tests)

We find Review Question 23-8 is sufficient for discussing cutoff if it is expanded

to cash disbursements too.

Summary of Audit Tests for the General Cash Account (page 744)

Figure 23-5 (page 744) provides a good summary of the types of audit tests
used for the audit of the general cash account.

(See Figure 23-5)

Proof of Cash (page 746)

In the discussion of proofs of cash, we ask several questions:

 What is the purpose of a proof of cash?

 Identify several misstatements of cash that a proof of cash will uncover.
 Identify several misstatements of cash that a proof of cash will not uncover.
 When is it necessary to do, and when can it be omitted?

Next, we use Figure 23-6 (page 747) to show an example of a completed proof
of cash.

(See Figure 23-6)

23-3
Audit of an Imprest Account – Payroll (page 749)

We discuss only one imprest account, usually payroll. The following are
typical questions:

 What does the term imprest mean?

 Why are imprest accounts used by companies?
 How does an imprest account affect the audit?
 Assuming an imprest payroll account, what should be emphasized, the
cash balance or changes in the balance?
 At what point in the audit are changes in the payroll cash account balances
audited?
 What testing needs to be done at year-end, assuming good controls?

23-4
 CHAPTER 23
CROSS-REFERENCE OF LEARNING OBJECTIVES AND PROBLEM MATERIAL

Multiple Discussion
Review Choice Questions
Learning Objectives Questions Questions and Problems Case
23-1 Show the relationship of cash in the bank to the 23-1, 23-2
various transaction cycles.

23-2 Identify the major types of cash accounts 23-1, 23-2,

maintained by business entities. 23-9
23-5

23-3 Design and perform audit tests of the general cash 23-3, 23-4, 23-18 23-20, 23-21,
account. 23-5, 23-6, 23-22, 23-23,
23-7, 23-8, 23-24
23-11, 23-15,
23-16, 23-17

23-4 Recognize when to extend audit tests of the 23-10, 23-12, 23-18, 23-19 23-20, 23-21,
general cash account to test further for material 23-15 23-23, 23-25
fraud.

23-5 Design and perform audit tests of the imprest 23-13

payroll bank account.

23-6 Design and perform audit tests of imprest petty 23-14

cash.
 TYPES OF CASH ACCOUNTS AND
THEIR RELATIONSHIP TO THE
GENERAL CASH ACCOUNT

Employees
Imprest
Payroll
Account
Branch Branch
Activities Bank
Account
General Small
Cash Imprest expenditures
Petty
Fund

All other
expenditures

Cash
Equivalents

T-23-1
WHICH OF THE FOLLOWING MISSTATEMENTS
WILL BE UNCOVERED BY A
CAREFULLY PREPARED INDEPENDENT
BANK RECONCILIATION?

 Cash receipts recorded in the cash receipts journal

but lost before deposit.

 A check recorded in the cash disbursements

journal for an amount $1000 greater than the
amount the check was written for.

 Cash receipt lost before it was recorded in the cash

receipts journal.

 Bank debit memo that should have been charged

to a different customer.

 A check written for $100 more than the amount on

the vendor’s invoice.

 A stop-payment by a customer where the client

was not informed that the stop-payment had
taken place.

T-23-2