PRACTICAL AUDITING Prepared by: Roda R.

Santos

Module 3
CASH

EXPECTED LEARNING OUTCOMES

After reading this chapter, you should be able to:

a) state the auditor's principal objectives in auditing cash balances;

b) identify internal control procedures to safeguard cash and ensure reliability of recorded cash
transactions;
c) apply audit procedures to establish management's assertions on cash balances;
d) prepare cash count sheet, based on actual cash count;
e) reconcile bank balances;
f) formulate audit adjustments to bring cash to correct balances, and
g) evaluate the appropriateness of the presentation of cash balance in the statement of financial
position; and

For financial statement purposes, the account title "Cash" refers only to cash items that are
unrestricted and immediately available for use in current operations. In a properly classified
statement of financial position, "Cash is normally presented as the first item in the current assets
section.

Although cash may not represent a significant amount compared to total assets in the
statement of financial position, more audit time is devoted to the examination of cash balances
because cash has a high degree of inherent risk. It is highly prone to misappropriation,
misapplication and other forms of frauds. Furthermore, most financial statement items flow
through the cash account, such that a misstatement in cash balance means misstatement of some
other accounts.

Audit Objectives

In the audit of cash, the auditor's principal objectives are to:

● obtain an understanding of internal control procedures adopted by the company to

safeguard cash;
● establish the existence of the recorded amount of cash;
● establish the completeness of recorded cash;
● determine that the client has rights to recorded cash; and
● establish that the presentation and disclosure of Cash is appropriate

Internal Control Over Cash

The auditor should consider control over cash transactions to determine extent of audit
procedures to be performed. One of the most important aspect cash control is the segregation of
the custodian function from the record keeping function. Segregation of incompatible duties
minimizes fraud, because the act misappropriation would involve at least two persons, and under
normal circumstances it is unlikely that one will seek the help of another in committing a wrongful
act Segregation of duties also may help detect unintentional errors because at least two persons
handle different aspects of the same transaction. However, the number of individuals involved in
cash transactions must be controlled, the individual responsibilities for cash handling must be
fixed and the individual duties must be limited to minimize if not eliminate fraudulent activities
involving cash.

Control over cash receipts should provide assurance that cash which should have been
received was in fact received, recorded correctly and deposited promptly. The basic principle is
that no one person should be allowed to collect, handle or transport and deposit cash without
additional control feature to ensure that all funds are accounted for.

Internal control procedures over cash receipts include the following:

PRACTICAL AUDITING Prepared by: Roda R. Santos

(a) No one person should be assigned the function of cash handling and record keeping.
(b) Official receipts must be pre-numbered and sequentially used.
(c) Each day's cash receipts must be deposited intact.
(d) Deposits should be matched with official receipts. The person reconciling the official
receipts with the deposits made should be one other than the person making the deposit.
(e) Cash sales should be recorded at the point of sale (point of sale system or POS).
(f) Cash register totals and credit card machines should be balanced daily. Any resulting cash
shortage or overage should be monitored.

Control over cash disbursements should provide assurance that disbursements are made only
for authorized business purposes and are property recorded. Internal control procedures for cash
disbursements include the following:

(a) All disbursements must be properly authorized and adequately documented. The adoption
of the voucher system, which requires review of supporting documents as support for
disbursements, is highly recommended.
(b) Payments must be made by checks, electronic fund transfer, or from petty cash fund.
(c) Issued checks must be sequentially numbered.
(d) Checks should be signed by at least two persons to prevent fictitious disbursements,
(e) Check signatories shall be persons in appropriate high levels in the organization
(f) Checks issued must be payable to specific entities (company or person) and must not be
made payable to "Cash".
(g) Periodic bank reconciliations must be made by a person independent of the authorization,
check signing function and cash receipts function. The reconciliation must be made at
least once a month to ensure that all deposits and disbursements are properly made and
recorded both by the entity and the bank.

Audit Procedures

Auditing cash and cash equivalents involves identifying the risks of material misstatements for
cash and gathering audit evidence to reduce these risks to an acceptable level. The common
risks of material misstatements associated with cash includes non-recording of cash transactions,
non-existence of cash balances and recording cash transactions in inappropriate reporting period.

The auditor has to trace the opening balance of cash to prior year's financial statements, or for
repeat engagement, prior year's working papers. Schedule showing the composition of the cash
items must be reconciled with the opening balance in the year under audit.

Auditing Cash on Hand

To validate existence of cash on hand, the auditor shall conduct a cash count. The count must be
conducted in the presence of the cash custodian. The custodian must be present throughout the
count. The auditor must obtain the signature of le custodian certifying that the fund was returned
intact. The count of the cash on hand balances and the count of other highly liquid instruments
must be made simultaneously to avoid any transfer of funds to temporarily conceal cash shortage.

In conducting the cash count, the items counted shall be compared with the cashier's
accountability. The items counted may include the following:

Currency and coins P xx

Checks
Checks representing collections (dated and post-dated) xx
Checks for disbursements (entrusted to the custodian) xx
Properly approved petty cash vouchers evidencing payments xx
IOUs with no supporting vouchers xx
Total per count P xx
PRACTICAL AUDITING Prepared by: Roda R. Santos

The cashier's accountability includes all items entrusted to the cashier for which he or she
is accountable to the entity or another party. The cash custodian may be accountable for the
following:

Imprest balance of the cash fund P xx

Checks or money items for payment to another (Meralco, PLDT, etc.) xx
Collections temporarily handled by the custodian for remittance to the general cashier xx
Other collections handled by the custodian xx
Cashier's accountability P xx

Ideally, the total items counted must equal the cashier's total accountability. Otherwise,
the discrepancy is a cash shortage or a cash overage. If the cashier's accountability exceeds the
items counted, the difference is cash shortage. Any unaccounted cash shortage requires
reclassification either as a receivable from the cashier or part of miscellaneous expenses. In
making the reclassification, the auditor has to consider the policy adopted by the company for
such shortages.

If the total amount of items counted exceeds the cashier's accountability, the excess is a
cash overage, which must also be reclassified. Ideally, the cash item representing cash overage
must be taken out of the cash fund and deposited to the general cash In bank account of the
company. An unaccounted cash overage is generally reclassified as miscellaneous income.

The auditor has to bring the cash fund balance equal to the actual cash items (currency
and coins) that are appropriately composing the undisbursed cash fund. All non-cash items must
be properly reclassified. Any other cash items belonging to the entity not forming part of the cash
fund, such as miscellaneous collections handled by the cashier shall be properly recorded and
deposited.

The auditor should seek an explanation from an official as to the existence of IOUS as
part of the items counted. Borrowing by the employees from the petty cash fund may be against
the entity's policy and defeats the purpose for which the petty cash fund is held by the entity. In
any case, the Petty Cash Fund balance after adjustment should represent only actual cash items
counted properly forming part of the undisbursed cash in the petty cash fund.

Auditing Cash in Bank

The auditor's tests of controls of cash receipts help determine that cash payment intended
for the company are received, are properly and promptly recorded, and are promptly and properly
deposited in the company's bank account Tests of controls related to cash receipts include

(a) footing cash receipts records;

(b) testing the postings of cash receipts to ledgers;
(c) comparing recorded receipts with bank statements;
(d) comparing deposit slips with recorded receipts; and
(e) comparing recorded receipts with the details in the official receipts.

Details in the official receipts for cash collections from customers must be matched with the
credit postings to the customers' subsidiary ledgers. Such detailed tracing may uncover lapping,
a fraud referring to misappropriation of collections from customers, delaying its recording and
posting the subsequent collections to the account of the customer who previously made the
payment. (Example: Collection from customer A is misappropriated by the cashier, subsequent
collection from customer B is posted to Customer A, and part or full collection from Customer C
is credited to the account of Customer B, and so on. Lapping is most likely to occur when an
employee receiving collections from customers has access to the accounts receivable records.

The auditor's tests of controls related to cash disbursements help the audition determine that
all cash disbursements are properly authorized and made only for goods and services that are
actually received. These tests include:
a) proving the footings of cash disbursements journal or check register;
PRACTICAL AUDITING Prepared by: Roda R. Santos

b) tracing the totals to the general ledger;

c) comparing checks returned with the entries in the cash disbursements journal or check
register; and
d) reconciling recorded disbursements with bank statements.

Ledger postings of cash receipts and cash disbursements must be reviewed to spot unusual
entries that may require special investigation.

The auditor must request confirmation of bank balance for each bank account maintained by
the client. The bank confirmation provides evidence in respect of existence, ownership, and
accuracy of cash balances. The bank confirmation request must be on the auditor's letterhead
and must be sent to all banks where the client has dealings. The request should be clear and
concise. The request must include confirmation of demand deposits, savings deposits, certificates
of deposits and information on compensating balances. The following types of information may
also be sought from the confirmation: bank balances with corresponding account numbers,
description of currency, loans from the bank, collateral provided on loans, maturity and interest
rate on loans, terms and repayment conditions of loans, contingent liabilities such as guarantees
and endorsements. Copies of the bank confirmations must be retained in the working papers. The
auditor when requesting bank confirmations should send the banks self-addressed prepaid
envelopes, so that bank replies are sent directly to the auditor. Sometimes, it may be necessary
to send a second request, specifically so when the financing institution failed to reply in the first
confirmation request.

In instances when the amount indicated in the confirmation request returned by the bank does
not agree with the ledger balance or when repeated non-responses are obtained from the
financing institution, the auditor shall obtain copies of the bank reconciliation prepared by the
client. A bank reconciliation is an audit evidence to support the financial statement assertions of
existence or occurrence, cut-off, accuracy and completeness related to Cash in Bank. For first
time audit, the auditor may need to obtain copies of the bank reconciliations at the close of the
prior year. Reconciling items listed should be traced to bank statements for the subsequent
months

The auditor has to test the clerical accuracy of the reconciliation and the details of the
supporting schedules. The extent and nature of the reconciling items must be reviewed for
reasonableness. Reconciling items listed in the bank reconciliation must be verified by obtaining
cutoff bank statements. Deposits in transit and outstanding checks must be traced in the cutoff
bank statement noting reasonableness of the time period between book recording and bank
recording. Canceled checks returned with the cutoff bank statement must be traced to the list of
outstanding checks. Large or unusual outstanding checks must be investigated. Appropriate audit
evidence should be obtained for significant unusual reconciling items.

The auditor shall consider preparing a proof of cash when there is reason to believe that a
client's employee or officer perpetrates misappropriation. A proof of cash is a reconciliation of the
beginning and ending balances of cash, cash receipts and cash disbursements during a specific
period. The purpose is to obtain an understanding of how the client and the bank recorded the
transactions affecting cash balance during the period.

If the client maintains cash accounts with at least two separate banks, a bank transfer
schedule shall be prepared showing transfers of cash balances from one bank to another,
especially towards the end of the reporting period.

Manipulation causing an amount of cash to be included simultaneously in the balance of two

or more bank accounts is referred to as kiting. Kiting is an attempt to temporarily conceal a cash
shortage at month end by issuing a check from one bank and depositing it to another. The deposit
is reflected in the latter account, but the withdrawal may not be reflected yet in the first bank
account due to clearing cutoff. For example, a fund transfer to Bank B at December 31 should be
reflected as a withdrawal from say, Bank A on the same date. A fund transfer posted as a deposit
to Bank B, without reflecting it as a disbursement from Bank A may indicate that kiting may have
occurred.