Chapter 10: Cash and Financial Investments

1. What is the primary purpose of bank confirmation? Bank reconciliation? Bank cutoff statement? Bank
transfer schedule?
2. How do auditors audit each line item on bank reconciliation?
3. What is kiting? How to determine improper transfers?
4. Understand lapping and the audit procedures used to detect lapping.

Cash _ worry that it may Over stated

General Cash
Payroll: Cash “0” maybe over stated,
Petty Cash: audit by counting the cash.
Bank Statement: Cancelled Check.
Bank Reconciliation: Prepare by client. Need to audit
Bank Confirmation: we confirm with the bank to confirm the balance.
_ Lapping
_ Kiting _ Bank Transfer Schedule

Bank Conciliation
Per Bank xx Per Book xx

Outstanding Check Bank fees

DIT NSF Check

Corrected bank Corrected book

=> the balances should be the same.
_ Outstanding Check: Check that already written but had not recognized yet
_ Non-Sufficient Fund Check: is a check that was not honored by the bank of the entity issuing the check,
entity’s bank account doesn’t contain enough money or the bank account has been closed.
_ Deposit in transit.

* Auditor check each item:

_ Per Bank amount: _ audit by asking the bank for bank statement, bank confirmation.
_ bank statement (A.K.A Cutoff Statement: is the bank statement at the middle of the month.)
_ Deposit in transit: may be over stated. Check in Cutoff Statement. Ex: u deposit the check the end of
February, the check will show on March Cutoff statement.
_ Lapping p 415, bad internal control, use money from customer 2 to pay for customer 1, who you took the
money, or use money from day 2, pay for day1. Whoever making a fraud couldn’t go to vacation, should keep
on doing this consistency.
_ Knitting P 424,( bank transfer schedule) moving money between 2 banks from 1 entity.
These illustrations suggest the following rules for determining when it is
likely that a cash transfer has misstated the cash balance:
A. The dates of recording the transfer per the books (from the cash
disbursements and cash receipts journals, respectively) are from
different financial statement periods or

B. The date the check was recorded by the bank (either the
disbursement or the receipt, but not both) is from the financial
statement period prior to when it is recorded on the books.
6006: 1. Wrong, different financial periods. Overstated. ½ and 12/30

Wrong: 12/30 Dr. B4

Cr. Rev.
1/2 Dr. Exp.
Cr. G
Corrected: 12/30 Dr. B4
Cr. G
6029: 1. The dates of recording the transfer per book is from same financial period. Good.
2. IF the bank date before the book date it is wrong. Check book disbursement and receipt day.
Wrong=> the receipt date
Kitting (The book Overstated), if it is unintentional mistake, we called it an error.

*. If the bank date before the book date on both sides, (disbursement and receipt side) it is actually Correct.
Figure 10.6 Confirmation Form

Need to have both Signature form the client and our firm. The address is ours.
10-35/41/42/43/50/51
10-35. During your audit of Miles Company, you prepared the following bank transfer schedule:

a. Describe the purpose of a bank transfer schedule.

b. Identify those transfers that should be investigated and explain the reason.

(a) The purpose of a bank transfer schedule is to trace bank transfers to disclose overstatement of cash
balances resulting from kiting. When a check drawn on one bank is deposited in another, several days
(called the float period) usually pass before the check clears the bank on which it is drawn. During this
period, the amount of the check is included in the balance on deposit at both banks. Kiting refers to the
manipulations that utilize such temporarily overstated bank balances to conceal a cash shortage or meet
short-term cash needs.

(b) The following checks should be investigated

Check No. 2020: The increase in one bank account and decrease in the other bank account should occur in
the same accounting period. Here the cash receipt was recorded prior to year-end, while the disbursement
was recorded after year-end. As a result of recording the debit and credit parts of the transaction in different
accounting periods, cash is overstated at year-end. Also, since the debit (deposit) was recorded prior to
year-end, the auditors must investigate where the offsetting credit occurred.

Check No. 3217: The entry recorded as a deposit by the bank as of year-end, should also be reflected in the
accounting records prior to year-end. An entry such as this one might indicate the concealing of a cash
shortage due to a misappropriation

10-41. Simulation
Items a through f represent the items that an auditor ordinarily would find on a client-prepared bank
reconciliation. The accompanying List of Auditing Procedures represents substantive auditing procedures.
For each item, select one or more procedures, as indicated, that the auditor most likely would perform to
gather evidence in support of that item. The procedures on the list may be selected once, more than once, or
not at all.
Assume
 The client prepared the bank reconciliation on 10/2/X5. The bank reconciliation is mathematically
accurate.
 The auditor received a cutoff bank statement dated 10/7/X5 directly from the bank on 10/11/X5.
 The 9/30/X5 deposit in transit—outstanding checks #1281, #1285, #1289, and #1292—and the
correction of the error regarding check #1282 appeared on the cutoff bank statement.
 The auditor assessed control risk concerning the financial statement assertions related to cash at the
maximum.
List of Auditing Procedures

A. Trace to cash receipts journal.

B. Trace to cash disbursements journal.
C. Compare to 9/30/X5 general ledger.
D. Confirm directly with bank.
E. Inspect bank credit memo.
F. Inspect bank debit memo.
G. Ascertain reason for unusual delay.
H. Inspect supporting documents for reconciling item not appearing on cutoff statement.
I. Trace items on the bank reconciliation to cutoff statement.
J. Trace items on the cutoff statement to bank reconciliation.

Adapted AICPA Task-Based Simulation

(a) D, I. The balance per bank may be traced to a standard form used to confirm account balance
information with financial institutions and to the cutoff statement (on which will appear the beginning
balance).
(b) A, G, H, I, J. One of the deposits in transit does not appear on the cutoff bank statement (the 9/29/X5
deposit for $4,500). Accordingly, that deposit should be traced to the cash receipts journal (procedure A),
the reason for the delay should be investigated (procedure G), and supporting documents should be
inspected (procedure H). Both deposits should be traced to and from the bank reconciliation and the cutoff
statement (procedures I and J).
(c) B, G, H, I, J One of the checks does not appear on the cutoff statement (check #988 dated 8/31/X5 for
$2,200). Accordingly, that check should be traced to the cash disbursements journal (procedure B), the
reason for the delay should be investigated (procedure G), and supporting documents should be inspected
(procedure H). All checks should be traced to and from the bank reconciliation and cutoff statement
(procedures I and J).
(d) E The credit memo from the bank for the note collected should be investigated.
(e) E, I The credit for the check that was charged by the bank for an incorrect amount should be
investigated on both the bank credit memo and on the cutoff statement.
(f) C The only source of the balance per books is the cash general ledger account as of 9/30/X5.

10-42. SimulationAuditors perform a number of procedures relating to cash—some unique, some not
unique. For each substantive procedure below, identify its primary objective or indicate that the procedure
 serves no purpose. Substantive Procedures:
A. Prepare a bank transfer schedule.
B. Prepare a four-column proof of cash.
C. Use a standard confirmation form to confirm account balance information.
D. Obtain bank cutoff statements.
E. Search for large checks to directors, officers, and employees.
Replies: A primary objective of the procedure is to:
1. Detect kiting.
2. Detect lapping.
3. Determine that receivables are converted to cash in a reasonable amount of time.
4. Establish the valuation of cash to reflect currency translation losses and gains.
5. Reconcile cash receipt and disbursement totals between company records and bank records.
6. Verify reconciling items on the year-end bank reconciliation.
7. Verify year-end cash and liability balance information.
8. Identify related party transactions.
9. None. This procedure serves no purpose related to cash.

(a) (1) Answer (1) is correct because a bank transfer schedule, which is appropriately used when a client
has two or more bank accounts, is prepared to detect kiting, manipulations that cause cash to be
included simultaneously in the balance of two or more bank accounts.

(b) (5) Answer (5) is correct because the middle two columns of a four column proof of cash is used to
reconcile cash receipt and disbursement totals between company records and bank records.

(c) (7) Answer (7) is correct because the standard bank confirmation includes questions that help the
auditor to verify both year-end cash and liability balance information.

(d) (6) Answer (6) is correct because a bank cutoff statement includes information on bank transactions
for the first 7-10 days after year-end, and accordingly is used to verify reconciling items on the
year-end bank reconciliation.

(e) (8) Answer (8) is correct because auditors search for related party transactions to determine whether
they are properly authorized, recorded, and disclosed.

10-43. Simulation
During your audit of Carla Pang Inc., you prepared the following bank transfer schedule.
Fill out the table below indicating the most likely situation as it relates to cash at year-end. Indicate the situation
using one of the following:
1. Year-end total cash is properly stated.
2. Year-end total cash is understated.
3. Year-end total cash is overstated.
Check Number Reply
2001

2002

6734

3580

2008

2009

4005

Check Reply Comment

Number
2001 Year-end total cash is properly The entire transfer cleared prior to year-end.
stated.
2002 Year-end total cash is properly The total cash on the books is proper, although the check
stated. has not yet cleared City Bank and is outstanding at year
end.
6734 Year-end total cash is overstated. The cash is in both book accounts at year-end, having
been recorded in City Bank, but not taken out of 1st
Bank.
3580 Year-end total cash is overstated. The cash is in both book accounts at year-end, having
been recorded in City Bank, but not taken out of 1st
Bank.
2008 Year-end total cash is properly Transfer recorded properly on books; there should be an
stated. outstanding check (City Bank) and a deposit in transit
(3rd National)
2009 Year-end total cash is properly Although the cash is in the wrong accounts on the books
stated. at year-end, the misstatement of each cancels itself out.
4005 Year-end total cash is understated. At year-end, the cash is recorded as disbursed on 3rd
National, but not received until the following year by City
Bank.
10-50. Listed below are eight interbank cash transfers for Steven Smith Co., indicated by the letters a through h,
for late December 20X1 and early January 20X2.
For each of the transfers a through h, (1) indicate whether cash is understated, overstated, or correct as a result
of the transfer; and (2) provide a brief example of what could cause the situation.
Answer in a form such as the one illustrated here.

SOLUTION: Steven Smith Co. (Estimated time: 20 minutes)

Transfer Understate Example (many others are possible)

d,
 Overstated
or Correct
b. Correct Book entries: On December 30 a check was written on the disbursing bank,
recorded as a cash disbursement in the cash disbursements records and recorded as
a receipt in the cash receipts records.
Bank entries The check was deposited in the receiving bank the next day,
December 31. On January 2, the check was received by the disbursing bank.
c. Understated Book entries: On December 31 a check was written on the disbursing bank to
transfer cash to the receiving bank. The journal entry made, however, was to credit
cash and debit an expense account (to fraudulently decrease 200X profits--perhaps
to decrease taxes) rather than to debit cash in the receiving bank. On January 2, an
entry was made to debit cash for the transfer and to credit a revenue account to
correct the 2000X misstatement, and to overstate the 200Y profits.
Bank entries: The check was deposited in the receiving bank on January 2. On
January 4, the check was received by the disbursing bank.

d. Correct Book entries: On December 31 a check was written on the disbursing bank,
recorded as a cash disbursement in the cash disbursements records and recorded as
a receipt in the cash receipts records. The check was mailed to the receiving bank.
Bank entries: The check was received by the receiving bank on January 2. On
January 4, the check was received by the disbursing bank
e. Correct Book entries: On January 1 a check was written on the disbursing bank, recorded as
a cash disbursement in the cash disbursements records and recorded as a receipt in
the cash receipts records. The check was mailed to the receiving bank.
Bank entries: The check was received by the receiving bank on January 3. On
January 4, the check was received by the disbursing bank.
f. Overstated Accounting entries: On December 31 a check was written on the disbursing bank
to transfer cash to the receiving bank. The improper journal entry made, however,
was to debit cash (in the receiving bank's account) and credit a revenue account (to
fraudulently increase profits). On January 1, an entry was made to credit cash for
the transfer and to debit an expense account to correct the 2000X misstatement, and
to understate the 200Y profits.
Bank entries: The check was deposited in the receiving bank on December 30. On
January 2 the check was received by the disbursing bank.
g. Overstated Book entries: Earlier during the month that amount of cash ($42,000) had been
stolen from the receiving bank. To conceal the shortage on December 31, the
embezzler wrote a check transferring $42,000 from the disbursing bank to the
receiving bank. The transfer was not recorded on the books until January 2 of
200Y
Bank entries: The check was deposited in the receiving bank on December 31. On
January 2 the check was received by the disbursing bank.
h. Correct (The total cash is correct here, but recorded in the wrong accounts as of year-end.)
Book entries: Although a check is written on the disbursing bank on December 30,
no entry was made on the books until January. For example, assume that a high
level employee had a blank check, was authorized to sign it, and did to transfer the
funds at year end. She forgot to record it in the books until January 3 when she
properly recorded the transfer.
Bank entries: The check was deposited in the receiving bank on December 30.
Bank Account One recorded the disbursement on December 31, the day it was
received.
10-51. An improper cutoff of transactions around year-end occurs when journal entries are recorded in the
wrong year. In this case, you are to determine the effects of various cutoff misstatements relating to recording
cash receipts received on accounts receivable and the recording of credit sales. To effectively consider the
effects of an improper cutoff, it is helpful to consider the underlying journal entries:

An example of a possible improper cutoff is to “close” the cash receipts journal on December 30 and include
December 31 sales in the subsequent year (e.g., the entry is dated January 1 rather than December 31). As a
result, cash is understated by $3,000, while accounts receivable is overstated by $3,000 for the year just ended.
The effects of closing the sales journal depend upon whether a periodic inventory or perpetual inventory system
is in use. The effects of “leaving open” journals past year-end and dating January entries as of December may
be determined in a similar manner.
Required:Assume that the client made the following actual credit sales and
received cash receipts as follows after 12/29/20X8:

Determine the overstatements and understatements that would result from the following situations. Assume that
each situation is independent of one another. As an illustration, situation 1 has been solved for you. To simplify
the problem, in the case of a perpetual inventory, assume that the year-end inventory count did not identify and
correct the misstatement(s).
CASE Cash Acct. Rec. Inventory CGS Sales Income

1. Zhang Inc. left the cash receipts $2,500 (o) $2,500 (u)
journal open after year-end for an
extra day and included January 1
cash receipts in the December 31
totals. Periodic inventory. What
effect would this have on 20X8?
2. Zhang Inc. closed the cash receipts $7,000 (u) $7,000 (o)
journal at 12/29 and reported the
last two days cash receipts in
January of 20X9. Periodic
inventory. What effect would this
have on 20X8?
3. Zhang Inc. left the sales journal $3,500 (o) $3,500 (o) $3,500 (o)
open after year-end for an extra day
and included January 1 sales in the
December 31 totals. Periodic
Inventory. What effect would this
have on 20X8?
4. Same as 3, but perpetual inventory. $3,500 (o) $2,200 (u) $2,200 (o) $3,500 (o) $1,300 (o)

5. Zhang Inc. closed the sales journal $3,000 (u) $1,900 (o) $1,900 (u) $3,000 (u) $1,100 (u)
at 12/29 and reported the two last
day's sales in January of 20X9.
Perpetual inventory. What effect
would this have on 20X8?
6. Zhang Inc. left both the sales $5,700 (o) $5,700 (u) $7,500 (o) $7,500 (o)
journal and the cash receipts journal $7,500 (o)
open through January 2 and
reported the first two days
transactions in December of 20X8.
Periodic Inventory. What effect
would this have on 20X8?