AUDIT OF CASH AND CASH EQUIVALENTS, PART 1

LESSON 1: IMPORTANCE OF CASH AUDIT

Cash is inherently risky. Its nature and size give it a very high degree of risk in terms of theft and fraud. Because of its
susceptibility of manipulation, the auditors devote more time in testing this account than other assets. Almost all business
transactions will be ultimately settled through the cash accounts, the audit of cash accounts also assists in the verification
of other asset and liability accounts as well as revenue and expenses.
A cash audit is a review of cash transactions between an identified start date and end date in accordance with the generally
accepted procedures of accounting. We audit cash to ensure proper documentation of cash received or disbursed and to
establish that the cash balance and deposits are accurate. We need to make sure that no material amount of cash has been
unauthorizedly used.
LESSON 2: DIRECTIONAL RISK FOR CASH
What is directional risk? This is the much probable situation that our client wants its stakeholders to see. A client might
desire an overstatement of assets and an understatement of liabilities since it makes the financial statements appear healthier.
The directional risk for cash is overstatement. Client normally would not want the stakeholders to see that they have shortage
of cash, because that would tantamount to inability to give dividends and pay creditors, failure to collect from debtors, and
the likes.
So, in performing your audit procedures, practice your professional skepticism. You should be able to do your job with
questioning mind. Understand the environment by knowing whether the client has sound internal control over cash, or none.
Sample Situation
The staff having access to cash think they are being paid too low (motivation). Cash is physically available to employees
(opportunity). And top management takes cash without proper recording of transactions (rationalization). In this case, the
control risk is very high, thus, you as auditor should perform more substantive tests (risk-based auditing).
As auditor, we must know that the goals of our client in handling cash should be to:
• Account for all cash transactions accurately so that correct information is available regarding cash flows and
balances.
• Make certain that enough cash is available to pay bills as they come due.
• Avoid holding too much idle cash because excess cash could be invested to generate income, such as interest.
• Prevent loss of cash due to theft or fraud.
In order to achieve these goals, common internal controls over cash receipts include the following:
• Prepare a record of all cash receipts as soon as cash is received. Most thefts of cash occur before a record is made
of the receipt. Once a record is made, it is easier to trace a theft.
• Deposit all cash receipts intact as soon as feasible, preferably on the day they are received or on the next business
day. Undeposited cash is more susceptible to misappropriation.
• Arrange duties so that the employee who handles cash receipts does not record the receipts in the accounting records.
This control feature follows the general principle of segregation of duties.
• Arrange duties so that the employee who receives the cash does not disburse the cash. This control measure is
possible in all but the smallest companies.
Common internal controls over cash disbursements include the following:
• Make all disbursements by check or from petty cash. Obtain proper approval for all disbursements and create a
permanent record of each disbursement. Many retail stores make refunds for returned merchandise from the cash register.
When this practice is followed, clerks should have refund tickets approved by a supervisor before refunding cash.
• Require all checks to be serially numbered and limit access to checks to employees authorized to write checks.
• Require two signatures on each check over a material amount so that one person cannot withdraw funds from the
bank account.
• Arrange duties so that the employee who authorizes payment of a bill does not sign checks.
Otherwise, the checks could be written to friends in payment of fictitious invoices.
• Require approved documents to support all checks issued.
• Instruct the employee authorizing cash disbursements to make certain that payment is for a legitimate purpose is
made out for the exact amount and to the proper party.
• Stamp the supporting documents paid when liabilities are paid and indicate the date and number of the check issued.
These procedures lessen the chance of paying the same debt more than once.
• Arrange duties so that those employees who sign checks neither have access to canceled checks nor prepare the
bank reconciliation. This policy makes it more difficult for an employee to conceal a theft.
• Have an employee who has no other cash duties prepare the bank reconciliation each month, so that errors and
shortages can be discovered quickly.
• Void all checks incorrectly prepared. Mark these checks void and retain them to prevent unauthorized use.
Sample Cash Control Deficiencies
In smaller entities, it is common to have the following control deficiencies:
One person receives and/or disburses money, records those transactions in the general ledger, and reconciles the related
bank accounts. The person performing the bank reconciliation does not possess the skill to perform the duty. Bank
reconciliations are not timely performed.

In these situations, the person may get money from customer, for example, and does not record the receipt, and just use the
money for personal use.
Did you know?
The cheapest and easiest internal control test is by involving the public. If a company requires all transactions be entered
in the cash register, the company can do a “promotion” that will verify employees are following this. The promotions would
be like “If you receipt has a red star on the back, get a free cookie” or “If you do not get a receipt, receive a free drink”.
Sound familiar? The public is now looking for a receipt for each transaction and will ask if they don’t receive it. The
benefit of finding theft will outweigh the cost of giving away a little free food. (Source: https://courses.lumenlearning.com)