MODULE 1: Audit of Cash

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The course reviews
internal controls, and
tests of controls in each
accounting
Learningelement andAt the end of the topic the learner will be able to:
Objectives:
transaction cycle. Each
 Apply
discussion thetake
will also GAAP on cash.
up the substantive tests
 Identify, explain and relate specific audit objectives, procedures
to be used to determine
and internal control measures pertaining to cash.
the material
misstatement
 Audit tocash
be
reported. This course
requires the students to
have mastery of the
financial accounting
process and standards
of reporting. The course
also includes the audit
of
assets excluding cash.z

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 What is Cash?

Cash includes money and other negotiable instrument that is payable in money
and accepted by the bank for deposit and immediate credit . It includes cash on
hand, demand deposits and other items that are unrestricted for use of current
operations.

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Cash

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Cash

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 What is Cash Equivalents?

Cash equivalents are short-term and highly liquid investments that are readily
convertible into cash and so near their maturity that they present insignificant risk
of changes in value because of changes in interest rates. [PAS 7.6] Items that may
qualify as cash equivalents include the following:

1. Time deposit
2. Money market instrument or commercial paper
3. Treasury bills, treasury notes and treasury bonds
4. Redeemable preference shares with mandatory redemption period.

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 Importance of Audit Cash and Cash Equivalents
The audit of cash is considered an important part of an audit mainly due to these
following reasons:

• 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.
• Cash is the highly liquid asset in a company and it is an area of high inherent risk
since there is a relatively high risk of misappropriation
• Liabilities, revenues, expenses and most other assets flow through the cash
account
• Cash is the most liquid of assets, thus the most susceptible to theft, embezzlement,
and misappropriation
• Errors in cash accounts may indicate errors elsewhere

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Audit Objectives

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 Internal Control over Cash Transactions

Ideally, the functions of the finance and accounting departments should provide
assurance that:

• All cash that should have been received was in fact received, recorded accurately, and
deposited promptly
• Cash disbursements have been made only for authorized purposes and have been
properly recorded
• Cash balances are maintained at adequate, but not excessive, levels by forecasting
expected cash receipts and payments related to normal operations

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 Internal Control over Cash Transactions

To avoid the likelihoods of the material misstatement, the entity would:

• Not permit any one employee to handle a transaction from beginning to end
• Separate cash handling from record keeping
• Centralize receiving of cash as much as possible
• Record cash receipts immediately
• Encourage customers to obtain receipts and observe cash register totals
• Deposit each day’s cash receipts intact
• Make all disbursements by check, with the exception of small expenditures from
petty cash
• Have monthly bank reconciliations prepared by employees not responsible for the
issuance of checks or custody of cash. The completed reconciliation should be
reviewed promptly by an appropriate officer.

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 Audit Working Paper for Cash

1. Lead schedule
2. Cash count sheets
3. Bank reconciliations
4. Proof of cash
5. Lists of outstanding checks
6. Lists of checks being investigated
7. Bank transfer schedule
8. Bank confirmations
9. Recommendations to the client for improving internal control, and
10. Notes concerning proper presentation of cash in the client’s balance sheet

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 Audit Procedures for Cash

Existence or Occurrence
• Count all cash on hand simultaneously
• Follow up subsequent dispositions of items included in the count
• Obtain or prepare reconciliations of bank accounts as of the balance sheet date
• Trace all bank transfers for the last week of the audit year and the first week of the
following year
• Confirm bank deposit and loan balances and other arrangements with bank

Valuation
• Trace a sample of entries in the Cash Receipts Journal to the Accounts Receivable
subsidiary ledgers, bank validated deposit slips and general ledger

Presentation and Disclosure

• Determine proper financial statement presentation and disclosure of cash

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 Substantive Testing—Cash and Cash Equivalents

Obtaining Analyses of Cash Balances and Reconcile them to the General Ledger

The auditor will obtain a schedule (lead schedule) that lists all of the client’s cash
account. This schedule will typically list the bank, the account number and other
relevant information, and the year- end balance per books. This list will also include
cash on hand and the sources of this cash on hand. The auditor will trace and reconcile
all the accounts to the general ledger as necessary

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 Substantive Testing—Cash and Cash Equivalents

Cash Count

Steps in Cash Count Problems

1. Identify the accountability:

a. If petty cash fund, the accountability is the imprest balance per general
ledger.
b. If undeposited collections, the accountability is total undeposited collections
per books/records adjusted further for any unrecorded collections (based on
the additional information of the problem.
*If there is no direct information about collections per records, the accountability is
collections per Official Receipts, Cash receipts voucher or other documents evidencing
collections.

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 Substantive Testing—Cash and Cash Equivalents

c. Other collections (e.g. return of expense advance, collection for charities, or

any other purposes not in tact and assumed to have been included among
currencies. If the said collections for any other purpose is in tact, the same
shall be ignored in the cash count.

2.Identify valid supports to the accountability as presented in the problem

a. For petty cash fund, acceptable valid support shall include:

-Bills and coins, replenishment check, encashable Accommodated checks
(valid cash item)
-Unreplenished petty cash expense vouchers (adjusted to expense
account)
-Employee IOU (adjusted to receivables)
-Postdated/NSF checks
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 Substantive Testing—Cash and Cash Equivalents

*unused postage is not a valid support where the accountability is the petty cash fund
*return of an expense advances (e.g. excess from travel advance) is added to the
accountability and not added to valid supports.

b. For undeposited collections

-Bills and coins
-Depositable customer collections checks as of the count date (Post dated,

stale, or NSF checks as of the count date are not included as valid collection,
thus should not be included as valid support)
-Copies of expense vouchers evidencing the use of the collection to pay
certain expenses
-Unused postage stamps (valid support where accountability is undeposited
collections)

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 Typical substantive audit procedures for cash
1. Review disclosures for compliance with generally accepted accounting principles.

2. Inquire of management concerning compensating balance requirements and

restrictions on cash. A compensating balance is an account with a bank in which a
company has agreed to maintain a specified minimum amount; compensating
balances are typically required under the terms of bank loan agreements. Such
restrictions on cash, when material, should be disclosed in the financial statements.

3. Send confirmation letters to financial institutions to verify existence of the amounts on

deposit.

4. Count cash on hand at year-end to verify its existence.

5. Prepare a bank transfer schedule for the last week of the audit year and the first week of
the following year to disclose misstatements of cash balances resulting from kiting.

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 Typical substantive audit procedures for cash
6. Review the cutoff of cash receipts and cash disbursements around year-end to verify that
transactions affecting cash are recorded accurately and in the proper period.

7. Review bank statements to verify that book balances represent amounts to which the client has
rights.

8. Perform analytical procedures to test the reasonableness of cash balances. Tests here may
include comparisons to prior year cash balances. These procedures help verify the existence and
completeness as well as the accuracy of cash transactions.

9. Review year-end bank reconciliations to verify that cash has been properly stated as of year-
end.

10. Obtain a bank cutoff statement to verify whether the reconciling items on the year-end bank
reconciliation have been properly reflected.

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 Typical substantive audit procedures for cash
11. Foot summary schedules of cash and agree their total to the amount which will appear on the
financial statements.

12. Reconcile summary schedules of cash to the general ledger.

13. Test translation of any foreign currencies.

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 Special audit considerations for cash

(1) Kiting
Kiting is a form of fraud that overstates cash by causing it to be simultaneously included in two or more bank accounts.
Kiting is possible because a check takes several days to clear the bank on which it is drawn (the “float period”). Following is
an example of how kiting can be used to conceal a prior embezzlement in a company that has two bank accounts (one in
Valley State Bank and one in First City Bank).

Date Situation
12/15 Bookkeeper writes himself a P10,000 check on the Valley account, and cashes it, no journal entry is made
12/16 Bookkeeper loses the money gambling in Bullhead City
12/31 Bookkeeper, fearing the auditors will detect the fraud, conceals the shortage by

a. Writing a P10,000 unrecorded check on First City account and depositing it in the Valley account. This will cover up the
shortage because Valley will credit the account for the P10,000, and the check will not clear the First City account until
January, no journal entry is made until after year end.
b. When the First City bank reconciliation is prepared at 12/31, the check is not listed as outstanding.

Kiting may be detected by preparing a bank transfer schedule, by preparing a four-column bank reconciliation for the Valley
account, or by obtaining a cutoff statement for the First City account.

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 Special audit considerations for cash

2. Bank transfer schedule . A bank transfer schedule shows the dates of all transfers of cash among the client’s various bank
accounts. Know that its primary purpose is to help auditors to detect kiting. The schedule is prepared by using bank
statements for the periods before and after year-end and by using the firm’s cash receipts and disbursements journals.

3. Bank reconciliations . Auditors generally prepare either a two- or a four-column bank reconciliation for
the difference between the cash per bank and per books. The four-column approach (also called a proof of cash) will allow
the auditor to reconcile

a. All cash receipts and disbursements recorded on the books to those on the bank statement and
b. All deposits and disbursements recorded on the bank statement to the books.

A four-column reconciliation will not allow the auditor to verify whether

a. Checks written have been for the wrong amounts and so recorded on both the books and the bank statement
and
b. Unrecorded checks or deposits exist that have not cleared the bank.

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 Special audit considerations for cash

4. Bank cutoff statements . A cutoff statement is a bank statement for the first 8-10 business days after yearend. Know that its
primary purpose is to help auditors to verify reconciling items on the year-end bank reconciliation. Tests performed using a
cutoff statement include verifying that outstanding checks have been completely and accurately recorded as of year-end, and
that deposits in transit have cleared within a reason able period. The statement is sent directly by the bank to the auditor.

In the above kiting example, the cutoff statement for the First City account will allow the auditor to detect the fraud since it
will include the December 31 unrecorded check.

5. Standard confirmation form . Auditors use a standard form to obtain information from financial institutions (Standard Form
to Confirm Account Balance Information with Financial Institutions). The form requests information on two types of balances
—deposits and loans . The form requests financial institutions to indicate any exceptions to the information noted, and to
confirm any additional account or loan balance information that comes to their attention while completing the form. Know
that the form is designed to substantiate evidence primarily on the existence assertion, and not to discover or provide
assurance about accounts not listed on the form (evidence on the completeness assertion is not elicited).

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 Exercise
Identify the audit procedures performed.

1. Stand by the payroll time clock to determine whether an employee clocks in just once.
2. Compare the gross profit percentage for the current year with the historical trend.
3. Examine duplicate sales invoices to determine whether an appropriate employee checked
prices and extensions and initiated the work as required by company.
4. Read the minutes of board meetings of the past year.
5. Obtain a letter from management stating that it made all books and records available to the
auditor.
6. Total the accounts receivable subsidiary ledger to determine whether it agrees with the general
ledger.
7. Inspect the year-end bank reconciliation to determine whether the internal auditor prepared it.
8. Confirm an accounts receivable balance.

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 Exercise
Identify the assertion that each of the following auditing procedures would test.

a. Prepare a proof of cash.

b. Foot the client-prepared bank reconciliation.
c. Trace each of the outstanding checks on the year-end bank reconciliation to the cut-off bank
statement.
d. Count all cash on hand.
e. Compare the date on checks dated on or shortly before year-end with the date of bank cancelled
the check.
f. Review minutes of the board of directors’ meetings for any restrictions placed on cash balances.
g. Investigate all material checks listed on the year-end reconciliation but not returned with the cut-
off bank statement. Valuation
h. Trace the balance on the bank reconciliation to the confirmation received directly from the bank.
Completeness

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 Problem Exercise 1

The following are the cash balances of LEONOR, INC. at December 31, 2020:

Undeposited collections (in currency and coins) P40,200

Current account – unrestricted 620,000

Checks written and recorded in December 2010

but are to be released to the Payees in January 2011 130,000

Restricted time deposits (expected use in June 2011) 2,000,000

Leonor, Inc. has agreed to maintain a P200,000 compensating balance in its unrestricted current account in accordance
with the loan covenant.

How much should Leonor, Inc. report as ash on its December 31, 2020, statement of financial position?

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 Problem Exercise 2
The accountant of SANTIAGO COMPANY is in the process of preparing the company’s financial statements for the year ended
December 31, 2020. He is trying to determine the correct balance of cash and cash equivalents to be reported as a current asset on
the statement of financial position. The following items are being considered:

• Balances in the company’s accounts at the Metropolitan Bank:

➢Current account P81,000
➢Savings account P132,600

• Undeposited customer checks of P22,200 (including a customer check dated January 2, 2021 or P3,000).
• Currency and coins on hand of P3,480
• Savings account at the Northern Philippines Bank with a balance of P2,400,000. This account is being used to accumulate
cash for future plant expansion (in 2021).
• Petty cash of P4,000 (currency of P1,200 and unreplenished vouches for P2,800).
• P120,000 in a current account at the Northern Philippines Bank. This represents a 20% compensating balance for P600,000 loan
with the bank. Santiago company is legally restricted to withdraw the funds until the loan is due in 2023.
• Treasury bills:
Two-month maturity bills P90,000
Seven-month bills 120,000
• Time Deposit - P100,000

What is the correct balance of cash and cash equivalents to be reported in the current assets section of the statement of financial
position?

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 Problem Exercise 3

On January 1, 2020, JERVS COMPANY established a petty cash fund of P10,000. On December 31, 2020, the petty cash
fund was examined and found to have receipts and the documents for miscellaneous general expenses amounting to
P8,120. In addition, there was cash amounting to P1,500.

What is the amount of petty cash shortage or overage?

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 Problem Exercise 4

The information below relates to CHARMAINE COMPANY’s cash in bank:

Balance per bank statement, December 31, 2020 P27,910

Collections recorded but not yet deposited in bank 1,950
NSF check – not recorded on books nor redeposited 2,000
Bank charges not recorded 40
Note collected by bank and not recorded on books 2,800
Outstanding checks 3,000

The cash balance in the books of Charmaine Company on December 31, 2020 is:

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 Comprehensive
EDGARDO CO. was organized on January 2, 2020. The following items are from the company’s trial balance
on December 31,2020.

Ordinary share capital P1,500,000

Share premium 150,000
Merchandise inventory 69,000
Land 1,000,000
Building 1,400,000
Furniture and Fixtures 367,000
Accounts Receivable 165,000
Accounts Payable 389,650
Notes- payable Bank 500,000
Sales 6,235,200
Operating Expenses ( including depreciation of 400,000) 1,005,150

Additional information is as follows:

1. Deposit in transit, December 31 P364,000
2. Service charge for December 2,000
3. Outstanding checks, December 31 475,000
4. Bank Balance, December 31 892,000
5. Edgardo Co.’s mark up on sales is 30%

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 Comprehensive
1. What is the total collection from sales?
2. What is the total payments for merchandise purchases?
3. What is the total cash receipts per books?
4. What is the total cash disbursement per books?
5. What is the cash balance per books on December 31?
6. What is the adjusted cash balance on December 31?

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 REFERENCES/TEXTBOOK/LINKS

• Applied Auditing by Asuncion, Ngina, and Escala

• Applied Auditing by Cabrera, Elenita

• Auditing Problems by Roque, Gerardo

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Any Questions

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