This page covers auditing cash and financial instruments including bank confirmation, cutoff for sales, bank reconciliation, and substantive testing.
Auditing of cash and financial instruments
Audit of Cash Bank Confirmation Bank Reconciliation Cutoff Statement
Auditing Cash Fraud Oriented Procedures
Auditing Financial Instruments Accounts
Example: Check Kiting
Example: Auditing Cash Cycle
The appropriate tests for the ending balance in the cash accounts depend heavily on the initial assessment of control risk, tests of controls, and substantive tests of transactions for cash disbursements. The company’s controls over cash disbursements assist the auditor in determining that cash disbursed is for approved company purposes, that cash disbursements are promptly recorded in the proper amount, and that cash cutoff at year-end is proper. If the results of the evaluation of internal control, the tests of controls, and the substantive tests of transactions are adequate, it is appropriate to reduce the tests of details of balances for cash, especially for the detailed tests of bank reconciliations. On the other hand, if the tests indicate that the client’s controls are inadequate, extensive year-end testing may be necessary.
An example in which the conclusions reached about the controls in cash disbursements would affect the tests of cash balances would be:
If controls over the issuance of blank checks, the review of payees, amounts, and supporting documentation, the signing of checks, and the reconciliation of bank statements and vendors’ statements are adequate, the auditor’s review of outstanding checks on the year-end bank reconciliation may be greatly reduced. The year-end outstanding checks can be verified by testing a sample of checks returned with the cutoff bank statement rather than tracing all paid outstanding checks and the final monthly checks in the cash disbursements journal to the last month’s cleared checks and the bank reconciliation.
The monthly reconciliation of bank accounts by an independent person is an important internal control over cash balances because it provides an opportunity for an internal verification of the cash receipts and cash disbursements transactions, investigation of reconciling items on the bank reconciliation, and the verification of the ending cash balance. Anyone responsible for the following duties would not be considered independent for the purposes of preparing monthly bank reconciliations:
- Issuance of checks
- Receipt and deposit of cash
- Other handling of cash
- Record keeping
Bank confirmations differ from positive confirmations of accounts receivable in that bank confirmations request several specific items of information:
- The balances in all bank accounts.
- Restrictions on withdrawals.
- The interest rate on interest-bearing accounts.
- Information on liabilities to the bank for notes, mortgages, or other debt.
Positive confirmations of accounts receivable request the customer to confirm an account balance stated on the confirmation form or designate a different amount with an explanation. The auditor anticipates few exceptions to accounts receivable confirmations, whereas with bank confirmations he expects differences between the balance per bank and balance per the books that the client must reconcile. Bank confirmations should be requested for all bank accounts, but positive confirmations of accounts receivable are normally requested only for a sample of accounts. If bank confirmations are not returned, they must be pursued until the auditor is satisfied as to what the requested information is. If positive confirmations of accounts receivable are not returned, second and maybe third requests may be made, but thereafter, follow-ups are not likely to be pursued. Alternative procedures, such as examination of subsequent payments or other support of customers’ accounts may then be used.
A cutoff bank statement is a partial period bank statement with the related cancelled checks, duplicate deposit slips, and other documents included in bank statements, which is mailed by the bank directly to the auditor. Rather than mailing the cutoff statement, the bank may provide direct electronic access to the auditor to allow the auditor to review transactions through a certain date. The purpose of the cutoff bank statement is to verify the reconciling items on the client’s year-end reconciliation with evidence that is inaccessible to the client.
Auditors are usually less concerned about the client’s cash receipts cutoff than the cutoff for sales, because the cutoff of cash receipts affects only cash and accounts receivable and not the income statement, whereas a misstatement in the cutoff of sales affects accounts receivable and the income statement.
For the purpose of detecting a cash receipt cutoff misstatement, there are two useful audit procedures. The first is to trace the deposits in transit to the cutoff bank statement to determine the date they were deposited in the bank account. Because the recorded cash will have to be included as deposits in transit on the bank reconciliation, the auditor can test for the number of days it took for the in-transit items to be deposited. If there is more than a two- or three-day delay between the balance sheet date and the subsequent deposit of all deposits in transit, there is an indication of a cutoff misstatement. The second audit procedure requires being on the premises at the balance sheet date and counting all cash and checks on hand and recording the amount in the audit files. When the bank reconciliation is tested, the auditor can then check whether the deposits in transit equal the amount recorded.