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Upon completion of this lesson, candidates should be able to:

Be familiar with the content of the standard bank confirmation form.

Verify the appropriateness of each of the items on an entity's bank reconciliation, supporting the entity's
reported cash balance.

Understand what is meant by the term kiting and how the auditor might address this issue.

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Study Guide

1. Review the Client's Bank Reconciliation for Each Cash Account

1. Request a cutoff bank statement approximately 10 days after year-end, to test the reconciling items on
the year-end bank reconciliation. (This request must come from management to the entity's financial
institution to provide information directly to the entity's auditors.)
1. Deposits in-transit—Verify that items listed as deposits in transit on the bank reconciliation have
been processed as deposits on the cutoff bank statement (testing for existence/occurrence
regarding the validity of those reconciling items); these should appear in chronological order on
the cutoff bank statement.
2. Outstanding checks—Look for checks processed with the cutoff bank statement and having a date
prior to year-end; trace those items to the client's list of outstanding checks for completeness.
(Note that checks outstanding at year-end will not necessarily clear the bank in order or within
the period encompassed by the cutoff bank statement.)
2. Confirm directly with the bank the balance according to the bank statement (usually confirm two
separate bank-related matters: (1) cash balances with emphasis on the existence assertion; and (2)
liabilities to the bank with emphasis on the completeness assertion)—Note that such evidence obtained
from independent sources outside the client organization is viewed as very reliable evidence.

Sample Bank Reconciliation As of 12/31/X1:

Balance per bank @ 12/31/X1 $Xa
Add: Deposits in transit  Xb
Less: Outstanding checks (X)c
Adjusted balance as of 12/31/X1 $X
Balance per books @ 12/31/X1  Xd
Add: Credits directly by bank (e.g., interest)  Xe
Less: Charges by bank (service charges, etc.) (X)e
Adjusted balance as of 12/31/X1 $X
Legend:

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2. Multiple Checking Accounts with Transfers Among Them

1. Prepare a schedule of interbank (or intercompany) transfers to verify that both sides of the transfer are
properly accounted for (i.e., verify that the cash receipts journal and the cash disbursements journal
both reflect the transfer in the same proper period) and to detect any kiting.
2. Kiting is an overstatement of the true cash balance at year-end caused by recording the receipt, while
failing to record the disbursement, associated with a transfer between cash accounts. (Note that
recording the disbursement, while failing to record the receipt part of a transfer between cash accounts
would result in a misstatement—however, it would be an understatement of the cash balance and,
therefore, would be inconsistent with kiting, which results specifically in an overstatement.)

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3. If Fraud (Misappropriation) Is Suspected—The auditor may prepare a proof of cash. This compares the
beginning balance per the bank plus deposits minus checks clearing the bank versus the beginning balance
per the books plus receipts minus disbursements according to the books.
4. Petty Cash—May count cash on hand at the client's request. (If the auditor chooses to perform any specific
audit procedures for an immaterial account, such as petty cash, analytical procedures are usually sufficient,
such as simply comparing the current year's general ledger balance to the prior year's general ledger
balance.)
5. Inquire of Management—About any restrictions on cash balances. If there is a minimum balance requirement
for cash, then that restriction should be disclosed.

Note
The management representations letter usually addresses any compensating balances (minimum balance
requirements) that constitute a restriction on spendable cash. (The usual management representations
comment that addresses all general restrictions on the entity's rights to its assets is: “The company has
satisfactory title to all owned assets, and there are no liens or encumbrances on such assets nor has any
asset been pledged as collateral.”)

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Notes

You haven’t made any notes or highlights yet.

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Flashcards

1
What is the schedule of It is used to verify that transfers between
the entity's bank accounts are recorded
interbank transfers used for? properly (and to detect kiting, which
overstates the cash balance).

2
What is meant by the term An overstatement of the true cash balance
at year-end caused by recording the receipt
“kiting”? while failing to record the disbursement
associated with a transfer between the
entity's cash accounts.

3
What does the proof of cash The beginning balance per the bank plus
deposits minus checks clearing the bank
compare? versus the beginning balance per the books
plus receipts minus disbursements
according to the books

4
What is the purpose of a bank To verify the existence and ownership
confirmation? of bank accounts
To provide evidence about the
completeness and terms of notes
payable with the bank

5
What is meant by the term It is a short-period bank statement obtained
directly from the bank (normally for a 10-
“cutoff bank statement”? day period) useful in verifying the deposits
in transit and providing some (usually
partial) evidence about outstanding checks
on a bank reconciliation.

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6
Review and test the entity's bank
reconciliations.
Prepare and test a schedule of
List some typical audit interbank transfers if there are
procedures applicable to cash multiple bank accounts with transfers
among them.
accounts. Prepare proof of cash if fraud is
suspected.
Count petty cash (but usually do not
do so due to its immateriality).
Inquire about minimum balance
requirements on bank accounts.

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Slides

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Knowledge Checks

Question 1 (PQ1036)

The auditor will most likely prepare a "proof of cash" when misappropriation of cash is suspected.
True
False

Question 2 (PQ1034)

The bank cutoff statement ordinarily enables the auditor to verify all of the outstanding checks and some of the
deposits in transit.
True
False

Question 3 (PQ1033)

The primary purpose of requesting a bank cutoff statement is to test the items on a client's bank reconciliation
supporting the recorded cash balance.
True
False

Question 4 (PQ1037)

To identify restrictions on cash balances, the auditor makes an appropriate inquiry of management, and
management's response is usually documented in the management representations letter.
True
False

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Supplementary Questions

Question 1 (EVID-0054B)
To gather evidence regarding the balance per bank in a bank reconciliation, an auditor would examine all of the
following except
Cutoff bank statement.
Year-end bank statement.
Bank confirmation.
General ledger.

Question 2 (EVID-0056B)
A cash shortage may be concealed by transporting funds from one location to another or by converting negotiable
assets to cash. Because of this, which of the following is vital?
Simultaneous confirmations.
Simultaneous bank reconciliations.
Simultaneous verification.
Simultaneous surprise cash count.

Question 3 (EVID-0051B)

The information below was taken from the bank transfer schedule prepared during the audit of Fox Co.'s financial
statements for the year ended December 31, 2005. Assume all checks are dated and issued on December 30, 20X5.

Bank accounts Disbursement date Receipt date

Check Per Per Per Per

no. From To books bank books bank

101 National Federal Dec. 30 Jan. 4 Dec. 30 Jan. 3
202 County State Jan. 3 Jan. 2 Dec. 30 Dec. 31
303 Federal American Dec. 31 Jan. 3 Jan. 2 Jan. 2
404 State Republic Jan. 2 Jan. 2 Jan. 2 Dec. 31

Which of the following checks might indicate kiting?

#101 and #303.

#202 and #404.
#101 and #404.
#202 and #303.

Question 4 (EVID-0055B)

Which of the following cash transfers results in a misstatement of cash at December 31, 2005?

Bank Transfer Schedule

Disbursement Receipt
Transfer Recorded Paid by Recorded Received

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in books bank in books by bank

a. 12/31/X5 1/4/X6 12/31/X5 12/31/X5
b. 1/4/X6 1/5/X6 12/31/X5 1/4/X6
c. 12/31/X5 1/5/X6 12/31/X5 1/4/X6
d. 1/4/X6 1/11/X6 1/4/X6 1/4/X6

a.
b.
c.
d.

Question 5 (EVID-0059B)

Miles Company
BANK TRANSFER SCHEDULE
December 31, 2005
Check Bank accounts Date disbursed per Date deposited per
no. From To Amount Books Bank Books Bank
2020 1st Natl. Suburban $32,000 12/31 1/5# 12/31 1/3@
2021 1st Natl. Capital 21,000 12/31 1/4# 12/31 1/3@
3217 2nd State Suburban 6,700 1/3 1/5 1/3 1/6
0659 Midtown Suburban 5,500 12/30 1/5# 12/30 1/3@

The tick mark # most likely indicates that the amount was traced to the

December cash disbursements journal.

Outstanding check list of the applicable bank reconciliation.
January cash disbursements journal.
Year-end bank confirmations.

Question 6 (EVID-0053B)
An auditor should trace bank transfers for the last part of the audit period and first part of the subsequent period to
detect whether
The cash receipts journal was held open for a few days after the year-end.
The last checks recorded before the year-end were actually mailed by the year-end.
Cash balances were overstated because of kiting.
Any unusual payments to or receipts from related parties occurred.

Question 7 (EVID-0060B)

Miles Company
BANK TRANSFER SCHEDULE
December 31, 2005
Check Bank accounts Date disbursed per Date deposited per
no. From To Amount Books Bank Books Bank
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no. From To Amount Books Bank Books Bank
2020 1st Natl. Suburban $32,000 12/31 1/5# 12/31 1/3@
2021 1st Natl. Capital 21,000 12/31 1/4# 12/31 1/3@
3217 2nd State Suburban 6,700 1/3 1/5 1/3 1/6
0659 Midtown Suburban 5,500 12/30 1/5# 12/30 1/3@

The tick mark @ most likely indicates that the amount was traced to the

Deposits in transit of the applicable bank reconciliation.

December cash receipts journal.
January cash receipts journal.
Year-end bank confirmations.

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