APPLIED AUDITING MODULE

SCHOOL OF ACCOUNTANCY

MODULE 2
AUDIT OF CASH AND CASH EQUIVALENTS, PART 1

OVERVIEW:
This module will serve as an introduction to the audit of cash and cash equivalents. This module shall give
you the basic knowledge in internal control system for cash accounts. This way, we will know what are the
control deficiencies of client under audit, that will help us decide whether to rely on their control or not.

KNOWLEDGE REQUIRED:
This module requires knowledge in the information systems and related cycles, such as revenue and
collection cycles; and familiarity with the different assertions made by the client.

LEARNING OBJECTIVES
After studying this module, you should be able to:
1. Know the importance of auditing cash and cash equivalents
2. Know the directional risk of cash
3. Review the common internal controls applied for cash transactions

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

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APPLIED AUDITING MODULE
SCHOOL OF ACCOUNTANCY

(rationalization). In this case, the control risk is very high, thus, you as auditor should perform more
substantive tests (risk-based auditing).

LESSON 3: INTERNAL CONTROL SYSTEM FOR CASH

In order to audit cash properly, we must be familiar with the cash receipts and disbursement cycles.
Through these cycles, we will learn whether our client has sound internal control or not.

Source:
Accounting Information
Systems by James A. Hall

Source:
Accounting Information
Systems by James A. Hall

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APPLIED AUDITING MODULE
SCHOOL OF ACCOUNTANCY

Refresh your knowledge with these cycles by reading the Accounting Information Systems book by James
A. Hall or Applied Auditing book by Ma. Elenita Cabrera

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:

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APPLIED AUDITING MODULE
SCHOOL OF ACCOUNTANCY

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.

You may watch a video at https://www.youtube.com/watch?v=jjykI2-FXko#action=share for a more

creative way of presentation . (When your means permit you do so )

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)

ACTIVITY SECTION

ACTIVITY 1:
Provide the document that corresponds with the following:
1. The document which is used to permit the immediate deposit of cash and to improve the control
over the custody of assets is the __________________________.
2. The document which accompanies the customer’s payments is the ________________________.
3. The request of payment by the customer for goods sold or services provided by the seller.
___________________
4. A ___________________ is the official notice from a business or a bank that documents a refund.
5. A ___________________ on a bank statement refers to a deduction from the bank account's
balance. In other words, a debit memo has the same effect as a check written on the bank account.
6. Once the customer has paid their bill, the supplier can issue a/an _________________________.
7. When a customer pays by cheque or cash, the seller will write a _______________________which
will be taken to the bank and presented together with the cheques and cash.

ACTIVITY 2: FILL IN THE BLANKS

Each month, the company receives from the bank a _______________ _______________ showing
its bank transactions and balances. For example, the statement shows _______________ paid and other
_______________ that reduce the balance in the depositor's account, _______________ and other
_______________ that increase the balance in the depositor's account, and the _______________
_______________ after each day's transactions. Remember that the bank statements are prepared from
the _______________ perspective. Therefore, every deposit received by the bank is _______________ to
the customer's account. The reverse occurs when the bank "pays" a check issued by a company on its
checking account balance: Payment _______________ the bank's liability and is therefore
_______________ to the customer's account with the bank. All paid checks are listed in _______________
_______________ on the bank statement along with the _______________ the check was paid and its
_______________. Upon paying a check, the bank stamps the check "paid"; a paid check is sometimes

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APPLIED AUDITING MODULE
SCHOOL OF ACCOUNTANCY

referred to as a _______________ _______________. In addition, the bank includes with the bank
statement memoranda explaining other _______________ and _______________ made by the bank to
the depositor's account.
A _______________ _______________ is used by the bank when a previously deposited customer's check
"bounces" because of _______________ _______________. In such a case, the check is marked
_______________ (non-sufficient funds) by the customer's bank and is returned to the _______________
bank. The bank then _______________ (decreases) the depositor's account, as shown by the symbol NSF
on the bank statement and sends the NSF check and _______________ memorandum to the depositor as
notification of the charge.

EVALUATION

Which part of the discussion did you Which part of the discussion did you
find most enjoyable to learn? find most difficult?

Do you have question(s) in mind? Write it here

END OF MODULE 2

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