Cash and

Cash Equivalents
Substantive Tests of Details of Balances

Lecture No. 1
Auditing and Assurance: Concepts and Applications 2
2nd Semester, SY 2020-2021

Presented by Jerome D. Marquez

 1. Understand the internal controls

Learning over custody of cash.

2. Design and perform audit tests of
cash and bank balances.
Outcomes 3. Recognize the possible fraud and
errors of cash and bank balances.
4. Recognize the extended audit
procedures of the general cash
account to test further for material
fraud.
 Recap and Connecting Previous Lessons
Aud Prac, Part 1 Course Outline
TOPICS TIME FRAME Risk Response: Tests of Controls and Substantive
Overview of the Risk-Based Audit Process Tests of Transactions and Account Balances
Phase I – Risk Assessment: Preliminary
Engagement Activities, Planning the Audit and · Substantive Tests of Cash Week 7 - 9
Performance of Risk Assessment Procedures
Week 1 & 2
Phase II – Risk Response: Designing Overall
Responses and Further Audit Procedures · Substantive Tests of Sales and Trade Week 10 & 12
· Audit of the Revenue and Collection Cycle: Receivables
Tests of Control and Substantive Tests of
Transactions · Substantive Tests of Cost of Goods Sold and
Week 13 & 14
Trade Payables
Week 3 & 4
· Audit of the Expenditure Cycle: Tests of
Controls and Substantive Tests of
Transactions · Substantive Tests of Inventories Week 15 & 16

· Audit of the Production Cycle: Tests of

Controls and Substantive Tests of · Substantive Tests of Provisions, Accrued and
Transactions Week 17 & 18
Other Liabilities/Assets

· Audit of Financing and Investing Cycle:

Week 5 & 6
Tests of Controls and Substantive Tests of
Transactions

· The Application of Analytical Procedures

 Course Outline
Aud Prac, Part 2
TOPICS TIME FRAME
Risk Response: Tests of Controls and Substantive • Substantive Tests of Prepaid Expenses and
Tests of Transactions and Account Balances Deferred Charges
Week 11 &12
Week 1 - 3
• Substantive Tests of Cash
• Substantive Tests of Provisions, Accrued and
Week 13 & 14
Audit of Financing and Investing Cycle: Tests of Other Liabilities/Assets
Week 4
Controls and Substantive Tests of Transactions

• Substantive Tests of Owners’ Equity Accounts Week 15 & 16

• Substantive Tests of Investments
Week 5 & 6
• Substantive Tests of Accounts in the Statement
Week 17 & 18
of Profit or Loss and Comprehensive Income
• Substantive Tests of Property, Plant & Week 7 & 8
Equipment

Week 9 & 10
• Substantive Tests of Intangible Assets
Topic Outline
Importance of the Audit of Cash and Bank Balances

The audit of cash is considered an important part of an audit mainly due to two
reasons:
1. 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.

2. 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.
Assertions for auditing cash and bank balances
Internal Controls for Cash and Bank Balances

Unless the client’s business is a retail business which

involves significant amount of cash balances daily, the
cash balance is usually immaterial in most audit.

From a good internal control point of view, an imprest

petty cash fund is usually maintained. It is operated by
established a fixed amount of petty cash fund transferred
from the business’s general cash in bank account.

Cash is more susceptible to theft; therefore, there is high

inherent risk for the existence, completeness, and
accuracy objectives.
Internal Controls for Cash and Bank Balances

Control objectives Description

Existence ▪ Division of duties among custody, recording,

authorization and replenishing petty cash fund.

▪ Imprest petty cash fund system in existence to control

petty cash. (accuracy, existence and completeness)

▪ All disbursements should be authorized and claims be on

approved forms (occurrence).

▪ Independent cash counts on a regular and surprise basis.

Completeness ▪ Prenumbered petty cash vouchers should be used for

withdrawing cash from the fund and a limit should be
placed on the size of reimbursements.
Control activities for cheque receipts

1. Segregation of duties in the handling of cheque receipts and recording.

2. Immediate preparation of incoming cheque listing and endorsement of

incoming cheques.

3. Timely deposit of cheques, preferably on a daily basis.

4. Cash receipt journal vouchers prepared from cheque listing and pay-in
slips and approved by senior accounting staff before input into cash
book.

5. Periodic bank reconciliations prepared by an independent accounting

staff members.

6. Independent review of bank reconciliation.

(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures

Analytical procedures
Since cash does not have a predictable relationship with other financial
statement accounts because of its residual nature, therefore, the auditor’s use of
analytical procedures for auditing cash balances is limited to:

1. Compare with prior years’ cash balances and to budgeted amount.

2. Identify receipts of the next accounting period and investigate the long
outstanding cheques, determine whether they should be reflected in the
balances at year end period.
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Substantive procedures of cash receipts and payments transactions
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Test of details of cash balances
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Bank Reconciliation
1. Test the mathematical accuracy of the bank reconciliation and agree the balance in the cash
book.

2. Agree the bank balance on the bank reconciliation with the balance on bank confirmation.

3. Trace the deposits in transit on the bank reconciliation to the cut-off bank statement covering a
week after the date on which the bank account is reconciled.

4. Agree any charges included on the bank statement to the bank reconciliation.

5. Agree the adjusted book balance on the cash account lead schedule.

6. Trace bank transfers for last week of financial year under review and first week of the following
year for proper cut-off.

7. Identify irregular items and obtain necessary explanation.

(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Bank Confirmation – Its Importance

1. Direct confirmation of bank balances gives the auditor independent, third-party evidence.

2. The bank letter may reveal details of security, borrowings and contingent liabilities which need
to be disclosed in the financial statements.

3. Information obtained from bank confirmation requests assists the auditor in discharging his
responsibilities to obtain sufficient appropriate audit evidence by providing external evidence in
relation to such matters as the existence, completeness and valuation of assets and liabilities.

4. The auditor may need to carry out additional tests on matters after reviewing the replies from
banks.
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Sending bank confirmation

1. Ensure that all banks that the client deals with are circularized.

2. The entity is to complete and sign the authorization on the bank confirmation request,
requesting its completion by the bank and then directly return to the auditor.

3. The balance for each bank account should be agreed to the following items:
(i) bank reconciliation
(ii) interest charges to interest expense account in the general ledger
(iii) details of loans to the disclosure in the statement of financial position to ensure it is
correctly classified into the current and non-current elements

4. If the bank does not respond to a confirmation request, the auditor should send a second
request or ask the client to remind the bank on this matter.
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Fraud-Related Audit Procedures

When the auditor assesses the client’s control over cash is weak and suspects
that some type of fraud or defalcation involving cash has occurred, the
following audit procedures are typically used to detect fraudulent activities in
the cash accounts:

(a) Proof of cash

(b) Testing for kiting
(c) Testing for lapping
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Fraud-Related Audit Procedures

PROOF OF CASH
A proof of cash is used to reconcile the cash receipts and disbursements recorded on the client’s books
with the cash deposited into and disbursed from the client’s bank account for a specific time period. The
purposes of the proof of cash are to ensure:

(a) All cash receipts recorded in the client’s accounting records were deposited in the client’s bank
account.
(b) All cash payments recorded in the client’s accounting records have been cleared.
(c) No bank transactions have been omitted from the client’s accounting records.

• However, a proof of cash cannot detect a theft of cash when the cash was stolen before being
recorded in the client’s books.
• If the auditor suspects that cash was stolen before being recorded in the client’s books, the audit
procedures for testing the completeness in recording cash receipt transactions should be
performed.
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Fraud-Related Audit Procedures

TEST FOR KITING

When cash has been stolen by an employee, he can conceal the cash shortage by means of kiting. This
involves an employee covering the cash shortage by transferring money from one bank account to another
and recording the transactions improperly on the client’s books.

➢ The cash shortage can be covered up by preparing a cheque on one account just before year end;
however, this transaction is not recorded until the next period. The cheque is deposited in a second
account just before year-end and recorded as a cash receipt in the current period.

➢ Kiting is detected by preparing an interbank transfer schedule. Interbank transfer schedule is usually
obtained if there are numerous bank transfers, regardless of internal controls or for the purpose of
detecting suspected fraud.

➢ Audit procedures that should be done on interbank transfer schedule are as follows:\
a. Verify the accuracy of the information by comparing the disbursements and receipts to cash book.
b. Compare the dates of transfers on the schedule with the bank statement, noting that all transfer a few
days before and after the end of the reporting period has been included on the schedule.
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Fraud-Related Audit Procedures

TEST FOR KITING

Example:

Which of the following cash transfers results in a

misstatement of cash at 31 December 2007?
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Fraud-Related Audit Procedures

TEST FOR KITING

Example:
Ans: B is correct
because the receipt is
recorded on the books
prior to year-end, while
the disbursement is
recorded subsequent to
year-end. Therefore,
the cash on the books is
overstated.

Which of the following cash transfers results in a

misstatement of cash at 31 December 2007?
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Fraud-Related Audit Procedures

TEST FOR LAPPING

Additional procedures can be performed to try to detect attempts at lapping accounts receivable collections
include:

1. Obtaining a cut-off bank statement and checking the proper listing of outstanding cheques and
deposits in transit on bank reconciliation.

2. Checking the details of customer payments listed in bank deposits in comparison to details
of customer payment in daily remittance list or other record of detail postings.

3. Comparing the cheques listed on a sample of deposit slips from the reconciliation month to the detail
of customer credits listed on the day’s posting to customer accounts receivable.
(b) Identify receipts of the next accounting period and investigate the long outstanding cheques, determine whether they should be reflected in the balances at year end period.

Substantive Procedures
Fraud-Related Audit Procedures

TEST FOR LAPPING

Additional procedures can be performed to try to detect attempts at lapping accounts receivable collections
include:

1. Obtaining a cut-off bank statement and checking the proper listing of outstanding cheques and
deposits in transit on bank reconciliation.

2. Checking the details of customer payments listed in bank deposits in comparison to details
of customer payment in daily remittance list or other record of detail postings.

3. Comparing the cheques listed on a sample of deposit slips from the reconciliation month to the detail
of customer credits listed on the day’s posting to customer accounts receivable.
TEST YOUR SELF
Question # 1

Which of the following balance-related audit objectives

typically is assessed as having high inherent risk for cash?
a. Existence.
b. Detail tie-in.
c. Cutoff.
d. Presentation and disclosure.
TEST YOUR SELF
Question # 2

Which of the following is the substantive tests of details for

cash accounts?
a. Examining the physical of petty cash
b. Obtaining bank confirmations and bank cutoff statements
c. Preparing interbank transfer schedules
d. All of the above
TEST YOUR SELF
Question # 3

In the audit of cash, auditors must distinguish between

verifying the client’s reconciliation of the balance on the bank
statement to the balance in the ______________.
TEST YOUR SELF
Question # 4

A ___________ is an excellent method of comparing recorded

cash receipts and disbursements with the bank account and
with the bank reconciliation.
TEST YOUR SELF
Question # 5

Auditors would prepare a proof of cash when the client has

material weaknesses in _____________ over cash.
TEST YOUR SELF
Question # 6

_______________is the transfer of money from one bank

account to another and improperly recording the transfer so
that the amount is recorded as an asset in both accounts.
TEST YOUR SELF
Question # 47
Which of the following misstatements is most likely to be
uncovered during an audit of a client’s bank reconciliation?
a. Payment to an employee for more than the hours actually worked.
b. Failure to record a collection of a note receivable by the bank on the
client’s behalf.
c. Duplicate payment of a vendor’s invoice.
d. Billing a customer at a lower price than indicated by company policy.
TEST YOUR SELF
Question # 8

A proof of cash is not an effective procedure for identifying

which of the following types of misstatements?
a. All amounts that were paid by the bank were recorded.
b. All recorded disbursements were paid by the bank.
c. All recorded cash receipts were deposited.
d. Some checks were written for incorrect amounts.
TEST YOUR SELF
Question # 9
The auditor uses a proof of cash to determine whether:

a. All recorded cash receipts were deposited

b. All deposits in the bank were recorded in the accounting records
c. All recorded cash disbursements were paid by the bank
d. All of the above
TEST YOUR SELF
Question # 10
The following are the procedures that may uncover fraud in the cash receipts
area, except:

a. Aging of receipts
b. Confirmation of accounts receivable
c. Review of the general ledger entries in the cash account for unusual items
d. Comparison of customer orders to sales and subsequent cash receipts
See you on Wednesday in our Live
Discussion for the elaboration of this
material including the answers to the
questions.

THANK YOU FOR YOUR

FOCUS &
SELF-DIRECTED ATTITUDE