Accounting Research Manager ® - Audit Private
Accounting Research Manager
Miller Interpretations and Other Resources
Knowledge-Based Audit Procedures
Chapter 9: Cash
Chapter 9: Cash
Audit Objectives and Procedures
The overall objective of auditing cash is to determine if cash is fairly presented in the financial
statements in conformity with generally accepted accounting principles. The following table summarizes
specific audit objectives related to financial statement assertions for cash and identifies common
substantive audit procedures that accomplish these objectives.
Specific Audit
Objectives
Cash physically exists and is
owned by the entity.
Common Substantive
Audit Procedures
Obtain bank confirmation and
cutoff bank statement.
Financial Statement
Assertions
Existence
Rights and obligations
Test bank reconciliations.
Cash receipts and cash
disbursements are recorded
correctly as to account,
amount, and period.
Obtain cutoff bank statement
Occurrence
Test bank reconciliations.
Completeness
Prepare or test bank transfer
schedule.
Accuracy Cutoff Classification
Cash balances include funds at
all locations, funds with
custodians, and deposits in
transit.
Obtain bank confirmation and
cutoff bank statement.
Completeness
Test bank reconciliations.
Prepare or test bank transfer
schedule.
Cash is properly classified and
presented in the financial
statements and adequate
disclosures are made.
Existence
Presentation and disclosure:
Completeness
Obtain bank confirmation.
Rights and obligations
Test bank reconciliations.
Presentation and disclosure:
Classification and
understandability
Bank Confirmations
In most audits, the auditor obtains a bank confirmation directly from most of the banks with which the
client has done business during the period of the financial statements being audited. If the bank does
not respond to a confirmation request, the auditor must send a second request or ask the client to
telephone the bank and ask that the confirmation be completed and mailed directly to the auditor.
The AICPA and the American Bankers Association, as a convenience to auditors and bankers, have
approved the use of a standard bank confirmation form referred to as Standard Form to Confirm
Account Balance Information with Financial Institutions (COR-802 ). It is typical for the bank to
confirm loan information and bank balances on the same form. The auditor should be aware, however,
that banks are not responsible for searching their records for bank balances or loans beyond those
included on the form by the client. Furthermore, banks are not expected to inform auditors of other
financial arrangements, such as lines of credit, compensating balance requirements, or contingent
liabilities for guaranteeing the loans of others. If the auditor intends to confirm this type of information,
the auditor should send a separate confirmation letter to the financial institution addressing the matters
of concern. Sample confirmation letters on such other financial arrangements are as follows: Request
for Confirmation of Lines of Credit (COR-815 ); Request for Confirmation of Contingent Liabilities
(COR-817 ); and Request for Confirmation of Compensating Balances (COR-818 ).
Practice Point: The auditor can either use a blank confirmation request or fill in the balances on
the form. The primary advantage of using the blank confirmation requests is that they may
provide a greater degree of assurance about the information confirmed; this is because there is a
risk that recipients of confirmation requests that already include the balances being confirmed
may sign and return the confirmations without verifying that the information contained on the
confirmation is correct. The primary disadvantage of using blank confirmation requests is that
they might result in lower response rates because additional effort may be required of the
recipients.
Cutoff Bank Statements
The purpose of a cutoff bank statement is to verify the reconciling items on the client’s bank
reconciliation as of the balance-sheet date. Typically, the auditor requests that the client have the bank
send, directly to the auditor, a bank statement for a period of time that is 10 to 15 days subsequent to
the balance-sheet date. The following are common audit procedures performed using the cutoff bank
statement:

Trace deposits in transit from the bank reconciliation to the cutoff bank statement to determine
if amounts agree and if there are unusual time delays between the date recorded per books and
the date recorded per bank.

Trace all cleared, prior-period checks listed in the cutoff bank statement to the outstanding
check list included in the bank reconciliation.

Examine the cutoff bank statement and enclosed data for unusual items (e.g., large checks
payable to cash).

Inspect returned checks (or facsimiles thereof) to determine whether checks have been altered
or double endorsed.

Determine that checks dated after the balance-sheet date are not listed as outstanding checks
as of the balance-sheet date.
The auditor should watch out for a significant number of checks that have not cleared the bank on the
cutoff bank statement. The client may have written checks but held them for mailing until after the
balance-sheet date. Such checks should be restored to cash by a journal entry.
If a cutoff bank statement is not received directly from the bank, the auditor can prove the subsequent
period bank statement as follows:

Foot all the canceled checks, debit memos, deposits, and credit memos.

Check to ensure that the bank statement balances when the footed totals are used.

Review the items included in the footings to make sure they were canceled by the bank in the
proper period and do not include any erasures or alterations.
See a sample confirmation letter for cutoff bank statements, Request for Cutoff Bank Statement (COR801 ).
Alternate procedures for verifying endorsements on checks when canceled checks are not returned
with the bank statements The audit procedure of verifying endorsements on the back of returned
checks is not mentioned as a required procedure by the auditing standards. The decision to use this
procedure should be based on the assessment of inherent and control risk factors of the client. If the
auditor concludes that check endorsements should be verified, he or she may use one or both of the
following alternative procedures:
1. Select a sample of canceled checks, and ask the bank to send the originals or photocopies,
front and back, to the auditor.
2. Confirm disbursements with the vendors.
Check 21 The Check Clearing for the 21st Century Act (“Check 21”) became effective on October 28,
2004. It creates a new negotiable instrument called a substitute check that permits banks to process
check information electronically and to deliver substitute checks to banks that want to continue
receiving paper checks. A substitute check is the legal equivalent of the original check and includes all
the information contained on the original check. Because the original check will no longer be available,
auditors should be aware of Check 21 when planning their audit engagements and consider what
changes they may need to make in their audit procedures.
Tests of Bank Reconciliations
The auditor should obtain a copy of the client’s year-end bank reconciliation and review it to determine
if it has been properly prepared. Common audit procedures performed by the auditor on bank
reconciliations include the following:

Trace bank balances on the bank reconciliation to the balances on the bank statement and the
bank confirmation response.

Trace checks included with the subsequent period bank statement to the list of outstanding
checks on the bank reconciliation for proper inclusion or exclusion as of the balance-sheet date.

Investigate all significant checks included on the outstanding check list that have not cleared the
bank on the subsequent period bank statement.

Trace deposits in transit listed on the bank reconciliation to the subsequent period bank
statement.

Account for and investigate other reconciling items on the bank statement and bank
reconciliation (e.g., bank service charges, bank errors and corrections).

Investigate the nature of old outstanding checks and determine that the company has complied
with the applicable unclaimed property law requirements, instead of reclassifying such checks to
miscellaneous income.
An example Bank Reconciliation template (AID-803
) is presented in this product.
Proof of Cash
In performing a proof of cash, the auditor reconciles deposits and disbursements according to one or
more bank statements with the receipts and disbursements shown in the client’s books. Usually, a proof
of cash is appropriate only when the client has material internal control weaknesses in cash. Therefore,
the auditor rarely finds it effective to perform a proof of cash.
A proof of cash typically includes the following:

A reconciliation of the balance on the bank statement with the general ledger balance at the
beginning of the proof-of-cash period

A reconciliation of deposits on the bank statement with the cash receipts journal for the proofof-cash period

A reconciliation of canceled checks clearing the bank with the cash disbursements journal for
the proof-of-cash period

A reconciliation of the balance on the bank statement with the general ledger balance at the
end of the proof-of-cash period
An example of Proof of Cash (AID-804
) is presented in this product.
Bank Transfer Schedule
Another common substantive audit procedure for cash is the preparation of a bank transfer schedule on
audits in which there are numerous bank accounts and interbank transfers. The primary objective of
preparing a bank transfer schedule is to test that the same deposit is not shown in two accounts at the
same time, a practice known as “kiting” if the overstatement is intentional. The auditor typically lists all
bank transfers made a few days (e.g., five business days) before and after the balance-sheet date and
traces each of them to the accounting records for proper recording. For example, if a bank transfer is
recorded in the current period as a disbursement, the auditor should examine the bank cancellation
date on the check to see when it cleared. If the check cleared after the balance-sheet date, it should be
included as an outstanding check. Similarly, transfers deposited in the bank near the end of the year or
included as deposits in transit should be traced to the cash receipts or disbursements journal to make
sure they have been recorded in the journals in the proper period. For example, if a transfer was
received by the bank and included as a deposit in transit on the bank reconciliation, kiting probably has
occurred.
At least four sets of records are involved in any bank transfer: the two general ledger cash accounts and
the two bank accounts. Therefore, the bank transfer schedule includes four dates: disbursement date
per books and per bank and receipt date per books and per bank. Once the bank transfer schedule is
prepared, the auditor should analyze each transfer to determine the appropriate treatment on the
individual bank reconciliations (i.e., as an outstanding check or a deposit in transit). Then the auditor
should trace each item that has been determined to be a reconciling item to the respective bank
reconciliation.
An example Bank Transfer Schedule (AID-805
) is presented in this product.
Analytical Review Procedures
Cash and cash equivalent accounts do not usually have a direct or predictable interrelationship with
other accounts. Consequently, except for the identification of significant fluctuations, analytical
procedures are usually limited to comparisons of interrelated balances and review of records for
unusual entries. Therefore, in many audits the year-end bank reconciliation is verified on a 100% basis. It
is also common for auditors to compare the ending balance on the bank reconciliation, deposits in
transit, outstanding checks, and other reconciling items with the prior-year reconciliation.
Potential Errors and Fraud and Examples of Fraud-Related Audit
Procedures
Potential Errors and Fraud Schemes
The following are types of potential errors and fraud relating to cash:
Cash Receipts

Cash receipts are recorded incorrectly.

Items are sold for cash but the sale is not recorded and cash is misappropriated.

Checks received are deposited but not recorded; checks are written to employees for the same
amount and also are not recorded.

Customer remittances are misappropriated and collectible accounts are written off or otherwise
credited.

Lapping (cash receipts misappropriated and shortages concealed by delaying postings of cash
receipts—for example, payment from customer A is diverted by the employee; payment from
customer B is applied to customer A’s account; customer C’s payment is applied to customer B’s
account; and so on).
Cash Disbursements

Payment for goods or services is not authorized or not received.

Checks are made out to wrong payees.

Duplicate payments of invoices are made.

Vendor invoices are altered and photocopied to conceal alteration; payment benefits third
parties.

Check signature or endorsement is forged.

Disbursements are misclassified or not recorded.

Disbursements are recorded at the wrong amount or in the wrong period.

Checks are issued for benefit of employees or third parties, and payees are changed in the cash
disbursements journal.

Cash disbursements journal is overstated; the overstated amount is recorded and the difference
is misappropriated.

Kiting (exploiting the time required for a check to clear the bank, commonly referred to as the
“float” period, to conceal shortage of cash) may occur.
Fraud-Related Audit Procedures
The following are example audit procedures that may be performed in response to cash fraud schemes:

Perform a proof of cash, rather than a mere review of the client’s bank reconciliation.

Perform surprise cash counts.

Compare payees with approved vendor lists.

Compare sales price to the price list.

Search for and investigate disbursements payable to “cash” or unusual sounding vendors.

Search for and investigate non-payroll check disbursements made to employees and related
parties.

Expand tests of cancelled checks and scrutinize unusual payees, authorized signatures,
endorsements, and amounts.

Examine supporting documentation for held checks.

Investigate void checks and analyze void transactions.

Test interbank transfers.

Obtain cutoff bank statements in addition to obtaining bank confirmations.

Compare bank deposits to cash receipts, noting any time lags in deposit dates.

Examine cancelled checks noting unusual patterns, e.g., time lags between the disbursement
date per books versus the date the check cleared the bank.

Match sales returns to original sales.

Confirm returned sales with customers.

Perform tests of controls over cash receipts and cash disbursements.
Financial Accounting and Reporting
The heading “Cash” in financial statements includes currency on hand and on deposit, demand deposits,
cash equivalents, and checks drawn before the balance-sheet date but not released (i.e., held checks).
Financial Accounting Standards Board Statement (FAS) No. 95 (Statement of Cash Flows ) (CT Section
C25 ) provides more details on the definition of cash.
Cash Equivalents
FAS-95 (CT Section C25) defines cash equivalents as short-term, highly liquid investments that are both
readily convertible to known amounts of cash and so near their maturity that they present insignificant
risk of change in value. Examples of such items are treasury bills, certificates of deposit, and moneymarket funds. Generally, only investments with original maturities to the entity of three months or less
are considered cash equivalents. Items not considered the equivalent of cash (e.g., marketable
securities) should be included in a separate financial statement heading.
Held Checks
As discussed earlier, any checks dated before the balance-sheet date and not mailed or otherwise
delivered to the payee should be added back to cash. While it may be difficult to determine which
checks have not been mailed as of the balance-sheet date, the auditor should inquire about material
checks or any blocks of checks that (1) are not returned with the subsequent period bank statement or
(2) are returned with the subsequent period bank statement but did not clear the bank within a
reasonable period of time (e.g., three to five business days after the balance-sheet date).
Restricted Cash
Cash available for general operations should be distinguished from cash restricted for special purposes.
The auditor should inquire about the existence of any restricted cash and the nature of the restriction.
Funds intended for use in increasing noncurrent assets or restricted for the liquidation of long-term debt
should be identified and classified separately or disclosed in the notes to the financial statements.
Restricted cash should be classified as a current or noncurrent asset according to the nature of the asset
or liability for which it is restricted.
Cash Overdrafts
Cash overdrafts should be presented as current liabilities if they are caused by payment of checks drawn
against insufficient funds. It is permissible, however, to offset an overdraft in one bank account with
available cash in other accounts in the same bank, but only if the available cash balance is not subject to
minimum or compensating balance requirements. Overdrafts should not be offset against certificates of
deposit, commercial paper, temporary investments, or other cash equivalents. Also, cash overdrafts in
one bank should not be offset with cash balances in another bank.
Disclosure of Cash Balances in Excess of Insured Amounts
Significant concentrations of credit risk arising from cash deposits in excess of federally insured limits
($100,000) should be disclosed in the financial statements.