CHAPTER TWO

2. AUDIT OF CASH AND MARKETABLE SECURITIES

Chapter Outline
 Internal control over cash transactions, receipts and disbursements
 Audit program for cash
 Internal control over marketable securities
 Audit program for marketable securities
2.1Introducing the Nature and Types of cash
Cash, the most liquid of assets, is the standard medium of exchange and the basis for
measuring and accounting for all other items. Companies generally classify cash as a
current asset. Cash consists of coin, currency, money orders, certified checks, cashier’s
checks, personal checks, ordinary checks, selling checks, negotiable checks, bank drafts,
etc.
Cash is the only account included in every business transactions and cycles. Cash is
important because of its susceptibility to theft and it can also be significantly misstated. The
relationship between cash in the bank and the other transaction cycles serves a dual
function: (1) it shows the importance of audit tests of various transaction cycles on the
audit of cash and (2) it aids in further understanding of the integration of the different
transaction cycles.
Cash typically has a small account balance, but auditors devote a large proportion of total
audit hours because:
– Liabilities, revenues, expenses and most other assets flow through
cash.
– It is the most liquid asset; so greater temptation for misappropriation.
– It is a high risk account.
Notice that valuation is generally not major concern in the audit of cash because the
financial statements are presented in monetary units; valuation of cash is typically a
problem only if conversion to or from foreign currency is involved.
The relationships between cash in the bank and transaction cycles have been illustrated in the
following diagram.

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 2.1.1 Types of Cash Accounts
Cash normally includes general, payroll, petty cash and less frequently saving accounts.
• The General cash account: General accounts are checking accounts similar
in nature to those maintained by individuals. The general cash account is the focal
point of cash for most organizations because virtually all cash receipts and
disbursements flow through this account. Cash sales, collections of receivables, and
investment of additional capital typically increase the account; business
expenditures decrease it.
• Imprest payroll Accounts: many companies establish a separate imprest
payroll account to improve internal control over payroll disbursements. When
payroll is paid, a check from the general account is drawn to deposit funds into the
payroll account.
• Imprest Petty cash: An imprest petty cash fund is not a bank account, but it
is sufficiently similar to cash in the bank to merit inclusion. A petty cash account is
often something as simple as a preset amount of cash set aside in a cash box for
incidental expenses. It is used for small cash acquisitions that can be paid more
conveniently and quickly by cash than by check, or for the convenience of
employees in cashing personal or payroll check. Petty cash fund is replenished as
necessary.
A fixed balance is maintained in the imprest account, and the authorized personnel
uses these funds for disbursements at their own discretion as long as the payments
are consistent with company policy.
• Branch Bank Account: For a company operating in multiple locations, it is
often desirable to have a separate bank balance at each location. Branch bank
accounts are useful for building banking relations in local communities and
permitting the centralization of operations at the branch level. In some companies,
the deposits and disbursements for each branch are made to a separate bank account,

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 and the excess cash is periodically transferred electronically to the main office
general bank account.
2.1.2 The Auditors’ Objectives in Audit of Cash
The overall objective of the audit of cash is to determine that cash is fairly presented in
conformity with GAAP. The auditors’ objectives in the audit of cash are to:
1. Use the understanding of the client and its environment to consider inherent
risk, including fraud risks, related to cash.
2. Obtain an understanding of internal control over cash transactions.
3. Determine the existence of recorded cash and the client’s ownership (right) of
cash.
4. Establish the completeness of recorded cash.
5. Establish the clerical accuracy of cash schedules.
6. Determine that the statement presentation and disclosure of cash are
appropriate.
2.2 Internal control over Cash transactions, Receipts and Disbursements
Internal control consists of all of the related methods and measures adopted within a
business to:
a. Safeguard assets from employee theft, robbery, and unauthorized use; and
b. Enhance the accuracy and reliability of its accounting records by reducing the
risk of errors (unintentional mistakes) and irregularities (intentional mistakes and
misrepresentations) in the accounting process.
2.2.1 General Principles of Internal Controls over Cash
To safeguard assets and enhance the accuracy and reliability of its accounting records, a
company follows internal control principles. The following six internal control principles
apply to most companies:
Principle1: Establishment of Responsibility
An essential characteristic of internal control is the assignment of responsibility to specific
individuals.
a) Control is most effective when only one person is responsible for a given task.
b) Establishing responsibility includes the authorization and approval of transactions.
Principle 2: Segregation of Duties
Segregation of duties is indispensable in a system of internal control. The rationale for
segregation of duties is that the work of one employee should, without a duplication of
effort, provide a reliable basis for evaluating the work of another employee. There are two
common applications of this principle:
a) The responsibility for related activities should be assigned to different
individuals. When one individual is responsible for all of the related activities, the
potential for errors and irregularities is increased.
 Related purchasing activities should be assigned to different individuals. Related
purchasing activities include ordering merchandise, receiving goods, and paying (or
authorizing payment) for merchandise.
 Related sales activities also should be assigned to different individuals. Related
sales activities include making a sale, shipping (or delivering) the goods to the
customer, and billing the customer.
b) The responsibility for record keeping for an asset should be separate from the
physical custody of an asset. The custodian of the asset is not likely to convert the
assets to personal use if one employee maintains the record of the asset that should
be on hand and a different employee has physical custody of the asset.
Principle 3: Documentation Procedures
Documents provide evidence that transactions and events have occurred.

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 • Documents should be pre-numbered and all documents should be accounted
for.
• Source documents for accounting entries should be promptly forwarded to the
accounting department to help ensure timely recording of the transaction and event.
Principle 4: Physical, Mechanical, and Electronic Controls
Physical controls relate primarily to the safeguarding of assets. Mechanical and electronic
controls safeguard assets and enhance the accuracy and reliability of the accounting records.
Use of physical, mechanical, and electronic controls is essential.
Examples of these controls include:
a. Safes, vaults, and safety deposit boxes for cash and business papers.
b. Locked warehouses and storage cabinets for inventory and records.
c. Computer facilities with pass key access or fingerprint or eyeball scans.
d. Alarms to prevent break-ins.
e. Television monitors and garment sensors to deter theft.
f. Time clocks for recording time worked.
Principle 5: Independent Internal Verification
Independent internal verification involves the review, comparison, and reconciliation of data
prepared by employees.
a. Verification should be made periodically or on a surprise basis.
b. Verification should be done by an employee independent of the personnel
responsible for the information.
c. Discrepancies and exceptions should be reported to a management level that
can take appropriate corrective action.
d. In large companies, independent internal verification is often assigned to
internal auditors.
Principle 6: Other Controls
a. Bonding of employees who handle cash.
b. Rotating employees' duties and requiring employees to take vacations.
2.2.2 Applications of Internal Control to Cash Receipts
Cash receipts may result from sales of goods and services on cash; collections from
customers on account; the receipt of interest, rents, and dividends; investments by owners;
bank loans and sale of bonds; and proceeds from the sale of non-current assets.
The following internal control principles explained earlier apply to cash receipts transactions:
1. Establishment of responsibility- Only designated personnel (cashiers) is authorized to
handle cash receipts.
2. Segregation of duties- Separate cash receipt from recordkeeping. Different
individuals receive cash, record cash receipts, and hold the cash.
3. Documentation procedures- Use remittance advice (mail receipts), cash register
tapes, and deposit slips.
4. Physical, mechanical, and electronic controls- Store cash in safes and bank vaults;
limit access to storage areas; and use cash registers.
5. Independent internal verification- Do not permit any one employee to handle a
transaction from beginning to end. For example, supervisors count cash receipts daily;
treasurer compares total receipts to bank deposits daily.
6. Other controls.
 Bond personnel who handle cash.
 Require vacations and rotation of employees.
 Deposit all cash receipts in bank daily.
2.2.3 Applications of Internal Control to Cash Disbursements
1. Cash is disbursed to pay expenses and liabilities or to purchase assets.

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 a) Internal control over cash disbursements is more effective when payments are made
by check, rather than by cash, except for incidental amounts that are paid out of petty
cash.
b) Cash payments are generally made only after specific control procedures have been
followed.
c) The paid check provides proof of payment.
d) The principles of internal control applicable to cash disbursements include:
 Establishment of responsibility - Only designated personnel (treasurer) are
authorized to sign checks. Make all disbursements by check or electronic fund
transfer, with the exception of small expenditures from petty cash.
 Segregation of duties - Different individuals approve and make payments; check
signor’s do not record disbursements.
 Documentation procedures - Use pre-numbered checks and account for them in
sequence; each check must have approved invoice.
 Physical, mechanical, and electronic controls - Store blank checks in safes with
limited access; print check amounts by machine with indelible (permanent) ink.
 Independent internal verification - Compare checks to invoices; reconcile bank
statement monthly. Have monthly bank reconciliation prepared by employees not
responsible for the issuance of checks or custody of cash. The completed
reconciliation should be reviewed promptly by an appropriate official
 Other controls - Stamp invoices PAID.
2. Methods of disbursing and/or safeguarding Cash:
a) Electronic Funds Transfer (EFT) System: A new approach developed to transfer
funds among parties without the use of paper (deposit tickets, checks, etc.). The
approach, called electronic funds transfers (EFT), uses wire, telephone, telegraph, or
computer to transfer cash from one location to another.
b) Petty Cash Fund - A cash fund used to pay relatively small amounts.
c) Use of a Bank. First it contributes significantly to good internal control over cash
by creating a separate set of records (bank and books). Second the asset account
Cash maintained by the company is the “flip-side” of the bank’s liability account for
that company. It should be possible to reconcile these accounts at any time. Each
month the company receives a bank statement showing its bank transactions and
balances. For example, some transactions and balances shown include:
 Checks paid and other debits that reduce the balance in the depositor's account.
 Deposits and other credits that increase the balance in the depositor's account.
 The account balance after each day's transactions.
d. Minimize the amount of cash that must be kept on hand
Summary
Important Internal Controls for Cash Disbursements are summarized below:
1. Segregate duties. The foundation of a good internal control system is segregation
of duties. The duties of authorization (signing a check or releasing a wire transfer),
custody (having access to the blank check stock or the ability to establish a wire
transfer), and recordkeeping (ability to record the transaction in the accounting
system) should be separated so that one individual cannot complete a transaction
from start to finish. The concept behind segregation of duties is that in order to
misappropriate cash, individuals would have to collude, rather than one individual
acting alone. For many businesses, proper segregation of duties can be difficult to
achieve. In these instances, company owners may want to consider the bank
statements delivered to them unopened. The owners should then review the bank
statements and the check images for any transactions that appear unusual, and

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 follow up on these transactions to obtain an understanding of them. This process
alone has uncovered many situations.
2. Review authorized signors. Carefully consider who your authorized signors are
(authorization of the transaction). Those individuals should not have access to the
blank check stock (custody of the asset) nor the ability to enter the transaction into
the accounting system (recording of the transaction). The use of a signature stamp,
although efficient, may be problematic in that you must have separate controls to
ensure that the stamp is not readily available for inappropriate use.
3. Consider requiring dual signatures. Your company may also want to consider the
use of dual signatures. A dual signature policy includes the establishment of a dollar
threshold over which checks require two signatures. The utilization of dual
signatures establishes an element of segregation of duties for disbursements over a
specified threshold in that these disbursements require more than one individual to
authorize the transaction.
4. Remember the wire transfers. The use of wire transfers has increased
significantly over the years, and segregation of duties around wire transfers is
paramount. The responsibilities for establishing a wire transfer should be segregated
from the responsibility of releasing the wire transfer. If this segregation is not
possible, consideration should be given to using a callback procedure, in which the
financial institution will call a specified individual when a wire transfer is initiated.
Most important, the call back cannot go to any individual who is able to initiate a
wire transfer.
5. Reconcile bank accounts in a timely manner. The bank reconciliation should be
completed in a timely manner by someone who is independent of the cash
disbursement process. The bank reconciliation should also include a review of the
bank statement and the check images that are returned with the bank statement for
unusual transactions. Any unusual items should be investigated and evaluated when
necessary.
2.3 Guidelines for Internal Control over Cash
Auditors need to determine whether following general guidelines for internal control over
cash have been followed by the client.
1. Do not permit any one employee to handle a transaction from start to finish.
2. Separate cash handling from recordkeeping.
3. Centralize receiving of cash to the extent practical.
4. Record cash receipts on a timely basis.
5. Encourage customers to obtain receipts and observe cash register totals.
6. Deposit cash receipts daily.
7. Make all disbursements by check or electronic funds transfer (EFT), with the
exception of small expenditures from petty cash.
8. Have monthly bank reconciliations prepared by employees not responsible for the
issuance of checks or custody of cash. The completed reconciliation should be
reviewed promptly by an appropriate official.
9. Monitor cash receipts and disbursements by comparing recorded amounts to
forecasted amounts.
2.4 Internal Control Weaknesses
Weak internal control procedures lead to or create opportunity for fraud and/or defalcation.
Thus it is important that the auditor should investigate client's internal control procedures to
see if defalcation techniques are practiced. Some of the defalcation techniques are discussed
as follows.

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 1. Withholding of Cash Receipts (Skimming): Proceeds from cash sales are
withheld at point of sales recording and receiving of cash. Skimming means to take
cash before recording it. For example, a cash register clerk can fail to register sales,
or under-register amounts, pocketing full or partial amounts, if the customer does
not wait for the receipt and changes or check amounts charged, registered and paid.
The clerk could record an amount less than received or record no sales at all to
pocket the amount.
2. Lapping: Cash collected on account from credit customers can be withheld and
entry postponed for the collection of receivables. This is usually practiced as
temporary borrowing, but in the long run may lead to cover up by more elaborate
means. Lapping is basically a way to conceal an unauthorized loan taken from the
company. For example, a clerk takes money paid by Mr. Assefa, which he intends
to pay back eventually. The next day, when Mr. Berhanu's payment arrives, he posts
it to Mr. Assefa's account. The next day, Ms. Konjit's money comes in, and the
clerk posts it to Mr. Berhanu's account, and so on. Sometimes the employee
manages to repay the loan, otherwise he may try to write off the amounts as bad
debts.
Of course, this is possible if the cashier-accountant receives cash and keeps accounts
receivables records at the same time.
Audit procedures to detect Skimming/Lapping
If the cashier is not smart enough to try and cover up skimming, it may be found by a)
counting cash on hand tracing from prelisting cash register tapes /receipt carbon copies
/remittance advices to cash receipts journal, bank records and the A/R master file. If the
control is present, the auditor may compare the records of the cashier to see if they all
match.
The auditor should examine all voided receipts and ensure the numerical continuity of
receipts. This prevents the cashier from stealing money, and later destroying the carbon
copy of the receipt.
The auditor should compare names, dates, and amounts on remittance advices with cash
receipts entries and deposit slip. If the dates, names and amounts in the remittance advice
and cash receipt entries and deposit slips are not the same, this is an indication of lapping.
This procedure is also time - consuming, so it is not done unless lapping is actually
suspected.
If the cash receipt is different from the amount owed, the auditor should investigate this to
determine why it happened. Most customers pay the exact amount that they owe, for each
invoice, so a payment different from the amount owed may mean that the accounting clerk
is dividing receipts to maintain the lapping scheme.
Lapping can be prevented by good control, such as segregating receiving and recording
duties, or by compulsory vacations for the receipts clerk. The clerk cannot continue to
cover his theft if he isn't there, and the new clerk will hopefully post the accounts correctly.
3. Sales Discount: Cash can be abstracted from sales discount not taken by customers.
That is, when customers pay full amount, only amounts net of discount are recorded
to customers and difference pocketed by recording it to discount.
4. Writing-off Bad Debts: Accounts receivable could be written-off as bad debts
when actually customers' remittance is pocketed. This is used to hide cash shortage
that may be apparent by repeated overlapping.
5. Fictitious Accounts Receivable: Goods could be taken for private use or stolen by
charging fictitious customers and writing-off as bad debts later on.
6. Check Kiting: Assume that an enterprise has two bank accounts say in Bank A and
Bank B. The enterprise writes a check to withdraw an amount from Bank A account

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 balance and deposit into the account in Bank B. The amount deposited in Bank B is
immediately reflected. But because of lag of time for clearance (float) it is not
reflected as deduction (withdrawal) from Bank A account soon enough.
Consequently, the cash position (current ratio) of the organization is temporarily
improved or overstated.
Kiting is practiced to cover up cash shortages, which an auditor might uncover.
Example of Kiting
Assume Tirf Trading House has two bank accounts- one in Dashen Bank and another in
Commercial Bank of Ethiopia (CBE). The following scenarios happen in Tirf Trading.
A) Kiting to cover Theft
Account clerk Mr. Atalay "borrows" incoming cash receipt (skimming) of 1,000 Birr.
However, he needs to post amounts to individual customer accounts in the A/R subsidiary
ledger. Otherwise, they will complain and his theft will be discovered. So he makes a
journal entry as follows.
Cash in Bank - Dashen 1,000
Accounts Receivable 1,000
But no deposit was made into the Bank
Then Mr. Atalay realizes that this incorrect entry will be discovered when the bank account
is reconciled. So on the last day of the fiscal year, he writes a check on the CBE account
for 1,000 Birr, and deposits it into Dashen Bank. But no entry will be made to decrease the
account balance in CBE. CBE does not know it as disbursement. The bank reconciliation
will now balance, because CBE will not debit the check until the next fiscal year. Mr.
Atalay assumes that by then he will be able to pay back the "loan".
B) Kiting to Overstate Current Ratio (Management Fraud)
W/ro Akeza is managing director of Tirf Trading. She has applied for a business loan at
Dashen Bank. Tirf Trading is having a difficult year, and needs the money very badly to
pay suppliers and payroll. She knows well the fundamental principle of banking. So she has
to convince Dashen Bank that Tirf Trading is having a good year. She decides to do this by
overstating the current ratio on the financial statements, because she knows this is a key
area for the loan officer's analysis.
On the last day of the fiscal year, she draws a check for 300,000 Birr from CBE and
deposits it to Dashen Bank. She gives the stamped deposit ticket to the accountant with the
instructions to make this entry on December 31.
Cash in Bank - Dashen Bank 300,000
Miscellaneous Income 300,000
CBE of course, will not process the check until next year, and it will not show up on the
bank reconciliation until January 31. By that time, W/ro Akeza hopes the loan will have
been granted, and a simple correcting journal entry can be made to correct the ledger
balance for Cash in Bank - Dashen.
Audit procedures to detect Kiting
The audit test to discover kiting is to prepare and examine a schedule of interbank transfers.
There are several things that should be audited on the interbank transfer schedule.
a) The accuracy of the information on the interbank transfer schedule should be
verified.
b) The interbank transfer must be recorded in both the receiving and disbursing banks.
If Birr 10,000 is transferred from bank A to B but only disbursement (in A) is
reduced, this is an evidence of an attempt to conceal a cash theft (kiting).
c) The date of recording of the disbursement and receipts for each transfer must be in
the same year. If a cash receipt was recorded in the current fiscal year and
disbursement in the subsequent year, it may be an attempt to cover cash shortage.

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 d) Disbursements on the interbank transfer schedule should be correctly included in or
excluded from year-end bank reconciliation as outstanding checks. An outstanding
check (CK) for the first bank is an outstanding deposit for the second bank.
e) Understating outstanding CKs on the bank reconciliation indicates the possibility of
kiting. The dates in disbursement books and dates of disbursement in bank must be
in the same year. If there are CKs recorded in book but not in bank, they must be
included as outstanding CKs in the preparation of bank reconciliation. But if there
are checks that are not included as outstanding CKs, this is an indication of
kiting.
f) Receipts on the interbank transfer schedule should be correctly included in or
excluded from year-end bank reconciliations as deposit in transit. Compare receipt
dates as per book and per bank. Any deposit recorded in book but not in bank
should be reflected as outstanding deposit in bank reconciliation. But if there are
receipts recorded as outstanding deposits whose amount is not recorded in cash
receipt journal, it is an indication of kiting.
7. Window-Dressing: Cash shortage or cash position can be improved by holding the
cashbook open beyond closing date to include subsequent receipts. This may be
encouraged by management to improve current period sales.
8. Cash Disbursements: Cash from petty cash could be misused for personal or other
unauthorized expenses by producing false voucher expenses, or voucher charges, or
overstating vouchers submitted for reimbursements or changing dates of previous vouchers.
9. Checks Payable to Self: Checks could be prepared for amounts made payable to
self, forging signatures and destroying returned checks or over footing cash disbursements.
10. Checks Payable to Others: Checks are prepared in payment of forged
endorsements or fictitious or previously used invoices, or over-invoiced vendors' invoices,
or padding payrolls.
It should be noted that all of the above defalcations are performed only in absence of proper
segregation of duties or when there is collusion among employees.
2.5 Audit Program for Cash
Audit program is a detailed listing of the specific audit procedures to be performed in the
course of audit engagement. The following audit program indicates the general pattern of
work performed by the auditors in the verification of cash.
2.5.1 Consider internal control over cash
Test of controls provide auditors with evidence as to whether prescribed controls are in use
and operating effectively. The result of these tests assists the auditor in evaluating the
likelihood of material misstatements having occurred. This implies that the auditor should
assure that the above internal control over cash receipts and cash disbursements are in
place. This can be achieved by preparing an internal control questionnaire for cash receipts
and cash disbursement. Some of the specific activities include:
1. Obtain an understanding of internal control over cash
2. Assess control risk and design additional tests of controls for cash
3. Perform additional tests of controls for those controls which the auditors plan to
consider to support their planned assessed level of control risks, such as
a. Test the account records and reconciliations made by re-performance.
b. Compare the details of a sample of cash receipts listing to the cash
receipts journal, A/R posting, and authenticated deposit slips.
c. Compare the details of a sample of recorded disbursements in the cash
payment journals to A/P postings, and purchase orders, receiving reports,
invoices, and paid checks.
4. Reassess control risk and modify substantive tests for cash.

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 2.5.2 Perform Substantive test of cash transactions and balances
Substantive tests are designed to detect material misstatement if they exist in the financial
statements. The amount of substantive testing done by the auditor is greatly influenced by
their assessment of the likelihood that misstatement exists. The auditor undertakes the
following activities in relation to the substantive test of cash transactions and balances.
1. Obtain analysis of cash balances and reconcile to the general ledger.
2. Send standard confirmation forms to financial institutions to verify amounts on
deposit.
3. Obtain or prepare reconciliation of bank accounts as of the balance sheet date and
consider need to reconcile bank activity for additional month.
4. Obtain a cut-off bank statement containing transactions of at least seven business days
subsequent to balance sheet date.
5. Count cash list on hand.
6. Verify the client’s cut-off of cash receipts and cash disbursements.
7. Analyze bank transfers for the last week of audit year and first week of following year
to disclose kitting.
8. Investigate any checks representing large or unusual payments to related parties.
9. Evaluate proper balance sheet presentation and disclosure of cash.
Brief discussion on some of the substantive audit procedures is presented below.
1. Obtain analysis of cash balances and reconcile to the general ledger: The auditor
will prepare or obtain a schedule that lists the entire client’s cash account. For
example for cash in bank account, this schedule will typically list the bank, the bank
account number, account type (checking a/c or saving a/c), and the year-end balance
per book. The auditors will trace and reconcile all accounts to the general ledger as
necessary.
2. Send standard confirmation forms to financial institutions to verify amounts on
deposit: Auditors usually obtain a direct receipt of a confirmation from every bank or
other financial institution with which the client does business. The main objective of
this confirmation letter is to corroborate (confirm) the existence of the amounts of
cash recorded on the balance sheet of the client. Ask banks if the amount of cash
indicated in balance sheet as ‘cash in bank’ really exists in the bank account.
After auditors receive the completed bank confirmation, the balance in the bank account
confirmed by the bank should be traced to the amount stated on the bank reconciliation.
Similarly, all other information on the reconciliation should be traced to the relevant audit
schedules. If the bank confirmation does not agree with the audit schedules, auditors must
investigate the difference.
3. Obtain or prepare reconciliation of bank accounts as of the balance sheet date In
order to ascertain the appropriateness a company’s cash position at the close of the
period, the auditor should reconcile the balance per bank statement at that date with
the balance per company’s accounting records.
A monthly bank reconciliation of the general bank account on a timely basis by someone
independent of the handling or recording of cash receipts and disbursements is an essential
control over the ending cash balance. Companies with significant cash balances and large
volumes of cash transactions may reconcile cash on a daily basis to online banking records.
The reconciliation ensures that the accounting records reflect the same cash balance as the
actual amount of cash in the bank after considering reconciling items. More important, the
independent reconciliation provides an opportunity for an internal verification of cash
receipts and disbursements transactions.

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If the client has already prepared bank reconciliation, there is no need for duplicating the
work. However, the auditors should examine/inspect the reconciliation in detail to satisfy
themselves that it has been properly prepared. Auditors test the bank reconciliation to
determine whether client personnel have carefully prepared the bank reconciliation and to
verify whether the client’s recorded bank balance is the same amount as the actual cash in
the bank except for deposits in transit, outstanding checks, and other reconciling items. In
verifying the reconciliation, the auditor uses information in the cutoff bank statement to
verify the appropriateness of reconciling items.
4. Obtain a cut-off bank statement
A cut-off bank statement is a partial-period bank statement and the related copies of
cancelled checks, duplicate deposit slips, and other documents included in bank statements,
mailed by the bank directly to the auditor’s (CPA firm’s) office. The purpose of the cut-off
bank statement is to verify the accuracy of reconciling items on the client’s year-end bank
reconciliation with evidence that is not accessible to the client. To fulfil this purpose, the
auditor requests the client to have the bank send the statement for 7 to 10 days subsequent
to the balance sheet date directly to the auditor.
Unreasonable delay in the presentation of these checks for payment constitutes a strong
implication that the checks were not mailed by the client until sometime after the close of
the year.
In examining the cut-off bank statement, the auditors will also watch for any paid checks
issued on or before the balance sheet date but not listed as outstanding on the client’s
yearend bank reconciliation. Thus, the cut-off bank statement provides assurance that the
amount of cash shown on the balance sheet was not overstated by omission of one or more
checks from listing of checks outstanding.
5. Count cash list on hand
The auditors should physically count the cash on hand, which may include cash receipts,
change funds and petty cash, to verify its existence. This is normally done at the close of
business on the last day of the fiscal period under audit. The auditor should take at least two
precautions in performing the count of cash.
• The cash count should be made simultaneously with the inspection of investments
and negotiable instruments. This requirement prevents the auditor from double counting
these assets. Furthermore, all cash should be controlled throughout the time of the cash
count to avoid the possibility of the auditor again being misled into counting a specified
amount of cash more than once. A common way of achieving this control is to seal each
container of cash immediately after it has been counted. After the count has been
completed, the auditor should retrace the counting cycle to certify that the individual
seals were not broken after the cash in them was counted.
• The count should always be made in the presence of the custodian of each of the
funds, and he or she should be asked to sign a receipt for the return of cash after the
count has been completed.
6. Analyse bank transfers for the last week of audit year and first week of following
year
Embezzlers occasionally cover a theft of cash by a practice known as kiting: transferring
money from one bank to another and incorrectly recording the transaction. The purpose of
analysing bank transfer is to disclose overstatement of cash balances resulting from kiting.
Kiting is a fraudulent scheme that seeks to take advantage of "float". Float refers to the
timing difference between the day a check is credited to an account in one bank, and
debited to an account in another bank.
Example of Inter-bank Transfer Schedule
Bank Account Date of Date of Receipt

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 Disbursement
Check No. From To Amount Books Bank Books Bank
5897 General Payroll $30,620 12/28 1 /3 12/28 12/28
6006 General Branch 4 24,018 ½ ¼ 12/30 12/30
6029 Branch 2 General 10,000 1/3 1 /5 1/3 12/31
Disclosure of Kiting: By comparing the dates on the schedule of bank transfers, auditors
can determine whether any manipulation of the cash balance has taken place. The increase
in one bank account and decrease in the other bank account should be recorded in the cash
journals in the same accounting period. Notice that Check No. 6006 in the transfer schedule
was recorded in the cash journals as a receipt on December 30 and a disbursement on
January 2. As a result of recording the debit and credit parts of the transaction in different
accounting periods, cash is overstated on December 31. For the cash receipts journal to
remain in balance, some accounts must have been credited on December 30 to offset the
debit to Cash. If a revenue account was credited, the results of operations were overstated
along with cash.
A bank transfer schedule should disclose this type of kiting because the transfer deposit
appears on the general account bank statement in December, while the transaction was not
recorded in the cash journals until January. Check No. 6029 in the transfers schedule
illustrates this discrepancy.
These illustrations suggest the following rules for determining when it is likely that a cash
transfer has misstated the cash balance:
1. The dates of recording the transfer per the books (from the cash disbursements and
cash receipts journals, respectively) are from different statement period, or
2. The date the check was recorded by the bank (either the disbursement or the receipt,
but not both) is from the financial statement period prior to when it is recorded on the
books.
7. Evaluate proper balance sheet presentation and disclosure of cash
Cash must be properly classified, described and disclosures need to be appropriate. Take the
following in to consideration:
1. Inquire of management. See management representation letter.
2. Evaluate restrictions on cash.
3. Assess cash flow statement.
a. Evaluate presentation (direct or indirect method).
b. Reconcile information with income statement and balance sheet.
4. Read financial statement notes.
2.6 Audit of Marketable securities
2.6.1 Definition of marketable Securities
Companies often invest excess cash accumulated during certain parts of the operating cycle
that will be needed in the reasonably near future in short-term, highly liquid cash
equivalents. These may include time deposits, certificates of deposit, and money market
funds.
Marketable securities (Short-term investments) are financial investments which are
convertible into cash within one year or one operating cycle. They are listed at their current
market value. Marketable securities are shown on the balance sheet as “Short-term
Investments”.
E.g. Commercial paper, marketable equity securities, and marketable debt securities. Cash
equivalents, which can be highly material, are included in the financial statements as a part of
the cash account only if they are short-term investments that are readily convertible to known

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amounts of cash, and there is insignificant risk of a change of value from interest rate
changes.
2.6.2 Nature of marketable Securities
Companies group investments in debt and equity securities into three separate portfolios for
valuation and reporting purposes as:
 Held-to-maturity,
 Trading, and
 Available-for-sale securities.
2.6.3 Potential Misstatements of Marketable securities
 Misstatement of recorded value of Securities
 Unauthorized Security transactions
 Incomplete recording of Securities
 Inadequate disclosure of the nature of Security
activities
2.6.4 Controls over Marketable Securities
 Establishment of formal security policies
 Review and approval of security activities by the security committee of the board of
directors
 Separation of duties among employees
- Authorizing purchases and sales
- Having custody of the securities
- Maintaining records
 Detailed records of all securities owned
 Registration in the name of the company
 Periodic physical inspection of securities
 Determination of accounting for complex securities by competent personnel
2.6.5 Objectives for the Audit of Marketable Securities To
consider the inherent risks, including fraud risks.
 To consider internal control over marketable securities.
 To determine the existence of recorded marketable securities and that the client has
rights to the securities.
 To establish the completeness of recorded marketable securities.
 To determine that the valuation of marketable securities is in accordance with GAAP.
 To establish the clerical accuracy of schedules of securities.
 To determine that the presentation and disclosure of marketable securities are
appropriate.
2.6.6 Substantive Audit Procedures: Marketable Securities
 Client prepares schedule of marketable securities activity including
– Marketable securities held at year-end
– Audit period transactions - purchases and disposals
 The schedule is footed to determine mathematical accuracy
 Auditor verifies cost or sales price by examining broker's advices
 Auditor recalculates gains/losses on disposal of securities
 Existence of securities owned at year-end is verified by physically examining
securities held by the client, or confirmation with client's broker for securities held by
the broker
 Current market values are verified by referring to market sources
 Auditor asks management about any changes in the expected holding period, and any
restrictions on securities

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