AUDIT OF CASH

Audit Program for Cash: Objectives and Procedures

The audit program for cash contains a statement of the audit objectives, the complete and
detailed procedures, and a conclusion.
The audit objectives are
a. Cash exists and is owned by the client
b. Cash balances reflect a proper cut-off of receipts and disbursements
c. Cash balances as presented in the balance sheet properly reflect all cash and cash
items on hand, in transit, or on deposit with third parties
d. Cash balances are properly classified in the financial statements, and any restrictions
on the availability of funds are properly disclosed
Basic procedures
1. Using the standard bank confirmation form, request confirmation as of the audit date for
bank accounts selected. Also request confirmation of material cash in savings institutions,
certificates of deposit, and compensating balances. Documents items selected for
confirmation and retain returned confirmations. Mail second requests, if necessary.
2. Obtain copies of each account's bank reconciliation for the work papers
a. Trace the bank balance on the reconciliation to the standard bank confirmation received
from the bank
b. Trace the reconciled book balance to the general ledger, trial balance or lead schedule as
applicable
Cash Management: Internal Controls Checklist
Research has shown that the most common item stolen was cash. Here is a checklist of
internal controls your business should have in place to protect your business from internal
employee theft and external theft:
1. Segregation of duties – On the accounts receivable side, ensure that the same
person who is receiving cash, is not also depositing it and recording it in the
accounting records. For accounts payable, ensure that the same person approving
payments is not also writing the checks and reconciling the bank account.

2. Make timely deposits – Cash and checks received at a business should be

deposited daily to decrease the chance of the money being stolen.

3. Review check signing authority – Review the records with the bank to ensure that
the appropriate person have check signing authority. Consider requiring more than
one signature for checks above a certain threshold.

4. Control access to check stock, accounting systems, and cash – Unused check
stock should be locked up. Access to computer systems or banking systems where
checks can be generated should require strong passwords. Cash and checks waiting
for deposit should be securely stored in a safe.

5. Discourage management override of controls – Management override of existing

controls should be strongly discouraged as it sets a poor example to employees
 about the importance of internal controls, and because external thieves are targeting
businesses this way. We have seen thieves pretending to email as the company
CEO requesting funds be wired, and the accounting employees follow those
instructions without following the normal process and controls for purchases resulting
in payments made to cybercriminals.

6. Reconcile the bank accounts – All bank accounts should be reconciled on at least
a monthly basis. Ideally, a person uninvolved in the day to day accounting activities
for cash receives an unopened bank statement with cancelled check copies to
reconcile the bank account from so that the statement activity and cancelled checks
can be reviewed for irregularities. If there are not enough team members for this to
happen, it is important that an owner, manager, or board member obtain the bank
statement and review for irregularities prior to the regular bookkeeper preparing the
reconciliation.
How to Audit Cash
The following are procedures in the audit of cash:
 Primary cash assertions
 Cash walkthrough
 Directional risk for cash
 Primary risks for cash
 Common cash control deficiencies
 Risk of material misstatement for cash
 Substantive procedures for cash
 Common cash work papers

Primary Cash Assertions

The primary relevant cash assertions are:
 Existence
 Completeness
 Rights
 Accuracy
 Cut off

Of these assertions, existence, accuracy, and cut-off are most important. The audit client
is asserting that the cash balance exists, that it’s accurate, and that only transactions within
the period are included.

Classification is normally not a relevant assertion. Cash is almost always a current asset. But
when bank overdrafts occur, classification can be in play. The negative cash balance can
be presented as cash or as a payable depending on the circumstances.

Cash Walkthrough
As we perform walkthroughs of cash, we normally look for ways that cash might be
overstated (though it can also be understated as well), whether intentionally or by mistake.

In performing cash walkthroughs, ask questions such as:

 Are timely bank reconciliations performed by competent personnel?
 Are all bank accounts reconciled?
 Are the bank reconciliations reviewed by a second person?
 Are all bank accounts on the general ledger?
 Are transactions appropriately cut off at period-end (with no subsequent period
transactions appearing in the current year)?
 Is there appropriate segregation between persons handling cash, recording cash, making
payments, and reconciling the bank statements
 What bank accounts were opened in the period?
 What bank accounts were closed in the period?
 Are there any restrictions on the bank accounts?
 What persons are on the bank signature cards?
 Who has the authority to open and/or close bank accounts?
 What is the nature of each bank account (e.g., payroll bank account)?
 Are there any cash equivalents (e.g., investments of less than three months)
 Were there any held checks (checks written but unreleased) at period-end?

As we ask questions, we also inspect documents (e.g., bank reconciliations) and make
observations (who is doing what?).

If controls weaknesses exist, we create audit procedures to address them. For example, if
during the walkthrough we review three monthly bank reconciliations and they all have
obvious errors, we will perform more substantive work to prove the year-end bank
reconciliation. For example, we might vouch every outstanding deposit and disbursement.

Directional Risk for Cash

What is directional risk? It’s the potential bias that a client has regarding an account balance.
A client might desire an overstatement of assets and an understatement of liabilities since
each makes the balance sheet appear healthier.

The directional risk for cash is overstatement. So, in performing your audit procedures,
perform procedures such as testing the bank reconciliation to ensure that cash is not
overstated.

Primary Risks for Cash

The primary risks are:
1. Cash is stolen
2. Cash is intentionally overstated to cover up theft
3. Not all cash accounts are on the general ledger
4. Cash is misstated due to errors in the bank reconciliation
5. Cash is misstated due to improper cut off

Common Cash Control Deficiencies

In smaller entities, it is common to have the following control deficiencies:
 One person receipts and/or disburses monies, 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

Risk of Material Misstatement (RMM)for Cash

Assess control risk at high for each assertion. If control risk is assessed at less than high,
then controls must be tested to support the lower risk assessment. Assessing risks at high is
usually more efficient than testing controls.

When control risk is assessed at high, inherent risk becomes the driver of the risk of material
misstatement (control risk X inherent risk = risk of material misstatement). For example, if
control risk is high and inherent risk is moderate, then my RMM is moderate.

The assertions that an auditor concern the most are existence, accuracy, and cut off. So
RMM for these assertions is usually moderate to high.
 Response to higher risk assessments is to perform certain substantive procedures: namely,
bank confirmations and testing of the bank reconciliations. As RMM increases I examine
more of the period-end bank reconciliations and more of the outstanding reconciling items.

Substantive Procedures for Cash

Customary audit tests are as follows:
1. Confirm cash balances
2. Vouch reconciling items to the subsequent month’s bank statement
3. Ask if all bank accounts are included on the general ledger
4. Inspect final deposits and disbursements for proper cutoff

The auditor should send confirmations directly to the bank. Some individuals create false
bank statements to cover up theft. Those same persons provide false confirmation
addresses. Then the confirmation is sent to an individual (the fraudster) rather than a bank.
Once received, the fraudster replies to the confirmation as though the bank is doing so.

Agree the confirmed bank balance to the period-end bank reconciliation (e.g., December 31,
2023). Then, agree the reconciling items on the bank reconciliation to the bank statement
subsequent to the period-end. For example, examine the January 2024 bank statement
activity when clearing the December 2023 reconciling items. Finally, agree the reconciled
balance to the general ledger cash balance for the period-end (e.g., December 31, 2023).
Cut-off bank statements (e.g., January 20, 2024 bank statement) may be used to test the
outstanding items. Such statements, similar to bank confirmations, are mailed directly to the
auditor. Alternatively, the auditor might examine the reconciling items by viewing online bank
statements. (Read-only rights can be given to the auditor.)

Common Cash Working Papers

Cash working papers normally include the following:
 An understanding of cash-related internal controls
 Risk assessment of cash assertions at the assertion level
 Documentation of any control deficiencies
 Cash audit program
 Bank reconciliations for each significant account
 Bank confirmations

The Imprest Petty Cash System

Petty cash, also known as imprest cash, is a fund established for making small payments
that are impractical to pay by check. Examples include postage due, reimbursement to
employees for small purchases of office supplies, and numerous similar items. The
establishment of a petty cash system begins by making out a check to cash, cashing it, and
placing the cash in a petty cash box:
A petty cash custodian should be designated to safeguard and make payments from this
fund. At the time the fund is established, the following journal entry is needed. This journal
entry, in essence, subdivides the petty cash portion of available funds into a separate
account.
Policies should be established regarding appropriate expenditures that can be paid from
petty cash. When a disbursement is made from the fund, a receipt should be placed in the
petty cash box. The receipt should set forth the amount and nature of expenditure. The
receipts are known as petty cash vouchers. At any point in time, the receipts plus the
 remaining cash should equal the balance of the petty cash fund (i.e., the amount of cash
originally placed in the fund).
Replenish Petty Cash
As expenditures occur, cash in the box will be depleted. Eventually the fund will require
replenishment. A check for cash is prepared in an amount to bring the fund back up to the
original level. The check is cashed and the proceeds are placed in the petty cash box. At the
same time, receipts are removed from the petty cash box and formally recorded as
expenses.
The journal entry for this action involves debits to appropriate expense accounts as
represented by the receipts, and a credit to Cash for the amount of the replenishment.
Notice that the Petty Cash account is not impacted — it was originally established as a base
amount, and its balance has not been changed by virtue of this activity.
Cash Short and Over
Occasional errors may cause the petty cash fund to be out of balance. The sum of the cash
and receipts will differ from the correct Petty Cash balance. This might be the result of
simple mistakes, such as math errors in making change, or perhaps someone failed to
provide a receipt for an appropriate expenditure. Whatever the cause, the available cash
must be brought back to the appropriate level.
The Cash Short (Over) account is an income statement type account. It is also applicable to
situations other than petty cash. For example, a retailer will compare daily cash sales to the
actual cash found in the cash register drawers. If a surplus or shortage is discovered, the
difference will be recorded in Cash Short (Over); a debit balance indicates a shortage
(expense), while a credit represents an overage (revenue).
Increasing the Base Fund
As a company grows, it may find a need to increase the base size of its petty cash fund. The
entry to increase the fund would be identical to the first entry illustrated; that is, the amount
added to the base amount of the fund would be debited to Petty Cash and credited to Cash.
Otherwise, take note that the only entry to the Petty Cash account occurred when the fund
was established.
Bank Reconciliation
One of the most common cash control procedures is the bank reconciliation. In business,
every bank statement should be promptly reconciled by a person not otherwise involved in
the cash receipts and disbursements functions. The reconciliation is needed to identify
errors, irregularities, and adjustments for the Cash account. Having an independent person
prepare the reconciliation helps establish separation of duties and deters fraud by requiring
collusion for unauthorized actions.

Using Bank Accounts

To obtain desired control objectives, a company can vary the number and location of banks
and the types of accounts.
► General checking account
► Demand deposit
► Savings deposit

Bank Reconciliation

Schedule explaining any differences between the bank’s and the company’s records of cash.

Purpose of Bank Reconciliation

The bank reconciliation process offers several advantages including:
 Detecting errors such as double payments, missed payments, calculation errors etc.
 Tracking and adding bank fees and penalties in the books
 Spot fraudulent transactions and theft
 Keeping track of accounts payable and receivables of the business

Pro forma bank reconciliation statement

Angel Co.
Bank Reconciliation
For the Month Ended Aug. 31, 2021
Balance per books, end P xx Balance per bank statement, end P xx
Add: Credit memos (CM) xx Add: Deposit in transit (DIT) xx
Less: Debit memos (DM) (xx) Less: Outstanding checks (OC) (xx)
Add/Less: Book errors xx Add/Less: Banks errors xx
Adjusted Balance P xx Adjusted balance P xx

Book - Reconciling Items:

Credit memos – are additions made by the bank not representing deposits made by the
depositor (book), and not yet recorded by the depositor.

Examples of credit memos include:

• Collections made by the bank on behalf of the depositor.
• Interest income earned by the depositor.
• Proceed from loan directly credited or added by the bank to the depositor’s account.
• Unrolled-over matured time deposits transferred by the bank to the depositor’s
account.

Debit memos – are deductions by the bank not representing checks issued by the
depositor.

Examples of debit memos include:

• Bank service charges representing bank charges for fees, interest, penalties, and
surcharges.
• No sufficient funds checks (NSF) – these are checks deposited and already added by
the bank to the account, but subsequent returned because of insufficient funds by the
drawer to pay for the check.
• Automatic debits, such as when the depositor and the bank agree that the bank will
make automatic payments of bills on behalf of the depositor.
• Payment of loans which the entity (depositor) agreed to be made out directly from its
bank account.

Book errors – errors committed by the depositor (e.g., erroneous recording in the books).

Bank – Reconciling Items:

 Deposit in transit – sometimes called undeposited collection, recognize as deposit by the
book but not yet credited by the bank. Deposit in transit often occur when deposits are
mailed to the bank, deposits place in a night depository, or deposit made after the bank cut-
off.

Outstanding checks – are checks issued and released to the payee but not yet encashed
with the bank.

Outstanding checks exclude the following:

Certified checks – the bank when certifying a checks, automatically debits the depositors
accounts.
Stale checks – checks that remains outstanding for a relatively long period of time, are
reverted back to cash, and are excluded from the from outstanding checks.

Bank errors – errors committed by the bank.

Credit memos, debit memos and book errors are referred to as book reconciling items. The
depositors should make reconciling entries for those items.
Deposit in transit, outstanding checks and book errors are referred to as bank reconciling
items. The depositors does not make reconciling entries for these items.

Bank Reconciliation: A Step-by-Step Guide

You receive a bank statement, typically at the end of each month, from the bank. The
statement itemizes the cash and other deposits made into the checking account of the
business. The statement also includes bank charges such as for account servicing fees.
Once you’ve received it, follow these steps to reconcile a bank statement:

1. COMPARE THE DEPOSITS

Match the deposits in the business records with those in the bank statement. Compare
the amount of each deposit recorded in the debit side of the bank column of the
cashbook with credit side of the bank statement and credit side of the bank column with
the debit side of the bank statement. Mark the items appearing in both the records.
2. ADJUST THE BANK STATEMENTS
Adjust the balance on the bank statements to the corrected balance. For doing this,
you must add deposits in transit, deduct outstanding checks and add/deduct bank
errors.
• Deposits in transit are amounts that are received and recorded by the
business but are not yet recorded by the bank. They must be added to the
bank statement.
• Outstanding checks are those that have been written and recorded in cash
account of the business but have not yet cleared the bank account. They
need to be deducted from the bank balance. This often happens when the
checks are written in the last few days of the month.
• Bank errors are mistakes made by the bank while creating the bank
statement. Common errors include entering an incorrect amount or
omitting an amount from the bank statement. Compare the cash account’s
general ledger to the bank statement to spot the errors.

3. ADJUST THE CASH ACCOUNT

The next step is to adjust the cash balance in the business account.
 Adjust the cash balances in the business account by adding interest or deducting
monthly charges and overdraft fees.
To do this, businesses need to take into account the bank charges, NSF checks
and errors in accounting.
• Bank charges are service charges and fees deducted for the bank’s
processing of the business’ checking account activity. This can include
monthly charges or charges from overdrawing your account. They must
be deducted from your cash account. If you’ve earned any interest on
your bank account balance, they must be added to the cash account.
• An NSF (not sufficient funds) check is a check that has not been honored by the
bank due to insufficient funds in the entity’s bank accounts. This means that the
check amount has not been deposited in your bank account and hence needs to
be deducted from your cash account records.
• Errors in the cash account result in an incorrect amount being entered or an
amount being omitted from the records. The correction of the error will increase
or decrease the cash account in the books.
4. COMPARE THE BALANCES
After adjusting the balances as per the bank and as per the books, the adjusted
amounts should be the same. If they are still not equal, you will have to repeat the
process of reconciliation again.
Once the balances are equal, businesses need to prepare journal entries for the
adjustments to the balance per books.

Proof of Cash
Many businesses prepare a reconciliation However, this approach leaves one gaping hole in
the control process. What if the bank statement included a 5,000 check to an employee near
the beginning of the month, and a 5,000 deposit by that employee near the end of the month
(and these amounts were not recorded on the company records)? In other words, the
employee took out an unauthorized “loan” for a while. The reconciliation would not reveal
this unauthorized activity because the ending balances are correct and in agreement. To
overcome this deficiency, some companies will reconcile not only the beginning and ending
balances, but also the total checks per the bank statement to the total disbursements per the
company records, and the total deposits per the bank statement to the total receipts on the
company accounts. If a problem exists, the totals on the bank statement will exceed the
totals per the company records for both receipts and disbursements. This added
reconciliation technique is termed a proof of cash. It is highly recommended where the
volume of transactions and amount of money involved is very large.
Also illegal is “kiting” which occurs when one opens numerous bank accounts at various
locations and then proceeds to write checks on one account and deposit them to another. In
turn, checks are written on that account, and deposited to yet another bank. And, over and
over and over. Each of the bank accounts may appear to have money; but, it is illusionary,
because there are numerous checks “floating” about that will hit and reduce the accounts.
Somewhere in the process the perpetrator makes a cash withdrawal and then vanishes.
That is why one will often see bank notices that deposited funds cannot be withdrawn for
several days. Such restrictions are intended to make sure that a deposit clears the bank on
which it is drawn before releasing those funds. Kiting is complex and illegal. Enhanced
electronic clearing procedures adopted by banks have made kiting far more difficult to
accomplish.