Substantive

Test of Cash

Auditing and Assurance:

Concepts and Applications
Topic Overview:
This chapter discusses the audit of cash and cash
equivalents, its objectives and procedures as well as
the management assertions relating to cash.
Learning Objectives:
1. Explain and identify the categories of management
assertions
2. Identify the audit objectives for cash and cash
equivalents
3. Describe the primary substantive audit procedures
for cash and cash equivalents
4. Identify assertions addressed by audit procedures
for cash and cash equivalents
Introduction
- Cash is one of the most important assets of a
business.
- Almost all the entity’s transactions ultimately result
in either receipt or payment of cash.
Introduction
- Because of the very nature of cash, it is considered a
high-risk area – most vulnerable to misappropriation
than other assets – that requires good internal controls
and careful monitoring.
- Due to its high degree of inherent risk, more audit
time is devoted to the audit of the account than is
indicated by its peso amount.
Management Assertions
- When auditing an account balance, the auditor should
use assertions for:
a. Classes of transactions
b. Account balances
c. Presentation and disclosures
in sufficient detail to form a basis for the assessment of
risks of material misstatement and the design and
performance of further audit procedures.
Management Assertions
- The auditor uses assertions in assessing risks by
considering the different types of potential
misstatements that may occur, and thereby designing
audit procedures that are responsive to the assessed
risks.
Assertions
Assertions used by the auditor fall into the following
three broad categories:
1. Assertions about classes of transactions and events
for the period under audit:
2. Assertions about account balances at the period end:
3. Assertions about presentation and disclosure
Assertions – Classes of Transactions
(Assertions in the statement of comprehensive
income)
a. Occurrence – transactions and events that have been
recorded have occurred and pertain to the entity
b. Completeness – all transactions and events that
should have been recorded have been recorded
Assertions – Classes of Transactions
c. Accuracy – amounts and other data relating to
recorded transactions and events have been recorded
appropriately
d. Cutoff – transactions and events have been recorded
in the correct accounting period
e. Classification – transactions and events have been
recorded in the proper accounts
Assertions – Account Balances
(Assertions in the statement of financial position)
a. Existence – assets, liabilities and equity interests
exist
b. Rights and obligations – the entity holds or controls
the rights to assets, and liabilities are the obligations of
the entity
Assertions – Account Balances
c. Completeness – all assets, liabilities and equity
interests that should have been recorded been recorded
d. Valuation and allocation – assets, liabilities and
equity interests are included in the financial statements
at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded
Assertions – Presentation & Disclosure
(Found in all the component of the complete set of
financial statements)
a. Occurrence and rights and obligations – disclosed
events, transactions and other matters have occurred
and pertain to the entity
b. Completeness – all disclosures that should have
been included in the financial statements have been
included
Assertions – Presentation & Disclosure
c. Classification and understandability – financial
information is appropriately presented and described,
and disclosures are clearly expressed
d. Accuracy and valuation – financial and other
information are disclosed fairly and at appropriate
amounts
Valuation vs. Allocation
Valuation – applies to both initial and subsequent
measurement of an asset or liability

Allocation – relates more on subsequent measurement

of prepayments, deferrals, intangible asset, wasting
asset and depreciable assets
Audit Procedures for Cash
- Substantive procedures for cash balances and
transactions:
1. Sending confirmation to banks or financial
institutions
2. Conducting surprise cash counts
3. Obtaining and testing bank reconciliation and if
appropriate, preparing proof of cash
Audit Procedures for Cash
4. Obtaining bank cutoff statement and tracing bank
transfers
5. Performing cash cutoff tests
6. Checking the appropriate valuation of cash
7. Performing analytical procedures to assess the
reasonableness of reported cash
Bank Confirmations
Primary Audit Objectives:
- Existence
- Valuation
- Rights and obligations
- Presentation and disclosure
Bank Confirmations
- The primary procedure when testing the existence
and rights and obligations in relation to the reported
cash in bank is through confirmation of the balances
of the company’s accounts with banks or financial
institutions.
- One objective when confirming bank accounts is to
search for undisclosed liabilities and commitments.
Bank Confirmations
- When determining whether to confirm a bank
account, the materiality of the account balance is not a
consideration. Instead, the auditor should consider
factors such as the volume of transactions passing
through the account and the purpose of the account.
Bank Confirmations
- Auditor is likely to confirm an account that has a
high volume of transactions and is the key account for
a trading operation.
- Closed account during the period should be included
in the confirmation.
Bank Confirmations
- The request for a bank confirmation should be issued
on auditor’s letterhead and sent to all banks where the
client has dealings.
- The request should be clear and concise and may
include balances and other information and request
confirmation, or to request details of balances and
other information.
Bank Confirmations
- Control over the content and dispatch of requests for
confirmation is the responsibility of the auditor.
- The client will need to authorize disclosure of the
relevant information.
- Replies should be sent directly to the auditor who
should enclose a stamped or business reply envelope
addressed to the office of the auditor to facilitate a
speedy response.
Bank Confirmations
- On receipt, the auditor should review the returned
bank confirmations for details of security, guarantees
and restrictions over the entity’s use of its cash, and
agree details of all such items with the entity.
- The auditor should review documents such as
minutes and agreements during the course of audit to
establish the existence of any restrictions over the
entity’s use of its cash.
Bank Confirmations
- Loan agreements between financial institutions and
their customers may provide that the cash that is
deposited in the financial institutions is pledged as
security for the loans.
- The auditor should check whether the amount
pledged is properly disclosed in the notes to financial
statements.
Cash Count
Primary Audit Objectives:
- Existence
- Valuation
- Rights
Cash Count
- Cash on hand ordinarily consists of undeposited cash
receipts, petty cash funds, and change funds.
- Cash count can be either conducted before or after
the reporting date.
- Cash counts should be conducted through the year
and should cover all branches and, if possible, all
tellers or cash custodian.
Test on Bank Reconciliation
Primary Audit Objectives:
- Existence
- Valuation
- Completeness
- Rights
Test on Bank Reconciliation
- Bank reconciliation is customarily prepared monthly
by the client as part of its internal control over cash.
- When auditing bank reconciliation, the auditor
would obtain a copy of bank reconciliation prepared
by the client.
- After obtaining a copy of bank reconciliation
prepared by the client, the auditor should:
Test on Bank Reconciliation
1. Verify the cash balance used in the bank reconciliation:
a. Trace balance per books in the ledger, cash receipts and
cash disbursement journal.
b. Trace balance per bank in the balance per bank
statement, reply to bank confirmation and cutoff bank
statement.
2. Check the accuracy of the footing in the bank
reconciliation.
Test on Bank Reconciliation
3. Obtain supporting documents for any book and bank
reconciling items:
a. Bank reconciling items can be verified by obtaining
“bank cutoff statement”. A bank cutoff statement is
normally prepared 8-10 business days after the reporting
date. Most items that were outstanding at year-end
would have cleared when the cutoff statement is
prepared (outstanding checks and deposits in transits).
Test on Bank Reconciliation
b. For book reconciling items, the auditor would
normally examine the bank statement provided and
examine any other supporting documents.
4. Examine whether there is an adjusting entry to
reflect the book reconciling items.
Test on Bank Reconciliation
- When testing bank reconciliation, the auditors should
place more importance on items that may be omitted
in the bank reconciliation to conceal cash shortage or
misappropriation of cash and any unusual transactions.
- The item normally omitted is outstanding checks.
- The auditor also needs to investigate any long
outstanding checks for a year or more.
Test on Bank Reconciliation
- Under normal banking practice, checks not encashed for a
period exceeding six months from issue is considered stale.
- Any large or unusual transactions, especially checks
payable to directors, officers, employees, affiliated
companies, or cash should be carefully reviewed by the
auditors to determine whether the transactions were properly
authorized, recorded and are adequately disclosed in the
financial statements as required by PAS 24 Related Party
Transactions.
Proof of Cash
- Based on the understanding of the auditor on internal
controls, the auditor may assess internal control over
cash receipts and cash disbursements as weak or
ineffective.
- In such cases, the auditor may consider preparing
proof of cash as an additional audit procedure aside
from testing bank reconciliation.
Proof of Cash
- Prepared to reconcile not only the account balance
but also the account transactions occurring during a
specified period.
Proof of cash is used to identify:
1. Cash receipts and disbursements recorded in the
accounting records, but not on the bank statement
2. Cash deposits and disbursements recorded on the
bank statement, but not on the accounting records
Proof of Cash
3. Cash receipts and disbursement recorded at
different amounts by the bank than in the accounting
records

- A proof of cash is essentially a fraud detection

procedure that may be used by the auditor and the
client, for any months during the year.
Tracing Bank Transfers
Primary Audit Objectives:
- Existence
- Completeness
- Rights
Tracing Bank Transfers
- Many businesses maintain checking accounts with a
number of banks and often find it necessary to transfer
funds from one bank to another.
- When a check drawn on one bank is deposited in
another, normally three working days will pass before
the check clears the bank on which it is drawn.
Tracing Bank Transfers
- During this period, the amount of the check is
included in the balance on deposit at both banks,
thereby causing overstatement of cash balances.
- Due to this effect of the clearing period, an employee
may take advantage of this period and manipulate
bank transfers to conceal cash shortage. (Kiting)
Cash Cut-off Tests
Primary Audit Objectives:
- Existence
- Rights
- Completeness
Cash Cut-off Tests
- The auditor should perform cutoff procedures on
cash receipts, disbursements and transfers to
determine if these transactions are reflected in the
proper period.
Cash Cut-off Tests
- Normally, the desire to show a more favorable
current ratio may cause some entities to record cash
disbursed in the first few days of a new accounting
period as disbursements of the preceding period or to
record cash receipts of the first few days of the
subsequent period as receipts of the preceding period.
(Window Dressing)
Cash Cut-off Tests
When testing cutoff of cash receipts and cash
disbursements at the reporting date, audit procedure
might include:
1. Comparing deposits on the bank statements
immediately before and after the reporting date with
entries in the cash receipts journal to establish the
reasonableness of the deposits in transit at the
reporting date
Cash Cut-off Tests
2. Comparing the dates of the disbursement and
receipt of intercompany payments or interbank
transfers immediately before and after the reporting
date to establish that both receipts and disbursements
were recorded in the proper periods
Cash Valuation
Primary Audit Objectives:
- Valuation
- Presentation and disclosure
Cash Valuation
- Some companies may maintain its bank account in
foreign currencies for some business purposes.
- If the bank account being reconciled is in a foreign
currency, the auditor should test the conversion of the
balance to the presentation currency (Philippine peso)
to determine whether cash is stated at its realizable
value.
Cash Valuation
- The auditor ordinarily should:
1. Obtain the period-end foreign exchange rate from
an independent source
2. Reperform the conversion of the cash balance into
the currency using this rate
3. Compare the resultant amount to the account
balance in the general ledger and accounting for any
differences
Cash Deposits in Closed Bank
- In some cases, a company may also have bank
deposits on banks deposits on banks that have closed
during the fiscal period.
- In considering the amounts to be reported in the
statement of financial position, the auditor should
consider that deposits in closed bank may be covered
under Philippine Deposits Insurance Corporation
(PDIC).
Cash Deposits in Closed Bank
- The auditor should also ensure that cash in closed
bank should not be included as part of “cash and cash
equivalents”, rather it should be part of non-trade
receivable.
Analytical Procedures on Cash
- Aside from the substantive test of balances and
transactions, the auditor may need to perform analytical
procedures to obtain evidence of reasonableness of the
cash reported in the financial statements. The auditor may:
1. Compare the listing of cash accounts with those of prior
periods and investigate any unexpected changes (credit
balances, unusual large balances, new accounts, closed
accounts) or the absence of expected changes
Analytical Procedures on Cash
2. Review interest received and/or paid in relation to
the average cash balances and/or bank overdrafts
3. Investigate any unusual fluctuations and significant
difference
Additional Audit Consideration:
Bank Overdrafts
- Bank overdrafts arises when bank balances are
overdrawn, it should be reported as current liabilities
and should not be netted to other bank accounts with
positive balance, unless it is part of the company’s
cash management or the amount involved is
immaterial.
Bank Overdrafts
- When verifying bank overdrafts, the auditor
performs same procedure when verifying cash
balances, which is performing bank confirmations.
Special Audit Consideration
1. Kiting
2. Lapping
3. Window Dressing
Kiting
- An irregularity whereby an overstatement of cash is
created by a cash transfer between bank accounts

- Characterized by recording the transfer to the other

bank as cash receipts but the disbursement is not
recorded
Kiting
- From an internal control point of view, kiting occurs
due to lack of segregation of duties between
accounting and cash custody.

- To detect kiting, the auditor may test the cutoff bank

statement and trace bank transfers
Lapping
- Done by misappropriating collections from one
customer and concealing this defalcation by applying
a subsequent collection made from another customer
- Used to conceal cash shortage
Lapping
- Can be detected by bank confirmation, surprise cash
count and comparing details of cash receipts journal
entries with the details of corresponding daily slips
Window Dressing
- Any deliberate misstatement of the assets, liabilities,
equity, income and expenses
- Accomplished by:
a. Recording as of the last day of the accounting
period collections made subsequent to the close of the
period
Window Dressing
b. Recording as of the last day of the accounting
period payments of accounts made subsequent to the
close of the period

- To detect this scheme, the auditor will ordinarily

verify cash cutoff of cash receipts and disbursements.