Substantive Audit Tests for Cash Balances

1. Substantive Audit Tests for Cash Balances • The most common substantive audit tests for cash balances include: • Cash counts • Footing of the cash journals and tracing of postings to the general ledger • Bank confirmations and cutoff bank statements • Bank transfer schedules • Proofs of cash

2. Cash Counts • Control cash until the count is finished. • Have the cash custodian present during the count. • Imprest Funds - Specific balance with one person responsible for the fund (e.g. petty cash). • Usually “cash on hand” is an immaterial financial statement item, but it still often is counted.

3. Foot Cash Journals and Trace Posting to the General Ledger • Foot the cash receipts journal and the cash disbursements journal and trace posting to the general ledger.

4. Financial Institution Confirmations • Confirmations are the most common substantive audit test for cash. • Use one standard form to confirm not only deposits, but also loan balances and related information. • Specific letters may be necessary to confirm some bank arrangements (e.g. lines of credit, compensating balances, etc.). • Cutoff bank statements are used to support the client’s year-end bank reconciliations.

5. Bank Transfer Schedules • Procedure is used when a client has more than one bank account. • Primary purpose is to ensure that the same deposit is not recorded in two accounts at the same time (i.e. the primary procedure to uncover kiting). • Schedule usually examines a few dates before and after the client’s fiscal year-end.

6. What is Kiting? • Kiting is intentionally manipulating bank transfers to overstate bank balances by showing the cash in two accounts at the same time. • Kiting is designed to either conceal a cash shortage (usually from theft) or to increase the cash reported on the balance sheet. • Good internal controls - particularly segregation of duties - make this difficult.

7. Proof of Cash • A comprehensive bank reconciliation. • It is four different reconciliations: • Beginning of the month bank to book balances. • Bank receipts for the month to book receipts. • Bank disbursements for the month to book disbursements. • Ending of the month bank to book balances. • Primary purpose is to provide evidence about existence and rights.

8. Audit of Sales • Sales is an income statement account that represents activity throughout the year, therefore an auditor emphasizes tests of transactions rather than tests of balances. • Strong client internal control policies for sales typically allow the auditor to support sales primarily through tests of controls rather than substantive testing. • Sales typically receives a low assessed level of control risk because of its interrelationships with cash and receivables.

9. Common Substantive Audit Tests for Sales

10. Substantive Audit Tests for Accounts Receivables

11. SAS No. 67 Requirement for Confirmations of Accounts Receivable • SAS No. 67 requires auditors to confirm accounts receivable unless they meet one of three conditions. • Accounts receivable are immaterial to the financial statements. • The use of confirmations would not be effective. • Confirmations are not necessary to reduce audit risk to an acceptably low level for the assertions relevant to accounts receivable. • Documentation must be in workpapers.

12. When Are Negative Confirmations Appropriate? • They are appropriate ONLY when ALLTHREE of the following conditions exist: • The combined assessed level of inherent risk and control risk is low • A large number of small individual balances is involved • The auditor has no reason to believe that the confirmation recipients are unlikely to give them consideration

13. Other Issues for Confirmations of Accounts Receivable • Nature of the Information Confirmed • Consider the customer’s record keeping system. • Timing of the Test - Interim or Year-end? • Extent of the Test • How many confirmations should be sent? • Which balances should be confirmed? • Subsequent Cash Collection is usually good support for receivable

14. Lapping: A Type of Fraud • Lapping is when, to cover a cash theft, an employee defers recording cash receipts from one customer and covers the shortage with receipts from another customer. • Weak segregation of duties control allows an employee to record the cash receipts and to reduce the customer’s balance in subsidiary ledger.