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
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.
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.
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.
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.
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.
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.
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.
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.
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
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
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.