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The effects of major accounting transactions on cash

Revenue

Sale of PPE

Issuance of long-term debt or share capital

CASH

Long-term debt and shareholders’ equity

Payroll

Purchases

PPE

Inventory

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INTRODUCTION

Cash in the bank and transaction cycles

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Cash in the bank and transaction cycles

Considered significant in almost all audits
The amount of cash flowing into and out of the cash account is often larger than that for any other account in the financial statements
The susceptibility of cash to embezzlement is greater than for other types of assets because most other assets must be converted to cash to make them usable
In the audit of cash, auditors must distinguish between verifying the client’s reconciliation of the balance on the bank statement to the balance in the general ledger, AND verifying whether recorded cash in the general ledger correctly reflects all cash transactions that took place during the year

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Types of cash accounts

General Cash Account

The focal point of cash
All cash receipts and disbursements flow through this account

Imprest Accounts

Companies establish a separate imprest payroll account to improve internal control over payroll disbursements
A fixed balance is maintained in the imprest payroll bank account
Another type, imprest bank account consists of one bank account for receipts and a separate one for disbursements (improves controls over receipts and disbursements)

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Cont.

Branch Bank Account

Imprest Petty Cash Fund

Cash Equivalents

Useful for building banking relations in local communities and permitting the centralization of operations at the branch level

Is not a bank account
A preset amount of cash set aside in a cash box for incidental expenses
Used for small cash acquisitions that can be paid more conveniently and quickly by cash than by cheque
Set up on the same basis as an imprest branch bank account, but the expenditures are normally for much smaller amounts

Include time deposits, certificates of deposits, and money market funds
Financial instruments that have a short maturity, highly liquid market, and low risk
Can be easily converted into cash within a year

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Audit of the general cash account

Inherent risk is high for the existence, completeness and accuracy objective (cash is more susceptible to theft than other assets)
Major internal controls include (a) adequate segregation of duties between the cheque signing and accounts payable functions, (b) signing of cheques only by a properly authorized person, (c) use of prenumbered cheques printed on special paper, (d) careful review of supporting documentation by cheque signer before cheques are signed, and (e) adequate internal verification (monthly reconciliation by an independent person)
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

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Cont.

In designing tests of details of cash balance, auditors perform the following procedures;

Receipt of a Bank Confirmation – auditors usually obtain directly from every bank or other financial institutions. If the bank does not respond to a confirmation request, the auditor should send a second request or ask the client to communicate with the bank to ask them to complete and return the confirmation to the auditor.
Receipt of a Cutoff Bank Statement – is a partial-period bank statement and the related copies of cancelled cheques, duplicate deposit slips, and other documents included in bank statements, mailed by the bank directly to the CPA firm’s office. The purpose is to verify the reconciling items on the client’s year-end bank reconciliation with evidence that is not accessible to the client (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)
Test of the Bank Reconciliation – to determine whether the bank reconciliation has carefully prepared 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 cheques and other reconciling items

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Fraud-oriented procedures

The procedures for uncovering fraud:

Extended tests of the bank reconciliation – perform when the auditor believes that the year-end bank reconciliation may be intentionally misstated. The purposes are to verify whether all transactions included in the journals for the last month of the year were correctly included in or excluded from the bank reconciliation AND verify whether all items in the bank reconciliation were correctly included
Proof of cash – auditors prepare when the client has material internal control weaknesses in cash. Auditor uses proof of cash to determine whether all recorded cash receipts were deposited, all deposits in the bank were recorded in the accounting records, all recorded cash disbursements were paid by the bank, and all amounts that were paid by the bank were recorded.
Tests of interbank transfers – also known as tests for kiting. Kiting is when an employee steals cash to cover cash shortage by transferring money from one bank account to another and recording the transactions improperly in the client’s books.

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Example of interbank transfer schedule

		Account 1 Disbursement		Account 2 Receipts
Transfer Number	Amount (RM)	Date recorded in Books	Date paid by Bank	Date recorded in Books	Date received by Bank
1	15,000	28/12	30/12	28/12	29/12
2	10,000	2/1	2/1	30/12	31/12
3	17,300	2/1	4/1	2/1	2/1

The date of the recording of the disbursements and receipts for each transfer must be in the same fiscal year. If the cash receipt was recorded in the current fiscal year and the disbursement in the subsequent fiscal year, it may be an attempt to cover a cash shortage.

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Audit of imprest petty cash

Often immaterial in amount, but many auditors verify petty cash because of the potential for embezzlement
Internal control for petty cash is the use of an imprest fund that is the responsibility of one individual
In addition, petty cash funds should not be mingled with other receipts, and the fund should be kept separate from all other activities
There should be limits on the amount of any expenditure from petty cash, as well as on the total amount of the fund

The types of expenditures that can be made from petty cash should be well defined by company policy
When a disbursement is made from petty cash, a responsible official’s approval on a prenumbered petty cash form
The total of the actual cash in the fund, plus the total unreimbursed petty cash forms that represent expenditures, should equal the total amount of the petty cash fund stated in the GL

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