Which of the following represents a typical substantive audit procedure for cash balances

FIGURE 10.3   Objectives of Major Substantive Procedures for Cash Transactions and Balances

Figure 10.3 relates these substantive procedures to the primary audit objectives.

In addition to concerns about the overstatement of cash, auditors are aware that cash may have been improperly abstracted during the period, even though the year-end cash may be properly stated. To distinguish between the situations, assume that the client's balance sheet shows “Cash $250,000.” For most clients, the primary risks are that errors or fraud either (1) create a situation in which $250,000 overstates actual cash, or (2) create a situation in which the $250,000 recorded year-end balance should be higher.

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   Concerning the first risk (overstated cash), a shortage may have been concealed merely by the insertion of a fictitious check in the cash on hand at year-end, or by the omission of an outstanding check from the year-end bank reconciliation. Note that the omission of an outstanding check may be indicative of either an error or fraud. For example, poor internal control may result in a situation in which human error resulted in the check not being recorded in disbursements. On the other hand, although recorded in cash disbursements, the check may have been omitted from the outstanding check list to allow the individual who has embezzled that amount of cash to hide fraud.

   Concerning the second risk—the year-end cash is correct, but should be higher—the auditors' problem is not misstated cash, but fraud and its effect on other accounts. Consequently, the auditors have in mind such basic questions as: (1) Do the client's records reflect all cash transactions that took place during the year? and (2) Were all cash payments properly authorized and for a legitimate business purpose? Examples of fraud that may be disclosed in searching for answers to these questions are:

   Based on their knowledge of the client and its environment, the auditors may identify other business risks that result in risks of material misstatements. In some engagements, the auditors may be particularly concerned with the risk of the completeness of recorded cash. As an example, management of a privately held company may be motivated to understate assets (including cash) to minimize income taxes. Also, for a particular client there may be a significant risk that management maintains bank accounts not recorded on the books for such purposes as making illegal bribes. Thus, in such situations, there is a heightened risk that not all cash may be recorded in the financial records. In other cases, the manner in which the client collects cash may present significant business and inherent risks. For example, a charitable organization may receive a large amount of funds from cash donations, creating a significant inherent risk that not all cash donations may be received and recorded.

   The auditors also may identify fraud risks related to cash transactions. In such cases, the auditors should obtain an understanding of the programs and controls used by management to mitigate these risks and determine whether the controls have been implemented. Strengths and weaknesses in the client's internal control serve to mitigate or increase the effects of these fraud risks.

   Other points to be made clear by the questionnaire include (1) whether check-signing authority is restricted to selected executives not having access to accounting records or to vouchers and other documents supporting checks submitted for signature, and (2) whether checks are mailed directly to the payees after being signed. The internal control questionnaire will also cover cash disbursements for payroll and for dividends, as well as bank reconciliation procedures.

   After the auditors have prepared a flowchart (or other description) of internal control, they will conduct a walk-through of the system. The term walk-through means to trace a transaction or a few transactions through each step of the system to determine that transactions actually are being processed in the manner indicated by the flowchart. The walk-through allows the auditors to determine that internal control as described in the working papers has actually been implemented.

   As the auditors verify their understanding of the cash receipts and disbursements cycles, they will observe whether there is appropriate segregation of duties and inquire about who performed various functions throughout the year. They will also inspect the various documents and reconciliations that are important to the client's internal control over cash receipts and disbursements. Cash forecasts or budgets also will be inspected and the auditors will review the evidence of the follow-up on variances from forecasted amounts of receipts and disbursements. In some cases, the auditors will review exception reports generated by the computer and the evidence of the follow-up on them. These tests of controls provide the auditors with evidence to support their assessed level of control risk.

By considering these risk assessments, the auditors are able to identify “what could go wrong” to cause the cash accounts to be materially misstated. Figures 10.4 and 10.5 provide examples of possible material misstatements of cash that may be identified by the auditors based on the client's operations and environment, and on weaknesses in its internal control over cash receipts and cash disbursements. Once these risks of material misstatement have been identified and assessed, the auditors can plan appropriate substantive procedures that address them.

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D.  Perform Further Audit Procedures—Tests of Controls.

1.  Examples of Tests of Controls.

Tests directed toward the effectiveness of controls help to evaluate the client's internal control and determine whether the auditors' planned assessed levels of the risks of material misstatement can be supported. Certain tests of controls are performed as the auditors obtain an understanding of the client's internal control; these tests were described in our discussion of that process. The following are examples of typical further tests of controls.

a.  Test the Accounting Records and Reconciliations by Reperformance.

To determine that the client's accounting procedures are operating effectively, the auditors perform tests of the accuracy of the client's journals and ledgers. In a computer-based system, journal and ledger entries may be created simultaneously from the same source documents, and the auditors might choose to use computer assisted audit techniques (CAATs) to test the accuracy of the accounting records.

   In a manual system, information on source documents is entered first in a journal; at a later date the information is summarized and posted from journals to ledgers. The auditors must manually determine that the documents are accurately entered to the journals, the journals are accurately footed, and the data are properly posted to the ledgers. The auditors also may decide to test the client's procedures for reconciling bank (financial institution) accounts. They may select a sample of the reconciliations performed during the year, noting who performed them, and reperform the reconciliation process by reference to accounting records, bank statements, and canceled checks.

b.  Compare the Details of a Sample of Cash Receipts Listings to the Cash Receipts Journal, Accounts Receivable Postings, and Authenticated Deposit Slips.

Satisfactory internal control over cash receipts demands that each day's collections be deposited intact no later than the next banking day. To provide assurance that cash receipts have been deposited intact, the auditors should compare the detail of the original cash receipts listings (mailroom listings and register tapes) to the detail of the daily deposit tickets. The detail of cash receipts refers to a listing of the amount of each individual check and the total amount of currency composing the day's receipts.

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FIGURE 10.4   Potential Misstatements—Cash Receipts

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FIGURE 10.5   Potential Misstatements—Cash Disbursements

   Comparison of the daily entries in the cash receipts journal with bank deposits may disclose a type of fraud known as lapping. Lapping is the concealment of a cash shortage by delaying the recording of cash receipts. The table on the following page provides an illustration.

   If cash collected from customer A is withheld by the cashier, a subsequent collection from customer B may be entered as a credit to A's account. B's account will not be shown as paid until a collection from customer C is recorded as a credit to B. Unless the money abstracted by the cashier is replaced, the accounts receivable as a group remain overstated; but judicious shifting of the overstatement from one account receivable to another may avert protests from customers receiving monthly statements. The following schedule makes clear how a lapping activity may be carried on. In companies in which the cashier has access to the general accounting records, shortages created in this manner have sometimes been transferred to inventory accounts or elsewhere in the records for temporary concealment.

   Lapping is most easily carried on when an employee who receives collections from customers is responsible for the posting of customers' accounts. Familiarity with customers' accounts makes it relatively easy to lodge a shortage in an account that will not be currently questioned.

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c.  Compare the Details of a Sample of Recorded Disbursements in the Cash Disbursements Journal to Accounts Payable Postings, Purchase Orders, Receiving Reports, Invoices, and Paid Checks.

Satisfactory internal control over cash disbursements requires that controls exist to provide assurance that disbursements are properly authorized. Testing cash disbursements involves tracing selected items back through the cash disbursements journal to original source documents, including vouchers, purchase orders, receiving reports, invoices, and paid checks. While examining these documents, the auditors have an opportunity to test many of the controls over cash disbursements. For example, they will notice whether all paid vouchers and supporting documents have been perforated or canceled. Also, they will determine whether agreement exists among the supporting documents and note the presence of all required authorization signatures. The auditors also may review the file of paid checks to test the client's procedures for accounting for the numerical sequence of checks.

2.  If Necessary, Revise the Risk of Material Misstatement Based on the Results of Tests of Controls.

When the auditors have completed the procedures described in the preceding sections, they should reassess the level of control risk for each financial statement assertion regarding cash. The auditors then decide what modifications, if any, are necessary to the planned audit program of substantive procedures for cash transactions and balances.

E.  Perform Further Audit Procedures—Substantive Procedures for Cash Transactions and Balances.

1.  Obtain Analyses of Cash Balances and Reconcile Them to the General Ledger. The auditors will prepare or obtain a schedule that lists all of the client's cash accounts. For cash in bank accounts, this schedule will typically list the bank, the account number, the account type, and the year-end balance per books. The auditors will trace and reconcile all accounts to the general ledger. 2.  Confirm Cash Balances with Financial Institutions. One of the objectives of the auditors' work on cash is to substantiate the existence of the amount of cash shown on the balance sheet. A direct approach to this objective is to confirm amounts on deposit and obtain or prepare reconciliations between bank statements and the accounting records.

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   Confirmation of amounts on deposit by direct communication with financial institution officials is obtained in most audits. Account balances are often confirmed with a standard form as illustrated by Figure 10.6. This standard confirmation formA confirmation form, agreed to by the AICPA, the American Bankers Association, and the Bank Administration Institute, that is designed to provide corroborating evidence about the client's account balances and outstanding loans., agreed to by the AICPA, the American Bankers Association, and the Bank Administration Institute, addresses only the client's deposit and loan balances. Information identifying accounts and loans and their balances is normally included on the form to assist the financial institution in completing it. Thus, the form is primarily used to corroborate the existence of recorded information. However, the confirmation may also lead to the discovery of additional accounts or loans and, therefore, it provides limited evidence about the completeness of recorded amounts. Although the personnel at the financial institution will not conduct a detailed search of the records, they will include information about additional deposits and loans that they note while completing the confirmation.

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FIGURE 10.6   Confirmation Form

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(K)		Electronic Confirmation of Cash and Loans
Confirmation.com provides an electronic service for CPAs and financial institutions. This service represents the implementation of a “business plan” developed by Brian Fox, CPA, as a part of an assignment in a master's level course.    While working as a CPA, Brian Fox identified certain inefficiencies and potential for fraud inherent in the written confirmation process. His vision for a solution, which has similarities to the “Paypal” model, was to develop a secure clearinghouse in which both CPAs and financial institutions could be assured that not only was the confirmation transmission process itself secure, but also that the proper, authorized individuals were responding.    Confirmation.com offers both In-Network and Out-of-Network electronic confirmations. When an audit team begins its fieldwork, they request confirmations electronically through Confirmation.com, which then allows the appropriate individuals at the banks to respond to the requests through the network. While the paper confirmation process ordinarily takes several weeks (at a minimum), electronic confirmation replies are often received within a day. Currently, most large banks and thousands of CPAs use the In-Network services of Confirmation.com. Confirmation.com's Out-of-Network service allows electronic confirmations to be sent to banks outside of the network.

   In more and more situations, auditors confirm balances with financial institutions electronically. As indicated in the Illustrative Case above, the auditors often use a clearing house approach. The personnel at the financial institution provide the auditors (with the client's authorization) access to a secure Web site that contains the requested information. Alternatively, the information may be provided on a Web site controlled and maintained by a trusted third-party service provider. When Web site location and access information is provided by the financial institution or a trusted third-party service provider, it meets the definition of a written confirmation from a third party and may be considered appropriate. However, if the Web site location and access information is obtained only from the client personnel, the information cannot be considered to be confirmed by a third party. In these situations, there is a risk that client personnel may create a fictitious Web site or account to misstate the balances being confirmed.

   The details of other financial arrangements may be confirmed with financial institutions, using separate confirmation letters sent to the individual at the financial institution who is responsible for the client's financial arrangements or is knowledgeable about those arrangements. For example, the auditors may send a separate confirmation form to corroborate compensating balance arrangements or authorized check signers. These confirmation forms are described in detail in Chapter 15.

3.  Obtain or Prepare Reconciliations of Bank (Financial Institution) Accounts as of the Balance Sheet Date and Consider the Need to Reconcile Bank Activity for Additional Months. Determining a company's cash position at the close of the period requires a reconciliation of the balance per the bank statement at that date with the balance per the company's accounting records. Even though the auditors may not be able to begin their fieldwork for some time after the close of the year, they will prepare a bank reconciliation as of the balance sheet date or test the one prepared by the client.

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   If the client has made the year-end reconciliation, there is no need to duplicate the work. However, the auditors should examine the reconciliation in detail to satisfy themselves that it has been properly prepared. Inspection of a reconciliation prepared by the client will include verifying the arithmetical accuracy, comparing balances to the bank statement and ledger account, and investigating the reconciling items. The importance of a careful review of the client's reconciliation is indicated by the fact that a cash shortage may be concealed merely by omitting a check from the outstanding check list or by purposely making an error in addition on the reconciliation.

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(K)		Controlling Confirmation Requests
The need to control the confirmation process is illustrated in the Parmalat fraud case. In that case, an SEC Litigation Release reports that the auditors received a bank confirmation confirming that a subsidiary of Parmalat held the equivalent of $4.8 billion (denominated in euros) in cash and marketable securities in a Bank of America account in New York City. The bank account and marketable securities did not exist.    It is believed that the auditors used Parmalat's internal mail to request financial information, and the confirmation was intercepted by a member of management. According to The Wall Street Journal, prosecutors believed that the reply information on the fraudulent confirmation was created in Parmalat's main offices by scanning Bank of America's logo into a computer, printing it out, and then passing the sheet of paper several times through a fax machine to make it look more authentic.

   There are many satisfactory forms of bank reconciliations. The form most frequently used by auditors begins with balance per bank and ends with unadjusted balance per the accounting records. The format permits the auditors to post adjusting entries affecting cash directly to the bank reconciliation working paper so that the final adjusted balance can be cross-referenced to the cash lead schedule or to the working trial balance.

   The mechanics of balancing the ledger account with the bank statement by no means completes the auditors' verification of cash on deposit. The authenticity of the individual items making up the reconciliation must be established by reference to their respective sources. The balance per the bank statement, for example, is not accepted at face value but is verified by direct confirmation with the bank, as described in the preceding pages. Other verification procedures associated with the reconciliation of the bank statement will now be discussed.

   The auditors should investigate any checks outstanding for a long period of time (e.g., six months). If checks remain outstanding for long periods, internal control over cash disbursements is weakened. Employees who become aware that certain checks have long been outstanding and may never be presented have an opportunity to conceal a cash shortage merely by omitting the old outstanding check from the bank reconciliation. Such omissions will serve to increase the apparent balance of cash on deposit and may thus induce an employee to abstract a corresponding amount of cash on hand. It is good practice for the client to eliminate long-outstanding checks of this nature by an entry debiting the Cash account and crediting Unclaimed Wages or another special liability account. This will reduce the work required in bank reconciliations, as well as lessen the opportunity for fraud.

   When internal control over the recording of cash receipts and disbursements is considered weak, the auditors may use additional reconciliation procedures. For example, a proof of cashAn audit procedure that reconciles the bank's record of cash activity with the client's accounting records for a test period. The working paper used for the proof of cash is a four-column bank reconciliation. may be prepared, which, in addition to reconciling the account balance, reconciles cash transactions occurring during a specified period. Specifically, the technique is used to identify:

   A proof of cash is essentially a fraud detection procedure that may be used for any months during the year.

   A proof of cash for the test period of September is illustrated in Figure 10.7. Notice that this working paper is so organized that the first and last columns reconcile the cash balance per bank and the balance per accounting records at the beginning of the test period (Column 1) and at the end of this period (Column 4). These outside columns are equivalent to typical monthly bank reconciliations. The two middle columns reconcile the bank's record of deposits with the client's record of cash receipts (Column 2) and the bank's record of paid checks with the client's record of cash disbursements (Column 3).

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FIGURE 10.7   Proof of Cash

   Next, consider the source of the figures used in this reconciliation. The amounts “per bank statement” are taken from the September 30 bank statement. The subsequent rows of deposits, checks, and other items are taken from the August and September bank reconciliations, and the amounts “per books” are taken from the client's Cash general ledger account and cash receipts and disbursements journals.

4.  Obtain a Cutoff Bank Statement Containing Transactions of at Least Seven Business Days Subsequent to the Balance Sheet Date. A cutoff bank statementA bank statement covering a specified number of business days (usually 7 to 10) after the client's balance sheet date. Auditors use this statement to determine that checks issued on or before the balance sheet date and paid during the cutoff period were listed as outstanding on the year-end bank reconciliation. Another use is to determine that reconciling items shown on the year-end bank reconciliation have cleared the bank within a reasonable amount of time. is a statement covering a specified number of business days (usually 7 to 10) following the end of the client's fiscal year. The client will request the bank to prepare such a statement and mail it directly to the auditors. The auditors may also obtain cutoff information electronically from the bank's Web site. In order to accept this as appropriate evidence, the auditors must become satisfied that the Web site is valid. This information is used to test the accuracy of the year-end reconciliation of the company's bank accounts. It allows the auditors to examine firsthand the checks (ordinarily on computer media) listed as outstanding and the details of deposits in transit on the company's reconciliation.

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   With respect to checks that were shown as outstanding at year-end, the auditors should determine the dates on which the bank paid these checks. By noting the dates of payment of these checks, the auditors can determine whether the time intervals between the dates of the check and the time of payment by the bank were unreasonably long. Unreasonable delay in the presentation of these checks for payment constitutes a strong implication that the checks were not mailed by the client until some time after the close of the year. The appropriate adjusting entry in such cases consists of a debit to Cash and a credit to a liability account.

   In examining the cutoff bank statement, the auditors will also watch for any paid checks issued on or before the balance sheet date but not listed as outstanding on the client's year-end bank reconciliation. Thus, the cutoff bank statement provides assurance that the amount of cash shown on the balance sheet was not overstated by omission of one or more checks from the list of checks outstanding.

Check 21 Act

Historically, checks have taken days to clear in large part because they have literally been flown about the country in the clearing process. Under the Check Clearing for the 21st Century Act (“Check 21 Act”)This act allows financial institutions to create and process electronic "substitute checks" in place of customer written hard-copy checks. The purpose of this act is to decrease the time for check clearing. checks may be processed electronically. Electronic processing involves creating a “substitute check,” an electronic image of the original that is processed in hours rather than days. The substitute check is the legal equivalent of the original check for all purposes. Under the Check 21 Act, any financial institution in the check clearing process may truncate (destroy) paper checks and create a substitute check for processing.

   This new form of check processing has several audit implications. First, if the client's checks are processed electronically, the auditors who wish to see evidence of the check itself must rely upon the substitute check because the original check will no longer be available; the substitute check may be available in paper, electronic, or both forms. Second, it becomes virtually impossible for a client to kite checks (manipulate bank balances so that temporarily overstated cash balances conceal a cash shortage, as discussed later in this chapter) if its financial institutions use this form of processing. However, the auditors should realize that while processing will be much faster, they should still expect reconciliations to include outstanding checks, because some checks drawn near the end of the year may be sent through the mail, and some checks will not be promptly presented for payment by payees.

5.  Count and List Cash on Hand. Cash on hand ordinarily consists of undeposited cash receipts, petty cash funds, and change funds. The petty cash funds and change funds may be counted at any time before or after the balance sheet date; many auditors prefer to make a surprise count of these funds.

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   The count of cash on hand is of special importance in the audit of banks and other financial institutions. Whenever auditors make a cash count, they should insist that the custodian of the funds be present throughout the count. At the completion of the count, the auditors should obtain from the custodian a signed and dated acknowledgment that the funds were counted in the custodian's presence and were returned intact by the auditors. Such procedures avoid the possibility of an employee trying to explain a cash shortage by claiming that the funds were intact when turned over to the auditors.

   A first step in the verification of cash on hand is to establish control over all negotiable assets, such as cash funds, securities and other investments, notes receivable, and warehouse receipts. Unless all negotiable assets are verified at one time, an opportunity exists for a dishonest officer or employee to conceal a shortage by transferring it from one asset category to another.

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   It is not uncommon to find included in cash on hand some personal checks cashed for the convenience of officers, employees, and customers. Such checks, of course, should not be entered in the cash receipts journal because they are merely substitutes for currency previously on hand. The auditors should determine that these checks are valid and collectible, thus qualifying for inclusion in the balance sheet figure for cash. This may be accomplished by the auditors' examination of the last bank deposit for the period and determination that it includes all checks received through year-end. The auditors will retain a validated deposit slip from this deposit for comparison to any checks subsequently charged back by the bank.

6.  Verify the Client's Cutoff of Cash Receipts and Cash Disbursements. An accurate cutoff of cash receipts (and of cash disbursements) at year-end is essential to a proper statement of cash on the balance sheet. The balance sheet figure for cash should include all cash received on the final day of the year and none received subsequently. If the auditors can arrange to be present at the client's office at the close of business on the last day of the fiscal year, they will be able to verify the cutoff by counting the undeposited cash receipts. It will then be impossible for the client to include in the records any cash received after this cutoff point without the auditor being aware of such actions.

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   Of course, the auditors cannot visit every client's place of business on the last day of the fiscal year, nor is their presence at this time normally essential to a satisfactory verification of cash. As an alternative to a count on the balance sheet date, auditors can verify the cutoff of cash receipts by determining that deposits in transit as shown on the year-end bank reconciliation appear as credits on the bank statement on the first business day of the new year. Results of the auditors' consideration of internal control will dictate the necessary scope of these procedures.

   The auditors should be aware of possible window dressingAction taken by the client shortly before the balance sheet date to improve the financial picture presented in the financial statements. related to cash transactions. For example, if the cash receipts are not deposited daily, cash received for a few days after the close of the year may be included in a deposit dated as of year-end, thus overstating the cash balance at the balance sheet date.

   Other approaches to window dressing improve but do not outright misrepresent the cash position. For example, a corporate officer who has borrowed money from the corporation may repay the loan just before the end of the year and then promptly obtain the loan again after year-end; in such a situation, disclosure in the notes to the financial statements may be appropriate.

   Other forms of window dressing do not require action by the auditors. Many companies make strenuous efforts at year-end to achieve an improved financial picture by rushing shipments to customers, pressing for collection of receivables, and sometimes paying liabilities down to an unusually low level. Such efforts to improve the financial picture to be reported are not improper. Before giving approval to the balance sheet presentation of cash, the auditors must exercise their professional judgment to determine whether the client has engaged in window dressing of a nature that causes the financial statements to be misleading.

7.  Analyze Bank Transfers for the Last Week of the Audit Year and the First Week of the Following Year. The purpose of analyzing bank transfers is to disclose overstatements of cash balances resulting from kitingManipulations causing an amount of cash to be included simultaneously in the balance of two or more bank accounts. Kiting schemes are based on the float period—the time necessary for a check deposited in one bank to clear the bank on which it was drawn.. 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, several days (called the float period) usually pass before the check clears the bank on which it is drawn. During this period, the amount of the check is included in the balance on deposit at both banks. Kiting refers to manipulations that utilize such temporarily overstated bank balances to conceal a cash shortage or meet short-term cash needs. Note that kiting is much more difficult in an environment of ever-increasing electronic transfers between accounts (rather than using paper checks) due to the virtual disappearance of the float period.

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   Auditors can detect manipulations of this type by preparing a schedule of bank transfers for a few days before and after the balance sheet date. This working paper lists all bank transfers and shows the dates that the receipt and disbursement of cash were recorded in the cash journals and on the bank statements. A partial illustration of a schedule of bank transfers is shown below.

Disclosure of Kiting

By comparing the dates on the schedule of bank transfers, auditors can determine whether any manipulation of the cash balance has taken place. The increase in one bank account and decrease in the other bank account should be recorded in the cash journals in the same accounting period. Notice that Check No. 6006 in the transfer schedule was recorded in the cash journals as a receipt on December 30 and a disbursement of January 2. As a result of recording the debit and credit parts of the transaction in different accounting periods, cash is overstated on December 31. For the cash receipts journal to remain in balance, some account must have been credited on December 30 to offset the debit to Cash. If a revenue account was credited, the results of operations were overstated along with cash.

   Kiting may also be used to conceal a cash shortage. Assume, for example, that a financial executive misappropriates $10,000 from a company's general checking account. To conceal the shortage on December 31, the executive draws a check transferring $10,000 from the company's branch bank account to the general account. The executive deposits the transfer check in the general account on December 31, but records the transfer in the accounting records as occurring early in January. As of December 31, the shortage in the general account has been replaced, no reduction has yet been recorded in the branch account, and no shortage is apparent. Of course, the shortage will reappear in a few days when the transfer check is paid from the branch account.

   A bank transfer schedule should disclose this type of kiting because the transfer deposit appears on the general account bank statement in December, while the transaction is not recorded in the cash journals until January. Check No. 6029 in the transfer schedule illustrates this discrepancy. These illustrations suggest the following rules for determining when it is likely that a cash transfer has misstated the cash balance:

   A third type of kiting uses the float period to meet short-term cash needs. For example, assume that a business does not have sufficient cash to meet the month-end payroll. The company might draw a check on its general account in one bank, deposit it in a payroll account in another bank, and rely upon subsequent deposits being made to the general account before the transfer check is presented for payment. If the transfer is properly recorded in the accounting records, this form of kiting will not cause a misstatement of the cash balance for financial reporting purposes. However, banks attempt to detect this practice and may not allow the customer to draw against the deposit until the check has cleared the other account. In some deliberate schemes to defraud banks, this type of kiting has been used to create and conceal overdrafts of millions of dollars.

p. 404 8.  Investigate Any Checks Representing Large or Unusual Payments to Related Parties. Any large or unusual checks payable to directors, officers, employees, affiliated companies, or cash should be carefully reviewed by the auditors to determine whether the transactions (1) were properly authorized and recorded and (2) are adequately disclosed in the financial statements.

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   To provide assurance that cash disbursements to related parties were authorized transactions and were properly recorded, the auditors should determine that each such transaction has been charged to the proper account, is supported by adequate vouchers or other documents, and was specifically approved in advance by an officer other than the one receiving the funds.

   The need for financial statement disclosure of transactions with related parties was discussed in Chapter 5. To determine that such transactions are adequately disclosed, the auditors must obtain evidence concerning the relationship between the parties, the substance of each transaction (which may differ from its form), and the effect of each transaction upon the financial statements. Disclosure of related party transactions should include the nature of the relationships, a description of the transactions, and the dollar amounts involved.

9.  Evaluate Proper Financial Statement Presentation and Disclosure of Cash. The balance sheet figure for cash should include only those amounts that are available for use in current operations. A bank deposit that is restricted in use (for example, cash deposited with a trustee for payments on long-term debt) should not be included in cash. Agreements to maintain compensating balances should be disclosed. The auditors must also make sure that the caption “Cash” or “Cash and Equivalents” on the client's balance sheet corresponds to that used in the statement of cash flows.

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Interim Audit Work on Cash

To avoid a concentration of audit work shortly after the year-end, CPA firms try to complete as many auditing procedures as possible on an interim basis during the year. The consideration of internal control over cash, for example, can be performed in advance of the client's year-end. The audit work on cash at year-end can then be limited to such substantive procedures as a review of the client's bank reconciliations, confirmation of year-end bank balances, investigation of the year-end cutoff, and a general review of cash transactions during the interval between the interim work on cash and the end of the period.

Is bank reconciliation a substantive procedures?

How does the auditor typically test for the existence of cash?

Which of the following is the most relevant assertion for cash?

How will the auditor most likely utilize the bank reconciliation as evidence in the audit of cash?