Auditing cash is a key part of the overall audit process. Today, I show you how to assess risk for cash and then I provide substantive procedures for auditing this area.
Can intentional misstatements of cash be covered up with fake bank statements and confirmations? Think about Parmalat and ZZZZ Best Carpet Cleaning. Fake bank statements do exist, and false bank confirmations can mislead auditors. Or maybe control weaknesses allow the theft of cash, and your client is unaware. There are many ways that cash can be misstated.
In this post, we will take a look at the following:
The primary relevant cash assertions are:
Of these assertions, I believe—in general— existence, accuracy, and cutoff are most important. The audit client is asserting that the cash balance exists, that it’s accurate, and that only transactions within the period are included.
Classification is normally not a relevant assertion. Cash is almost always a current asset. But when bank overdrafts occur, classification can be in play. The negative cash balance can be presented as cash or as a payable—depending on the circumstances. See my cash overdraft post for more information.
As we perform walkthroughs of cash, we are normally looking for ways that cash might be overstated (though it can also be understated as well). We are asking, “What can go wrong—whether intentionally or by mistake?”
In performing cash walkthroughs, ask questions such as:
As we ask questions, we also inspect documents (e.g., bank reconciliations) and make observations (who is doing what?).
If controls weaknesses exist, we create audit procedures to address them. For example, if—during the walkthrough—we review three monthly bank reconciliations and they all have obvious errors, we will perform more substantive work to prove the year-end bank reconciliation is correct—such as vouching every outstanding deposit and disbursement.
What is directional risk? It’s the bias that a client might have regarding an account balance. A client might desire an overstatement of assets and an understatement of liabilities—each makes the balance sheet look healthier.
The directional risk for cash is overstatement. So, in performing your audit procedures, perform procedures to ensure that cash is not overstated—such as testing the bank reconciliation.
The primary risks are:
In smaller entities, it is common to have the following control deficiencies:
In my smaller engagements, I usually assess control risk at high for each assertion. If control risk is assessed at less than high, then controls must be tested to support the lower risk assessment. Assessing risks at high is usually more efficient than testing controls.
When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (controls risk X inherent risk = risk of material misstatement). The assertions that concern me the most are existence, accuracy, and cutoff. So my RMM for these assertions is usually moderate to high.
My response to higher risk assessments is to perform certain substantive procedures: namely, bank confirmations and testing of the bank reconciliations. As RMM increases I examine more of the period-end bank reconciliations and more of the outstanding reconciling items. Also, I am more inclined to use cut-off bank statements and confirm the balances.
My customary audit tests are as follows:
The auditor should send the confirmations directly to the bank. Some companies create false bank statements to cover up theft. Also, some companies—again, to cover up theft—provide false bank confirmation addresses. Then the confirmation is sent to the company (or an accomplice) rather than the bank. Once received, the company replies to the confirmation as though the bank is doing so. You can lessen the chance of fraudulent confirmations by using Confirmation.com, a company that specializes in bank confirmations.
Agree the confirmed bank balance to the period-end bank reconciliation (e.g., December 31, 2016). Then, agree the reconciling items on the bank reconciliation to the bank statements subsequent to the period-end. For example, examine the January 2017 bank statement activity when clearing the December 2016 reconciling items. Finally, agree the reconciled balance to the general ledger cash balance for the period-end (e.g., December 31, 2016).
Cut-off bank statements (e.g., January 20, 2017 bank statement) may be used to test the outstanding items. Such statements—similar to bank confirmations—are mailed directly to the auditor. Alternatively, an auditor might examine the reconciling items by viewing online bank statements. (Read-only rights can be given to the auditor.)
My cash work papers normally include the following:
Today, we looked at how to audit cash. We’ve discussed how to perform cash risk assessment procedures, the relevant cash assertions, the cash risk assessments, and substantive cash procedures. To get the most benefit from this post, compare your cash work in one or two audit files to this post.
If you audit cash differently, please share your ideas in a comment below.
Next week, we’ll look at how to audit receivables and revenue.
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses.He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events.Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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