Audit of Cash Balances
This is one chapter we always cover. For one reason, it ties the various transaction cycles together. Secondly, students will frequently do work in this area early in their professional careers. Students are told that there will be reasonably heavy testing of their knowledge of bank reconciliations and proofs of cash on the next exam.
The following are the major subjects covered in this session:
Chapter opening vignette
Cash in the bank and transaction cycles
Types of cash accounts
Effect of proper segregation of duties and an independent bank reconciliation
Audit of the general cash account
Summary of audit tests for the general cash account
Proof of cash
Audit of an imprest account - payroll
Chapter Opening Vignette — “ Society Expects a Lot from Auditors ”
Like the vignette at the beginning of Chapter 10, this vignette illustrates a large defalcation. In this case, the auditors apparently complied with auditing standards, but missed the fraud. The technical issue that was the focus of the resulting trial was whether the auditors should have done more testing of internal control.
This case provides a basis for a discussion of a substantive procedures approach versus an internal control reliance audit approach on small clients. It provides an opportunity to highlight the importance of obtaining an understanding of internal control in every audit, which involves assessing the design and implementation of controls. A heavy focus on substantive testing is less likely to uncover a defalcation than an internal control reliance approach where more tests of controls and substantive tests of transactions are performed.
The vignette also illustrates the typical litigation format for accountants malpractice suits where two auditing "experts" contradict each other and the jury is left to sort out who is more believable. This can lead to a discussion about whether lay jury members can be expected to understand technical accounting and auditing concepts and issues.
In this case, it was quite clear that the jury made a misinformed decision. Whether the defendant firm would appeal is essentially an economic decision. In this case, it was decided not to appeal.
Cash in the Bank and Transaction Cycles (page 750)
Studying the relationship of cash to the various transaction cycles is an essential part of the course, because it helps students integrate material learned in other chapters. We spend a few minutes on Figure 23-1 (page 751), making sure that students understand these interrelationships.
(See Figure 23-1)
At this point, Review Question 23-2 helps students see the link of testing in the various transaction cycles to the testing of the year end cash balances.
Types of Cash Accounts (page 752)
It is useful to summarize the types of cash accounts discussed in the beginning of the chapter to make sure that students understand the difference between each one and how they tie into the general cash account. T-23-1 provides a good summary of the types of cash accounts.
Effect of Proper Segregation of Duties and an Independent Bank Reconciliation
The importance of these two controls over cash accounts deserves emphasis. At this point, we refer students to the bank reconciliation in Figure 23-4 (page 756) and talk about the types of misstatements that would and would not be uncovered by an independent bank reconciliation.
(See Figure 23-4)
The questions on T-23-2 help clarify this from a control and an audit point of view.
Definitions (pages 759 and 762)
Before going into detail about the audit of cash in the bank, it is desirable to define certain terms. For the first two, we state their purpose. In the case of kiting, we explain what it is, and how it can be detected.
Cutoff bank statement (page 759)
Proof of cash (page 762)
Kiting (page 762)
Problem 23-23 is a useful one to make sure that students know the procedures to uncover kiting.
Audit of the General Cash Account (page 753)
First we discuss the methodology for designing tests of details of balances as shown in Figure 23-3 (page 754), with emphasis on risk and materiality of the cash receipts and cash disbursements transactions.
(See Figure 23-3)
Next we ask students to identify the starting point for auditing cash (client's year- end bank reconciliation), and why it is the starting point. Students are then asked to refer to Figure 23-4 (page 756) and are asked to identify all procedures that would normally be performed on a client-prepared bank reconciliation. We also discuss a standard bank confirmation, using Figure 23-5 (page 758).
(See Figures 23-4 and 23-5)
The following questions and problems are then used:
23-5 - Bank confirmation compared to accounts receivable confirmation
23-18 - Multiple choice questions
23-21 - Objectives of various audit procedures
Problems 23-22 and 23-24 give students practice in preparing a bank reconciliation.
Cutoff Tests (see Table 23-1 , page 757, for detailed cutoff tests)
We find Review Question 23-8 is sufficient for discussing cutoff if it is expanded to cash disbursements too.
Summary of Audit Tests for the General Cash Account (page 760)
Figure 23-6 (page 760) provides a good summary of the types of audit tests used for the audit of the general cash account.
(See Figure 23-6)
Proof of Cash (page 762)
We usually assign Case 23-26 as advance preparation. It is difficult and time consuming to complete, but students also learn a lot by completing it. The discussion of proofs of cash is started by going over this case. We then ask several questions:
What is the purpose of a proof of cash?
Identify several misstatements of cash that a proof of cash will uncover.
Identify several misstatements of cash that a proof of cash will not uncover. When is it necessary to do, and when can it be omitted?
Next, we use Figure 23-7 (page 763) to show an example of a completed proof of cash.
(See Figure 23-7)
Audit of an Imprest Account -Payroll (page 765)
We discuss only one imprest account, usually payroll. The following are typical questions:
What does the term imprest mean?
Why are imprest accounts used by companies?
How does an imprest account affect the audit?
Assuming an imprest payroll account, what should be emphasized, the cash balance or changes in the balance?
At what point in the audit are changes in the payroll cash account balances audited?
What testing needs to be done at year-end, assuming good controls?
CROSS-REFERENCE OF LEARNING OBJECTIVES AND PROBLEM MATERIAL
Questions and Problems
Show the relationship of cash in the bank to the various transaction cycles.
Identify the major types of cash accounts maintained by business entities.
23-1, 23-2, 23-9
Design and perform audit tests of the general cash account.
23-22, 23-23, 23-24
Recognize when to extend audit tests of the general cash account to test further for material fraud.
23-10, 23-12, 23-15
Design and perform audit tests of the imprest payroll bank account.
Design and perform audit tests of imprest petty cash.
TYPES OF CASH ACCOUNTS AND
THEIR RELATIONSHIP TO THE
GENERAL CASH ACCOUNT
WHICH OF THE FOLLOWING MISSTATEMENTS WILL BE UNCOVERED BY A CAREFULLY PREPARED INDEPENDENT BANK RECONCILIATION?
Cash receipts recorded in the cash receipts journal but lost before deposit.
A check recorded in the cash disbursements journal for an amount $1000 greater than the amount the check was written for.
Cash receipt lost before it was recorded in the cash receipts journal.
Bank debit memo that should have been charged to a different customer.
A check written for $100 more than the amount on the vendor ' s invoice.
A stop-payment by a customer where the client was not informed that the stop-payment had taken place.