Auditing Cash: The Why and How

This article covers risk assessment and audit procedures for cash

Today we look at how to audit cash.

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. 

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How to Audit Cash

In this post, we will take a look at the following:

  • Primary cash assertions
  • Cash walkthrough
  • Directional risk for cash
  • Primary risks for cash
  • Common cash control deficiencies
  • Risk of material misstatement for cash
  • Substantive procedures for cash
  • Common cash work papers

Primary Cash Assertions

The primary relevant cash assertions are:

  • Existence
  • Completeness
  • Rights
  • Accuracy
  • Cutoff

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. 

Cash Walkthrough

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:

  • Are timely bank reconciliations performed by competent personnel?
  • Are all bank accounts reconciled?
  • Are bank reconciliations reviewed by a second person?
  • Are all bank accounts on the general ledger?
  • Are transactions appropriately cutoff at period-end?
  • Is there appropriate segregation between persons handling cash, recording cash transactions in the general ledger, reconciling the bank statements, making payments
  • What bank accounts were opened?
  • What bank accounts were closed?

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.

Directional Risk for Cash

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.

Primary Risks for Cash

The primary risks are:

  1. Cash is stolen 
  2. Cash is intentionally overstated to cover up theft 
  3. Not all cash accounts are on the general ledger
  4. Cash is misstated due to errors in the bank reconciliation
  5. Cash is misstated due to improper cutoff 

Common Cash Control Deficiencies

In smaller entities, it is common to have the following control deficiencies:

  • One person receipts and/or disburses monies, records those transactions in the general ledger, and reconciles the related bank accounts
  • The person performing the bank reconciliation does not possess sufficient skills to carry out the task appropriately
  • Bank reconciliations are not timely performed 

Risk of Material Misstatement for Cash

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. 

risk of material misstatement for cash

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.

Substantive Procedures for Cash

My customary audit tests are as follows:

  1. Confirm cash balances
  2. Vouch reconciling items to the subsequent month’s bank statement
  3. Ask if all bank accounts are included on the general ledger
  4. Inspect final deposits and disbursements for proper cutoff 

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.)

Common Cash Work Papers

My cash work papers normally include the following:

  • An understanding of cash-related internal controls 
  • Risk assessment of cash assertions at the assertion level
  • Documentation of any control deficiencies
  • Cash audit program
  • Bank reconciliations for each significant account
  • Bank confirmations

In Summary

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. 

Continuing Audit Series

This post is a part of my series titled the Why and What of Audits. If you’ve missed the prior articles, click here

Next week, we’ll look at how to audit receivables and revenue.

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