23-1
Chapter 23
Audit of Cash and Financial Instruments
Concept Checks
P. 748
1. The appropriate tests for the ending balance in the cash accounts depend
heavily on the initial assessment of control risk, tests of controls, and
cutoff at year–end is proper. If the results of the evaluation of internal control,
the tests of controls, and the substantive tests of transactions are adequate,
year–end testing may be necessary.
An example in which the conclusions reached about the controls in cash
disbursements would affect the tests of cash balances would be:
bank reconciliation may be greatly reduced. The year–end outstanding
checks can be verified by testing a sample of checks returned with the
2. The monthly reconciliation of bank accounts by an independent person
is an important internal control over cash balances because it provides an
opportunity for an internal verification of the cash receipts and cash
disbursements transactions, investigation of reconciling items on the
23-2
P. 727
1. An auditor compares the “date of deposit according to the books” to the
“date of disbursement according to the books” to detect kiting carried out by
the payroll account on December 31, but does not record the
disbursement out of the general checking account until January 1, the
record the cash disbursement. When comparing the dates of deposit and
disbursement, the auditor is looking to ensure both were recorded in the
schedule.
2. Accounting standards related to fair value estimates make the audit of
these estimates difficult due to the significant amount of management
judgment involved. Management first applies judgment to determine
whether the fair value estimate will be a level 1, 2, or 3 estimate. If the fair
Review Questions
23–1 The appropriate tests for the ending balance in the cash accounts
of transactions are adequate, it is appropriate to reduce the tests of details of
balances for cash, especially for the detailed tests of bank reconciliations. On
the other hand, if the tests indicate that the client’s controls are deficient,
extensive year–end testing may be necessary.
23-3
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23–2 An imprest bank account for a branch operation is one in which a fixed
balance is maintained. After authorized branch personnel use the funds for proper
disbursements, they make an accounting to the home office. After the expenditures
have been approved by the home office, a reimbursement is made to the
branch account from the home office’s general account for the total of the cash
disbursements. The purpose of using this type of account is to provide controls
over cash receipts and cash disbursements by preventing the branch operators
from disbursing their cash receipts directly, and by providing review and
approval of cash disbursements before more cash is made available.
include the following:
a. Examination of all checks clearing with the statement (including
those on the previous month’s outstanding check list) and
comparison of payee and amount to the cash disbursements journal.
reasonable amount of time.
c. Follow–up on old outstanding checks to determine why they are
still outstanding.
23–4 Bank confirmations differ from positive confirmations of accounts
1. The balances in all bank accounts.
2. Restrictions on withdrawals.
3. The interest rate on interest–bearing accounts.
4. Information on liabilities to the bank for notes, mortgages, or other
debt.
Positive confirmations of accounts receivable request the customer to
confirm an account balance stated on the confirmation form or designate a
different amount with an explanation. The auditor anticipates few exceptions to
accounts receivable confirmations, whereas with bank confirmations he expects
differences between the balance per bank and balance per the books that the
client must reconcile. Bank confirmations should be requested for all bank
23-4
23–4 (continued)
The reason why more importance is placed on bank confirmations than
accounts receivable confirmations is that cash, being the most liquid of assets,
must be more closely controlled than accounts receivable. In addition, other
23–5 This is a good auditing procedure that attempts to discover if any
23–6 A cutoff bank statement is a partial period bank statement with the
related cancelled checks, duplicate deposit slips, and other documents included
in bank statements, which is mailed by the bank directly to the auditor. Rather
23–7 Auditors are usually less concerned about the client’s cash receipts cutoff
than the cutoff for sales, because the cutoff of cash receipts affects only cash
For the purpose of detecting a cash receipt cutoff misstatement, there
are two useful audit procedures. The first is to trace the deposits in transit to the
cutoff bank statement to determine the date they were deposited in the bank
account. Because the recorded cash will have to be included as deposits in
transit on the bank reconciliation, the auditor can test for the number of days it
whether the deposits in transit equal the amount recorded.
23–8 The misstatements that are of the greatest concern to auditors in bank
reconciliations are intentional ones to cover up a cash shortage, usually resulting
balance, a highly unlikely occurrence.
23-5
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23–9 This question deals with a situation where a company’s bank received
an electronic deposit of cash from credit card agencies making payments on
behalf of customers purchasing products from the company’s online Web site.
The company does not have the electronic deposit recorded in the general
ledger. The company’s bank reconciliation should include an adjustment for this
transaction, which would increase the book balance of cash and decrease
accounts receivable from credit card agencies.
23–10 The purpose of the four–column proof of cash is to verify:
Whether all recorded cash receipts were deposited.
records.
Whether all recorded cash disbursements were paid by the bank.
to uncover are:
Cash received that was not recorded in the cash receipts journal.
Checks that cleared the bank but have not been recorded in the
cash disbursements journal.
shifting of shortages from account to account and the crediting of subsequent
receipts to the wrong accounts receivable.
Kiting is a procedure used to conceal cash shortages from employers
and auditors, to conceal bank overdrafts from the bank or banks affected, or to
and the shortage “reappears” unless the process is repeated.
If a depositor desires to write a check for which he does not have funds
on deposit, he can deposit a transfer check large enough to cover the payment,
even though the transfer check itself creates an overdraft. The transfer process
23-6
23–11 (continued)
Kiting to pad a cash position typically occurs at the end of a fiscal
The following audit procedures would be used to uncover lapping:
Confirm accounts receivable and give close attention to
exceptions made by customers about payment dates. The
confirmation procedure is better applied as a surprise at an interim
The deposit of these funds should be made under the auditor’s
control, and the details of the deposit should later be compared
with the cash receipts book and the accounts receivable records.
Compare the details of remittance lists (if prepared), stamped
Compare the check vouchers received with the customers’ checks
with stamped duplicate deposit slips, the entries in the cash book,
Kiting might be uncovered by the following audit procedures:
As a surprise count of cash and customers’ checks on hand is
made as a test for lapping, determine that checks representing
bank statements.
23-7
23–11 (continued)
on the books. Protested (N.S.F.) checks should be investigated to
determine they are not fictitious checks deposited temporarily to
cover a shortage.
This emphasis affects the auditor’s evidence accumulation in auditing
year–end cash as in these examples:
Verifying whether cash transactions are properly recorded
Testing of bank reconciliations
Obtaining bank confirmations
the model used and the reasonableness of estimates. This will require judgment
on the auditor’s part as well as knowledge of valuation techniques and the
market factors that affect assumptions used (e.g., liquidity risk, credit risk, interest
rate risk). The auditor can develop an independent estimate to corroborate the
and compare this to management’s estimate.
If the fair value of the financial instrument has declined, the auditor
must consider whether the financial instrument is other–than–temporarily impaired,
which would require recognition of an impairment loss. This assessment is also
Multiple Choice Questions From CPA Examinations
23–14 a. (4) b. (3) c. (2)
23–15 a. (2) b. (4) c. (2)
23–16 a. (3) b. (2) c. (2)
Discussion Questions and Problems
23–17
a.
MOTIVATION
b.
INTERNAL CONTROL
c.
AUDIT PROCEDURE
1. Original check was
unauthorized and
illegal. Outstanding
check made the
bank reconcile.
Independent bank
reconciliation that
includes accounting
for all cash disburse–
ment transactions.
Verify the bank reconciliation,
including cash disburse–
ments for all material
outstanding checks.
2. To cover a shortage.
Internal verification of
bank reconciliation,
including accounting
for all checks recorded
in the cash disburse–
ments journal as
cleared or still
outstanding.
Verify the bank reconciliation
by tracing checks dated on
or before June 30 in the
cash disbursements journal
to checks clearing with the
June 30 bank statement.
Any checks not clearing
should be included on the
June 30 outstanding check
list.
3. To cover a shortage.
Internal verification of
bank reconciliation.
Foot outstanding check list.
4. To cover a cash
shortage or to
improve the current
ratio.
Independent bank
reconciliation.
Obtain bank confirmation.
5. To cover a shortage.
Internal verification of
bank reconciliation,
including accounting
for all checks recorded
in the cash disburse–
ments journal as
cleared or still
outstanding.
Trace all checks dated on
or before June 30 that
cleared with the cutoff bank
statement to the June 30
outstanding check list.
23-9
23-17 (continued)
6. Hold open books
to improve cash
position.
Independent bank
reconciliation.
Trace deposits in transit to
cutoff bank statements to
determine deposit date.
7. Kiting–covering
a defalcation or
padding a cash
position.
Independent bank
reconciliation.
Trace all interbank transfers
to accounting records.
in preparing its reconciliation.
3. To create a list of outstanding checks for follow–up to determine
why they have not cleared and to investigate the possibility of a
misstatement of cash and accounts payable.
4. To assure that all loans, terms, and arrangements with the bank
disclosed in the financial statements.
5. To reconcile the recording of cash receipts and cash disbursements
between the bank and the client’s books and to prepare a bank
misstatement.
8. To verify the valuation of the equity investment.
23-10
23–19 a. Bank reconciliation:
Balance per bank $ 1,522
Add:
Deposits in transit 2,000
Check erroneously charged to Pittsburgh Supply 646
Less: outstanding checks (2,218)
(1) 6/30 DIT 600
July deposits per books 26,874
July deposits per bank (25,474 )
7/31 DIT $ 2,000
(2) 6/30 O/S checks $ 2,578
b. Adjusting entry:
Miscellaneous expense $ 107
Interest expense 400
Note payable 6,000
To record adjustments arising from
7/31/16 bank reconciliation.
cash disbursements journal.