UNIT IV APPLICATION OF THE RISK-BASED AUDIT PROCESS PHASE II - RISK RESPONSE: SUBSTANTIVE TESTS OF DETAILS OF BALANCES Chapter 11 Audit of Cash Balances 12 Audit of Trade Receivables, Allowance for Doubtful Accounts and Sales 13 Audit of Inventories, Cost of Sales and Trade PayablesAudit of Investments Audit Property, Plant and Equipment, and Related Depreciation and Depletion Audit of Intangible Assets Audit of Non-Trade Payables and Other Long-Term Liabilities Audit of Owners’ Equity Audit of Prepaid Expenses, Deferred Charges and Accruals Audit of Other Accounts in the Statement of Profit or Loss and Comprehensive IncomeChapter AUDIT OF CASH BALANCES Expected Learning Outcomes After studying this chapter, you should be able to: 1. Describe the auditors’ objectives for the substantive audit of cash in bank and on hand. Explain the nature of the appropriate audit procedures to accomplish the objectives for the audit of cash. Understand the preparation of audit working papers to document the audit procedures for cash. RVgsgsCHAPTER 11 AUDIT OF CASH BALANCES INTRODUCTION Since cash generally has a higher degree of in! k devoted to the audit of the account than is indicated by its peso amount. The amount of cash flowing in and out of the cash account is frequently larger than for any other account in the financial statement. Furthermore, the susceptibility of cash to defalcation is greater than for other types of assets because most other assets must be converted to cash to make them usable. As discussed in the preceding chapters, the following misstatements which result in the improper payment of or failure to receive cash may be uncovered through the tests of controls and substantive tests of transactions. Failure to bill a customer Billing a customer at a price lower than c Abstraction of cash receipts from customers before they are rec Duplicate payment of a vendor's invoice Improper payments of officers' personal expenses Payment for merchandise or goods that were not received Payment to an employee for more hours than he or she has worked Payment of interest to a related party for an amount far exceeding the going herent risk, more audit time is alled for by company policy orded PYAWAYNS rate The first three misstatements could be uncovered as part of the audit of the revenue and cash receipts cycle, the next three in the audit of the acquisition and payment cycle, and the last two in the tests of the payroll and personnel cycle and the financing and investing cycle, respectively. Entirely different types of misstatements are normally discovered in applying substantive test of details of balances. Examples are Cash received by the client subsequent to the statement of financial position date but recorded as cash receipts in the current year b. Deposits recorded as cash receipts near the end of the year, deposited in the bank in the same month but still reported as a deposit in transit in the bank reconciliation Understatement of the outstanding checks in the bank reconciliation d. Payments on notes payable debited directly to the bank balance by the banks but not entered in the client's records a.Audit of Cash Balances _323 it is important only that the reader di substantive tests of transacti determine whether the bool istinguish between tests of controls and as that are related to the cash account and tests that balance reconciles to the bank balance. To blend the conceptual and procedural aspects of substantive tests for cash balances as well as for other accounts, the audit program presented is keyed to and discussed in the context of the financial statement assertions discussed later. AUDIT OBJECTIVES AND PROCEDURES An audit program of representative year-end substantive testing procedures in the examination of cash is presented in Figure 11-1. These procedures are discussed in the remainder of this chapter. Figure 11-1: Substantive Testing of Cash ‘Assertions ‘Audit Objectives ‘Audit Procedures Existence or occurrence | A. To determine whether cash | 1. Obtain analysis of cash exists at year-end and cash- balance and reconcile to the related transactions occur general ledger. within the year. 2. Confirm bank balances as of B. Todetermine that all cash statement of financial position balances of the client are date. reflected on the statement of | 3. Perform cash count financial position at year- procedures for cash on hand. end, 4. Obtain (prepare) bank reconciliations as of the | statement of financial position | date. 5. Trace all transfers occurring between banks near year- end. I. Completeness ©. Todetermine whether all | 6 Obtain a cutoff bank cash transactions are statement containing recorded in the proper transactions several days accounting period. subsequent to the statement, of financial position date Examine items retumed with the cutoff bank statements, 7. Prepare proof of cash and ‘econcile cash transactions occurring during a specified period as they are recorded by the bank and the client324 Chapter 11 7a % Venly the cents cult of cash receipts and cash disbursements, Ti Rights and obligations D_ To determine that cash 9. a ‘and balances are availabe for use without restrictions or if confirmation letters, with restrictions, properly indicated in the statement of financial position WW. Valuation or allocation To determine if cash is 70. Verify existence of cash in recorded and presented at banks under receivership, the proper amount. ccash subject to courts restraining order, in foreign banks and in foreign currency. This is in addition to the foregoing procedures which will enable the auditor to verify proper valuation of cash, V. Presentation and F—To determine whether cash | 17. Investigate any checks disclosure is presented in accordance representing large or unusual applicable Financial payments to related partes. Reporting Standards. 12, Evaluate proper financial statement presentation and disclosure of cash. Discussion of Substantive Audit Procedures 1. Obtain analysis of cash balance and reconcile to the general ledger. This schedule will typically list the bank, the account number, account type (current, savings, time deposit) and the year-end balance per books. This balance will then be traced and reconciled to the general ledger as necessary. Confirm balances as of the statement of financial position date. A direct approach in proving existence of cash is to confirm amounts on deposit by communicating with financial institution officials. Figure 11-2 illustrates a standard bank confirmation form that may be used to this purpose. To assist the financial institution in completing the form, information identifying accounts, loans and their balances are typed by the auditor. Other information such as additional accounts, loans, may be provided by the financial institution. Bank confirmation request should be (a) sent to all banks in which the client has an account, (b) signed by the client, (c) mailed by the auditor, and returned diregily to the auditor. —Audit of Cash Balances 325 Figure 11-2: Confirmation Form ACCOUNT BALANCE INFOI WITH FINANCIAL INSITUTIONS “ame — ocr) f ORIGINAL o ‘Tobe maled to accountant ———__TeSeavien Coporaton CUSTOMER NAME ‘We have provided to our accountants the following information as. Finencl of the lose of dusiness on December 31, 20X7, regarding our irsituion’s stem Bank and Trust Co, \eposit ard foan balances Please confi the accuracy oF the Nameand ——_Intramuros, Manila ‘nlormation, noting any exceptions to the in‘ormaton provided. If aaess the balances have been left blank, glease complete this form by {umshing the balance in the appropriate space below.” Although we do nol request nor expect you to conduct a comprehensive Getaled search of your records. ¢ dumg the process of Completing this contmation additional information about other ‘posit end loan accounts we may have with you comes fo your atenton, please clude such normaton below. Please use the enclosed envelope to retum the frm drecty to our accountants 1 Althe cose of business onthe date listed above, ou recor indicates ne folowing depost balances) ACCOUNT NAME ‘ACCOUNT NO. INTEREST RATE BALANCE General Account 785-7850 Nove PSO, 600 Payroll Account 266.7850 Nove 11500 2_ We are direct table to he nancial inst fo loans al he dose o business onthe dae sted above as flows ‘ACCOUNT DATE THROUGH | DESCRIPTION NO / DATE | INTEREST | WHICHINTEREST | OF vescrrion | sarances_| pue_| rate ISPAD | COLLATERAL EaRST 4,000,000 | ensoxs | — s% T2iS20x7 San Miguel Cap. | | nares Cred Line 2o0000 | 3308 | 6% raion Boa~ January 6, 20X8 (Gients Autioned Sqnatuey (ate) ‘The information presented above by the customer isin agreement with ou records. Although we have not conducted a comprehensive, detailed search of our records, no olher deposit or loan socounts rave come 10 our attention except as an AEE _Jamary 31,208 Financial instittton Authorized Signature) — (Date) Controller (Tie) EXCEPTIONS ANDIOR COMMENTS Please retum this form drecty i our accountants ‘Cruz & Corel CPAs: * Oniinarly balances are intentionally left blank # they are not available at the 2775 Ayala Avenue ine he om 5,326 Chapter 11 3. Perform cash count procedures for cash on hand Existence of undeposited collections, petty cash funds and other funds may be verified by conducting a surprise count of these funds. Figure 11-3 illustrates a cash count sheet that the auditor may use. In conducting the cash count the auditor should follow these procedures: I Control all cash and negotiable instruments held by the client unti! all funds have been counted. Insist that the custodian of the cash be present throughout the count, Obtain a signed receipt from the custodian on return of the funds to | the client. Ascertain that all undeposited checks are payable to the order of the client either directly or through endorsement. Figure 11-4 illustrates the working papers to determine the adjusted balance of Petty Cash Fund wr 4 4. Obtain (prepare) bank reconciliations as of the statement of financial position date. If client provides the auditor with the reconciliation of the balance per the bank statement at the statement of financial position date with the balance per the company's accounting records. he should examine such in detail to satisfy himself that is has been properly prepared. A careful review of the client's reconciliation is important because a cash shortage may be concealed by omitting a check from the outstanding checks list or by purposely making an error in addition on the reconciliation. The examination of the client-prepared bank reconciliation should also include: a. Tracing bank balances to bank confirmation responses b. Verifying the validity of the reconciling items c. Scanning the bank statements for erasures and alteration Figures 11-5, 11-6, and 11-7 illustrate the forms of bank reconciliation. The forms most frequently used by auditors are those shown in Figure 11-5 (Bank to Books) and Figure 11-7 (Adjusted balances).{ Amon Fin Per Bows a Rasa Es — Daearee om Medi of Cavh Balances 327 | Reby cy a he stow hd of P at__AWPM | iret on somes ena (Otter Funds. (Simutaneousy counted or physically controled) Feporly —] Revewaaby iw [Doe] intl [Daw a5 counted 11 my presence dy - nd he same was euro me iact Thole ae ab oer Foe (Signature of Cashier) Figure 11-4: Adjusted Balance of Petty Cash Fund j XCompany Petty Cash Fund ____12134/20x7 Balance per ledger Add (Deduct) Adjustments AJE (1) to take up unreplenished ex; xpenses ____(2) to take up advances to employee: Balance as adjusted TP xK) 0%)528 Chapter 1 Figure 11-8: Bank Reconciliation Statement (Baak Balance to Hook Balance Method) X Company Bank Reconciliation Statement Peli iad Sareea December 31, 20X7 , Balance per bank statement | Add: Book dette not yet credited by the bark (0.9, undeposted colectons) Bank detuts not yet cresited by fhe company (9. serace charges for the mont of December, NSF Shecks retumed 1 December) i Less Book credits not yet detsted by he bank (e.g. outstanding checks Bank credits nat yet cetited by he ompany { (0.9, proceeds of note colected by bank) Batance per books Figure 11-6: Bank Reconciliation Statement (Book Balance to Bank Balance Method) | X Company | Bank Reconciliation Statement L _ December 31, 20X7 | Balance per books _ oe Pax | Add: Book credits not yet debited by the bank (e.g. outstanding checks) Prox Bank credits not yet debited by the company L {€.9., proceeds of note collected by bank) Total Less: Book debits not yet credited by the bank | (e.g., undeposited collection) - x Jf Bank debits not yet credited by the company (e.g., bank charges for the month of December, NSF checks returned in December) Balance per bank seOO dit of Cash Balances 329 R ion Statement (Adjusted Balances Method) X Company Bank Reconciliation Statement December 31, 20X7 ssted balance per bank 7 ‘radu + Book | (e.g.. undeposited collections)’ | me [ess Book credits not yet debited by the bank - 7 (e.g., outstanding checks) ‘Aqusied bank balance debits not yet credifed by the bank —|—____f T Unadjusted balance per books Add: Bank credits not yet debited by the company (e.g., proceeds of note collected by bank) bl Tess: Bank debits not yet credited by the company (eg. bank charges) (on | [ Adjusted book balance Prox 5. Trace all transfers occurring between banks near ‘year-end. Tracing bank. transfers is an effective procedure to disclose overstatement of cash balances resulting from kiting. Kiting is an irregularity involving transfer of cash between banks, 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 the period, the amount of the check is included in the balance on deposit at both banks. The bank balances are temporarily overstated to conceal a cash shortage or meet short-term cash needs. Figure 9.8 illustrates kiting. Kiting can be prevented by segregation of functions; it can be detected by (a) obtaining and using a bank cutoff statement and as mentioned (b) tracing bank transfers. Figure9.8 Kiting Metrobank Equitable PCI Bank Date Description Book | Bank | Book | Bank 20X6 Dec 30 | Bank transfer not recorded on the books 100,000 20X7 Jan3_| Record bank transfer on the books 100,000 (100,000) Jan 4 | Bank transfer clears bank drawn on (100,000).330 Chapter I 2 6. Obtain a cutoff bank statement containing transactions several days subsequent to the statement of financial position date. A cutoff bank statement is a statement covering a specified number of business days (usually 7 to 10) following the end of the client's fiscal year This statement should be sent directly by the bank to the auditor. Upon receipt of the statement, the auditor should | (a) Trace all prior year dated checks to the outstanding checks listed on the bank reconciliation. ; (b) Trace deposits in transit on the bank reconciliation to deposits on the cutoff statement. (c) Scan the cutoff statement and enclosed data for unusual items. 7. Prepare proof of cash and reconcile cash transactions occurring during a specified period as they are recorded by the bank and the client. A proof of cash is a simultaneous reconciliation of bank transactions and balances with corresponding data per books for a "specified time period, A proof of cash is a substantive test that is generally prepared only when internal control over the recording of cash receipts and disbursements is considered weak. This is essentially a fraud detection procedure which may be used for the last month of the year or for selected months during the year. Figures 11-9, 11-10, and 11-11 illustrate the Proof of Cash working papers.fi igure 11-9: P Audit of Cash Balances 33% X Company Proof of Cash For the month ended December 31, 20X7 roof of Cash or Reconciliation of Receipts and Disbursements (Bank Balance to Book Balance Method) Nov. 30 Balance December Dec. 31 Receipts Disbursements | Balance Balance per bank statement Pax Px Px Px Aad (Deduct) Reconcting Nems 7 Deposit in transit (received by the bank in the succeeding month) November 30 December 31 mo (a) x T Outstanding checks (paid by the bank in the succeeding month) November 30 December 31 (xx) (a) xx (or) J Bank charges (recorded by the company in the succeeding month) November December x a (oa) wm T Notes collected by bank (recorded by the ‘company in the succeeding month) ‘November December (a) (ay) (xx) 5, Check of another company erroneously charged by the bank (corrected in the following month) November December (a) (a) x % Deposit another company erroneously credited by the bank (corected in the following month) November December (xx) Elz FE FE Balance per books332 Chapter |! Figure 11-10; Proof of Cash (Book Balance to X Company Proof of Cash Nov. 30 Balance Pax Balance per books. ‘Add (Deduct) Reconciling items 1. Deposit in transit (received by the bank in the succeeding month) November 30 December 31 2. Outstanding checks (paid by the bank in the succeeding month) November 30 December 31 3. Bank charges (recorded by the ‘company in the succeeding month) November December 4. Notes collected by bank (recorded by the company in the succeeding month) November December 5. Check of another company erroneously charged by the bank (corrected in the following month) November December 8. Deposit of another company erroneously credited by the bank (corrected in the following month) November December Balance per bank statement (a) (@) (a) P| * Bank Balance Met For the month ended December 31, 2 Receipts. (Se thod) ~ KT December Dec. 31 Disbursemenis Balance Prxx Pax (=) (a) (x) x (x) (xx) ers | & ErAa of Cash Balances 393 11-11: Proof of Cash (Adjusted Balances Method) Figure X Company Proof of Cash For the month ended December 31, 20X7 Nov. 30 December Dec. 31 Balance Receipts Disbursements Balance | uni iusted book balance Prax Prx Px Px {Deduct ‘Adjustments | 's of note collected by bank (recorded by the company in the Creoeding month) November 30 x (xx) December 31 x ~ | Bank charges (recorded by the ‘company in the succeeding month) November December Adjusted book balance (x) gelz ? Bl Bk 2 BE Unadjusted bank balance Prx ‘Add (Deduct) Adjustments Deposit in transit (received by the bank in the succeeding month) November ~ (x) December peg Outstanding checks (paid by the in the succeeding month) November 30 (x) (oo) December 31 x (x) Check of another erroneously charged by the bank (corrected in the following month) November 1 (x) December (x) x Deposit of another company erroneously credited by the bank November December {Adjusted bank balance pe el = Bl 2 bkee eS Pe ee ae ee ee Le ee ee eee ee eS en 334 Chapter 11 8. Verify the client's cutoff of cash receipts and cash disbursements. Ifa cash count can not be done on the statement of financial position date to verify the accuracy of the client's cutoff of cash receipts. the auditor ean trace the deposits in transit on the year-end bank reconciliation to the credits on the bank statement on the first business day of the new year To ensure an accurate cutoff of cash disbursement, the auditor should determine the number of the last check prepared on each bank account on the statement of financial position date and verify whether all checks up to this number have actually been mailed. For cash receipts, the auditor should verify the number of the last official receipt and cash sales invoice used on the statement of financial position date. 9. Review bank statements and banks' replies to confirmation letters. The auditor should review any bank overdrafts and note the existence of any funds that may be subject to withdrawal restrictions in order to determine the effect(s) (if any) on financial statement presentation. 10. Verify existence of cash in bank under receivership, cash in foreign banks or in foreign currency. This can be done through examination of minutes, loan agreements and confirmations. 11. Investigate any checks representing large or unusual payments to related parties. Any large or unusual checks payable to directors, officers, employees, affiliated companies should be carefully reviewed to determine if whether the transactions were properly authorized, recorded and adequately disclosed in the financial statements. 12. Evaluate proper financial statement presentation and disclosure of cash. Review financial statements to make sure (a) material savings accounts and certificates of deposit are disclosed separately from cash in the bank, (b) cash restricted to certain uses and compensating balances are adequately disclosed, and (c) bank overdrafts are included as current liabilities,___ Audit of Cash Balances 335, _— juustrative Audit Case 9.1: Petty Cash Fund and Undeposited Collections Lina Reyes is the cashier of the Luzon Glass Company. As representative of the Los, Tan and Associates, CPAs, you were assigned to verify her cash on hand pape moming of January 4, 20X8. You began to count at 9 00 A.M. in the resence Of Miss Reyes. In the course of your counting, you found currencies in waper pills and coins together with checks, vouchers and other items, which are F entioned below: Bills 9 one hundreds, 25 fifties, 50 twenties, 120 tens Coins P5.00- 4rolls and S$ loose (50 pieces to a roll) 1.00- 8 rolls and 15 loose (100 pieces to a roll) 0.25- 2rolls and 2 loose (500 pieces to a roll) 0.10- 3 rolls and 40 loose (500 pieces to a roll) 0.05 - 2 rolls (400 pieces to a roll) Checks Maker Date Payee ‘Amount Rose Manalo, 1212317 Luzon Glass Co 600 Asst. Manager tuiss L. Reyes, 1212607 Luzon Glass Co 400 Cashier [Link] K David, Janitor T220K7 350 ER Tirao, Clerk 12220X7 250 Pedro Munar, 12/240X7 150 |__ Bookkeeper Petty Cash Vouchers for Replenishment [Payee Date Account Charged ‘Amount U Cruz. Messenger T216Ix7 __| Advances to Employees | P100.00 Rosario & Co 12/180K7 Supplies 145.00 Vietory Liner 12/180X7 Freightin 182.50 | Bureau of Posts (stamps) 128IX7 Supplies 300.00 A Vallo, Carpenter 12/201X7 Repairs 450.00 {8 Tello 12200X7 Miscellaneous Expense | 154.00Se 336 Chapter I Your investigation also disclosed the following: 1. The balance of cash fund per books is 9,000. Cash sales riemey + 20X8 amounted to P8,650 per sales records, while cash receipts book and deposit slip showed that only P7,650 was deposited in the bank on January 3, 20X8 3. The following employees’ pay envelopes have been opened and the money removed. Each envelope was marked “unclaimed.” v N. Roy P332.50 G. Gloria 247.50 Required 1. Prepare working papers showing your cash count. ; 2. Prepare necessary adjusting journal entries without explanation as of December 31, 20X7. 3. Determine the amount at which the Petty Cash Fund will be stated in the statement of financial position as of December 31, 20X7. Solution: Mustrative Audit Case 11-1 EXHIBIT 11-1 Requirement (1) TOTAL BILLS AND COINS CASH ITEMS ‘Checks for depositAudit of Cash Balances _337 ymeplenished vouchers Date Payee Paniculars $2187 Rosano & Co. Supplies 12/18K7 Victory Liner Freightin P 145.00 121817 Bureau of Posts Supplies 12250 1220x7 A Valo Repairs 300.00 12200K7 B. Tello Miscellaneous fe 140 1B150 Agvances or IOUS mex LG 121 L Cruz 12230XT A David Poa 12007 R Tirao 250.00 vanextP. Mana 15000 95000 Total Amount of Fund Per Count 9,716.00 Total Amount of Fund Per Books or Receipts f Petty Cash Fund per ledger 9,000.00 Unclaimed Wages per opened envelopes. 580.00 Undeposited collection Cash sales, 1/28 8,650.00 Less: Amounted deposited, 1/3/X8 7,850.00 1,000.00 10,580.00 Shortage } \certty that the above fund of P9,716 00 was counted in my presence by (name of auditor) of Santos, Tan and Associates, CPAs on January 4, 20X8 at 9:00 AM and was retumed to me intact. | Lina Reyes LINA REYES Cashier Requirement (2) Adjusting Journal Entries 12/31X7 1. Supplies expense (145,00 + P300.00) PadS.00 | Freightin 182.50 Repairs and maintenance 450.00 Miscellaneous expense 154.00 Petty cash fund _— 2. Advances to employees 850.00 Petty cash fund eam 3 Cash in bank S00) Salaries payable rare 4, Accounts receivable - Cashier me Petty cash fund oeae 338 of Chee Requirement (3) Luzon Glass Company Petty Cash Fund December 31, 20X7 ___— | ___ December 31, 2 Balance per ledger ——} ‘Add (Deduct) Adjustments AJE (1) To take up unreplenished expenses (2) To take up advances to employees (3) To take up shortage per cash count Net adjustment Balance as adjusted Proof. 6,634.50 Bills and coins Checks for deposit ae a Total cash counted Less: Non-fund items Unclaimed wages 58000 | 00 Undeposited collections oe | Balance for Petty Cash Fund P6054 30 Illustrative Case 11-2: Audit of Cash and related Accounts using the Bank Reconciliation Statement The following example illustrates the preparation of a bank reconciliation and the required adjusting entries for the Bulacan Corporation for the month ended June 30, 20X7. The unadjusted cash balances are as follows: Cash balances per bank statement, June 30, 20X7 P249,223.00 Cash balance per company records, June 30, 20X7 248,758.80 The bank statement disclosed the following information: I. A customer note for P24,000 plus P240 interest was collected on June 30, 20X7. A customer check for P2,762.80 was returned because of insufficient funds (NSF check). 3. The month service charge was P300.: —————_____ Audit of Cash Bolonces 4 review of the Company records disclosed the fot mes following: 1. A deposit for P22,857.40 maik appese on i Bank statement $4 40 the bank on June 29, 20X7 did not 2. Customer checks totaling p awaiting deposit, ® P6.548.00 were on hand at the end of June 3. The following company chee weno Pr a Were outstanding at the end of June: #864 2,943.60 #865 5,265.00 Check #843 wri 4 ied titties i P1,824.00 in payment of a creditor account and ncluded es canceled checks in the bank statement has been e ly recorded as P384.00 in the company records EXHIBIT 11-2 illustrates a bank reconciliation based on the foregoing data. EXHIBIT 11-2: Bank Reconcili: ion Adjusted cash balance ar BULACAN CORPORATION Bank Reconciliation June 30, 20X7 Balance per bank statement 7 249,223.00 ‘Add Deposit intransit 22,857 40 Check on hand 6,548.00 278,628.40 Deduct: Outstanding checks _ i #862 1923.80 #864 #865 | Adjusted cash balance: Balance per company records |Add: Note collected or bank 24,000.00 Interest on note 240.00 Deduct: Bank service charge aE z oe - NSF check returned +440.00 Error in recording check #843 ee340 Chapter 11 ~ . 24,240.00 : _ 4,000, Noes Receivable (note coleted) a 300.00 2. Miscellaneous Expense (bank service charge) 2,762.80 ‘Accounts Receivable (NSF check) 4440.00 ia Payable (error) 4,502.80 ash 268,496.00, the amount that would appear The entries adjust the cash account to P. as the Cash balance (along with any petty cash) on the June 30, 20X7 statement of financial position. PROOF OF CASH (FOUR-COLUMN RECONCILIATION) The independent certified public accountant responsible for auditing the company records normally will prepare more comprehensive bank reconciliation. This type of reconciliation, termed a proof ‘of cash, incorporates the monthly cash receipts and payments to test the internal control over cash and provides additional evidence of the accuracy of the cash balance. Therefore, the proof of cash identifies the sources of differences between the company records and the bank statement (such as receipts and disbursements). There are several forms of a proof of cash (sometimes called a four-column reconciliation); again, our discussion focuses on the form that arrives at adjusted balances. This form of the proof of cash begins with the reconciliation made the previous month and accounts, in summary form, for all of the receipts and payments that have transpired during the current month. In essence, the proof of cash provides four separate reconciliations: 1. The reconciliation of the bank and book balance for the previous month. 2. The reconciliation of the receipts recorded by the bank for the current. month with the receipts recorded on the books. 3. The reconciliation of the payments recorded by the bank for the current month with the payments recorded on the books. 4. The reconciliation of the bank and book balances for the current month. Illustrative Audit Case 11-3: Audit of Cash using "Proof of Cash" The proof of cash for the Bulacan Corporation (IIlustrative Audit Case 11-2) requires the following in addition to that given in the preceding case: 1. May 31, 20X7 bank balance P272,348.40 2. Deposit in transit received by the bank June 2, 20X7 24,803.00Total receipts recorded by the bank during June, 20X7 4, Total payments recorded by the bank during June, 20X7 5. May 31, 20X7 book balance 1g checks on May 31, 20X7 7. Total receipts per books during June, 20X7 8. Total payments per books during June, 20X7 Solution: Mustrative Audit Case 11-3 Audit of Cash Balances 341 528,423.40 551,548.80 289,630.40 3,263.00 4,258.00 508,785.80 549,657.40 The proof of cash for the Bulacan Corporation is shown in Exhibit 11-1. BULACAN CORPORATION Proof of Cash June 30, 20X7 Reconciation June une’ Reconciliation May 31, 20X7 Receipts Payments | June 30, 20X7 Balance per bank 272,348.40 | _P528,42340 | _P551,548.80 | P249,223.00 Deposit in transit May 24,803.00 | (24,803.00) June 22,857.40 22857 0 Undeposied cash 6,548.00 6,548.00 ‘Oustanding checks: May 31, 20X7 #781 (3,283.00) (3:263.00) #782 (4,258.00) (4,258.00) June 30, 20X7 #862 792380 | (1,923.80) #864 2,943.60 [__ (2,943.60) #865 5.26500 | (5,265.00) | Adjusted Balance Pamees040 | P533,025.80 | P554,160.20 | P268,496.00 | Balance per books 76963040 | P506,765.80 | P549°657.40 | P248,758.80, [une service charge 300.00 (300.00) [NSF check 2,762.80 | (2,762.80) | ror in recording check #843 1.40.00 | (7,440.00) | |_Nole and interest collected 24,240.00 24,240.00 UAusted Balance | Pao.630.40 | |__ P554,160.20 | P266,496.00 | beM2 Chapter : Mastrative Case H1-4: Cash and Other Items from the accounting records of the The folowing information has been extracted Oracle, Corporation 1 Cash on hand (undeposited sales receipts) P 1,020 2 Certificates of deposit 25,000 3. Customer's note receivable 1,000 4 Reconciled balance in First Standard Bank checking account (350) 5 Reconciled balance in Prime National Bank checking account 9,350 6 Balance in Rural Bank savings account 8,560 7. Customer's postdated check 1,350 8 Employee travel advances 1,600 ® Cash in bond sinking fund 4,200 10. Bord sinking fund investments 8,090 11. Postage stamps 430 Required. account, and discuss the statement of Determine the balance in Oracle's Cash financial position treatment of any items not included as cash. Solution: Wustrative Audit Case 11-4 Cash shall consist of: Item 1. Cash on hand (undeposited sales receipts) P 1,020 5. Reconciled balance in Prime National Bank checking account 9,350 6. Balance Rural Bank savings account 8,560 18.930 Total cash on hand and in bank The following items are not included in cash: Item 2. Certificates of deposit - If maturity of the instrument is three months or less at the time of purchase, this will be shown as Cash Equivalents. Otherwise, it will be shown as Short-term Investments. j Customer's note receivable will be shown among Notes Receivable. Reconciled balance (negative) in First Standard Bank checking account will be presented among Current Liabilities. Customer's postdated check will be shown as part of Accounts Receivable. Employee travel advances will be shown among Prepaid Expenses. fed as Long-term Investment. Cash in bond sinking fund will be presente Bond sinking fund investments will be-presented as Long-term Investment. Postage stamps will be part of Prepaid Expenses. Ro SSwoaon2 ——____ Audit g Illustrative Audit Case 11-5; ‘ash Balances 343 Reconciliation of Bank and Company Cash Amounts The December 31, 20X7 bank st p2,049.25 balance. On this date the overdraft. In reconciling thes fatement for Miguel Corporation showed a company's Cash account reflected a P325.60 € amounts, the following information is discovered: Cash on hand for undeposited sales receipts, December 31, 20X7, P130.25. Customer NSF check returned with bank statement, P420.40. Cash sales of P640.25 for the week ended December 18, 20X7 were recorded on the books. The cashier Teports this amount missing, and it was not deposited in the bank. 4. Note receivable of P2,500 and inter recorded on the books. Deposit in transit December 31, 20X7, P350.00. 6. A customer check for P290.40 in payment of its account was recorded on the books at P940.20. 7. Outstanding checks, P2,040.55. Includes a duplicate check of P70.85 to G. Violet, who notified Miguel that the original was lost. Miguel stopped payment on the original check and has already adjusted the cash account in the accounting records for this amount est of P25 collected by the bank and not Required: |. Prepare-a December 31, 20X7 bank reconciliation for Miguel Corporation. a 2. Prepare any journal entries necessary by Miguel Corporation to record the information from Requirement | Solution: Mustrative Audit Case 11-5 Requirement 1 MIGUEL CORPORATION Bank Reconciliation December 31, 20X7 Balance from bank statement P2,049.28 Add: Deposit in transit P 350.00 Cash on hand (undeposited sales receipts) 130.25 480.25 P2,529.50 Deduct: Outstanding checks (2,040.55)* Adjusted cash balance P_488.95 ii:34 Chapter 11 P (325.60) Balance from company records Add: Note collected by bank 2,500.00 Interest on note —25.00 2,525.00 P 2,199.40 Deduct: Missing deposit P ee Error in recording collection (P940.20-P290.40) . NSF check returned _420.40 — _(1,710.45) P_488.95 Adjusted cash balance * Since the cash account has been adjusted for the original P70.85 check to G. Violet and payment has been stopped, the outstanding checks do not include the original check and no adjustment needs to be made. Requirement 2 20X7 Dec. 31 Accounts Receivable (error) 649.80 ‘Accounts Receivable (NSF check) 420.40 Loss from Cash Shortage or Accounts Receivable - Cashier (missing deposit) 640.25 Cash 1,710.45 31 Cash 2,525.00 Notes Receivable 2,500.00 25.00 Interest Revenueee ___Audit of Cash Balances 348 REVIEW QUESTIONS, EXERCISES AND PROBLEMS Questions "When auditors fyi 7 " particularly comceeaTweTE a client's bank reconciliation they are ehecksmay) include fa ith the possibility that the list of outstanding concerned with the possibilfe et or ftitious check, and also are deposit in transit." brie of omission from the reconciliation of a accurate statement. ze the above quotation and pee = lapte 2. During the first few months of the year Olano, the cashier in a small company, was engaged in lapping operations. However, she was able to restore the amount of cash "borrowed" by March 31, and she refrained from any fraudulent acis after that date. Will the year-end audit probably lead to the discovery of her lapping activities? Explain 3. Although the primary objective of an independent audit is not the discovery of fraud, the auditors in their work on cash take into consideration the high relative associated with this asset. One evidence of this attitude is evidenced by the CPA's alertness of signs of lapping. Required: a. Define /apping. b. Explain the audit procedures that CPAs might utilize to uncover lapping. (AICPA adapted) 4. Describe the following types of cash accounts: (a) general checking accounts, (b) cash management accounts, (c) imprest payroll accounts, and (d) petty cash accounts. |. Match the following assertions with their associated description: (a) existence or occurrence, (b) completeness, (c) rights and obligations, (d) valuation or allocation, (e) presentation and disclosure. i. Cash accounts are properly classified on the balance shcet and disclosed in the notes to the financial statements. ii. Cash balances exist at the balance sheet date. , iii, The recorded balances reflect the true underlying economic value of those assets.346 Chapter 1) ne f the balance iv. The company has title to the cash accounts as 01 sheet date, i have tak v. Cash balances include all cash transactions that en place during the period. Evaluate the following statement made by Poa tesatvabllone pie In comparison with other accounts, such as accoun h contains lees inher plant and equipment, it is my assessment that cas! with cash.” Do mn tisk. There are no significant valuation problems erent risk? Ex oe agree or disagree with the auditor’s assessment of in| * Explain, Give two reasons audit work on cash is likely to be more oor’ than might appear to be adjustified by the relative amount of the balance sheet figure for cash, “If the auditors discover any evidence of employee fraud during their work on cash, they should extend their investigation as far as necessary to develop a complete set of facts, regardless of whether the amounts involved are or not material.” Do you agree with the quoted statement? Explain. During the audit of a small manufacturing firm, you find numerous checks for large amounts drawn payable to the treasurer and charged to the Miscellaneous Expense account. Does this require any action by the auditor? Explain. . What action should be taken by the auditors when the count of cash on hand discloses a shortage?Audit of Cash Balances 347 Exercises Exercise 1 During the audit of Evolutioy n Buildi i i year-end bank reconciliation ing Supply, you are given the following Prepared by the client: Evolution Building Su ipply Bank Reconciliation December 3 Balance per 12/31 Sh P 97,468 Add: Deposits in transit 8,934 P 106,402 Less: Checks outstanding 41516 Balance per ledger, 12/31 P_ 64,886 According to the client's accounting records, checks totaling P62,964 were issued between January | and January 14 of the following year. You have obtained a cutoff bank statement dated January 14 containing paid checks amounting to P100,880. Of the checks outstanding at December 31, checks totaling P7,200 were not returned in the cutoff statement, and of those issued per the accounting records in January, checks totaling P 16,400 were not returned. Required: a, Prepare a working paper comparing (1) the total of all checks returned by the bank or still outstanding with (2) the total per client's records of checks outstanding at December 31 plus checks issued from January 1- 14, b. Suggest four possible explanations for the situation disclosed in your working papei. State what action you would take in each case, including any adjusting entry you would propose.ON ee Exercise 2 transfers for SPF Co Listed below are eight interbank cash arly Janu letters a through h, for late December 20X8 and early Disturbing Receiving Bank Meee (iortiyO2y Per Bank Per Books Per Bank bikie Teo a = 1229 1229 1229 1280 S00 b 102 1230 tas a a 1281 if & @ 6 3S 104 1101 ft 102 1101 1231 1231 ee 9. 103 102 1231 102 e400 h 12/31 103 12/30 1103 , For each of transfers a through h (1) indicate whether cash is understated, and (2) provide a brief example of what overstated, or correct as a result; ‘ could cause the situation. Answer in a form such as the one illustrated here. Understated, Transfer | Overstated, or Example Correct a Correct Book entries: The transfer was recorded in the accounting records as a check written on the disbursing bank on December 29 and a corresponding cash receipt recorded to receiving bank on that date. Bank entries: The check was taken to the receiving bank on December 29 and deposited. The accounts are both in the same bank, and accordingly the transaction was recorded in both accounts as of that date. b. ¥ h. Exercise 3 Items a through f represent the items that an auditor ordinarily would find on a client-prepared bank reconciliation. The accompanying List of Auditing Procedures represents substantive auditing procedure. For each item, select ~ or more procedures, as indicated, that the auditor most likely would perform to gather evidence in support of that if i at item. The the list may be selected once, more than once, or not at all CteAssume Audit of Cash Balances _349 « Theclient Prepared the bank reconciliation on 10/2/XS. «The bank reconciliation is mathematically accurate. The auditor received a cutoff bank statement dated 10/7/XS directly from the bank on 10/11/XS. « The SONS deposit in transit — outstanding checks #1281, #1285, #1289, and #1292 — and the correction of the error regarding check #1282 appeared on the cutoff bank statement. « The auditor assessed control risk concerning the financial statement assertions related to cash at the maximum. [Link] to cash receipts | List of Audting Procedures S journ H. Ing ing for reconciling item B. Trace to cash disbursements journal ieepeaial Snot Toman C. Compare to 9/30/XS general ledger. |. Trace items on the bank reconciliation D. Confirm directly with bank to culoff statement E. Inspect bank credit memo. J. Trace items on the cutoff statement to F. _ Inspect bank debit memo. bank reconciliation G._Ascertain reason for unusual delay. [ GENERAL COMPANY Bank Reconeiliation 48 National Bank of US Bank Account September 30, 20X5 a. Select 2 procedures Balance per bank P28,375 . Select 5 procedures Deposits in transit 9/29)X5 4,500 9/30/X5 1525 6,025 34,400 . Select § procedures ‘Quistanding checks #988 _ 8/31/X5 2,200 #1281 _9/26)X5 675 #1285 _9/27/X5, 850. #1289 _9/29/X5 2,500 #1292_9/30/X5, 7.225 |_ (13,450) 20,950 d. Select 1 procedure Sustomer note collected by bank 3,000) e. Select 2 procedures Error. Check #1282; written on 9/26/X5 for P270 was erroneously charged by bank as P720; bank was notified on 10/2/X5 450 {. Select 1 procedure Balance per books 18,400 |380 Chapter 11 fe ee gy tg ee 350 Chapter 11 Exercise 4 | ash — some unique, ting to ¢ yes . ecures aH Seslow, identify its primary Auditors perform a number of proc: purpose. some not unique. For each substantive proc ae objective or indicate that the procedure serve: Substantive Procedures: a. Prepare a bank transfer schedule. b. Prepare a four-column proof of ¢ c. Use a standard confirmation information. |. Obtain bank cutoff statements. ies! e. Search for large checks to directors, officers, and employ’ ash. form to confirm account balance Replies: A primary objective of the procedures is to: 1. Detect kiting. x Baie dee receivables are converted to cash in a reasonable 4. Caan ieienaen of cash to reflect currency translation losses and gains. 5. Reconcile cash receipt and disbursement totals between company records and bank records. ae 6. Verify reconciling items on the year-end reconciliation. 7. Verify year-end cash and liability balance information. 8. Identify related party transactions. 9. None. This procedure serves no purpose related to cash. Exercise 5 You re the senior auditor-in-charge of the July 31, 20X0, audit of Reliable Auto Part, Inc. Your newly hired staff assistant reports to you that she is unable to complete the four-column proof of cash for the month of April 20X0, which you instructed her to do as part of the consideration of internal control over cash. You assistant shows you the working paper that she has prepared. Your review of your assistant’s work reveals that the dollar amounts of all the items in her working paper are correct. You learn that the accountant for Reliable Auto Parts, Inc., makes no journal entries for bank service chargespi _ Audit of Cash Balances 381 or note collections until the month following the bank's recording of the item. In editon, Reliable’s accountant makes no journal entries what soever for NSF check that are redeposited and cleared. Your assistant’s working paper appears below, RELIABLE AUTO PARTS, INC. Proof of Cash for April 20X0 July 31, 20X0 Balance ~ 331x0_| Deposits | Checks Per bank statement P71,682.84 | P61,688.19 | P68,119.40 its in transit: — 2118.18 (2.118 16) AL 30X0 4518.16 4,918.16 Duistanding checks: AL 3131X0 (14,888.16) 14,888 16 At 4/3000 (22,914.70) | 22,914.70 Bank service charges: [_ March 20X0 (2218) 22.18 [Apa 20x0. (19.14) 19.14 [Hote receivable collected by bank 473000 18,180.00 16,180.00 NSF check of customer LG. Wang, charged back by bank 3/31/X0, redeposited and cleared 4/3/X0 (18.19 | 418.19 Balances as computed 56,472.49 | 05,004.54 | 60,095.90 | 108,964.45 Balances per book 59,353.23 | 45,689.98 | 76,148.98 | 28,294.23 Unlocated diference aa074) | 39,314.56 |P(16,053.08) | 80,071.22 Required: Prepare a corrected four-column proof of cash in good form for Reliable Auto Parts, Inc., for the month of April 20X0.352 Chapter 11 Problems Problem 1 ion is being examined by reconciliat bank atements of Concrete The following client-prepared rae of te financial st Karen, CPA, during an examinal Products, Inc.: Concrete Products, Inc. Bank Reconciliation December 31, 20X Balance per bank (a) P18,37591 Deposits in transit (b) December 30 1,474.10 December 31 2,840.69 4,311.79 Outstanding checks ©: ae 6,000.00 1941 671.80 1966 320.00 1984 1,855.42 1985 3,621.22 1986 2,576.89 1991 4,420.88 19,466.21) Subtotal 3,221.49 NSF check returned Dec. 29 (d) 200.00 Bank charges 5.50 Customer note collected by the bank (P2,750 plus P2765 interest) (e) (3,025.00) Balance per books (f) P 550,09 Required: Identify one or more substantive audit procedures that should be performed by Karen in gathering evidence in support of each of the i in this bank reconciliation. Reisen ce) ene)——— , lem 2 - Audit of Cash Balances ¥83 Problem Toyco, a retail toy chain, fy deposits of credit card sales intro oe Bank B). Each day, Toye es in two bank credit cards and makes daily Caan credit card bank accounts (Bank A and slips, and authorized sal les its credit card sales slips, bank deposit processing for data entr Fe brasil documents, and send them to data general ledger credit c a ‘ach week, detailed computer printouts of the been instructed to ma cash accounts are prepared, Credit card banks have general bank account. The automatic weekly transfer of cash to Toyco"s Faclade sales toh he credit card banks charge back deposits that 7 fi fal olders of stolen or expired cards. The auditor examining the a inancial statements has obtained copies of the detailed general ledger cash account Printouts, a Summary of the bank statements, and the manually propared bank reconciliations, all for the week ended December 31, as shown Revit we the December 31 bank reconciliation and the related information contained in the following schedules and describe what actions the auditor should take to obtain evidence for each item on the bank reconciliation. Assume that all amounts are material and that all computations are accurate. Organize your answer sheet as follows, using the code contained on the bank reconciliation. ; Code Number Actions to Be Taken by the Auditor to Obtain Evidence 22 3. etc. Toyco Bank Reconciliation for December 31, 20%3 Bank A BankB Code No. ‘Add or (Deduct) {Balance per bank stalement, December 31 8,600 P 2 Deposits in transit, December 31 2200 6000 3__ Redeposit of invalid deposits (deposited in wrong account) 1,000 1.400 4. Difference in deposits of December 29 (2,000) (100) 5. Unexplained bank charge _ 400 4 6__ Bank cash transfer nol yel recorded : 0. 2600 7. Bank service charges 4 500 8 Chargebacks not recorded - stolen cards 100. + 9. Sales returns recorded but not reported to the bank (600) t fi 10. Balance per general ledger, December 31 P9700354 Chapter 11 Toyco 4 Detailed general Ledger Credit Card Accounts Printouts for the Week Ended December 31, 20X3 Bank A Bank B Dr. or (Cr.) | Beginning balance, December 24 P12,100 P4,200 Deposits: December 27 2,500 5,000 December 28 3,000 7,000 December 29 -0- 5.400 December 30 1,900 4,000 December 31 2,200 6,000_| Cash transfer, December 17 (10,700) 0- Chargebacks - expired cards (300) (1,600) Invalid deposits (deposited in wrong account) (1,400) (1,000) Redeposited of invalid deposits 1,000 1,400 Sales returns for week ended December 31 (600) (1,200) | Ending balance P_9.700 P29,200 | Toyco Summary of the Bank Statements for the Week Ended December 31, 20X3 Bank A Bank B (Charges) or Credits Beginning balance, December 24 P10,000 -0- Deposits dated: December 2 2,100 4,200 December 27 2,500 5,000 December 28 3,000 7,000 December 39 2,000 5,500 December 30 1,900 4,000 Cash transfers to general bank account: December 27 (10,700) o- December 31 - (22,600) Invalid deposits (deposited in wrong account) (1,400) (1,000) Bank service charges -0- (500) Bank charge (unexplained) __(400) (0) | Ending balance P_ 8,600 Po]