Dr. Donald K. McConnell Jr. Audit of Cash Balances Dr. Donald K. McConnell Jr. 11/13/2018

A Typical Bank Reconciliation in Auditor Format Page 23-1 in packet 11/13/2018

Ways That a Bank Reconciliation Can Be Manipulated to Cover a Cash Shortage Overstate balance per bank Overstate deposits in transit Include a fictitious deposit in transit Omitted outstanding check(s) Understate the amount of a listed outstanding check Include a fictitious bank debt memo (e.g. an NSF check) Reconciliation does not foot 11/13/2018

How Does a Company Reduce the Risk of Manipulated Bank Reconciliations? Reconciliations should be done by persons with no cash recording or (especially) cash custody functions 11/13/2018

Controls over the Bank Reconciliation Process Bank statement must go to reconciler unopened! Coverage of necessary controls (pg. 691 in text) 11/13/2018

Four Column Cash Trace (Proof of Cash) An optional test done on a test month (if at all) at interim Typically only done when: Very high cash control risk Where cash fraud is suspected Purpose to verify: Cash inflows for month can be tied to bank deposits Cash outflows for month can be tied to bank charges Example work paper (pg. 699 text) A personal audit experience 11/13/2018

Audit of Petty Cash Not often done anymore. Why? Small fund size makes fraud self-limiting How it is done Client employee must be present when you have access to any client assets! Same with inventory observation, but don’t let them know what you are counting! 11/13/2018

Year End Considerations in Audit of Cash Examine or confirm negotiable securities as of year end. Why? Year end cash receipt and disbursement cut off tests 11/13/2018

Cash Receipts Cut off Verify year-end deposits in transit are clearing on a timely basis When should a deposit clear the bank if actually made on 12/31? A personal audit experience 11/13/2018

Cash Disbursements Cut off Auditor observes/records last check number issued at year-end Improper disbursements cut off more prone to affect current ratio than improper receipts cut off 11/13/2018

Most Fundamental Year End Substantive Test: Audit of Client Bank Reconciliations 11/13/2018

Audit of Year-end Bank Reconciliations One of first things you’ll do as a new auditor A universal practitioner complaint: new auditors have trouble preparing/auditing bank reconciliations! Audit concerns: Do reconciling items exist? [e.g., a fictitious deposit in transit] Are reconciling items complete? [e.g., omitted outstanding check(s)] Are reconciling items properly valued? Were transaction cutoffs accurate? Cutoff bank statement obtained to verify the above 11/13/2018

Cutoff Bank Statement: Fundamental to Auditing Bank Reconciliations What is a cutoff bank statement? Visualize your monthly bank statement: it’s exactly the same, but typically for less than a month! Cutoff confirmation request sent to bank (example packet pg. 23-1-3) Generally request bank statement for first two weeks following year end be mailed directly to auditor 11/13/2018

Auditing the Clients Year-end Bank Reconciliation(s) Obtain a copy of client prepared year-end bank reconciliation(s) Cutoff bank statement details used to verify existence, completeness, valuations, cutoffs of reconciling items Obtain AICPA standard cash confirmation request , unless Au 330.10 conditions exist Example in packet (pg. 23-1-1) 11/13/2018

Other Cutoff Bank Statement Considerations Auditors increasingly using unopened client January bank statement(s) In lieu of cut off bank statement Because of cost considerations What if bank mails cutoff bank statement to client? Must “prove” the compromised bank statement (p. 692 text) A personal audit experience Have client sign off acknowledging return of cutoff bank statement! 11/13/2018

Standard AICPA Cash Confirmation Request Always obtained unless combined IR and CR are low for cash existence assertion (AU 330.10) To confirm only two issues: Bank account balances Bank loans Bank not obligated to search for other bank balances or loans Cash confirmation therefore existence or occurrence assertion oriented 11/13/2018

Standard AICPA Cash Confirmation Request (con.) Example in text page 695 is a characteristic blank form confirmation Other banking relationships must be confirmed on a separate confirmation letter. Examples: Lines of Cr., contingent liabilities Compensating balance arrangements A personal audit experience 11/13/2018

Why Do Many Auditors “Over Audit” Cash? Cash is highly vulnerable to manipulation, theft, and is often poorly controlled in small businesses 11/13/2018

How Can Substantive Cash Testing Be Restricted When Combined IR and CR are Low? One of my larger clients had over 100 bank accounts! If many bank accounts, mail AICPA cash confirmation requests: On all active bank accounts, unless AU 330.10 conditions exist On a sample of the remaining “PR Purposes” bank accounts Trace samples of checks dated in December clearing cutoff bank statement to year end outstanding check list 11/13/2018

A Primary Substantive Test: Schedule of Interbank/ Intercompany CashTransfers To detect kiting schemes Kiting requires multiple bank accounts Two forms of kiting schemes exist: Bank transfer affected to cover a cash shortage (bank float allows) Bank transfer booked to create fictitious cash What is the book entry for a cash transfer? Exemplary work paper (packet pg. 23-2) 11/13/2018

Schedule of Interbank/ Intercompany CashTransfers (con.) Practically speaking, clients actively making cash transfers would not have more than one or two cash transfers at year end. Generally done, regardless of system of internal controls 11/13/2018

Schedule of Interbank/ Intercompany CashTransfers (con.) Would bank cash transfer test be necessary for wire transfers? What is the issue? bank float ordinarily eliminated. Yes The test is still necessary because: International wire transfers don’t clear “bang-bang” [there is typically float] Did you ever have an e-mail lost in cyberspace? 11/13/2018