Chapter Two

Auditing Cash and marketable securities

Learning Objectives:
After studying this chapter, students should be able to:
 Describe cash and each types of cash account
 Design and perform audit tests of cash and bank balances.
 Audit cash payments according to the standard audit procedures for cash payments.
 Audit cash on hand and in bank according to the standard cash audit procedures for cash
on hand and in bank.
 Recognize the extended audit procedures of the general cash account to test further for
material fraud.
2. 1. Introduction
Cash is the only account that is included in several cycles except inventory and warehousing
therefore the audit of cash balance depends heavily on the results of the tests in other cycles.
Cash is important primarily because of the potential for fraud but also because there may be
errors.

In the audit of cash, it is important to distinguish between verifying the client’s reconciliation of
the balance on the bank statement to the balance in the general ledger. Verifying whether
recorded cash in the general ledger correctly reflects all cash transactions that took place during
the year. This is because there are some misstatements ultimately results in the improper
payment of the failure to receive cash, but none will normally be discovered as a part of the audit
of the bank reconciliation; such as:
 Failure to bill a customer
 Billing a customers at lower price
 A defalcation of cash, before they are recorded
 Duplicate payment of a vendor’s invoice
 Payment for row material that were not received
 Payment to an employee for more hours than he or she worked
 Payment of interest to a related party for an amount in excess of the going rate.
2.2. Definition of cash
Cash represents currency on hand and cash on deposit in bank accounts including:
 Certificates of deposit
 Time deposits
 Savings accounts and
 money market funds
» Virtually all accounting transactions pass through the cash account at some point.
2.3. Types of Cash Accounts
The entity’s management must be concerned with the control and safekeeping of cash. The use
of different types of bank accounts keeps in controlling the entity’s cash.
a. The general cash account:
-Is the focal point of cash because all cash receipts and disbursements flow through this account.
The disbursements for the acquisition and payment cycle are normally paid from this account,
and the receipt of cash in the sales and collection cycle are deposited in this account.
» Hence, most companies focus an audit of cash

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b. Imprest payroll Account:
Is established to record:
payroll payments made for employees and
Separate cash receipts and disbursements accounts for branch banking.
In an imprest account a fixed balance, is maintained in a separate account and this amount
should always be shown as a balance.
i.Branch Bank Account
For a company operating in multiple locations, it is often desirable to have a separate bank
balance at each location.
Branch bank accounts are useful for building public relations in local communities and
permitting the centralization of operations at the branch level.
ii.Imprest Petty cash fund
fund of cash maintained within the company for small cash acquisitions or to cash employees’
checks; the fund’s fixed balance is comparatively small and is periodically reimbursed.
A petty cash account usually does not exceed a few hundred birr and may not be reimbursed
more than once or twice each month.

Imprest payroll account

Branch bank account

General Cash Account

Cash equivalence
Imprest petty cash fund

2.4. Audit of Cash Balances

Cash is the only account that is included in several cycles. It is a part of every cycle except
inventory and warehousing; therefore the audit of cash balance depends a lot on the results of
tests in other cycles.
The audit of cash is considered an important part of an audit mainly due to two reasons:
(a) Almost all business transactions will be ultimately settled through the cash
accounts, the audit of cash accounts also assists in the verification of other asset
and liability accounts as well as revenue and expenses.
(b) Cash is the highly liquid asset in a company and it is an area of high inherent risk
since there is relatively high risk of misappropriation.
Hence, Audit of cash is important because of it is potential for fraud as well as, there may be
errors.
In the audit of cash, it is important to distinguish between the client’s reconciliation balances on
the bank statement to the balance in the general ledger-verifying whether recorded cash in the

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general ledger correctly reflects all cash transactions that took place during the year. Entirely
different types of misstatements are normally discovered as part of tests of bank reconciliation.
These include:
 Failure to bill a customer
 Billing a customers at lower price
 A defalcation of cash, before they are recorded
 Duplicate payment of a vendor’s invoice
 Payment for raw material that were not received
 Payment to an employee for more hours than he or she worked
 Payment of interest to a related party for an amount in excess of the going rate & etc
Selected specific audit objectives for Cash Balances
The audit objectives for Cash Balances related to obtain to sufficient, competent evidence about
each significant financial statement assertion that pertains Cash Balances.
To achieve each of these specific audit objectives, the auditors employ various parts of the audit
planning and audit testing methodology.
The assertions for auditing cash balances are as follows:
Assertions Descriptions
1. Existence  Objective attempts to determine whether all cash transactions are
actually in existence and belong to the company at a given date or
at the year-end date.
2. Completeness  Objective concerned to determine whether all cash transactions
that, there is no unrecorded cash.
3. Accuracy  Objective attempts to determine whether cash at bank stated on the
reconciliation is accurate.
4. Cut-off  The cutoff objective attempts to determine whether amounts are
recorded in the proper period.
5. Presentation and  The auditor must ensure that all necessity’s discourses are made. To
disclosure ensure that the cash balance and related statement of comprehensive
income entries are correctly disclosed in the financial statements in
accordance with legislation and accounting standards.
6. Detail tie-in  Cash in the bank as stated on the reconciliation foots correctly and
agrees with the general ledger.

2.5. Audit of the General cash account

In testing the year-end balance in the general cash account, the auditor must accumulate
sufficient evidence to evaluate whether cash, as stated on the balance sheet, is fairly stated and
properly disclosed in accordance with six of the nine balance-related audit objectives used for
tests of details balances. Rights to general cash, its classification on the balance sheet, and the
realizable value of cash are not a problem.

2.5.1. Methodology for auditing-year-end-cash

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 Set tolerable misstatement and assess Phase I
inherent risk for cash in bank
Phase I

Assess control risk for cash in bank Phase I

Design and perform tests of control &

substantive tests of transactions for Phase II
several cycles

Phase II

Design and perform analytical

procedures for cash in bank balance Phase III

Phase III
Design tests of details of cash in bank Audit procedures
balance to satisfy balance related audit Sample size
objectives. Phase III
Items to select

Timing

Cycle affected include sales & collection, acquisition & payment, payroll Personnel and capital
acquisition and repayment.
Set Tolerable Misstatement & Assess Inherent Risk (Phase1)
Because cash is more susceptible to theft other than assets, there is a high inherent risk for
the existence, completeness, and accuracy objections, and after there is a potential for a
misstatement of cash. Therefore these objectives should be the focus of in auditing cash
balances.
Assess control risk (Phase 1)
Internal controls over year-end cash balance in the general account can be divided into two
categories
 Control over the transaction cycles affecting the recording of cash receipts and
disbursements.
 Independent bank reconciliation.
Major controls over transactions cycle affecting cash receipts and payments include:
 Segregation of duties between the check signing and accounts payable functions

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  Signing of check only by proper authorized person
 Use of pre-numbered check printed on special paper
 Adequate control over blank and void check.
 Careful review of supporting documentation by the check signers before checks are
signed
 Adequate internal verifications
Careful bank reconciliation by competent client personnel includes:
 Compare cancelled check with cash disbursements records for date, payee, and
amount.
 Examine cancelled checks for signature endorsement, and cancellation.
 Compare deposits in the bank with recorded cash receipts for date, customer, and
amount
 Account for the numerical sequence of checks, and investigate missing ones.
 Reconcile all items causing a difference between the bank and the bank balance and
verify their property.
 Reconcile total debits on the bank statement with the totals in the cash disbursement
record.
 Reconcile total credits on the bank statement with the totals in the cash receipts
records.
 Review month –end inter banks transactions for propriety and proper recording
 Follow up on outstanding checks & stop payment notice.
Design and perform tests of controls and substantive tests of transactions
(Phase II)
As a cash balance is affected by all other cycles except inventory and warehousing, an extremely
large number of transactions affected cash, appropriate tests of control and substantive tests of
transactions should be maintained.
Design and perform analytical procedures (phase II)
Since in many organizations, the year-end bank reconciliation is extensively audited, using
analytical procedures to test the reasonableness of the cash balance will be less important than it
is for most other audit areas.
Design tests of details of cash balance (phase III)
A detail test of cash balance i.e. tests of the component parts that are used in the computation of
the ending balance of cash should properly designed and tested.
2.6.Fraud-Related Audit Procedures
When the auditor assesses the client’s control over cash is weak and suspects that some type of
fraud or defalcation involving cash has occurred, the following audit procedures are typically
used to detect fraudulent activities in the cash accounts:
(a) Proof of cash
(b) Testing for kiting
(c) Testing for lapping
A) Proof of cash
A proof of cash is used to reconcile the cash receipts and disbursements recorded on the client’s
books with the cash deposited into and disbursed from the client’s bank account for a
specific time period. The purposes of the proof of cash are to ensure:
(a) All cash receipts recorded in the client’s accounting records were deposited in the
client’s bank account.
(b) All cash payments recorded in the client’s accounting records have been cleared.
(c) No bank transactions have been omitted from the client’s accounting records.

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However, a proof of cash cannot detect a theft of cash when the cash was stolen before being
recorded in the client’s books. If the auditor suspects that cash was stolen before being
recorded in the client’s books, the audit procedures for testing the completeness in
recording cash receipt transactions should be performed.

B. Test of kiting
When cash has been stolen by an employee, he can conceal the cash shortage by means of kiting.
This involves an employee covering the cash shortage by transferring money from one
bank account to another and recording the transactions improperly on the client’s books.
The cash shortage can be covered up by preparing a cheque on one account just before year end;
however, this transaction is not recorded until the next period. The cheque is deposited

C. Test for Lapping

Additional procedures can be performed to try to detect attempts at lapping accounts receivable
collections include:
(a) Obtaining a cut-off bank statement and checking the proper listing of outstanding
cheques and deposits in transit on bank reconciliation.
(b) Checking the details of customer payments listed in bank deposits in comparison
to details of customer payment in daily remittance list or other record of detail
postings.
(c) Comparing the cheques listed on a sample of deposit slips from the reconciliation
month to the detail of customer credits listed on the day’s posting to customer
accounts receivable.