Professional Scheme
Relevant to Paper 2.6

The work given to junior staff in practising firms can be less than inspiring. One of the more interesting aspects though, is the audit of cash. Checking the bank reconciliation and sending out and following up the reply to the bank letter both involve a proper understanding of how the cash system works and what can go wrong. It is important that the audit of cash goes well. Auditors may be forgiven for making errors of judgement in complex technical areas but cash is generally either in the bank, or it is not. The majority of frauds involve the misappropriation of small amounts of cash and if auditors do not detect the misappropriation of large amounts, the public has very little sympathy! This is why it is particularly important for auditors to be on their guard when their suspicions are aroused. Cash frauds often take a long time to come to light and almost always involve persons in positions of responsibility who have tried to cover the theft carefully. It is necessary, of course, for auditors to pursue their suspicions discreetly, without embarrassing those who might be quite innocent.

If you have experience of cash audits, it should stand you in good stead in the exam. In many countries though, bank reconciliations are not performed at all. This is because the company�s cash records are written up from the bank statements, and accounts for �cash in transit� are used instead. Many countries also use bankers� drafts rather than cheques in the normal course of business. It is important that students do understand the audit of bank reconciliations, even if they have no experience of them, because they are examined very regularly.

Bank reconciliations

Reconciliations may reconcile the cash book to the bank statement, or vice versa. Think about how you would go about auditing the example below.

Uncleared cheques are usually a type of timing difference. Cheques are often sent to suppliers on the last day of the period. Suppliers will not have received the money through the postal system on that day, and neither will they have banked it. As far as the bank is concerned, no payment has yet been made. Such cheques are �uncleared�, and are sometimes known as �unpresented� cheques. The bank statement should be reviewed after the period end to ensure that all uncleared cheques do �clear�. Where cheques do not clear within two weeks or so, the following situations may have arisen:

(i) cheques are sometimes written out of the cash book, but not posted to suppliers until after the period end. If the amounts involved are material, it is necessary to write back such cheques, which increases both cash and creditor balances;

(ii) if a cheque has not been presented to the bank by the supplier after 6 months, it may be that the supplier has lost it or has gone out of business. In any case the cheques will be �stale� and the bank will not honour it even if it is presented. The auditor should consider the need for the creditor to be reinstated and a new cheque issued, or the need for the cheque to be written back as income.

�Deposits not credited� are also a type of timing difference. They represent cheques or cash received by the company and taken to the bank, but not yet credited by the bank.

Again, the bank statement should be reviewed after the period end to ensure that all deposits are promptly credited. If there is a delay between deposit and credit of more than a few days, suspicions of �teeming and lading� may arise. Teeming and lading is essentially the theft of cash. Cash for cash or credit sales is stolen, and cash received from subsequent sales is used to cover up the theft. This is a very common fraud.

�Differences� must be investigated even if they are small, as they may represent large errors in both directions that net each other off. If any �difference� is divisible by 9, it is likely that a transposition error has occurred, e.g., 112 + 340 = 452, and 112 + 430 = 542. 542 � 452 = 90, which is divisible by 9.

The balance per the bank statement and the balance per the cash book can be checked to the bank statement and the cash book respectively. Reconciliations are normally performed on a monthly basis and will normally be signed by someone such as the financial controller as evidence of review. Reconciliations should be checked for arithmetical accuracy!

Before the bank reconciliation proper is performed, it is often necessary to adjust the cash book for items that should be accounted for, but are only �picked up� when the bank statement is received.

You might audit this schedule as follows:

(i) check the original balance per cash book to the cash book itself;

(ii) check the sundry receipts and direct debits to the bank statement and to the relevant accounts in the general ledger, ensuring that the correct accounts are posted;

(iii)check to ensure that the addition error is an addition error;

(iv) ensure that all of the adjustments are made in the cash book so that the balance carried forward is correct;

(v) ensure that the schedule itself is correctly cast.

The following is a slightly amended version of part (a) of a question that appeared on a recent paper:

Newpiece Textiles � Question, part (a)

Your firm is the auditor of Newpiece Textiles and you are auditing the financial statements for the year ended 31 October 20X1. The company has a turnover of $2.5 million and a profit before tax of $150,000.

The company has supplied you with the following bank reconciliation. You have entered the �date cleared� on the reconciliation which is the date the cheques and deposits appeared on November�s bank statement.

Notes:
CJ = Cash Journal Date
ARL = Accounts Receivable Receipt
CS = Receipt from Cash Sales
APL = Accounts Payable Payment
CP = Cheque Payment � Other Expenses

All cheques for accounts payable payments are written out at the end of the month.

You are required to describe:

(ii) the adjustments you will probably require if your investigations confirm the problems highlighted in (i) above (10 marks).

Take the time to make sure that you understand the information given. On the face of it, there may not appear to be anything particularly �wrong� with the reconciliation, until perhaps, we look at the dates. It seems odd that receipts from cash sales are taking anything up to 10 days to clear. All of the uncleared cheques have cleared by the time we come to perform the audit, but there does appear to be some delay. It is these matters that give us cause for concern. Controls over cash are also relevant, as they are to part (b) below.

Newpiece Textiles � Suggested Answer, part (a)

(i) Matters giving cause for concern and investigations.

1 there appears to be considerable delay between the banking of receipts from cash sales and crediting by the bank, receipts are taking anything up to 10 days to clear, cash should normally clear within three working days. This may indicate the possibility of teeming and lading;

2 enquire of management as to the reasons for the delay and corroborate any explanations;

3 for each of the receipts on the bank reconciliation, check the date stamped by the bank on the paying in slip and ensure that it is on or before 31 October;

4 check a sample of receipts to the relevant sales documentation, such as till rolls, check the amounts and dates and pay careful attention to any apparent alterations;

5 tests of controls over cash and cash sales should have given some indication of the likelihood of substantive errors at the year-end;

6 there is some delay in the presentation of accounts payable payments. This may indicate that cheques were not posted to suppliers until after the year-end;

7 enquire of management as to the reasons for the delay and corroborate any explanations;

8 examine correspondence with suppliers and supplier statements in order to establish when the supplier believed that the payment was received;

9 check replies to any direct confirmation of creditors to further substantiate dates of payment.

(ii) Adjustments

1 if there is evidence of teeming and lading, adjustments should be made regardless of the amounts involved. The auditor should consider the integrity of management, staff and systems, and the effect of audit work already performed, in the light of any such discoveries;

2 the delay in the payment of suppliers, may be more difficult to prove, and the client may be unwilling to make adjustments in the absence of persuasive evidence. It is common practice to make such delays in order to improve cash flows and it can be an indicator of cash flow or going concern problems;

3 we should press for an adjustment increasing creditors and cash, but the amounts involved may not be sufficiently material to warrant it.

The following constitutes a slightly amended version of part (b) of the question above.

Newpiece Textiles � Question, part (b)

The manager in charge of the audit has asked you to consider the petty cash system and recommend what audit work may be necessary. You have found that petty cash is recorded in a hand written analysed petty cash book and is not kept on an imprest system. From the petty cash book you have recorded the petty cash expenditure for each month.

You are required to:

(ii) assuming the audit manager decides that further audit work is necessary, describe the detailed substantive tests of transaction and balances you should carry out on the petty cash system (6 marks).

The information in the question clearly highlights potential problems in the months of December and August. Information given at the beginning of part (a) of the question is relevant to the calculations of materiality.

Newpiece Textiles � Suggested Answer, part (b)

(i) Risk and materiality

1 if petty cash is well controlled, it may be possible to assess the area as low risk. An imprest system is not the only way of controlling petty cash, however, in this case, the very high expenditure recorded in December and August may indicate that controls are not in place, or are not operating properly. For this reason, petty cash may not in this case be assessed as low risk;

2 petty cash is a vulnerable asset, which means that is may be assessed as moderate or high risk in any case;

3 total petty cash expenditure represents nearly 16% of profit before tax, which is clearly material, even though it represents less than 1% of turnover. The expenditure in December and August represents 64% of the total and audit efforts should clearly be directed towards these two months;

4 it may be possible to test controls in this area, which may enable us to reduce the volume of substantive testing required, however, it may be more efficient to take a wholly substantive approach in this area in any case, even if controls are present.

(ii) Further substantive procedures

1 we should perform analytical procedures on receipts into the petty cash system, and petty cash balances at the end of each month, in order to establish any further unusual patterns which may require further corroboration;

2 we should enquire as to the reasons for the high levels of expenditure in the months of December and August and corroborate explanations;

3 for the months of December and August, we should select a sample of payments covering both high value items and items of average value, and ensure that they represent bona fide, properly authorised petty cash expenditure, that has been posted to the correct accounts;

4 for any payments selected in 3 above, where we would normally expect payment to be made by cheque, we should establish the reason for payment in cash, and assess the implications;

5 for the remaining months, we should select a representative sample and perform the same tests as in 3 and 4 above;

6 for any errors discovered, we should assess the implications for petty cash expenditure as a whole and consider the need for additional testing. Any errors should be noted and reported to management, any systematic or significant errors should be included in the report to management;

7 we should consider the need to count petty cash, possibly on a �surprise� basis. This is an effective test, and one that would require the permission of management. We should pay particular attention to any discrepancies found, and the existence of any �IOU�s� or similar unauthorised withdrawals.

The audit of cash is a frequently examined area and time studying it is therefore well-spent. Questions set are usually practical questions similar to the one above, rather than theoretical ones and they are worth practising, particularly if you do not have day-to-day dealings with cash in your work. As a professional accountant, you are likely to have to deal with cash at some point during your career in any case and most accountants are from time to time asked to act as treasurers of clubs or societies!