Auditing Special Purpose Frameworks: Auditing Cash Classifications—Part 2

Read more from Larry Perry here and in the Today's World of Audits archive.

In my last article, I outlined the basic accounting standards for cash with reference to requirements from U.S. GAAP. For most special purpose frameworks, particularly the AICPA's Financial Reporting Framework for Small- and Medium-Sized Entities, there are no significant differences from U.S. GAAP for cash and cash equivalents.

Below are some common substantive tests-of-balances procedures for cash.

Analytical Procedures

Analytical procedures may consist of absolute comparisons of dollar balances with prior years' account balances, or with budgets, ratio comparisons and trend analysis; and computations based on financial or operational data designed to predict the balance in a general ledger account. Analytical procedures also extend beyond numerically based procedures to become a part of an auditor's thought process.

Challenging financial information or the lack of such information that appears unusual; maintaining a positive, healthy skepticism when considering client responses to inquiries; and searching for the cause of a problem beyond its symptoms are examples of analytical thinking. The term "professional skepticism" is used in the clarified auditing standards to describe this kind of thinking. It is loosely defined as neither blindly trusting every client or, on the other hand, considering each client dishonest as an auditor gathers information.

For all levels of risk of material misstatement, some specific analytical procedures normally performed for cash would include:

  • Compare account balances with the preceding year or years. Investigate significant changes in amounts or deviations from trends.
  • Investigate accounts opened or closed during the year.
  • Investigate credit balances to determine if they represent actual bank overdrafts.
  • Compute quick current ratio (cash and net receivables to current liabilities) and compare among years.

Other Substantive Tests of Balances Procedures for Cash

The nature, extent, and timing of detailed tests of balances procedures should be determined based on the assessed level of risk of material misstatement for each financial statement classification (assertion level). The assessed level of risk should be determined based on the documentation of the auditor's risk assessment procedures.

To illustrate the audit program modification process, following are suggested basic procedures for cash at three levels of risk of material misstatement (RMM):

High RMM:

  • Prove all major bank reconciliations at the engagement date.
  • Trace most bank statement reconciling items to cutoff statements.
  • Confirm all bank accounts or perform alternative procedures.
  • Perform a search for unrecorded bank transfers for a significant period before and after the yearend.

Slightly less than high RMM:

  • Prove all major bank reconciliations at the engagement date.
  • Trace large and/or unusual reconciling items to cutoff statements.
  • Confirm all bank accounts or perform alternative procedures.
  • Perform a search for unrecorded bank transfers for a lesser period before and after the yearend.

Moderate to low RMM:

  • Prove only major bank reconciliations at the engagement date (moderate RMM) or read bank reconciliations for reasonableness (low RMM).
  • Inquire about large and/or unusual reconciling items (low RMM) and consider tracing to subsequent month's bank statement (moderate RMM).
  • A cutoff statement may not be requested and the client's copy of a subsequent month's bank statement may be used (normally when RMM is low).
  • Confirm all bank accounts or perform alternative procedures.
  • Inquire about bank transfers, scan disbursement and receipts records and bank reconciliations, and obtain support for any material bank transfers.

The inherent risk of misappropriation of cash may raise the risk of fraud occurring and going undetected. High levels of professional skepticism should be used when performing cash audit procedures. High levels of professional skepticism include:

  • Making inquiries for all unusual matters. Even a small variance in expectations revealed in analytical procedures or a small unidentified entry in bad debt expense (or other accounts), for example, could lead to a material error or fraud.
  • Evaluating and clarifying management's responses to inquiries and communicating the responses to an engagement leader when such responses may indicate error or fraud—or when the staff assistant doesn't know if it indicates error or fraud!
  • Carefully evaluating client data and records for the possibility they could be erroneous or fraudulent.
  • Paying attention to discussions and activities of client personnel that may raise suspicion about error or fraud.

Web-based continuing education presentations for auditing cash and other financial statement classifications are available by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.

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