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1. Fraud Risk Related to the Cash Cycle
1. Fraud Risk Related to the Cash Cycle
Cash is an area with high fraud risk, especially when internal control is weak. Lapping and kiting are two common cash fraud schemes.
1.1. Lapping
1.1. Lapping
The theft of cash is often concealed by failing to account for cash receipts. The most common of these methods is known as lapping. Lapping occurs when an employee withholds funds received by a customer for personal use and fails to apply these receipts of cash or checks to the customer's receivable balance. The unrecorded receipt is covered by applying a subsequent receipt to the previously unrecorded account.
1.2. Kiting
1.2. Kiting
Kiting occurs when a check drawn on one bank is deposited in another bank and no record is made of the disbursement in the balance of the first bank until after year-end. Kiting may be used to cover a cash shortage or to pad a company's cash position. Kiting results in an intentional overstatement of cash in the financial statements as the cash is simultaneously reflected in two different bank accounts.
2. Internal Controls Related to the Cash Cycle
2. Internal Controls Related to the Cash Cycle
Segregation of duties is a key control over cash. Proper segregation of duties demands that close consideration be given to check-writing authority. Separation of cash handling, record keeping, and reconciliation of bank statements should exist, as well as separation of petty cash activities. Good internal control for cash would also include the use of a voucher system for cash disbursements.
A sample bank confirmation. Image source: Becker 2023, p. A4-22.
3. Performing Specific Procedures to Obtain Evidence: The Cash Cycle
3. Performing Specific Procedures to Obtain Evidence: The Cash Cycle
3.1. Auditing the Cash Balance
3.1. Auditing the Cash Balance
Completeness, Valuation and Allocation, Existence: The primary audit procedures performed to test the completeness, valuation and allocation, and existence of the ending cash balance are the bank confirmation and the audit of the year-end bank reconciliation.
Bank Confirmation: The standard bank confirmation should be sent to all banks with which the client has done business during the year, regardless of whether there is a year-end balance to confirm. This is done because the bank confirmation, in addition to verifying year-end balances, also provides evidence about actual loans, contingent liabilities, discounted notes, pledged collateral, and guarantee or security agreements.
Bank Reconciliation: The year-end bank reconciliation for every account should be tested by:
Footing the bank reconciliation and the list of outstanding checks.
Agreeing the balance per the books on the year-end bank reconciliation to the general ledger.
Agreeing the balance per the bank on the year-end bank reconciliation to the balance per the bank confirmation.
Agreeing deposits in transit and outstanding checks to the cutoff bank statement. The cutoff bank statement is obtained by the auditor from the bank and covers the first 10 to 15 days of the period after year-end. Reconciling items should generally clear during the 10- to 15-day period. Any item that does not clear should be investigated by the auditor and resolved with the client if necessary.
3.2. Auditing Cash Receipts and Cash Disbursements
3.2. Auditing Cash Receipts and Cash Disbursements
🧮 Practice Problem: LO4-03, MCQ-02574
🧮 Practice Problem: LO4-03, MCQ-02574
On receiving a client's bank cutoff statement, an auditor most likely would trace:
Prior-year checks listed in the cutoff statement to the year-end outstanding checklist.
Deposits in transit listed in the cutoff statement to the year-end bank reconciliation.
Checks dated after year-end listed in the cutoff statement to the year-end outstanding checklist.
Deposits recorded in the cash receipts journal after year-end to the cutoff statement.
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