AUDIT OF CASH AND FINANCIAL INSTRUMENTS

Submitted to Fulfill The Tasks of Auditing 2

Lecturing Assosiated by :
Mr. Atta Putra Harjanto, S.E., M.Ak.

Arranged By Group 10:

1. Novemia Annisa Ramadhanti (7211420025)

2. Maskur Riyanto (7211420106)
3. Tarisa Regina Putri (7211420195)

ACCOUNTING DEPARTEMENT

FACULTY OF ECONOMY

UNIVERSITAS NEGERI SEMARANG

2022
 TABLE OF CONTENS

CHAPTER I : PRELIMINARY 3
A. Background 3
B. Formulation of The Problem 3
C. Objectives 3
CHAPTER II : THE DISCUSSION 4
A. Types of Cash Accounts and Financial Instruments 4
B. Cash in Bank and Transaction Cycle 5
C. Audit of The General Cash Account 6
D. Fraud-Oriented Procedures 10
E. Audit of Financial Instrument Accounts 11
CHAPTER III : CASE EXAMPLE 14
A. Cases of misstatements due to errors or fraud in the audit of cash and the procedures taken. 14
CHAPTER IV : CLOSING 16
A. Conclusion 16
REFERENCE 17

CHAPTER I : PRELIMINARY

A. Background
Cash is a general account that is always owned by the company, every payment and
 receipt transaction will be associated with this account. Cash has a variety of types, is
highly liquid,tend to be easily embezzled or stolen, and there may be material
misstatements that could affect the overall financial statement information.

Likewise with financial instruments, the types also vary, often the assessment of financial
instruments becomes complex. Because it has various accounting standards according to
its type.

So both need to be audited and the audit approach varies. To understand the types of cash
balances and financial instruments in the company, auditors need to first understand the
client's business and industry.

B. Formulation of The Problem

1. What types of cash and financial instruments?
2. How is the relationship between cash in the bank and the transaction cycle?
3. What are the stages of auditing the general cash account?
4. What are the procedures for disclosing fraud in cash?
5. What are the stages of auditing the financial instruments?

C. Objectives
The purpose of the establishment of this paper is to find out that cash is an account with
various types, prone to theft, and misstatement. Likewise, there are various financial
instruments and different accounting treatments. Therefore, a different audit treatment is
needed. As well as to know the various methods of auditing cash and financial
instruments.

CHAPTER II : THE DISCUSSION

A. Types of Cash Accounts and Financial Instruments

As an auditor, understanding the types of cash and financial instruments is necessary.
Because each type must have a different audit approach. To find out what the types are, it
is necessary to understand the client's business and industry.
 1. General cash account : almost all transactions of expenses and receipts use this
account. For example, such as payment of debt or income then use this account.
As for cash receipts, such as receiving payments from clients, it will be deposited
into the general cash account
2. Imprest Account : an account used to make a certain amount of cash available
for a limited purpose. In imprest account, the balance will be created with a fixed
amount. Authorized personnel can use the balance but must comply with
company regulations. When the balance on this imprest account runs out, a
request for replenishment will be made from the general account which is usually
done by online transfer.
3. Branch Bank Account: for companies that have subsidiaries/branches, and
operate in different locations, it will be easier to use a separate bank balance that
is adjusted to the location of the company's branch. For deposits and
disbursements through branch bank accounts if there is excess cash, it will be
transferred electronically and periodically to the main company's commercial
bank account.
4. Imprest Petty Cash Fund: funds created to finance unexpected expenses or
small company needs. for example, such as paying for office supplies (ATK),
stamps, gasoline, dishes for guests, charitable donations. The amount of the
balance formed and the time of replenishment will always be the same
5. Cash Equivalent: this cash is short term and highly liquid. Examples include
time deposits, certificates of deposit, money market funds. Usually companies
combine cash and cash equivalents accounts.
6. Financial Instruments: include investments in securities, debt securities (bonds)
and equity, derivative instruments. Financial instruments can also be grouped into
securities that are traded, available for sale or held to maturity. Companies can
buy securities if there is excess cash (temporary investment)

B. Cash in Bank and Transaction Cycle

The relationship between the two has an important role:

1. It is necessary to audit various transaction cycles in a cash audit

2. Help understand the integration of various transaction cycles

The amount of cash coming in and going out of a cash account is often greater than that of other
accounts. In addition, cash is more susceptible to being embezzled because cash is highly liquid
than other assets, which must be converted to cash in order to be used.

In a cash audit, the auditor must be able to distinguish between proving that the reconciliation
made on the client's bank balance with the balance in the general ledger is correct. As well as
checking the correctness of all transactions that occur related to cash, and ensuring that the
amount of cash recorded in the general ledger is correct. This reconciliation mentioned in SA 500
A57 about sources of audit evidence: some audit evidence is obtained by performing audit
procedures to test the accounting records...internally consistent and consistent with the financial
statements. In the initial section, namely the definition, explains what is meant by accounting
records, namely records of initial accounting entries and supporting records, including worksheets
and spreadsheets that support cost allocation, calculation, reconciliation, and disclosure.

The following is an example of the relationship between the transaction cycle and cash in the
bank:

Also there are list of misstatement that happen in reconciliation, where this misstatement can only
be detected by substantive test of transaction :

1. sales and collection cycle: failure to bill customers, withholding cash receipts before
they are recorded, by recording them as bad debts (cash embezzlement)
 2. payment cycle: improper payments in the form of personal expenses of employees,
payments for raw materials that are not received.
3. payroll cycle : Payments to employees for more hours worked than he/she
work on.
4. Fail to enter checks that have not been cleared by the bank on the list of outstanding
checks, even though they have been recorded in the cash disbursements journal.
5. Cash received by client recorded as cash receipt in the current year, but it actually cash
from date after balance sheet.
6. Payments of notes payable that are debited directly to the bank balance by the bank, but
have not been entered in the client's record.

C. Audit of The General Cash Account

● Identify Client Business risks affecting Cash (phase I)
In SA 315, Business risk is a risk as a result of conditions, events, circumstances, actions
or the absence of significant actions that can have a negative impact on the entity's
willingness to achieve its objectives and in carrying out its strategies or from setting goals
and strategies that are not appropriate.
Client business risk may arise from inappropriate cash management policies , and also
more likely to arise from cash equivalents and the types of investments. so. The auditor
should understand the risks from the client’s investment policies and strategies, as well as
management controls that mitigate these risks.
● Set performance Materiality and assess Inherent risk (phase I)
Because the cash transactions affecting the balance are almost always material.
Therefore, the potential often exists for material misstatement of cash. SA 320 (A10)
there is high inherent risk for the existence, completeness, and accuracy objectives. These
objectives are usually the focus in auditing cash balances and the auditor may conclude
that risks to these objectives are significant risks
● Assess Control risk (phase I)
Internal controls over year-end cash balances in the general account can be divided into
two categories:
1. Controls over the transaction cycles affecting the recording of cash receipts and
 disbursements
2. Independent bank reconciliations

A monthly bank reconciliation of the general bank account on a timely basis by someone
independent of the handling or recording of cash receipts and disbursements is an
essential control over the ending cash balance. The reconciliation ensures that the
accounting records reflect the same cash balance as the actual amount of cash in the bank
after considering reconciling items. More important, the independent reconciliation
provides an opportunity for an internal verification of cash receipts and disbursements
transactions

A careful bank reconciliation by competent client personnel includes the following

actions:
➔ Compare cancelled checks or electronic bank records of payment with the cash
disbursements records for date, payee, and amount
➔ Examine cancelled checks or electronic bank records of payment 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 book and bank balance and
verify their appropriateness for the client’s business
➔ Reconcile total debits on the bank statement with the totals in the cash disbursements
records
➔ Reconcile total credits on the bank statement with the totals in the cash receipts
records
➔ Review month-end interbank transfers for appropriateness and proper recording
➔ Follow up on outstanding checks and stop-payment notices

● Design and perform tests of Controls and Substantive tests of transactions (phase II)
Because the cash balance is affected by all other cycles except inventory and
 warehousing, an extremely large number of transactions affect cash.

● Design and perform Substantive analytical procedures (phase III)

In many audits, the year-end bank reconciliation is extensively audited. Using substantive
analytical procedures to test the reasonableness of the cash balance is therefore less
important than it is for most other audit areas. auditors normally compare the ending
balance in cash with previous months’ balances. These substantive analytical procedures
may uncover misstatements in cash. SA 520, A4-A5 about Substantive Analytical
Procedure.

● Design tests of Details of Cash Balance (phase III)

The starting point for the verification of the balance in the general bank account is to
obtain a bank reconciliation from the client for inclusion in the auditor’s documentation
To audit cash in the bank, the auditor verifies whether the bank reconciliation
received from the client is correct. The most important objectives are existence,
completeness, and accuracy. Therefore, they receive the greatest attention. In addition to
these balance-related objectives, the auditor also performs tests related to the four
presentation and disclosure objectives, uch as review of minutes and loan agreements to
determine if there are restrictions on cash that must be disclosed. As in all other audit
areas, the actual audit procedures depend on materiality and the risks in cash that the
auditor has identified in other parts of the audit.

The following three procedures merit additional discussion because of their importance
and complexity: receipt of a bank confirmation, receipt of a cutoff bank statement, and
tests of the bank reconciliation.SA 505
1. Receipt of a bank confirmation,
The importance of bank confirmations in the audit extends beyond the verification of the
actual cash balance. Typically, the bank confirms loan information and bank balances.
After auditors receive the completed bank confirmation, the balance in the bank account
confirmed by the bank should be traced to the amount stated on the bank reconciliation.
Similarly, all other information on the reconciliation should be traced to the relevant audit
 schedules.
2. Accessing Cutoff Bank activity after Year-end A cutoff bank statement is a partial-period
bank statement and the related copies of or digital access to cancelled checks, duplicate
deposit slips, and other documents included in bank statements, provided by the bank
directly to the CPA firm’s office or through online access to the bank’s electronic records
of the client’s bank account information.
The purpose of the cutoff bank statement or electronic access to account information on
the bank’s system is to verify the reconciling items on the client’s year-end bank
reconciliation with evidence that is maintained by the bank, not the client. To fulfill this
purpose, the auditor requests the client to have the bank provide directly to the auditor a
partialperiod statement, or digital access to the information, for 7 to 10 days subsequent
to the balance sheet date.
Alternatively, auditors can wait until the subsequent period bank statement is available to
verify reconciling items, if a cutoff statement is not received directly from the bank or
online access to client bank account information is not available to the auditor. The
purpose is to test whether the client’s employees have omitted, added, or altered any of
the documents accompanying the statement. Obviously, this tests for intentional
misstatements. The auditor performs the following verification in the month subsequent
to the balance sheet date:
• Foot the lists of all cancelled checks, debit memos, deposits, and credit memos
• Verify that the bank statement balances when the footed totals are used
• Review the items included in the footings to make sure that they were cancelled by the
bank in the proper period and do not include any erasures or alterations

3. Tests of the bank reconciliation.

Auditors test the bank reconciliation to determine whether client personnel have carefully
prepared the bank reconciliation and to verify whether the client’s recorded bank balance
is the same amount as the actual cash in the bank except for deposits in transit,
outstanding checks, and other reconciling items.
The auditor’s verification of the reconciliation involves several procedures:
● Verify that the client’s bank reconciliation is mathematically accurate.
 ● Trace the balance on the bank confirmation and/or the beginning balance shown in
online client banking records or in the cutoff statement to the balance per bank on
the bank reconciliation to ensure they are the same.
● Trace checks written and recorded before year-end and included with the cutoff bank
statement to the list of outstanding checks on the bank reconciliation and to the cash
disbursements journal in the period or periods prior to the balance sheet date.
● Investigate all significant checks included on the outstanding check list that have not
cleared the bank on the cutoff statement.
● Trace deposits in transit to the cutoff bank statement.
● Account for other reconciling items on the bank statement and bank reconciliation.

D. Fraud-Oriented Procedures
In designing procedures for uncovering fraud, auditors should carefully consider the
nature of the deficiencies in internal control, the type of fraud that is likely to result from
the deficiencies, the potential materiality of the fraud, and the audit procedures that are
most effective in uncovering the fraud.
Procedures that may uncover fraud in the cash receipts area include:
● Confirmation of accounts receivable
● Tests performed to detect lapping
● Review of the general ledger entries in the cash account for unusual items
 ● Comparison of customer orders to sales and subsequent cash receipts
● Examination of approvals and supporting documentation for bad debts and sales
returns and allowances
The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements (SA 240)
A18. SA 315 and SA 610, establishes requirements and provides guidance in audits of
those entities that have an internal audit function. In carrying out the requirement of those
SAs in the context of fraud, the auditor may inquire about specific internal audit activities
including, for example: The procedures performed, if any, by the internal auditors during
the year to detect fraud. Whether management has satisfactorily responded to any
findings resulting from those procedures.

❖ Extend Tests of The Bank Reconciliation

When the auditor believes that the year-end bank reconciliation may be intentionally
misstated, it is appropriate to perform extended tests of the year-end bank reconciliation.
The extended procedures verify whether all transactions included in the journals for the
last month of the year were correctly included in or excluded from the bank reconciliation
and verify whether all items in the bank reconciliation were correctly included.
Assume for a December 31st year-end:
1. Start with the bank reconciliation for November and compare all reconciling items
with the canceled checks and other documents in the December bank statement.
2. Compare all remaining canceled checks and deposit slips in the December bank
statement with the December cash disbursements receipt journals.
3. Trace all uncleared items in the November bank reconciliation and the December
cash disbursements and receipt journals to the client’s Decmber bank reconciliation.
4. Verify that all reconciling items in the December bank reconciliation represent items
from the November bank reconciliation and December’s journals that have not yet
cleared the bank.
In addition to these four tests, the auditor must carry out procedures subsequent to the end
of the year with the use of the bank cutoff statement.
❖ Proof of Cash
If the client has a material internal control weakness, the auditor may prepare a proof of
cash to determine the following:
● All recorded cash receipts were deposited
● All deposits in the bank were recorded in the accounting records
● All recorded cash disbursements were paid by the bank
● All amounts that were paid by the bank were recorded
A proof of cash includes the following four reconciliation tasks:
1. Reconcile the balance on the bank statement with the general ledger balance at the
beginning of the proof-of-cash period.
2. Reconcile cash receipts deposited per the bank with receipts recorded in the cash
receipts journal for a given period.
3. Reconcile electronic payments and cancelled checks clearing the bank with those
recorded in the cash disbursements journal for a given period.
4. Reconcile the balance on the bank statement with the general ledger balance at the
end of the proof-of-cash period.
A proof of cash of this nature is commonly called a four-column proof of cash that
contains one column for each of the four types of information listed above. A proof of
cash can be performed for one or more interim months, the entire year, or the last month
of the year.
 SA 240
A40. Examples of possible audit procedures to address the assessed risks of material
misstatement due to fraud, including those that illustrate the incorporation of an element
of unpredictability, are presented in Appendix 2.
● Performing procedures on account or other reconciliations prepared by the entity,
including considering reconciliations performed at interim periods.
❖ Tests of Interbank Transfers
Embezzlers occasionally cover a theft of cash by a practice known as kiting (this means
transferring money from one bank to another and incorrectly recording the transaction).
There are several things that should be audited on the interbank transfer schedule:
● The accuracy of the information on the interbank transfer schedule should be verified.
 ● The interbank transfers must be recorded in both receiving and disbursing banks.
● The date of recording of the disbursements and receipts for each transfer must be in
the same fiscal year.
● Disbursements on the interbank transfer schedule should be correctly included in or
excluded from year-end bank reconciliations as outstanding checks.
● Receipts on the interbank transfer schedule should be correctly included in or excluded
from year-end bank reconciliations as deposits in transit.

E. Audit of Financial Instrument Accounts

In testing the year-end balance of financial instruments, the auditor must accumulate
sufficient appropriate evidence to evaluate whether the financial instruments accounts, as
stated on the balance sheet, are fairly stated and properly disclosed in accordance with all
eight balance-related audit objectives:
● Existence
● Completeness
● Accuracy
● Classification
● Cutoff
● Detail tie-in
● Realizable value
● Rights
Methodology for auditing year-end financial instruments:
● Identify Client Business Risks Affecting Financial Instruments (Phase I)
Business risks associated with financial instruments will vary depending on the
significance and aggressiveness of a company’s investing activity. Risks will be
higher for companies investing in less liquid securities or derivative financial
instruments, and when investments represent a greater proportion of total assets.
● Set Performance Materiality and Assess Inherent Risk (Phase I)
The financial instruments account balances may be material depending on the type
and frequency of investment activity. Factors that impact inherent risk of financial
instruments include management’s objectives related to investment activity (e.g
 hedging to minimize risk), the complexity of the securities or derivatives, the
company’s prior experience with certain investments, and whether external factors
such as credit risk or interest risk impact the relevant assertions. Many of these risks
related to the audit objectives.
● Assess Control Risk (Phase I)
Auditor needs to understand design and operating effectiveness of internal controls.
There are 4 things management needs to have to assess control risk:
1. An investment strategy and an awareness of the level of exposure to various risks
2. Procedures in place to properly classify financial instruments as trading,
available-for-sale, or held-to-maturity based on intent
3. Procedures in place to initiate and record transactions
4. Strong internal controls over determining fair value estimates.

● Design and Perform Tests of Controls and Substantive Tests of Transactions (Phase
II)
Tests of transactions to be performed related to financial instruments include tests of
purchases and sales of securities and derivatives or settling of hedging transactions,
associated gains or losses, and interest and dividend income.

● Design and Perform Substantive Analytical Procedures (Phase II)

Substantive analytical procedures are typically not as important in assessing the year-
end balance for financial instruments. However, substantive analytical procedures
may be used to test the reasonableness of interest and dividend income.

● Design Tests of Details of Financial Instruments Balances (Phase III)

The starting point for testing the ending balance of financial instrument accounts is to
obtain a schedule of investment activity for the year. The most important objectives
are existence, accuracy, and realizable value for investments in securities, while
completeness is also important for derivative financial instruments.
 CHAPTER III : CASE EXAMPLE

A. Cases of misstatements due to errors or fraud in the audit of cash and the procedures
taken.
This case is taken from Arens book.
1. The auditor suspects that there is a lapping scheme because the accounting
department employees who have access to cash receipts also handle the accounts
 receivable ledger and refuse to take vacation or sick leave.

Procedure: compare the details of the cash receipts journal entry with the details
of the corresponding daily deposit slips.

2. The entity's cash receipts in the first few days of the following year are properly
deposited in the general operating account after the end of the year. However, the
auditor suspects that the entity recorded the cash receipts on its books during the
last week of the audit year.

Procedure: compare the details of the cash receipts journal entry with the details
of the corresponding daily deposit slips.

3. The auditor noticed a significant increase in the number of times petty cash was
replenished during the year and suspected that the custodian had stolen the money
from the petty cash fund.
Procedure: Check invoices, receipts, and other documentation supporting petty
cash replenishment.

4. During testing the payroll bank account reconciliation, the auditor noticed that
one employee's checks were significantly larger than other payroll checks.
Procedure: Matches gross amount on payroll with agreed hours and rate of pay.

5. The auditor suspects that the controller wrote several checks and recorded cash
disbursements just before the end of the year but did not send the checks until
after the first week of the following year.
Procedure: Obtain bank cutoff reports and compare cleared checks with year-end
reconciliations.
 CHAPTER IV : CLOSING

A. Conclusion
Although in most audits, cash is immaterial, all transactions that affect cash are almost
always material. Thus, an audit must be carried out in order to detect any misstatements
that might be the level of misstatement that could affect all the information in the
financial statements. The audit must be able to ensure that cash is in accordance with five
of the eight balance-related audit objectives (existence, completeness, accuracy, cutoff,
and tie-in details). (internal control risk). This cash audit also helps find misstatements
due to fraud or error, this is because cash is a very liquid asset and is easily embezzled or
stolen. Likewise with financial instruments that have various types and have different
accounting treatment for each type, it is necessary to audit financial instruments by
ensuring that all accounts of financial instruments on the balance sheet are reasonable and
in accordance with the eight audit objectives related to balances.
 REFERENCE

Arens, A. A, Elder, R. J.,Beasley, M. S., & Hogan, C. E. 2014. Auditing and Assurance
Services. United States: Pearson Education, Inc.