How to Audit Cash: Key Audit Procedures

Auditing a company’s cash is a foundational element of nearly every financial statement audit. Cash is the most liquid asset a company holds, meaning it can be readily used for any purpose. This liquidity also makes cash highly susceptible to theft and fraudulent activities. The primary purpose of a cash audit is to ensure the amount of cash reported on a company’s balance sheet is accurate. Auditors follow a structured process to verify these balances by understanding internal processes, testing systems, and gathering direct evidence.

Assessing Risks and Understanding Assertions for Cash

Before any testing begins, an auditor must first understand and assess the risks associated with a client’s cash. The most significant inherent risk is misappropriation, or theft, because cash is fungible and easily transferable. Another primary risk is misstatement, which can arise from errors in recording transactions or from intentional manipulation.

To structure their audit, auditors use a framework of management assertions, which are claims made by management about their financial statements. For cash, the existence assertion confirms that the cash balance shown on the books actually exists. The completeness assertion addresses the risk that all cash transactions that occurred during the period have been properly recorded.

The valuation assertion ensures that cash is recorded at its correct value, which is relevant for companies holding foreign currencies that must be translated into U.S. dollars at the proper exchange rate. The rights and obligations assertion verifies that the company has legal title to the cash it reports. The presentation assertion requires that cash is correctly classified on the balance sheet and any significant details are properly disclosed in the footnotes.

Testing Key Internal Controls Over Cash

After identifying risks, the auditor’s next step is to evaluate the company’s internal controls over cash. Strong internal controls reduce the likelihood of errors or fraud, and their effectiveness can influence the extent of the auditor’s subsequent testing. The focus is on the systems and procedures the company has in place to safeguard its cash.

A fundamental control is the segregation of duties. In a well-designed system, different individuals are responsible for handling cash receipts, authorizing payments, recording transactions, and reconciling bank accounts. An auditor will make inquiries of personnel and observe workflows to confirm that no single individual has control over a transaction from beginning to end.

Auditors also examine the company’s bank reconciliation process. A bank reconciliation is a comparison between the cash balance on the company’s books and the corresponding balance on its bank statement. The auditor inspects these reconciliations to ensure they are performed on a timely basis and looks for evidence of independent review, such as a manager’s signature.

Controls over cash receipts and disbursements are also tested. For disbursements, the auditor may inspect a sample of payments to ensure they were properly authorized according to company policy, such as requiring two signatures for checks over a certain amount. These tests provide evidence about the reliability of the client’s processes throughout the year.

Performing Substantive Audit Procedures

Once the auditor has assessed risks and tested internal controls, they perform substantive procedures to gather direct evidence about the cash balance at the end of the financial period. The most common substantive procedure is the bank confirmation. The auditor prepares a standard confirmation form and sends it directly to every bank the client does business with. This request asks the bank to independently verify the account balances held by the client and requests information about any loans or lines of credit.

Testing the client’s year-end bank reconciliation is another detailed procedure. The auditor obtains the reconciliation and agrees the “balance per bank” to both the bank statement and the bank confirmation. They then trace the “balance per books” to the company’s general ledger.

The most intensive part of this test involves examining the reconciling items, such as outstanding checks and deposits in transit. The auditor vouches these items to the subsequent month’s bank statement to confirm they cleared the bank in a reasonable amount of time, which verifies the proper cutoff of transactions.

To address the specific risk of kiting, auditors often prepare a bank transfer schedule. Kiting is a fraudulent act that involves transferring money from one bank to another and recording the receipt in the current period while recording the disbursement in the next. The schedule tracks all transfers between company bank accounts around the year-end date, allowing the auditor to verify that both sides of each transfer were recorded in the same accounting period. For companies that maintain a small amount of cash on hand, known as petty cash, the auditor may perform a surprise count to verify its existence.

Finalizing and Documenting the Cash Audit

The final phase of the cash audit involves aggregating the findings and preparing comprehensive documentation. The auditor reviews all misstatements discovered during testing, such as unrecorded bank service fees or checks that were voided but not written off. These findings are evaluated to determine if they are material, meaning significant enough to mislead a user of the financial statements, either on their own or when combined with other errors.

A final step is to review the financial statement presentation of cash. The auditor ensures that cash is properly classified as a current asset on the balance sheet. Based on evidence gathered from bank confirmations, they also verify that any necessary disclosures, such as cash amounts that are restricted for a specific purpose or pledged as collateral, are clearly described in the notes to the financial statements.

Thorough documentation, often referred to as workpapers, is prepared to record every step of the audit. These workpapers provide a clear trail of the procedures performed, the evidence obtained, and the conclusions reached by the audit team. They must contain sufficient detail to allow an experienced auditor with no prior connection to the engagement to understand the work that was done.