Auditing Cash and Cash Equivalents – Risk, Assertions, And Procedures

Overview:

Cash and Cash Equivalent is scoped under IAS 7, Statements of Cash Flows. In Cash and Cash Equivalents, there are two separate components. The first is cash which comprises cash on hand and at the bank.

The second is Cash Equivalents which are investments that are short-term, highly liquid, and are readily convertible to known amounts of cash which are subject to insignificant changes in value.

An example of Cash Equivalents is short-term bank deposits that are less than three months. Equity investments are generally excluded from Cash Equivalents unless they are Cash Equivalents in substance. An example would be an investment in preferred shares with a short maturity period and a specified redemption date.

Risks:

Before the auditors can decide what procedures to perform, the risks associated with auditing Cash and Cash Equivalents should first be identified:

  • Risk of Material Misstatement: The Risk of Material Misstatement when auditing Cash and Cash Equivalents is generally low as most cash or bank balances can be easily verified through a cash count procedure or by obtaining external bank balance confirmation from the bank. However, the risk is always higher when auditing Cash Equivalents as interpreting the terms of such investments often requires a lot of judgment.
  • Control Risk: The Control Risk related to Cash and Cash Equivalents is the absence of appropriate approval in the payment process, absence of appropriate process over the preparation of bank reconciliation, and investment being wrongly or not classified as Cash and Cash Equivalents.
  • Detection Risk: Detection Risk is the risk that an auditor is not able to detect the material misstatements in the reported amounts of Cash and Cash Equivalents and classification error in investment.
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The audit risk for Cash and Cash Equivalents is generally low aside from complex investments whereby the classification requires judgment.

Assertions:

For an auditor to be reasonably assured of the Cash and Cash Equivalent balances, tests will be performed to cover the audit assertions. The assertions applicable to Cash and Cash Equivalents are:

  • Completeness: All Cash and Cash Equivalents belong to the entity have been recorded and presented in the financial statements including those held by a third party.
  • Rights and Obligations (Ownership): The Cash and Cash Equivalents belong to the entity and there is no cash held on behalf of a third party in the entity’s Cash and Cash Equivalents without appropriate disclosures in the financial statements.
  • Valuation: Cash and Cash Equivalents will be remeasured only when the balance is originally in foreign currency and when there is a difference between the spot and foreign exchange rate at the end of the accounting period.
  • Existence: The reported Cash and Cash Equivalent balance exists at the reporting date either in the form of cash held physically or in the bank.
  • Presentation and Disclosure: The Cash and Cash Equivalent amount in the financial statements and relevant disclosure notes to the financial statement are complete and following the applicable accounting standards.

Procedures:

Audit Procedures for testing Cash and Cash Equivalents include Test of Controls and Substantive Tests. 

Test of Controls:

Controls that are relevant to Cash and Cash Equivalents include payment approval and recording process, classification of investment, bank reconciliation process, and segregation of duties.

  • Payment Approval and Recording Process: This control is to ensure all payments made by the entity are approved by the appropriate level of personnel depending on the payment amount involved and subsequently recorded correctly.
  • Classification of Investment: This control is to ensure that the entity has in place a process to interpret the terms of the investment and make a judgment on the classification of investment as to whether it belongs to Cash and Cash Equivalents.
  • Bank Reconciliation Process: This control is to reconcile the entity’s recorded cash balance to the bank statement and ensure all differences are solely due to timing differences.
  • Segregation of Duties: This control is crucial here as in any other processes. It effectively ensures the work of the original preparer has been scrutinized and approved which reduces the risk of any material error or fraud.
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Substantive Audit Procedures for Cash and Cash Equivalents:

Substantive Audit Procedures for Cash and Cash Equivalents consist of the following components:

1) Substantive Analytical Procedures:

Substantive Analytical Procedures analyze the changes or lack of changes in the entity’s financial’s performance. The changes or lack of changes must be benchmarked against a set expectation such as historical performance, latest business developments, and any other information relevant to the entity. This will allow the auditor to detect potential areas with a higher risk of material misstatements.

For example, a significant increase is noted in Cash and Cash Equivalents near the end of the accounting period. This substantial increase can be checked against the entity’s sales collection timing and sales performance near the end of the accounting period.

It could also indicate that the entity may have recorded some of its cash receipts from the next accounting period in the current one if the information obtained does not correlate with each other.

2) Test of Details for Cash and Cash Equivalents:

To test details for Cash and Cash Equivalents, audit procedures are designed around assertions. Example and description of test of details are given in the table below:

Audit AssertionExample of Audit Procedure
Completeness  Obtaining external bank confirmation and ensure that all the balances stated in the confirmation are recorded by the entity.
Rights and ObligationsReviewing agreement or relevant supporting documents in regards to certain cash held on behalf of third parties.
ValuationRecomputing the translation of foreign currency bank balance to local currency to ensure the revaluation is correct.   Reviewing bank reconciliation prepared by the entity to ensure reconciliation of the recorded bank balances to the bank statements is done correctly.
ExistenceInspecting bank statements, performing physical cash count, and obtaining bank confirmation to ensure the cash exists.
Presentation and DisclosureReviewing the financial statements prepared by the entity and identifying if information regarding Cash and Cash Equivalents has been sufficiently disclosed per the applicable accounting standard.
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