Auditing Problems Handout #02 (AP02) Cash and Cash Equivalents PDF

SCHOOL OF BUSINESS ADMINISTRATION AND ACCOUNTANCY General Luna Road, Baguio City Philippines 2600 Telefax No.: (074) 442-3071 Website: www.ubaguio.edu E-mail Address: [email protected]...

SCHOOL OF BUSINESS ADMINISTRATION AND ACCOUNTANCY General Luna Road, Baguio City Philippines 2600 Telefax No.: (074) 442-3071 Website: www.ubaguio.edu E-mail Address: [email protected] Auditing Problems Handout #02 (AP02) Cash and Cash Equivalents Quick Notes in Solving Problems  Cash – includes money or its equivalent that is readily available for unrestricted use. o Cash on hand – undeposited collections awaiting deposit and other current funds held as of the reporting date o Cash in bank – deposits in banks that are available for immediate withdrawal and unrestricted use o Items of cash (keyword is “unrestricted”):  Coins and currencies (undeposited cash collections: COH)  Bank drafts – guarantees by bank to advance funds on the demand by the party to whom the draft was directed; a written order addressed to the bank to pay an amount of money to the order of the maker (COH)  Money orders – similar to bank drafts but are drawn from post offices or other financial institutions; a demand credit instrument issued and payable by a post office (COH)  Checks – such as Cashier’s checks, Personal checks, Manager’s checks, Traveller’s checks, and Certified checks received from customers or other external parties (COH)  Demand deposits (checking or current accounts) and savings accounts (CIB)  Cash funds set aside for use in current operations, such as:  Petty cash fund  Payroll fund  Change fund  Dividend fund  Tax fund  Travel fund  Interest fund  Other types of imprest bank accounts used in current operations  Revolving fund – similar to petty cash fund but is used for a limited or specific purpose set by management  Unreleased or undelivered checks drawn1  Postdated check drawn1 - checks dated at a future date  Stale checks drawn1  Unrestricted deposits in foreign banks that are available for immediate withdrawal (measured at face amount translated to current exchange rate as of reporting date)  Compensating balances that are not legally restricted as to withdrawal (must be disclosed); if silent: not legally restricted  Treasury warrants - a warrant for the payment of money into or from public treasury AP02 – Cash and Cash Equivalents Page 1 of 9  o Items that are NOT cash:  Postdated checks received2 – checks dated at a future date (classified as receivables)  IOUs or advances to employees (classified as receivables)  Cash funds not available for use in current operations; general rule: NOT part of cash (classified as “other assets”)  Pension fund – if related liability is current, then pension fund is current AND PART OF CASH  Sinking fund – if related bonds payable is current, then sinking fund is current AND PART OF CASH  Preference share redemption fund – if mandatory redemption is already one year or less from the reporting period, current AND PART OF CASH  Plant expansion fund – always noncurrent even if expected to be disbursed next year  Depreciation fund  Contingency fund – noncurrent investment  Insurance fund – noncurrent investment  Postage stamps (classified as prepaid supplies)  Unused credit line3 (not included; disclosed)  Restricted deposits in foreign banks that are not available for immediate withdrawal (classified as receivables)  Compensating balances that are legally restricted as to withdrawal (must be disclosed and presented as “cash held as compensating balance” as current (short-term loan) or noncurrent (long-term loan))  Deposits in escrow – restricted amount held in trust for another party, e.g., a deposit required by a court of law for a pending case (part of other current/noncurrent asset AND reported as liability)  NSF/DAUD/DAIF checks received – included as part of receivables  Certificate of deposit – a savings certificate entitling the bearer to receive interest (classified as investment, unless invested within three months before maturity)  Cash equivalents – “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.” o Only debt instruments acquired within 3 months or less before their maturity date o Items of cash equivalents4:  Treasury bills, notes, or bonds acquired 3 months or less before maturity date  T-bills: 90d – 1y; if silent: cash equivalent  T-notes: 1y - 10y; if silent: investment  T-bonds: >10y; if silent: investment  Money market instrument or commercial paper acquired 3 months or less before maturity date; if silent: cash equivalent  Time deposit (3 months); if silent: cash and cash equivalent  Redeemable preference shares acquired 3 months or less before specified redemption date o Items that are NOT cash equivalents:  Debt instruments originally invested/acquired for more than three months before maturity date (classified as investments)  Checks and bank drafts (cash, NOT cash equivalents)  Equity securities (investments in stocks) AP02 – Cash and Cash Equivalents Page 2 of 9   Bank overdraft – a negative (credit) balance in the cash in bank account resulting from overpayment of checks in excess of the amount of deposit. o General rule: presented as part of “current liabilities”; exceptions:  Offset if two or more accounts are maintained in the same bank AND the other bank account is unrestricted  Offset if the overdraft is part of cash management (like in a zero-balancing checking account)  Measurement o Cash – measured at face value o Cash in foreign currency - Should be translated to Philippine Peso using the closing rate or spot rate at the reporting date o Cash in closed banks/Banks in bankruptcy - Measured at estimated realizable value and to be included among noncurrent assets if the amount recoverable is lower than face value  Accounting for cash shortages and overages o Shortage – debit “Cash Short or Over” suspense account (just like “loss”); afterwards, close to “Receivable” if due to the fault of an employee, or “Loss” if investigation is without merit o Overage – credit “Cash Short or Over” suspense account (just like “gain”); afterwards, close to “Payable” if due to cash belonging to an employee, or “Loss” if investigation is without merit  Petty Cash Fund o Journal Entries Imprest Fund System Fluctuating Fund System a. To establish the fund Petty cash fund XX Petty cash fund XX Cash in bank XX Cash in bank XX b. Payment of expenses/disbursements out of PCF Memo entry in the petty cash Expenses XX journal Petty cash fund XX c. Replenishment of petty cash payments Expenses XX Petty cash fund XX Cash in bank XX Cash in bank XX d. To adjust the unreplenished expenses Expenses XX No adjusting entry Petty cash fund XX e. Increase in the fund Petty cash fund XX Petty cash fund XX Cash in bank XX Cash in bank XX f. Decrease in the fund Cash in bank XX Cash in bank XX Petty cash fund XX Petty cash fund XX  Accounting for Petty Cash Items o Computation of petty cash shortage or overage Petty cash as accounted for XX Less: Petty cash accountabilities (XX) Overage (Shortage) XX AP02 – Cash and Cash Equivalents Page 3 of 9  o Computation of petty cash as accounted for Coins and currencies XX Unexpended employees’ contributions[a] XX Cash collections of accounts receivable or sales XX Unclaimed salary XX Checks for deposit[b] XX Stale checks XX Post-dated checks[c] XX Unreplenished vouchers[d] XX Petty cash as accounted for XX Notes: a. Examples are contributions for Christmas party, birthday party, etc. b. Examples of checks: - Employees’ checks (good, NSF, or post-dated) in settlement of cash advanced from the petty cash fund (these are accommodated checks or checks cashed out from the fund and are not treated as accountabilities) - Check of the company as a replenishment of petty cash fund - Check of the company payable to the petty cash custodian representing his/her salary c. Post-dated checks are checks that are dated after reporting date AND cash count date d. Unreplenished vouchers are expenses, IOUs that are taken from the petty cash fund o Computation of petty cash accountabilities Petty cash ledger balance XX Petty cash impurities[a] Unexpended employees’ contributions XX Cash collections of accounts receivable or sales XX Unclaimed salary XX Stale checks XX Company’s check in payment of liability [b] XX Petty cash accountabilities XX Notes: a. Petty cash impurities are items which do not belong to the fund but for one reason or another are nevertheless fount in the petty cash box (checks issued in settlement of cash advanced from the PCF are excluded in computing for accountabilities) b. Examples are for the payment of utilities; include in accountabilities if among the checks for deposits o Computation of adjusted petty cash fund balance Coins and currencies XX Add: Expenses paid out of the PCF after reporting date XX Check of the company in the name of the PC Custodian as a Replenishment check of the petty cash fund; or XX Salary of the PC Custodian XX Adjusted PCF balance XX AP02 – Cash and Cash Equivalents Page 4 of 9   Bank reconciliation o Pro forma bank reconciliation statement Books Bank Balance per books, end. XX Balance per bank statement, end. XX Add: Credit memos (CM) XX Add: Deposits in transit (DIT) XX Less: Debit memos (DM) (XX) Less: Outstanding Checks (OC) (XX) Add/Less: Book errors XX Add/Less: Bank errors XX Adjusted balance XX Adjusted balance XX o Book reconciling items:  Balance per books, end. – unadjusted cash balance in the accounting records at the end of the current month  Credit memos – additions (bank credits) made by the bank to the depositor’s bank account but not yet recorded by the depositor; items of credit memos:  Collections made by bank on behalf of depositor  Interest income earned by the deposit  Proceeds from loan directly credited or added by bank to depositor’s account  Unrolled-over matured time deposits transferred by the bank to the entity’s account  Debit memos – deductions (bank debits) made by the bank to the depositor’s bank account but not yet recorded by the depositor; items of debit memos:  Bank service charges  NSF/DAIF checks  Auto-debits  Payment of loans  Book errors – errors committed by the depositor o Bank reconciling items:  Balance per banks, end. – the ending cash balance in the bank statement of the current month  Deposits in transit – deposits made but not yet credited by the bank to the depositor’s bank account  Outstanding checks – checks drawn and released to payees but are not yet encashed with the bank  NOT OCs: o Certified checks o Stale checks  Bank errors – errors committed by the bank o Errors Effect of the errors Treatment Understatement of cash receipts Add on the unadjusted cash balance Overstatement of cash receipts Deduct from the unadjusted cash balance Understatement of cash Deduct from the unadjusted cash disbursements balance Overstatement of cash Add on the unadjusted cash disbursements balance AP02 – Cash and Cash Equivalents Page 5 of 9  o Computation of deposits in transit Deposits in transit, beginning XX Add: Deposits made by the company this month XX Total deposits to be acknowledge by the bank XX Less: Deposits acknowledged by the bank this month (XX) Deposits in transit, end XX Deposits in transit DIT, beg. bal. XX Deposits made during current Deposits credited by bank month: during current month: Total Debits per Total Credits per books XX XX bank statement Less: CM last Less: CM current month (XX) (XX) month Less: Effect of Less: Effect of book error bank error last last month (XX) (XX) month Add/Less: Effect Add/Less: Effect of of book error bank error current month XX XX XX XX current month XX DIT, end. bal. o Computation of outstanding checks Outstanding checks, beginning XX Add: Checks issued by the company this month XX Total checks to be paid by the bank XX Less: Checks paid by the bank this month (XX) Outstanding checks, end XX Outstanding checks XX OC, beg. bal. Checks encashed by bank during Checks drawn during current current month: month: Total Debits per Total Credits per bank statement XX XX books Less: DM current Less: DM last month (XX) (XX) month Less: Effect of Less: Effect of bank error book error last last month (XX) (XX) month Add/Less: Effect Add/Less: Effect of bank error of book error current month XX XX XX XX current month OC, end. bal. XX AP02 – Cash and Cash Equivalents Page 6 of 9   Proof of cash o Summary of treatment of proof of cash items Beg. End. Adjusted Balance Method Rec. Disb. Bal. Bal. Books Cash in bank per books XX XX XX XX Credit Memo – last month XX (XX) Credit Memo – this month XX XX Debit Memo – last month (XX) (XX) Debit Memo – this month XX (XX) Adjusted balance XX XX XX XX Bank Cash in bank per bank XX XX XX XX DIT – last month XX (XX) DIT – this month XX XX OC – last month (XX) (XX) OC – this month XX (XX) Adjusted balance XX XX XX XX o Errors (both books and bank) Beg. End. Errors Rec. Disb. Bal. Bal. Errors last month corrected this month Overstatement of CR (XX) (XX) Understatement of CR XX (XX) Overstatement of CD XX (XX) Understatement of CD (XX) (XX) Errors last month not yet corrected this month Overstatement of CR (XX) (XX) Understatement of CR XX XX Overstatement of CD XX XX Understatement of CD (XX) (XX) Errors this month not yet corrected Overstatement of CR (net amount) (XX) (XX) Understatement of CR (net amount) XX XX Overstatement of CD (net amount) (XX) XX Understatement of CD (net amount) XX (XX) o NSF Checks Beg. End. NSF Checks Rec. Disb. Bal. Bal. Books NSF last month (XX) (XX) NSF this month XX (XX) NSF recorded as reduction of CR, returned last month, recorded this month (XX) XX NSF recorded as reduction of CR, returned this month, also recorded this month XX XX Bank NSF returned this month and redeposited also this month (no entry was recorded in the books both on the return and redeposit (XX) (XX) AP02 – Cash and Cash Equivalents Page 7 of 9 Quick Notes Related to the Audit of Cash Internal Controls Over Cash: 1. Segregation of incompatible duties (CARE) a. Custody – treasurer b. Authorization – manager c. Recording – accountant d. Execution – purchasing department 2. Imprest system 3. Bank reconciliation 4. Cash counts 5. Minimum cash balance 6. Lockbox accounts 7. Non-encashment of personal checks from petty cash fund 8. Voucher system Audit Objectives: To determine that: 1. Cash balances at the end of the reporting period represent cash and cash items on hand, in transit to, or in depository banks. 2. Cash transactions have been properly recorded. 3. Cash balances are properly described and classified, and adequate disclosures with respect to amounts restricted as to withdrawal are made in the financial statements. Audit Procedures: 1. Conduct a cash count of undeposited collections, petty cash, and other funds.  Obtain custodian’s signature to acknowledge return of items counted.  Reconcile items counted with general ledger balances.  Trace undeposited collections counted to bank reconciliation.  Follow up dispositions of items in cash counted: o Undeposited collections should be traced to bank deposits. o Checks accommodated in petty cash should be deposited after the count to establish their validity. o IOUs in the petty cash should be confirmed and traced to collections in the next payroll period. o Expense vouchers should be traced to the succeeding replenishment voucher.  Coordinate cash count with count of marketable securities and other negotiable assets of the client.  Obtain confirmation of year-end fund balances of cash not counted in branches or other offices. 2. Confirm bank balance by direct correspondence with all banks in which the client has had deposits and loans during the year. 3. Obtain bank reconciliation.  Check arithmetical accuracy of reconciliation.  Trace balance per book to the general ledger balance of cash account.  Trace balance per bank to bank statement and compare with amount confirmed by bank.  Establish authenticity of reconciling items by reference to their respective sources, like: o Bank debit or credit advices. o Duly approved journal vouchers.  Investigate checks outstanding for a long period of time. o Consider adjustment, especially if the check is already stale. o Consider the possibility of an erroneous preparation of the check.  Investigate any unusual reconciling items. AP02 – Cash and Cash Equivalents Page 8 of 9   Where internal control over cash is weak, consider preparing a proof of cash reconciliation. 4. Obtain cutoff bank statement showing the client’s transactions with the bank at least one week after the reporting date, and:  Trace year-end reconciling items, like: o Deposit of the year-end undeposited collections. o Completeness of year-end outstanding checks. o Corrections of bank errors.  Examine supporting documents of year-end outstanding checks that did not clear in the cutoff bank statement. 5. Obtain a list of interbank transfers of funds a few days before and after the reporting date.  Vouch supporting documents.  Ascertain that the related receipts and disbursements were booked by the client within the same day or at least within the same month. 6. Test reasonableness of cutoff by:  Comparing dates of checks returned with cutoff bank statement to dates of recording in the cash disbursements register.  Tracing receipts recorded a few days before the reporting date to bank deposits. 7. Inspect savings account passbook and certificates of deposits.  Reconcile with book balances.  Update interest earned posting on passbooks, if necessary.  Compare balances with bank confirmation reply. 8. Determine any restrictions on availability of cash. 9. Determine propriety of financial statement presentation and adequacy of disclosures. --- End of handout --- Prepared by: Franklin Jan L. Wayang, CPA AP02 – Cash and Cash Equivalents Page 9 of 9