Chapter 1 Audit of Cash and Cash Equivalents PDF

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Chapter 1 Audit of Cash Cash Equivalents AUDIT PROGRAM FOR CASH 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...

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Chapter 1 Audit of Cash & Cash Equivalents AUDIT PROGRAM FOR CASH

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 disclosure with respect to amounts restricted as to withdrawal are made in the financial statements.

Page 2 Audit Procedures: 

Conduct a cash count of undeposited collections, petty cash and other funds.

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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:  Undeposited collections should be traced to bank deposits  Checks accommodated in petty cash should be deposited after the count to establish their validity.  IOUs in the petty cash should be confirmed and traced to collections in the next payroll period.  Expense vouchers should be traced to the succeeding replenishment voucher.

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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.

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Confirm bank balance by direct correspondence with all banks in which the client has had deposits and loans during the year.

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Obtain or prepare 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:  Bank debit or credit advices.  Duly approved journal vouchers.

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Investigate checks outstanding for a long period of time. Page 3  Consider adjustment, especially if the check is already stale.  Consider the possibility of an erroneous preparation of the check.  Investigate any unusual reconciling items.  Where internal control over cash is weak, consider preparing a proof of cash reconciliation. 4. Obtain cutoff bank statement showing the client’s transactions within the bank at least one week after the reporting date, and:  Trace year-end reconciling items, like:  Deposit of the year-end undeposited collections.  Completeness of year-end outstanding checks.  Correction of bank errors.  Examine supporting documents of year-end outstanding checks that did not clear in the cutoff 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 the cutoff bank statement to dates of recording in the cash disbursements register.  Tracing receipts recorded to a few days before reporting date to bank deposits. 7. Inspect savings account passbook and certificates of deposit  Reconcile with book balances. Page 4  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.

Problem 1-1

Cash and Cash Equivalents In connection with your audit of the financial statements of ONOR COMPANY for the year ended December 31, 2010, you gathered the following information. 1. The company maintains its current account with the Tsunami Bank. The bank statement on December 31, 2010 showed a balance of P638,340. Your audit of the company’s account with Tsunami Bank disclosed the following:  A check for P22,500 received from a customer whose account is current had been deposited and then returned by the bank on December 28, 2010. No entry was made for the return of this check. The customer replaced the check on January 15, 2011.  A check for P5,720 was cleared by the bank as P7,520. The bank made the correction on January 2, 2011.  A check for P3,500 representing payment of an employee advance was received and deposited on December 27, 2010, but was not recorded until January 3, 2011. Page 5  Post dated checks totaling P67,300 were included in the deposits in transit. These represent collections of current accounts receivable from customers. The checks were actually deposited on January 5, 2011.  Various debit memos for drafts purchased for payment of importation of equipment totaling P230,000 were not yet recorded. These purchases were previously set up as accounts payable. Said equipment arrived in December 2010.  Interest earned on the bank balances for the 4th quarter of 2010, amounting to P1,950 was not recorded.  Bank service charges totaling P1,260 were not recorded.  Deposit in transit and outstanding checks at December 31, 2010 totaled P136,250 and P276,380, respectively.

2. Various expenses from the company’s imprest petty cash fund dated December 2010 totaled P16,250, while those dated January 2011 amounted to P5,903. Another disbursement from the fund dated December 2010 was a cash advance to an employee amounting to P3,500. A replenishment of the petty cash fund was made on January 8, 2011. 3. The company’s trial balance on December 31, 2010 includes the following accounts: Cash in bank – Tsunami Bank

P 748,320

Cash in bank – Earthquake Bank (restricted account for plant expansion, expected to be disbursed in 2011) 700,000 Petty cash fund

30,000

Time deposit, placed December 20, 2010 and due March 20, 2011 1,000,000 Money market placement – Prudential Bank

4,000,000

1. What is the adjusted Petty cash fund balance on December 31, 2010? A. P4,347 C.P30,000 B. P10,250 D.P24,097 2. The petty cash shortage on December 31, 2010 is A. P 0 C. P3,500 B. P5903 D. P4,347 3. What is the adjusted Cash in bank – Tsunami Bank balance on December 31, 2010? A. P 500,010 C. P432,710 B. P748,320 D. P429,110 4. The entry to adjust the Cash in bank – Tsunami Bank account should include a debit to A. Accounts receivable for P89,800. B. Accounts receivable for P86,300. C. Accounts payable for P228,200. D. Interest expense for P1,950.

5. The December 31, 2010 statement of financial position should show “Cash and cash equivalents “ at A. P6,142,970 C. P4,442,960 B. P5,439,360 D. P5,442,960 Solution 1-1 1. Petty cash fund per trial balance Various expenses dated December 2010 Employee cash advance Adjusted petty cash fund balance

P30,000 (16,250) (3,500) P10,250

Answer: B 2. The petty cash shortage cannot be determined because of insufficient information. Answer: A Page 7 3.

Book P748,320 (22,500)

Unadjusted balances NSF check Bank error (P7,520 – P5,720) Unrecorded Cash receipt 3,500 Post dated checks (67,300) Deposits in transit (P136,250 – P67,300) Bank debit memos (230,000) Interest earned 1,950 Bank service charges (1,260) Outstanding checks Adjusted balances P432,710 Answer: C 4. Accounts receivable (P22,500 + P67,300) 89,800 Accounts payable 230,000 Bank service charges 1,260 Cash in bank – Tsunami Bank Advances to employees Interest income

Bank P638,340 1,800

68,950

(276,380) P432,710

315,610 3,500 1,950

Answer: A Cash in bank – Tsunami Bank Petty cash fund Time deposit Money market placement Cash and cash equivalents

P432,710 10,250 1,000,000 4,000,000 P5,442,960

Answer: D Page 8 Problem 1-2 Computation of Correct Cash Balance The following are the cash balances of LEONOR, INC. at December 31, 2010: Undeposited collections (in currency and coins)P40,200 Current account – unrestricted 620,000 Disbursement checks written and recorded in December 2010 but are to be released to the Payees in January 2011 130,000 Restricted time deposits (expected use in June 2011) 2,000,000 Leonor, Inc. has agreed to maintain a P200,000 compensating balance in its unrestricted current account in accordance with the loan covenant.

How much should Leonor, Inc. report as ash on its December 31, 2010, statement of financial position? A. P590,200 B. P2,790,200 Solution 1-2

C. P790,200 D. P750,000

Undeposited collections

P40,200

Current account – unrestricted

620,000

Unreleased/Undelivered checks

130,000

Total

P790,200

Answer: C 1. The P200,000 compensating balance should be reported as part of cash because it is not legally restricted as to withdrawal. Page 9 2. The time deposits should be reported separately as shortterm financial assets or temporary investments in the company’s statement of financial position because the term is more than three months but within one year. Problem 1-3 Cash and Cash Equivalents The accountant of SANTIAGO COMPANY is in the process of preparing the company’s financial statements for the year ended December 31, 2010. He is trying to determine the correct balance of cash and cash equivalents to be reported as a current asset on the statement of financial position. The following items are being considered: 

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Balances in the company’s accounts at the Metropolitan Bank:  Current account P81,000  Savings account P132,600 Undeposited customer checks of P22,200 (including a customer check dated January 2, 2011 or P3,000). Currency and coins on hand of P3,480 Savings account at the Northern Philippines Bank with a balance of P2,400,000. This account is being used to accumulate cash for future plant expansion (in 2011).

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Petty cash of P4,000 (currency of P1,200 and unreplenished vouches for P2,800).  P120,000 in a current account at the Northern Philippines Bank. This represents a 20% compensating balance for P600,000 loan with the bank. Santiago company is legally restricted to withdraw the funds until the loan is due in 2013.  Treasury bills: Two-month maturity bills P90,000 Seven-month bills 120,000  Time Deposit P100,000 Page 10 What is the correct balance of cash and cash equivalents to be reported in the current assets section of the statement of financial position? A. P547,480 C. P430,280 B. P427,480 D. P327,480 Solution 1-3 Savings and current accounts – Metropolitan Bank (P132,600 + 81,000) P213,600 Undeposited customer checks (P22,000 – P3000)

19,200

Currency and coins on hand

3,480

Petty Cash

1,200

Two-month treasury bills Time deposit

Total cash and cash equivalents

90,000 100,000*

P427,480

*It is assumed that the term is three months or less and therefore qualifies as a cash equivalent. Answer: B

The following items are not included in the computation above: 1. P3,000 postdated customer check. 2. P2,400,000 cash balance at Northern Philippines Bank which represents a compensating balance that is restricted as to withdrawal. 3. P120,000 in a checking account at Northern Philippines Bank which represents a compensating balance that is restricted as to withdrawal. 4. 7-month treasury bills totaling P120,000.  Under PAS I: Presentation of Financial Statements, current assets include cash or cash equivalents unless they are restricted from being exchanged or used to settle a liability for at least 12 months after the reporting date. Page 11 

As stated in PAS 7, cash equivalents are 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. These normally include short-term investments with maturities of three months or less from the date of acquisition.

Problem 1-4

Identifying Cash Items Which of the following items should be included in the cash balance at December 31, 2010?

I.

– A check payable to the company, dated January 3, 2011 in payment of a sale made in December 2010. II. – A check payable to a vendor, dated and recorded in the company’s books on December 31, 2010, but not released until January 4, 2011. A. I only C. Both I and II B. II only D. Neither I nor II

1-4 

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The check payable to the company (I) is a postdated check, i.e., dated after the end of the reporting period. The amount should be shown as a receivable on the December 31, 2010 statement of financial position. The disbursement check (II) was not released until after the end of the reporting period. The amount should be included in the cash balance at December 31, 2010. Answer: B Page 12

Problem 1-5

Cash and Cash equivalents on the Statement of Financial Position Your audit of the December 31, 2010, financial statements of DIONISIO CORP. reveals the following: Current account at Prime Bank

P

Current account at Prudent Bank

(30,000) 135,000

Treasury bills (acquired 3 months before maturity) 300,000 Treasury bills (maturity date is Dec. 31, 2011)

1,500,000

Payroll account 390,000 Foreign bank account – restricted (translated using the December 31, 2010, exchange rate) 2,000,000 Postage stamps

1,250

Employee’s postdated check

4,500

IOU from the vice-president

8,000

Credit memo from a supplier for a purchase return

8,100

Traveler’s check

21,000

Money order

12,900

Petty cash fund (3,000 in currency and expense receipts for P12,000) 15,000

What amount would be reported as “cash and cash equivalents” on the statement of financial position on December 31, 2010? A. P840,050 B. P873,900

C.P849,400 D.P861,900

Solution 1-5 Current account at Prudent Bank

P135,000

Treasury bills (acquired 3months before maturity)

300,000

Payroll account

390,000

Traveler’s check

21,000 Page 13

Money order Petty cash fund Total cash and cash equivalents

12,900 3,000 P861,900

Answer: D

Problem 1-6

Compensating Balance VICTORIA, INC. needs P2,000,000 to finance its expansion program. Victoria, Inc. is negotiating a loan with Metropolis Bank which

requires company to maintain a compensating balance of 10% of the loan principal on deposit in a current account at the bank. Victoria, Inc. currently maintains a balance of P20,000 in its current account. The current account earns interest of 2% per annum; the interest rate on the loan is 12% per annum. 1. What is the principal amount of the loan? A. P2,200,000 C. P1,980,000 B. P2,000,000 D. P2,220,000 2. What is the effective interest rate on the loan? A. 13.2% C. 13% B. 11.8% D. 12%

Solution 1-6 1. (X= Principal amount of the loan) 10%X = P20,000 + (X – P2,000,000) 10%X = P20,000 +X – P2,000,000 10%X-X = -P1,980,000 90%X = P1,980,000 X = P1,980,000÷90% X = P2,200,000 Answer: A

Page 14 2. Annual interest payment (P2,200,000 x 12%) P264,000 Interest income on the loan proceeds in the compensating balance (P200,000 x %) 4,000 Effective interest P 260,000 Divide by loan proceeds ÷ P 2,000,000

Effective interest rate

13%

Answer: C Problem 1-7

Compilation of Correct Cash Balance The Cash account of the BEA CORPORATION as of December 31, 2010 was composed of the following:

On deposit in current account with the Bank of PI Cash collection not yet deposited to the bank

P900,000 350,000

A customer’s check returned by the bank for Insufficient fund

150,000

A check drawn by the Vice-President of the Company dated January 15, 2011

70,000

A check drawn by a supplier dated December 28, 2010 for goods returned y the company

60,000

A check dated May 31, 2010 drawn by the company the Bank of Manila in payment of custom duties. Since the importation did not materialize, the check was returned by the customs broker. This check was an outstanding check in the reconciliation of the Bank of Manila. Petty cash fund of which P10,000 is in currency, P7,200 in form of employee’s IOUS; and P2,800 is supported by approved petty cash vouchers for

410,000

expenses all dated prior to closing of the books on December 31, 2010 Total

20,000 P1,960,000

Less: Overdraft with the Bank of Manila secured by Page 15 a chattel mortgage on the inventories Cash balance per ledger

300,000 P1,660,000

What is the amount of cash to b e reported on the December 31, 2010 statement of financial position of Bea Company? Solution 1-7 Current account – Bank of PI Undeposited collection

P900,000 350,000

Supplier’s check for goods returned by the company

60,000

Petty cash fund

10,000

Bank of Manila (P410,000 – P300,000) Correct cash balance

110,000 P1,430,000

Problem 1-8 Petty Cash Fund On January 1, 2010, JERVS COMPANY established a petty cash fund of P10,000. On December 31, 2010, the petty cash fund was

examined and found to have receipts and the documents for miscellaneous general expenses amounting to P8,120. In addition, there was cash amounting to P1,500. 1. What is the amount of petty cash shortage or overage? A. P380 overage C. P1,880 shortage B. P380 shortage D. P1,880 overage 2. What entry would be required to adjust the petty cash fund on December 31, 2010? A. Miscellaneous general expenses 8,120 Cash short or over 380 Petty cash fund 8,500 B. Miscellaneous general expenses 8,120 Cash short or over 380 Petty cash fund 7,740 C. Miscellaneous general expenses 8,120 Petty cash fund 8,120 D. Miscellaneous general expenses 8,500 Cash short or over 380 Petty cash fund 8,120 Solution 1-8 1. Cash Miscellaneous general expenses Petty cash accounted Petty cash per ledger Petty cash

P1,500 8,120 9,620 10,000 P 380

Answer: B 2. Miscellaneous general expenses Cash short or over Petty cash fund Ansawer: A Problem 1-9

Petty Cash Fund

8,120 380 8,500

The auditor for SAMANTHA, INC. examined the petty cash fund immediately after the close of business, July 31, 2010, the end of the company’s natural business year. The petty cash custodian presented the following during the count: Currency

P1,650

Petty cash vouchers: Page 17 Postage

420

Office supplies expense

900

Transportation expense

340

Computer repairs

800

Advances to office staff

1,500

A check drawn by Samantha, Inc., payable to the petty cash custodian Postage stamps An employee’s check, returned by bank, marked NSF

7,200 300 1,000

An envelope containing the currency of P1,890 for a gift for a retiring employee

1,890 P16,000

The general ledger shows an imprest petty cash fund balance of P16,000. 1. How much is the petty cash shortage or overage? A. P2,190 overage C. P1,890 shortage B. P2,190 shortage D. P1,890 overage 2. What is the adjusted balance of the petty cash fund at July 31, 2010? A. P10,740 C. P7,200 B. P3,540 D. P8,850

Solution 1-9 1. Currency Petty cash vouchers (P420 + P900 + P340 + P800 + P1,500) Replenishment check Employee’s NSF heck Petty cash accounted Petty cash fund per ledger (custodian’s accountability) P...