CHAPTER

7
7-1.

SUBSTANTIVE TESTS OF CASH

The quoted statement is not accurate. In their work on cash, auditors are primarily concerned with the risk of an overstatement of the cash balance. The listing of a non-existent or fictitious check on the outstanding list would have the effect of understating the clients cash position, because too large an amount for outstanding checks would be deducted from the balance per bank, resulting in understatement of the ad usted balance. The other element of the quoted statement relating to the auditors concern over the possible omission of a deposit in transit is also in error. To omit a deposit in transit would cause an understatement of the year-end cash balance. If the quoted statement were revised into acceptable form, it would read along the following lines! "#hen auditors are verifying a clients bank reconciliation, they are particularly concerned with the possibility that an outstanding check may be omitted or that a non-existent deposit in transit may be included.

7-2.

There is no assurance that the lapping activities of the cashier will be discovered during the annual audit. $ince no shortage exists as of the balance sheet date, the only procedure which might disclose the irregularities would be a comparison of the individual checks listed on duplicate deposit tickets with the credits to customers accounts. $ince a test of this nature would probably not be made for more than a small sample of control listings it is likely that the "borrowing% and subsequent restoration of borrowed funds might go undetected. &a' "(apping% is a defalcation in which a cash shortage is concealed by delaying the crediting of cash receipts to the proper accounts receivable. The first step in the fraud is to withhold from a bank deposit cash remitted by a customer. ) few days later, because the customer must receive credit for his remittance, the first customers account is credited with an amount from a remittance made by a second customer. The process requires the continuous shifting of shortages from account to account and the crediting of subsequent receipts to the wrong account receivable. &b' The following audit procedures would be used to uncover lapping!

7-3.

7-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition &*' +ompare the detail of mailroom control listings &if prepared' to entries in the cash receipts ournal, postings to the accounts receivable subsidiary ledger, and the detail of authenticated duplicate deposit slips. This procedure should indicate any delay in ournali,ing, posting, and-or depositing incoming cash receipts. &.' If control listings are not prepared, compare the remittance advices received with customers checks to the cash ournal entries, postings to accounts receivable, and deposit slips. If the client stamps remittance advices with the date received, particular attention should be given to comparing this date with the date of the related ournal entry and posting. &/' +onfirm accounts receivable and give close attention to exceptions made by customers about payment dates. The confirmation procedure is better applied as a surprise at an interim date so that a person engaged in lapping will not have been able to bring the "lapped% accounts up to date. If the confirmations are always prepared at year-end, the confirmation procedure may be anticipated by the person doing the lapping and the shortage given a different form such as kiting of checks. &+onfirmation of accounts receivables has not been discussed in this chapter, but some students may be familiar enough with this procedure to include it in their answer.'

7-4.

West, Inc. The outstanding checks said by the controller to have been distributed after 0ecember /* should be reversed to the extent that they were actually distributed after that date. )n actual overdraft should be revealed and not eliminated by improper ournal entries. The primary purpose of the reversal is to properly cut off the cash and show the proper cash balance. $howing the correct cash balance eliminates "window dressing%1 recorded but undistributed checks would distort the current ratio by reducing both cash and accounts payable.

7-5.

Cavite Company Requirement (a) )d usting 2ournal 3ntries - *../*.45 )23 &*' 6as and oil $upplies expense 0elivery expense 8epairs and maintenance )dvances to employees :etty cash fund )dvances to employees :etty cash fund /.4 .74 /.4 744 944 *,;44 .44 .44

&.'

Substantive ests o! "as# &/' )ccounts receivable - cashier :etty cash fund $hortage in :+< determined as follows! Accounting! +urrency +oins +heck =nreplenished vouchers >$< check Total :+< per ledger $hortage &9' +ash in bank $alaries payable *44

7-3
*44

: *,.44 .44 *,944 *,;44 .44 9,;44 5,444 : &*44' 954 954

Requirement (b) +avite +ompany :etty +ash <und *../*.45 ?alance per ledger )dd &0educt' ad ustments )23 &*' &.' &/' >et ad ustment ?alance as ad usted 7-6. Pampanga Company Requirement (a) :roper composition of the <und, **-*4-47 +urrency and coins +ashed checks Aouchers >$< checks Total (ess! :etty cash receipt vouchers 8eturn of expense advance $ale of money orders : .44 *44 : .,.44 544 B94 .74 : /,B44 : 5,444 & *,;44' & .44' & *44' & .,.44' : .,@44

/44

7-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition ?alance of <und per count ?alance of <und per records $hortage The cashier attempted to conceal the shortage by! *' .' /' )dding instead of deducting the cash received thereby overstating the accounting of the fund by $ubmitting blank money orders claimed to have been purchased $ubmitting additional vouchers claimed to have been misplaced Total Requirement (b) )udit :rocedures a. +ashed checks * 3xamine checks as to payee, date, endorsements and subsequent . deposit. . 0etermine if checks were cashed with prior approval of a responsible . official. b. Aouchers not yet replenished * Aouch supporting documents, invoices, etc. . . 3xamine vouchers as to approval by authori,ed officials, signature of . payee, etc. >$< checks * 0etermine reason why >$< checks are still on hand. . . +onfirm directly with drawers. . 8eturn of excess travel advance * 3xamine liquidation of travel advance as reported and determine . accuracy of the amount returned. . Aouch supporting invoices. . $ale of money orders * 3xamine latest report of the :ampanga +o. to establish proper . accountability. . +onfirm directly with the :ampanga +o. all unreported money orders . sold as well as unissued as of >ovember *4. Aouchers subsequently presented * 3xamine vouchers as to date, approval, amount and nature of : /,944 5,444 &: *,744'

: 744 744 944 : *,744

c.

d.

e.

f.

Substantive ests o! "as# . . . g.

7-5

expenditures. +onfirm directly with employees those items representing wage advance.

?ook balance of the :etty +ash <und. * Trace to the general ledger the balance of the fund. .

7-7.

Requirement ($) ?ank 8econciliation, 2une /4

?alances, 2une *........................................... )dditions! 0eposits in transit................................. >ote and interest collected................... 8ecording error &;99 C @59'................ 0eductions! Dutstanding checks............................... >$< check............................................ $ervice charge...................................... +orrect cash balance.................................... Requirement (2) )d usting entry )ccounts receivable..................................... $ervice charge expense................................ )ccounts payable.................................. Interest revenue.................................... >otes receivable................................... +ash...................................................... 7-8. Form Company Requirement (a) <orm +ompany ?ank 8econciliation $tatement 7./4.47 ?alance per bank statement )dd! +ash on hand Total (ess! Dutstanding checks +heck no. *;. *;/ *;9 : .B,444 ;,..@ /7,..@ : *,494 B.4 @*7 9,444 *.4 ;4 74 *,@44 .,*B4 %an& :*@,444 *7,444 *,@74 ;4 &7,444' :.@,444 &9,444' &*.4' :.@,444 %oo&s :/4,*B4 &derived'

7-6

Solutions Manual to Accompany Applied Auditing, 2006 Edition *;5 ?alance as ad usted ?alance per books )dd! >ote collected by bank Total (ess! $hortage ?alance as ad usted Requirement (b) Requirement (c) The cashier attempted to conceal the shortage by! &*' =nderstating the outstanding checks &a' 3xcluding check E*;. &b' =nderfooting list of outstanding checks &.' )dding instead of deducting note collected by bank thereby covering up Total Requirement (d) $uggestions to improve internal control! &*' ?ank reconciliation statement should be prepared by someone other than the cashier. &.' +ollections should be deposited intact. :*,494 .44 *,444 :.,.94 $hortage is P2,240. 7;. /,.7@ : /.,;74 : /9,B44 544 /5,.44 .,.94 : /.,;74

7-9.

Jonas Company )nalysis of the bank statement and cash account will reveal the following! a. b. 0eposit in-transit, 2une /4!....................................... +hecks outstanding! E 7............................................................................ E 7@........................................................................... Interest earned on bank balance................................ : ;44 *,/44 :.,B44

:.,.44 : *44

c.

?ank 8econciliation, 2une /4 ?ank 3nding 2une balance............. :..,5@4 ?ook 3nding 2une balance............. :..,;@4

Substantive ests o! "as# 0eposits in-transit................. +hecks outstanding! E7.................................. E7@................................. +orrect cash balance............. .,B44 &;44' &*,/44' :./,4@4 Interest earned.......................

7-7
*44

:./,4@4

The following ournal entry must be made by 2onas +ompany! +ash.................................................................................. Interest revenue................................................. Apple Company Requirement ($) &a' 0eposits in-transit C )ll deposits &E5* through E57' e'cept E57 have been recorded by the bank1 therefore, the deposit in-transit is! E57, :/,544. This amount can be verified as! :.,444 F :*;4,444 C :*@@,544 G :/,544. &b' +hecks outstanding! Inspection of the check numbers reveals that the following are outstanding! E*.*, :*,4441 E*BB, :.,5441 E*B@, :/,4441 and E*B;, :*,5441 total, :@,444. This amount can be verified as! :7,444 F :*;@,444 C :*;7,444 G :@,444. Requirement (2) %an& :B7,554 944 /,544 7,444 B.4 *4,444 &@,444' &.44' &54' &.4' :B.,954 %oo&s :57,444 *44 *44

7-10.

?alances, 0ecember *................................. )dditions! +ash on hand........................................ 0eposit in-transit &E57'......................... >ote collected....................................... :rincipal......................................... Interest........................................... <unds received from foreign revenue... 0eductions! +hecks outstanding &E*.*, E*BB-*B;'.. >$< check, +ustomer ?elinda............. =nited <und transfer............................. ?ank service charge.............................. +orrect cash balance.................................... Requirement (() 2ournal entries from bank reconciliation! &a' +ash......................................................

:B.,954

*7,B.4

7-8

Solutions Manual to Accompany Applied Auditing, 2006 Edition >ote receivable.............................. Interest revenue............................. <oreign revenue............................. &b' )ccount receivable, >$< check, +ustomer ?elinda.............................. +ontributions, =nited <und.................. 3xpense, bank service charge............... +ash............................................... .44 54 .4 .B4 7,444 B.4 *4,444

7-11.

Mindanao Company Requirement (a) Hindanao +ompany ?ank 8econciliation $tatement *../*.47 =nad usted ?alance )dd &0educt' 8econciling Items a' Dutstanding checks b' 8eceipts of *../*.47 deposited *...4B c' $ervice charge for >ovember d' :roceeds of bank loan e' 0eposit of *.../.47 omitted from bank statement f' 8eturned check from Tome +o. g' 3rror by bank in entering *..*7.47 deposit, understated by h' +heck of Hina Hfg. +o. erroneously charged against Hindanao acct. i' >ote of 2. $antos +o. collected by bank, *..*4.47 ' 3rroneous bank debit memo k' 3rror by bank in entering *..9.47 deposit1 overstated by l' 0eposit of Hina Hfg. +o. erroneously credited to the companys account Total =nlocated difference )d usted balance %an& : @@,9@;.*. &/.,*4@.9.' 5,/*B..4 &/.@5' ;,@B5.44 .,@;..9* &9*B.54' *.44 .,;74.44 .,4*5.44 5,444.44 & *4.44' %oo&s : 5@,;@/.97

& *,@*;..4' : B4,B...** : B4,95..** .B4.44 : B4,B...** : B4,B...**

Requirement (b) Ad)usting *ournal Entries+ ,ecember ($, 2006 *. .. ?ank charges +ash in bank +ash in bank /.@5 /.@5 ;,@B5.44

Substantive ests o! "as# Interest expense :repaid interest (oan payable /. 9. )ccounts receivable +ash in bank +ash in bank ?ank charge >otes receivable Interest income +ash in bank )ccounts receivable - $ales Hiscellaneous income **4.44 59@.44

7-9

*4,5//.44 9*B.54 9*B.54 .,4*5.44 5.44 .,444.44 .4.44 .B4.44 .B4.44

5.

7-12.

Asia Envelope Company )$I) 3>A3(D:3 +DH:)>I :roof of +ash <or the month ended 5-/*-47
%alance ./$/06 :/,57*.44 =nad usted book balance )dd &0educt' )d ustments ?ank service charges )pril /4 Hay /* >$< checks returned )pril /4 Hay /* 0raft collected by bank )pril Hay +heck >o. 7*.; erroneously recorded in the check register +orrect )mount :@B 8ecorded as B@ )d usted book balance =nad usted bank balance )dd &0educt' )d ustments 0eposit in transit )pril /4 Hay /* :9,.94.44 :B,94/.54 ;54.44 :9*,94..*B :9*,BB7..B &;54.44' ;.5.94 MAReceipts ,isbursement :9.,B44.*B :9*,7/*.95 %alance ./($/06 :9,7.;.B.

&7.44'

&7.44' 7.@4 &@*5.44' **@.44 &*,544.44' .4..44

&7.@4'

&@*5.44'

&**@.44'

*,544.44

.4..44

;.44 :94,;99..5 :95,/*B.5B

&;.44' :9,7;B.;. :/,@7...4

;.5.94

7-10

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Dutstanding checks )pril /4 Hay /* +hecks of )sia 3ngine +orp. erroneously charged to companyJs account )pril Hay )d usted bank balance &9,97/.44' &9,97/.44' *9;.7@

&*9;.7@'

/9;.54 KKKKKKKK :9,.94.44

&/9;.54' KKKKKKKKK &74.44' :9*,94..*B :94,;99..5

74.44 :9,7;B.;.

7-13.

Tarlac Co !a"# ($) Tarlac +ompany :roof of +ash <or the month ended *../*.47
%alance $$0(0006 ?alance per bank statement )dd &0educt' 8econciling items Dutstanding checks >ovember /4 0ecember /* >$< checks returned in 0ecember 0eposits in transit >ovember /4 0ecember /* ?ank charges >ovember 0ecember +heck of another company erroneously charged by bank in >ovember, corrected in 0ecember ?alance per books : 95,.94 &*4,444' ,ecember Receipts :*44,444 ,isbursements :*/5,.94 &*4,444' 9,444 &.95' .,544 .4 &.,544' /,544 .4 &.5' %alance $20($006 :*4,444

&9,444' .95 /,544 .5

.74 : /@,4.4

&.74' :*44,B94 : *.@,;;4 : ;,BB4

(2) )d usting 2ournal 3ntries - *../*.47 *. )ccounts receivable +ash in bank .95 .95

Substantive ests o! "as# .. (() ?alance per books *../*.47 (ess! )23 &*' &.' ?alance as ad usted :;,BB4 :.95 .5 .B4 :;,544 ?ank charges +ash in bank .5 .5

7-11

7-14. a.

eni!s Company :ost-dated check C report as accounts receivable because it is not negotiable until the date on the check. 8eport as an account receivable because it is not a negotiable instrument at this time. 0ebit )ccounts 8eceivable, and credit +ash. If ultimately not collectible, write off as a bad debt. 8eport as >ote 8eceivable or as a short-term investment. It is inappropriate to report &or record' this as cash. Include the :.44 balance in petty cash in the balance reported as cash. Immediately replenish the fund for :*7@ and record it on 0ecember /* as a debit to expenses &including the :* cash short' and a credit to +ash. )lternatively, an ad ustment may be made debiting expenses for :*7@ and crediting petty cash fund on 0ecember /*, .445. 8eport the :/4 of postage stamps as prepaid postage expense C stamps are not cash. Include the cashiers check in the balance because it will be accepted by banks for immediate deposit. These checks should not be recorded as .445 payments because the company still has full control of them. The note and interest should not be included in the cash balance it has not been collected. The :.4,444 should be reported as a note receivable and interest of :954 &i.e., :.4,444 x ;L x /-*.' should be accrued by a debit to interest receivable and a credit to interest revenue for :954. Mowever, if the bank reports that the note has been collected on or before 0ecember /* and a credit to the companys account has been made, this item may be included in the cash balance.
Balance Sheet Classification

b.

c. d.

e. f. g. h.

7-15.

7-12

Solutions Manual to Accompany Applied Auditing, 2006 Edition

Cash X X Cash Equivalent ST Investments Other

Checking account Savings account Rare coins kept for long-term speculation Postdated checks received Money orders received Petty cash fund Treasury bills purchased when two months remain in term Compensating balance for a shortterm loan * shown separately

X X X X X X Balance Sheet Classification Cash ST Equivalent Investments

Cash Sinking fund to retire a bond in five years Certificate of deposit !si"-month term# Short-term investment in marketable e$uity securities

Other X

X X

7-16.

Cordial Company ?ank 8econciliation, *../*.47 ?ank =nad usted balance )dd &0educt' )d ustments 0eposit in transit &:*B5,.54 - :54,444' :ost dated customers check recorded on *../*.47 >ote collected by bank Dutstanding checks &:.97,B54 - :*9,B54 - :/B,.*4' +heck payable to a supplier released on 2an. 5, .44B +heck dated 2an. 9, .44B recorded and released in 0ec., .447 3rroneous bank credit corrected on 2an. ., .44B )s corrected =nlocated difference &shortage' :/54,444 *.5,.54 &*' & 54,444' *5,444 &*;9,B;4' &.' *9,B54 /B,.*4 &/4,444' .54,974 /*4,974 &74,444' &9' &7' &7' ?ooks :.;/,544

Substantive ests o! "as#

7-13

?alance as ad usted

:.54,974

:.54,974

&/'

Suggested ans1er to t#e multiple c#oice questions+ *. b .. d /. b 9. c 5. a 7. d

7-17.

Pa"lo Corporation :)?(D +D8:D8)TID> :roof of +ash 2uly /*, .447 Reconciliation 6/(0/06 :*/,4/*.B@ *97.B/ *uly Receipts :*4,45*.*B *,4;@.5* &*97.B/' 9B..54 .B.44 */../ *9..9 &/B..*5' &55..94' &*;7.@4' :9,.5;.79 :9,*4..7; **/.*5 /7.44 B.@4 :9,.5;.79 *uly ,isbursements :5,/.7.5. Reconciliation 2/($/06 :*B,B57.9/ *,4;@.5* 9B..54 &.B.44' &*/../' &*9..9'

?ank cash balance 0eposit in transit! 2uly 2une =ndeposited cash Dutstanding checks! 2uly! E*/95 E*/5/ E*/59 2une! E*4@. E*4@7 E*4@B )d usted balance ?ook cash balance >$< check 3rror >ote collected Interest $ervice charge )d usted balance

&/B..*5' &55..94' &*;7.@4' :*.,45B.*7 :*.,45B.*7

:**,9B5.95 :*4,974.95 *,444.44 *5.44

:*;,.B..;B :*@,9*9.;. &**/.*5' &/7.44' *,444.44 *5.44 &B.@4' :*;,.B..;B

:*.,45B.*7

:**,9B5.95

7-14

Solutions Manual to Accompany Applied Auditing, 2006 Edition

7-18.

Jayce Corporation 2)I+3 +D8:D8)TID> :roof of +ash )ugust /*, .447 Reconciliation 2/($/06 : ;,@5..97 ;5/.B* August Receipts :*7,B55.79 *,./5./. &;5/.B*' 9.*.7@ 57.@; /9*.B. *@5.B5 &/95..7' &*57.B.' &;B.9/' :*9,;*/.@4 :*9,@*/.;5 ;7.B5 &;.44' *..*4 :*9,;*/.@4 August ,isbursements :*9,;.@.@5 Reconciliation 3/($/06 :**,7B;..5 *,./5./. 9.*.7@ &57.@;' &/9*.B.' &*@5.B5'

?ank cash balance 0eposit in transit! )ugust 2uly =ndeposited cash Dutstanding checks! )ugust! E..75 E..7; E..B4 2uly! E.*54 E.*5* E.*5. )d usted balance ?ook cash balance >$< check 3rror in recording check >ote collected Interest $ervice charge )d usted balance

&/95..7' &*57.B.' &;B.9/' :*4,.47.B7 :*4,.47.B7

:*B,95@.;/ :*5,;*/.;/ *,544.44 95.44

:*.,B5*.@; :**,/47.B9 &;7.B5' ;.44 *,544.44 95.44 &*..*4' :*.,B5*.@;

:*4,.47.B7

:*B,95@.;/

Substantive ests o! "as# 7-19. #irsten $im, Inc. *. .. )pril * :etty +ash................................................................ +ash........................................................... )pril *4 +ash Dver and $hort................................................ Transportation-In..................................................... $upplies 3xpense..................................................... :ostage 3xpense...................................................... 8eceivablesN3mployees........................................ Hiscellaneous 3xpense............................................ +ash &:.44 C :.B'..................................... )pril .4 :etty +ash................................................................ +ash........................................................... .44

7-15

.44 . 74 .5 // *B /7 *B/ *44 *44

/.

7-20.

)ssuming no disbursements were made from )pril .4 to )pril /4 and the cashier made up the shortage of :., the answer is $300 %"&. Franco's A!to (epair )ervice +ash Dver and $hort....................................................... )ccounts 8eceivableN3mployees................................. &:94.44 F :/9.44' >eo <ranco, 0rawingsO.................................................. 8epair 3xpense................................................................ :ostage 3xpense &:.4.44 C :..;4'.................................. Dffice $upplies................................................................ +ash &:/44.44 C :*5..4'.................................. 4 5ote+ #is debit mig#t also be made to t#e capital account0 Ans1er* P+,.20 &not among the choices1 <aculty may add choice &e' :*5..4' 7.95 B9.44 *B4.44 *9./5 *B.*4 ..;4 .@9.@4

7-21.

Petty Cas-, .an/ (econciliation ?alance per bank )dd! +ash on hand 0eposit in transit 0educt +hecks outstanding )d usted bank balance ?alance per books )dd! >ote collected :7,5.. .97 /,444 /,.97 ;,B7@ &554' :;,.*@ :@,/*5 ;/4

7-16

Solutions Manual to Accompany Applied Auditing, 2006 Edition 0educt $ervice +harge )d usted cash balance, Hay /* :;,.*@ F :/44 G P0,,+1 %a& ;,.95 &.B' :;,.*@

7-22.

Po2der Inc. :owder, Inc. ?ank 8econciliation >ovember /4, .447

?alance per bank statement, >ovember /4, .447 )dd! +ash on hand, not deposited 0educt! Dutstanding checks E*..9 E*./4 E*./. E*.// +orrect cash balance, >ov. /4 ?alance per books, >ovember /4, .447 )dd! ?ond interest collected by bank 0educt! ?ank charges not recorded in books +ustomers check returned >$< +orrect cash balance, >ov. /4 : .B.94 5B..*/

:57,.B9..4 *,;*5.94 5@,*@;.74 :*,7/5..; .,97@./4 /,7.5.*5 9@..*B

@,.*4.;* :9;,;B@.7; :9;,*B@... O *,944.44 54,5B@... 5;;.5/ $49%978.69 &c'

Substantive ests o! "as# O+omputation of balance per books, >ovember /4, .447 ?alance per books, Dctober /*, .447 )dd receipts for >ovember 0educt disbursements for >ovember ?alance per books, >ovember /4, .447

7-17

: 9*,@9B.@5 *B/,5./.;* .*5,/B*.B7 *77,*;/.59 : 9;,*B@...