- Describe what is meant by a cutoff bank statement and state its purpose.
- Why are auditors usually less concerned about the client’s cash receipts cutoff than the cutoff for sales? Explain the procedure involved in testing for the cutoff for cash receipts.
The Correct Answer and Explanation is :
1. What is a cutoff bank statement and its purpose?
A cutoff bank statement is a bank statement that covers a specific, short period after the client’s year-end date, typically 7–10 days. It is requested directly from the bank by auditors to verify transactions such as checks that have cleared the bank and deposits made shortly after the end of the reporting period. The purpose of the cutoff bank statement is to provide evidence for the timing of cash transactions and to ensure proper recording in the correct accounting period, preventing misstatements due to cutoff errors.
The statement allows auditors to confirm:
- The accuracy and completeness of outstanding checks and deposits listed on the bank reconciliation at year-end.
- That no material misstatements have occurred by deliberately omitting or including transactions in the wrong reporting period.
2. Why are auditors less concerned about the cutoff for cash receipts than for sales?
Auditors are usually less concerned about the cutoff for cash receipts because cash is recorded when it is physically received, reducing the likelihood of errors or manipulations in its timing. Conversely, the sales cutoff can be more prone to errors or intentional manipulation, as management might record sales prematurely (before performance obligations are met) to inflate revenue.
Procedure for Testing Cash Receipts Cutoff
To test the cash receipts cutoff, auditors:
- Review the cash receipts journal and bank statements for a short period before and after year-end.
- Compare recorded cash receipts with supporting documentation, such as deposit slips and bank confirmations, to verify timing.
- Ensure receipts were recorded in the proper accounting period, verifying that deposits in transit at year-end were indeed received early in the next period.
- Investigate any significant delays between the physical receipt of cash and its recording.
This procedure ensures that transactions are recorded in compliance with the matching principle, mitigating the risk of misstated financial statements due to cutoff errors. However, the inherent risk is lower for cash receipts than for sales, making the latter a greater area of focus during audits.