Describe what is meant by a cutoff bank statement and state its purpose.
(Objective 23-3)
AUDIT OF THE GENERAL CASH ACCOUNT
The trial balance of Hillsburg Hardware Co. on page 150 includes only one cash account. Notice, however, that all cycles, except inventory and warehousing, affect cash in the bank. In testing the year-end balance in the general cash account, the auditor must accumulate sufficient appropriate evidence to evaluate whether cash, as stated on the balance sheet, is fairly stated and properly disclosed in accordance with five of the eight balance-related audit objectives used for all tests of details of balances (existence, completeness, accuracy, cutoff, and detail tie-in). Rights to general cash and its classifi – cation on the balance sheet are generally not of concern, and the realizable value of cash is not appli cable. The methodology for auditing year-end cash is essentially the same as that for all other balance sheet accounts and discussed in detail. Most companies are unlikely to have significant client business risks affecting cash balances. However, client business risk may arise from inappropriate cash management policies or handling of funds held in trust for others. Client business risk is more likely to arise from cash equivalents and other types of investments. Several financial services firms have suffered large trading losses from the activities of individual traders that were hidden by misstating investment and cash balances. The auditor should understand the risks from the client’s investment policies and strategies, as well as management controls that mitigate these risks. The cash balance is not material on many audits, but cash transactions affecting the balance are almost always extremely material. Therefore, the potential often exists for material misstatement of cash. Because cash is more susceptible to theft than other assets, there is high inherent risk for the existence, completeness, and accuracy objectives. These objectives are usually the focus in auditing cash balances. Typically, inherent risk is low for all other objectives. Internal controls over year-end cash balances in the general account can be divided into two categories:
- Controls over the transaction cycles affecting the recording of cash receipts and disbursements
- Independent bank reconciliations In preceding chapters, we discussed controls affecting the recording of cash trans – actions, which are essential in assessing control risk for cash. For example, in the acquisition and payment cycle (Chapter 18), major controls include adequate segrega – tion of duties between the check signing and accounts payable functions, signing of checks only by a properly authorized person, use of prenumbered checks printed on special paper, careful review of supporting documentation by the check signer before checks are signed, and adequate internal verification. Similar controls apply to electronic payments. If controls affecting cash-related transactions are operating effectively, control risk is reduced as are the audit tests for the year-end bank reconciliation. A monthly bank reconciliation of the general bank account on a timely basis by someone independent of the handling or recording of cash receipts and disbursements is an essential control over the ending cash balance. Companies with significant cash balances and large volumes of cash transactions may reconcile cash on a daily basis to online banking records. If a business defers preparing bank reconciliations for long periods, the value of the control is reduced and may affect the auditor’s assessment of control risk for cash. The reconciliation ensures that the account ing records reflect the same cash balance as the actual amount of cash in the bank after considering recon – ciling items. More important, the independent recon ciliation provides an opportunity for an internal verification of cash receipts and disbursements trans actions. If the bank statements are received unopened by the reconciler, and physical control is maintained over the statements until the recon ciliations are complete, copies of can celled checks, duplicate deposit slips, and other documents included in the statement can be examined without concern for the possibility of alterations, deletions, or additions. A careful bank reconciliation by competent client personnel includes the following actions:
- Compare cancelled checks or electronic bank records of payment with the cash disbursements records for date, payee, and amount
- Examine cancelled checks or electronic bank records of payment for signature, endorsement, and cancellation
- Compare deposits in the bank with recorded cash receipts for date, customer, and amount
The Correct Answer and Explanation is :
A cutoff bank statement is a bank statement covering a specific period shortly after the end of an accounting period, typically 7 to 10 days following the fiscal year-end. This statement includes all transactions—such as paid checks, deposits, and other debits and credits—that occurred during this interval. Importantly, the cutoff bank statement is sent directly from the bank to the auditor, ensuring its integrity and independence from client intervention.
The primary purpose of obtaining a cutoff bank statement in an audit is to verify the reconciling items on the client’s year-end bank reconciliation. By examining this statement, auditors can confirm that outstanding checks and deposits in transit, as recorded by the client at year-end, have subsequently cleared the bank. This verification process provides assurance that the cash balance reported in the financial statements is accurate and that transactions are recorded in the correct accounting period, thereby supporting the cutoff and completeness assertions in the audit of cash.
In summary, the cutoff bank statement serves as a critical audit tool, enabling auditors to substantiate the accuracy of the client’s cash records and ensuring that financial statements present a true and fair view of the company’s financial position.