Risk of Material Misstatement for Cash

Cash includes cash equivalents. Cash is shown under the “current assets” of the balance sheet. These are the liquid assets of the company. The most important component for any audit is checking cash. The inherent risk and control risks are both high in the handling and management of cash.

Auditors should ask following questions while auditing the cash:

  1. Who are authorized signatories to bank cheque?
  2. What is the process and who prepares bank reconciliations?
  3. Are all bank accounts reconciled?
  4. Who and how they reconcile the bank account balances to all respective general ledgers?
  5. How is the cut-off determined with respect to the accounting period for cash transactions?
  6. Is there segregation of duties among persons handling cash, making payments, and reconciling the balances
  7. Are there any cash equivalents?
  8. How many cheques are in transit?

The inherent risk and control risk in the obligations form the risk of material misstatement with respect to cash. The risk of being susceptible to misstatement due to the nature of the cash is the inherent risk of the cash transactions. Control risk occurs when the internal control system of the client fails to prevent or detect material misstatement in the cash. Some risks associated with cash are unauthorized transactions, wrong recording of cash, and non-confirmation with cash policies of the company.

Fraud Risk in the Cash

Most of the financial frauds in the history of finance have occurred in cash. Basically, two types of cash frauds have existed. One would be stealing cash by collusion among staff and others would be to overstate cash in the balance sheet colliding with auditors. Incentive, opportunity, and rationalization form the triad of any cash fraud.

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The person who does cash fraud may feel they are being paid little incentive and hence, they engage in stealing cash. When the staff is working closely with cash affairs, this provides them opportunity due to proximity to cash. Rationalization of cash fraud happens when the top management thinks it to do so. This creates an unethical company environment.

Inherent Risk for Cash

Inherent risks are outside the scope of auditors. However, auditors need to find and test controls in order to know what level of inherent risk the company is dealing with in case of cash. Cash has a high inherent risk because of its nature. The followings are the reason stating why cash is inherently risky:

  1. Cash has the highest volume of transactions. All the business operations are done in cash. Hence, the high volume creates tilt in being more susceptible to error as compared to other items of the balance sheet.
  2. Cash can be easily stolen and manipulated through accounting gimmicks. The staff can collude in order to steal cash from the accounts in a slow manner.
  3. Cash is the most liquid current asset that a company can have. Hence, it is most susceptible to fraud and manipulations as it can be easily transferable from one account to another bank accounts.
  4. Cash is received when debts are taken. Hence, it creates unnecessary pressure in the management towards handling of cash in the situation of liquidity crunch. When there is pressure, irrational decisions are high in number.  

Control Risks for cash

Control risk is the risk that internal controls cannot prevent, detect, or correct material misstatement that could occur on financial statements. If the inherent risk is high, a test of controls needs to be done. Auditors need to assess the level of control risk the client has with cash. It would depend on how effective the internal controls exist in the client’s place. Control risks occur when the same person is handling cash as well as authorizing cash transactions.

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It occurs when there is no proper authority in place to oversee the cash transactions that happen in the company. Control risks increase as a result of the inherent risk of cash transactions. Further, cash attracts fraud which can be observed from the history of accounting and finance.

The segregation of duties and responsibilities is the most important internal control mechanism for cash. Auditors shall try to lower the detection risk to a tolerable level. Some of the control procedures followed by auditors are:

  1. Separate persons are hired for receiving cash, recording cash, and reconciling cash balances.
  2. Only the person authorized to handle cash should have physical access to cash.
  3. Authorization of cash transactions shall be done by the appropriate authority of the company.
  4. Cash receipt journal is reconciled to accounts receivable daily
  5. The cash receipts are pre-numbered and prepared chronologically.