24.2 Auditing Practice: Cash and Receivables
Key Takeaways
Auditing problems start from the unadjusted balance, analyze each finding, compute the audited balance, and record adjusting entries.
Certified checks are not outstanding, bank errors need no book entry, and book-side reconciling items require adjusting entries.
In a proof of cash, receipts per books equal receipts per bank minus beginning plus ending deposits in transit.
Postdated customer checks and IOUs are receivables, while undelivered or postdated checks to suppliers are added back to cash and payables.
Customer credit balances are reclassified as liabilities, premature sales are reversed, and the allowance is adjusted to the amount required by the aging.
Auditing Practice: Cash and Receivables
About half of the Auditing subject tests auditing practice, meaning problems in which the candidate audits an account balance, determines the correct amount, and prepares the adjusting entries. This section works through the standard problem types for cash and receivables: bank reconciliations, proof of cash, classification of cash items, and adjustments to receivables and the allowance for expected credit losses.
1. How to Approach an Auditing Problem
- Start from the unadjusted (client) balance.
- Analyze each finding: is the client's balance too high or too low, and what is the other side of the entry?
- Compute the audited (correct) balance and prepare the adjusting journal entries (AJEs).
- Summarize the effect on profit. Balance sheet reclassifications (for example, customer credit balances moved to liabilities) do not affect profit.
2. Bank Reconciliation (Adjusted Balance Method)
Findings for Rizal Trading at December 31:
| Bank side | Amount (PHP) | Book side | Amount (PHP) |
|---|---|---|---|
| Balance per bank statement | 1,250,000 | Balance per books | 1,154,500 |
| Deposit in transit | 180,000 | Note collected by bank (50,000 principal plus 2,000 interest), not recorded | 52,000 |
| Outstanding checks per list (250,000, including a PHP 20,000 certified check) | (230,000) | Bank service charge not recorded | (500) |
| Check of another depositor charged to Rizal's account in error | 15,000 | Customer's check returned NSF | (18,000) |
| Check to a supplier for 36,500 recorded as 63,500 | 27,000 | ||
| Adjusted bank balance | 1,215,000 | Adjusted book balance | 1,215,000 |
A certified check is not outstanding, because the bank already set aside the funds when it certified the check. The bank error needs no book entry; the auditor asks the client to have the bank correct it.
Adjusting entries (book side only):
| Entry | Debit | Credit |
|---|---|---|
| Cash / Notes receivable / Interest income | 52,000 | 50,000 / 2,000 |
| Bank service charges / Cash | 500 | 500 |
| Accounts receivable / Cash (NSF check) | 18,000 | 18,000 |
| Cash / Accounts payable (correction of recorded amount) | 27,000 | 27,000 |
3. Proof of Cash (Four-Column Reconciliation)
A proof of cash reconciles the beginning balance, receipts, disbursements, and ending balance, which reveals errors that a single-date reconciliation can hide.
- Receipts per books (correct) = Receipts per bank - Beginning deposits in transit + Ending deposits in transit (plus or minus other reconciling items)
- Disbursements per books (correct) = Disbursements per bank - Beginning outstanding checks + Ending outstanding checks
Example: December receipts per bank are PHP 2,000,000, deposits in transit were PHP 120,000 on November 30 and PHP 180,000 on December 31. Receipts per books should be 2,000,000 - 120,000 + 180,000 = PHP 2,060,000. If the books show a different amount, the difference points to unrecorded receipts or deposit errors.
4. What Belongs in Cash and Cash Equivalents
| Item | Proper treatment |
|---|---|
| Customer's postdated check | Accounts receivable, not cash |
| IOUs and employee advances in the petty cash fund | Receivables; petty cash equals the actual coins and currency counted |
| Check to a supplier recorded as paid but undelivered or postdated at year-end | Add back to cash and restore accounts payable |
| Sinking fund or cash restricted for long-term debt | Noncurrent asset |
| Compensating balance that is legally restricted | Separate line or disclosure; noncurrent if it supports long-term borrowing |
| Bank overdraft | Current liability, unless offset against another account in the same bank where a right of offset exists |
| Treasury bill or time deposit with original maturity of three months or less | Cash equivalent (PAS 7); maturity is measured from the date of acquisition |
Example. The Cash account shows PHP 2,000,000. It includes PHP 5,000 of employee IOUs in petty cash, a PHP 40,000 postdated customer check, and a PHP 300,000 bond sinking fund. It excludes a PHP 60,000 check to a supplier still held in the vault and a PHP 25,000 check dated January 5 that was recorded as a December disbursement.
Correct cash = 2,000,000 - 5,000 - 40,000 - 300,000 + 60,000 + 25,000 = PHP 1,740,000.
5. Receivables and the Allowance for Expected Credit Losses
Key procedures are confirmation (positive requests for large or unusual balances; negative requests only when risk is low and many small homogeneous balances exist), sales cutoff testing, and review of the aging schedule and subsequent collections.
Example. Accounts receivable per ledger is PHP 3,200,000, and the allowance for expected credit losses is PHP 90,000. The auditor finds:
- Customer credit balances of PHP 45,000 were netted against receivables.
- Goods with a selling price of PHP 120,000 (cost PHP 84,000) were billed and recorded as sales on December 31 but shipped January 2, FOB shipping point.
- After these corrections, the auditor's review of the aging schedule supports a required allowance of PHP 125,000.
| Item | Amount (PHP) |
|---|---|
| Accounts receivable per ledger | 3,200,000 |
| Reclassify customer credit balances | 45,000 |
| Reverse premature sale | (120,000) |
| Correct gross accounts receivable | 3,125,000 |
| Required allowance | (125,000) |
| Net realizable amount | 3,000,000 |
Adjusting entries: Accounts receivable / Customer advances (liability) PHP 45,000; Sales / Accounts receivable PHP 120,000; Impairment loss / Allowance for expected credit losses PHP 35,000 (125,000 - 90,000). If the goods were left out of the year-end count because they were treated as sold, the auditor also debits Inventory and credits Cost of goods sold PHP 84,000.
The bank statement shows PHP 800,000 on December 31. Deposits in transit are PHP 90,000, and the list of outstanding checks totals PHP 140,000, including a PHP 15,000 certified check. What is the adjusted bank balance?
PHP 750,000
PHP 765,000
PHP 780,000
PHP 885,000
For January, the bank statement shows receipts of PHP 1,500,000. Deposits in transit were PHP 60,000 on December 31 and PHP 85,000 on January 31. There are no other reconciling items for receipts. What should January receipts per books be?
PHP 1,475,000
PHP 1,645,000
PHP 1,500,000
PHP 1,525,000
Which item qualifies as a cash equivalent at December 31 under PAS 7?
A six-month time deposit acquired in September with three months remaining at year-end
A customer's postdated check dated January 10
A 90-day Treasury bill acquired on December 1
A bond sinking fund held by a trustee
Sections you finish are checked off in the contents.