Auditing Cash and Bank Balances: AUD CPA Exam Study Guide
Auditing Cash and Bank Balances: The Complete AUD Study Guide
Directional risk, fraud schemes, bank confirmations, bank reconciliations, and transfer schedules -- everything the AUD exam tests on cash.
Cash is one of the highest-risk accounts on any audit engagement. It is susceptible to physical theft, intentional overstatement, and reconciliation errors. For that reason, auditors devote specific procedures to cash that do not apply to most other balance sheet accounts. For AUD candidates, cash is tested heavily because it touches multiple core concepts at once: assertions, fraud risk, confirmation procedures, and the mechanics of the bank reconciliation.
This guide covers the full cash auditing framework, from the directional risk underlying every cash procedure to the specific mechanics of confirmations, reconciliations, and transfer schedules, with annotated exhibits showing exactly what each document looks like in practice.
Jump to:
Studying for AUD? Start with the free course.
My Free CPA 101 Course includes the AUD study framework I used to score a 90, including how to approach the heavily conceptual question style that makes AUD uniquely challenging.
Get My Free CPA 101 CourseDirectional Risk and Cash Assertions AUD
Understanding why directional risk exists matters for the AUD exam because it explains which assertions are most important for every asset account. Companies have an incentive to report higher assets and lower liabilities because it makes them look more financially stable to investors and creditors. This means the audit procedures for any asset should be designed primarily to test whether that asset is overstated.
For cash, the relevant assertions and the question each one is asking are:
| Assertion | The Question It Asks | Priority for Cash |
|---|---|---|
| Existence | Is the cash balance real? Does the reported cash actually exist? | Highest -- directly addresses overstatement risk |
| Rights and Obligations | Does the cash actually belong to the company? | High -- cash held in trust or restricted cash must be identified |
| Valuation, Allocation, and Accuracy | Is the cash recorded for the correct amount? | High -- directly tested through the bank reconciliation |
| Cutoff | Is the cash recorded in the correct period? | Moderate -- particularly important for year-end deposits and disbursements |
| Completeness | Are all cash accounts included? Have any been omitted? | Moderate -- confirmed through bank confirmations, which can reveal unknown accounts |
Kyle's 90+ Score Insight: The AUD exam will ask which assertion is most important for a given account. For any asset account, existence is the primary concern because of directional risk. For any liability account, completeness is the primary concern because companies tend to understate liabilities. Memorizing this pairing (asset = existence, liability = completeness) will get you through a large number of AUD assertion questions without needing to reason through each one from scratch.
Why Cash Is a High Fraud Risk High-Yield
There are three distinct categories of cash fraud risk that auditors address through specific procedures:
Physical Theft (Misappropriation of Assets)
Cash can be physically stolen by employees, either directly from the company's funds or indirectly by intercepting customer payments before they are deposited. This is the most common form of cash fraud and is the mechanism behind the lapping scheme described below.
Intentional Overstatement (Fraudulent Reporting)
A company may intentionally report a cash balance that does not exist. This is the mechanism behind kiting, where the same funds are recorded in two accounts simultaneously to inflate the reported balance. This is fraudulent financial reporting, not asset theft.
Bank Reconciliation Errors
Even without intentional fraud, errors in preparing the bank reconciliation can result in a misstated cash balance. This is why auditors do not simply review the reconciliation but reperform it independently from the source documents.
Inherent Risk for Cash: Because cash is susceptible to both theft and intentional misstatement, it is treated as a high inherent risk account on virtually every audit engagement. High inherent risk means the auditor must design more persuasive substantive procedures for cash than they might for a lower-risk account like prepaid expenses.
Cash Fraud Schemes: Lapping and Kiting AUD
Lapping
Lapping is a theft scheme where an employee steals a customer's payment and then uses subsequent customer payments to cover up the theft. The stolen payment is never deposited, so the employee must continually "lap" new incoming payments to keep accounts receivable balances from showing a deficit.
Employee steals Customer A's payment of $500 instead of depositing it.
Customer B's payment arrives. Employee applies it to Customer A's account to cover the theft. Customer B's account now shows an open balance.
Customer C's payment arrives. Employee applies it to Customer B's account. The cycle continues indefinitely until the employee is caught, confesses, or repays the funds.
Safeguards Against Lapping
Lockbox at the Bank
Customers send checks directly to a bank lockbox rather than to the company. Since no employee ever handles incoming checks, physical interception is impossible. This is the most effective control against lapping.
Mandatory Vacations
Lapping requires the employee to continuously apply new payments to cover previous theft. If the employee is forced to take a vacation, the scheme breaks down because no one is managing the cover-up, making the discrepancies visible.
Kiting
Kiting is a fraudulent financial reporting scheme, not theft. It involves exploiting the float between bank accounts to make the same funds appear in two places simultaneously. Kiting occurs specifically at year-end when companies want to report a higher cash balance.
At year-end, a company writes a $5,000 check from Account A and transfers it to Account B.
The company does NOT reduce Account A's balance. Account A still shows the full $5,000 because the check has not yet cleared.
Account B records a deposit in transit of $5,000. The same funds now appear in both accounts simultaneously at year-end, overstating cash by $5,000.
Safeguard: Bank Transfer Schedule
The primary control against kiting is a bank transfer schedule, which documents when each transfer was initiated, when it cleared the sending account, and when it was credited to the receiving account. A properly prepared transfer schedule makes it impossible for the same funds to appear in both accounts at year-end without detection.
Lapping vs. Kiting: Keep Them Straight. Lapping is about stealing cash (misappropriation of assets) and involves accounts receivable. Kiting is about inflating the reported cash balance (fraudulent financial reporting) and involves multiple bank accounts. The AUD exam tests both schemes and will ask you to identify which one is occurring based on a scenario description. The key differentiator: if an employee is stealing money, it is lapping. If the same funds appear in two accounts, it is kiting.
Want to see how AUD concepts connect across the full audit process?
Read our full breakdown of CPA exam pass rates by section and understand what the AUD pass rate means for how you should be studying this material.
Cash Confirmations High-Yield
The auditor sends a confirmation request directly to the bank, not through the client. This ensures the client cannot intercept or alter the response. The bank completes the form and returns it directly to the auditors. This makes bank confirmations strong evidence for multiple assertions simultaneously.
What Assertions Do Bank Confirmations Test?
| Assertion | How the Confirmation Tests It |
|---|---|
| Existence | The bank independently confirms that the account and balance exist at the specified date. |
| Rights and Obligations | The confirmation identifies the account holder, confirming the cash belongs to the company. |
| Valuation, Allocation, and Accuracy | The balance confirmed by the bank is compared to the balance per the company's records. |
| Completeness | The bank may disclose additional accounts or loan balances the auditor was not aware of, helping ensure nothing has been omitted from the financial statements. |
Bank Confirmation: Annotated Exhibit
Below is an example of a standard bank confirmation form for Coffee Co. as of December 31, 2021. The confirmation shows both the deposit account balance and an outstanding line of credit.
Standard Form to Confirm Account Balance Information with Financial Institutions
1000 Bayview Drive
Please confirm the accuracy of the information provided, noting any exceptions in the space below.
1. At the close of business on the date listed above, our records indicated the following deposit balance(s):
| Account Name | Account No. | Interest Rate | Balance |
|---|---|---|---|
| Bank of America Checking Account | 100002 | 5% | $2,000 |
2. We were directly liable to the financial institution for loans at the close of business as follows:
| Account No./Description | Balance | Due Date | Interest Rate | Date Through Which Interest Is Paid | Description of Collateral |
|---|---|---|---|---|---|
| Line of Credit | $22,500 | 6/30/22 | 5% | 12/31/21 | Company's fixed assets |
What Happens if the Bank Does Not Respond?
Send a second confirmation.
If the bank does not respond to the first confirmation, the auditor is required to send a second confirmation. This is a mandatory step, not optional.
Perform alternative procedures if no response to the second confirmation.
If the bank does not respond after the second confirmation, the auditor performs alternative procedures. These may include examining subsequent bank statements, reviewing the year-end bank statement directly, or tracing cash receipts and disbursements. Alternative procedures are fully acceptable forms of audit evidence.
If alternative procedures cannot be performed: scope limitation.
The only problem arises if the auditor cannot perform alternative procedures. That situation creates a scope limitation, which may affect the type of opinion the auditor issues.
Alternative Procedures Do NOT Increase Detection Risk. AUD exam questions frequently imply that relying on alternative procedures instead of confirmations increases detection risk. This is false. Alternative procedures are a fully acceptable substitute when confirmations are unavailable. Detection risk is not affected by which specific substantive procedure is used, as long as the procedure provides sufficient appropriate evidence. Do not let the exam's framing trick you into selecting an answer that links alternative procedures to increased risk.
Reviewing the Bank Reconciliation AUD
Video: Bank Reconciliation Explained
This video walks through how a bank reconciliation works, why the bank balance and book balance differ, and what the auditor is looking for when they reperform it.
The bank reconciliation starts with the bank statement's ending balance and adjusts for two types of reconciling items to arrive at the book balance:
Deposits in Transit
An incoming check that has been recorded on the company's books but has not yet cleared the bank. Deposits in transit are always an addition to the bank balance. They represent cash the company has received and recorded but the bank has not yet processed.
Outstanding Checks
A check the company has written and recorded as a disbursement, but the payee has not yet deposited it. Outstanding checks are always a deduction from the bank balance. They represent cash the company has paid out on its books but the bank does not yet show as paid.
+ Deposits in Transit
− Outstanding Checks
= Adjusted (Book) Balance
How the Auditor Tests the Bank Reconciliation
Agree the bank statement balance to the year-end bank statement.
The starting balance on the reconciliation must tie exactly to the company's official bank statement at year-end. This is the first thing the auditor checks. If the balance on the reconciliation does not agree to the statement, the reconciliation has been manipulated.
Test deposits in transit.
The auditor verifies that deposits in transit listed on the year-end reconciliation actually cleared the bank shortly after year-end. If a deposit in transit never clears, it may be fictitious. The auditor reviews the bank statement for the first few weeks after year-end to confirm clearance.
Test outstanding checks for stale checks.
Outstanding checks should clear the bank within a reasonable time after being issued. A stale check is an outstanding check that is so old it is no longer likely to be cashed. Stale checks should be removed from the outstanding check list. Leaving them on the reconciliation artificially depresses the book balance, which could mask a misstatement.
Agree the book balance to the trial balance.
The ending book balance on the reconciliation must match the cash balance on the company's trial balance (general ledger). This confirms that the reconciliation connects properly to the financial statements.
Bank Reconciliation: Annotated Exhibit
The exhibit below shows a bank reconciliation for Bank of America Checking Account (Account #102-10) as of 12/31/21. Auditor comments appear in red, showing how an auditor would tick-and-tie each item when reperforming the reconciliation.
As of 12/31/21 • Auditor's comments in red
| Bank Statement Ending Balance | $2,000.00 | "Agrees to the ending balance per the 12/31/21 bank statement." |
| Deposits in Transit | ||
| Check #320 — deposited 12/29/21 | $60.00 | |
| Check #450 — deposited 12/30/21 | $200.00 | |
| Check #500 — deposited 12/31/21 | $250.00 | "Verified that check #500 cleared the bank on 1/2/22." |
| Total Deposits in Transit | $510.00 | |
| Outstanding Checks | ||
| Check #434 — issued 6/30/21 | ($500.00) | "Issued 6 months ago -- auditor should investigate whether this is a stale check." |
| Check #440 — issued 12/27/21 | ($125.00) | |
| Check #450 — issued 12/30/21 | ($250.00) | |
| Total Outstanding Checks | ($875.00) | |
| Account Balance Per Calculation | $1,635.00 | "Recalculated the ending balance, no issues noted." |
| Account Balance Per General Ledger | $1,800.00 | "Agrees to the company's 12/31/21 trial balance." |
| Variance | ($165.00) | "The calculated balance is $165 less than the GL. Given that this variance is less than the trial misstatement amount of $1,000, we will pass on further review." |
Reading the Exhibit: Check #434 was issued on 6/30/21 -- six months before year-end. This is a strong indicator of a stale check. The auditor should inquire whether this check is still outstanding or whether it has been voided. If it is truly stale, it should be removed from the outstanding checks list, which would reduce the reconciling deductions and increase the calculated balance. The $165 variance between the calculated balance and the GL balance is noted but deemed immaterial relative to the $1,000 misstatement threshold, so no further investigation is required on that point alone.
The Auditor Reperforms, Not Just Reviews. AUD questions will sometimes describe an auditor who "reviewed" the bank reconciliation. That alone is not sufficient. The auditor should independently reperform the reconciliation, tracing the bank statement balance, deposits in transit, and outstanding checks to source documents. Simply reading through a reconciliation prepared by the client does not provide sufficient evidence because it does not test whether the reconciliation is accurate.
Bank Transfer Schedules AUD
The transfer schedule lists each inter-account transfer and shows:
| Column | What It Captures | Why It Matters |
|---|---|---|
| Transfer date | The date the company initiated the transfer | Establishes when the funds left the sending account on the books |
| Amount | The dollar amount transferred | Identifies the size of potential double-counting |
| Sending account | The account from which funds were drawn | Confirms the deduction was recorded in the sending account |
| Date debited from sending account | When the bank cleared the transfer from the sending account | If later than year-end, funds may still appear in the sending account at year-end |
| Receiving account | The account that received the funds | Confirms the deposit was recorded in the receiving account |
| Date credited to receiving account | When the bank credited the receiving account | If this is before year-end and the sending account debit is after year-end, kiting may exist |
How to Detect Kiting Using a Transfer Schedule
A transfer is properly recorded if the books and the bank are consistent for both sides of the transaction. Kiting appears as an asymmetry between when the sending account was debited and when the receiving account was credited:
Properly Recorded Transfer (No Kiting)
The company records the debit to Account A and the credit to Account B on the same date. The bank processes both in the same period. The same funds appear in one account at a time.
Kiting Signal
Account B shows a deposit in transit (credit recorded before year-end) but Account A's balance has not been reduced (debit not recorded until after year-end). The same $5,000 appears in both accounts simultaneously at year-end.
Kyle's 90+ Score Insight: The AUD exam will sometimes ask which procedure is most effective for detecting kiting. The answer is always the bank transfer schedule. The exam may also ask whether confirmations alone would detect kiting. They would not, because each bank confirms only the balance in its own account. The kiting appears when you look at both sides of the same transfer simultaneously, which is exactly what a transfer schedule does.
Cash Audit Procedures: Summary Exam Reference
| Procedure | What It Tests | What It Detects | Key Rules |
|---|---|---|---|
| Bank Confirmation | Existence, Rights, Valuation, Completeness | Fictitious balances, undisclosed accounts, unknown loan obligations | Sent directly to the bank. Two confirmations required before switching to alternative procedures. |
| Bank Reconciliation (Reperformance) | Valuation, Accuracy, Cutoff | Errors in reconciling items, stale checks, unrecorded bank charges | Auditor reperforms from source documents. Deposits in transit verified in subsequent period. Stale checks identified and removed. |
| Bank Transfer Schedule | Existence, Cutoff | Kiting (double-counting of transfers at year-end) | Tracks both the sending and receiving side of each transfer to confirm consistent recording across accounts. |
Frequently Asked Questions
Why is existence the most important assertion for cash?
Because of directional risk. Companies tend to overstate their assets to appear more financially healthy to investors and creditors. Since cash is an asset, the primary risk is overstatement, and existence directly asks whether the reported balance actually exists. Every substantive procedure for cash (confirmations, reconciliations, transfer schedules) is designed primarily to address the existence assertion.
What is the difference between lapping and kiting?
Lapping is misappropriation of assets (theft), where an employee steals a customer's payment and covers it up by applying subsequent customers' payments to the previous customer's account. Kiting is fraudulent financial reporting, where the same funds appear in two bank accounts simultaneously at year-end to artificially inflate the cash balance. Lapping involves accounts receivable. Kiting involves multiple bank accounts and a bank transfer schedule is the primary detection procedure.
Do alternative procedures increase detection risk when a bank does not respond to a confirmation?
No. This is a common AUD exam trap. Alternative procedures are fully acceptable substitutes for confirmations when the bank does not respond. They do not increase detection risk as long as they provide sufficient appropriate evidence. The only issue is if the auditor cannot perform alternative procedures at all, which would create a scope limitation.
What is a stale check and why does it matter?
A stale check is an outstanding check that is so old it is unlikely to ever be cashed. Outstanding checks are deductions in the bank reconciliation. If a stale check is left on the outstanding check list, the calculated book balance is understated because you are deducting a check that will never clear. The auditor should identify stale checks and remove them from the outstanding list, which requires an adjustment to the company's books.
What is the auditor's procedure for deposits in transit?
The auditor verifies that deposits in transit listed on the year-end reconciliation actually cleared the bank in the period immediately after year-end (typically within the first few days of the new year). If a deposit in transit does not appear on the subsequent bank statement, it may be fictitious. This is one of the most direct procedures for testing cutoff and existence for cash.
What does a bank confirmation reveal beyond the cash balance?
A bank confirmation also discloses any loan balances, lines of credit, or other liabilities the company has with that bank. This serves the completeness assertion for liabilities. An auditor who receives a confirmation showing a $22,500 line of credit must verify that this amount is recorded correctly in the company's liabilities, not just that the cash balance is accurate.
Studying AUD and want a stronger framework for the entire audit process?
Cash is just one part of the substantive testing phase. Understanding how cash procedures connect to risk assessment, materiality, and the audit report is what separates candidates who score in the 80s from those who score in the 60s. My Free CPA 101 Course walks through the entire AUD framework using the same approach I used to score a 90 on the exam.
Kyle Ashcraft is a CPA who scored a 90 on AUD and 90+ on all four CPA exams. Kyle founded Maxwell CPA Review, a boutique exam-prep company offering a comprehensive CPA exam review course and private AUD tutoring.