Auditing Cash and Bank Balances: AUD CPA Exam Study Guide
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Cash is one of the highest-risk accounts on any audit engagement, because it is the one asset that can simply be taken. For AUD candidates, that is exactly why it shows up so often: a single cash question can test assertions, fraud risk, and the mechanics of a bank reconciliation all at once, and it is easy to lose points not because the concept is hard but because the vocabulary (lapping, kiting, stale checks, deposits in transit) gets tangled.
This guide works through the full cash-audit framework, from the directional-risk logic that explains which assertion matters most, to annotated exhibits showing exactly what a bank confirmation and a bank reconciliation look like when an auditor reperforms one.
In this guide
- What assertions matter most for cash, and why?
- Why is cash such a high fraud risk?
- What's the difference between lapping and kiting?
- What does a bank confirmation actually prove?
- How does an auditor test the bank reconciliation?
- How do you catch kiting with a transfer schedule?
- How do the cash procedures fit together?
- Frequently asked questions
What assertions matter most for cash, and why?
Directional risk says companies tend to overstate assets and understate liabilities, because that combination makes the balance sheet look healthier to investors and creditors. Cash is an asset, so the auditor's default concern is always that the cash balance has been overstated. That single fact determines which assertion gets the most attention.
| Assertion | The question it asks | Priority for cash |
|---|---|---|
| Existence | Is the cash balance real? | Highest, addresses overstatement risk directly |
| Rights and obligations | Does the cash actually belong to the company? | High, restricted or trust cash must be identified |
| Valuation, allocation and accuracy | Is the cash recorded for the correct amount? | High, tested directly through the bank reconciliation |
| Cutoff | Is the cash recorded in the correct period? | Moderate, matters most for year-end deposits and disbursements |
| Completeness | Are all cash accounts included? | Moderate, confirmed through bank confirmations, which can surface unknown accounts |
The mnemonic that answers most AUD assertion questions. For any asset account, existence is the primary concern, because directional risk means assets get overstated. For any liability account, it flips: completeness is the primary concern, because liabilities get understated. Asset, existence. Liability, completeness. That pairing alone resolves a large share of the assertion questions AUD asks.
Why is cash such a high fraud risk?
Cash carries elevated fraud risk for three distinct reasons, and each one drives a different audit procedure later in this guide.
Physical theft (misappropriation of assets)
Cash can be stolen directly, or indirectly by intercepting a customer payment before it is deposited. This is the most common form of cash fraud, and it is the mechanism behind lapping.
Intentional overstatement (fraudulent financial reporting)
A company can report a cash balance that does not exist. This is the mechanism behind kiting: recording the same funds in two accounts at once to inflate the reported total. This is fraud in the financial statements, not theft of an asset.
Bank reconciliation errors
Even without intent, a reconciliation prepared incorrectly can misstate the cash balance. That is why an auditor does not just review a client's reconciliation. They reperform it from source documents.
Because cash is exposed to both theft and intentional misstatement, it is treated as high inherent risk on nearly every engagement. High inherent risk means the auditor needs more persuasive substantive evidence for cash than for a lower-risk account like prepaid expenses.
What's the difference between lapping and kiting?
Lapping is misappropriation of assets: theft. Kiting is fraudulent financial reporting: lying about the books. The AUD exam expects you to tell them apart from a scenario description, not just recite the definitions.
Lapping
An employee steals a customer's payment instead of depositing it, then uses the next customer's payment to cover the shortfall, and keeps doing it indefinitely.
- Employee steals Customer A's $500 payment instead of depositing it.
- Customer B's payment arrives. Employee applies it to Customer A's account to hide the theft. Customer B's account now shows an open balance.
- Customer C's payment arrives and gets applied to Customer B's account. The cycle continues until the employee is caught, confesses, or repays the funds.
The two controls that actually stop it. A lockbox at the bank means customers mail payments straight to the bank, so no employee ever handles the check to intercept it. Mandatory vacations work because lapping requires continuous upkeep: force the employee out for a week and the cover-up collapses on its own.
Kiting
Kiting exploits the float between two bank accounts so the same funds appear to exist in both at once, typically staged right at year-end.
- At year-end, the company writes a $5,000 check from Account A and deposits it into Account B.
- Account A's balance is not reduced. It still shows the full $5,000 because the check has not cleared.
- Account B records a $5,000 deposit in transit. The same $5,000 now sits in both accounts simultaneously, overstating cash by $5,000.
The primary safeguard is a bank transfer schedule, covered in full below.
Keep them straight. If an employee is pocketing money, it is lapping, and it involves accounts receivable. If the same funds show up in two bank accounts at once, it is kiting, and it involves a transfer schedule to catch it.
Want the framework for the rest of AUD, not just cash?
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What does a bank confirmation actually prove?
A bank confirmation is a direct written exchange between the auditor and the client's bank, sent by the auditor and returned straight to the auditor, never routed through the client. Because it comes from an independent third party the client cannot alter, it is strong evidence for several assertions at once.
| Assertion | How the confirmation tests it |
|---|---|
| Existence | The bank independently confirms the account and balance exist at the specified date. |
| Rights and obligations | The confirmation names the account holder, confirming the cash belongs to the company. |
| Valuation, allocation and accuracy | The bank's confirmed balance is compared to the balance on the company's own records. |
| Completeness | The bank may disclose accounts or loan balances the auditor did not already know about. |
Annotated exhibit
Below is a standard confirmation for Coffee Co. as of December 31, 2021, showing both a deposit 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 below.
1. At the close of business on the date 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 | Interest paid through | Collateral |
|---|---|---|---|---|---|
| Line of credit | $22,500 | 6/30/22 | 5% | 12/31/21 | Company's fixed assets |
What happens if the bank never responds?
- Send a second confirmation. This step is mandatory, not optional, the first time a bank fails to respond.
- Perform alternative procedures if the second confirmation also gets no response. Examining subsequent bank statements, reviewing the year-end statement directly, or tracing receipts and disbursements are all fully acceptable substitutes.
- Only a true dead end is a problem. If alternative procedures cannot be performed at all, that creates a scope limitation, which can affect the audit opinion.
A trap worth knowing by name. AUD questions often imply that falling back on alternative procedures increases detection risk. It does not. Alternative procedures are a fully acceptable substitute for a confirmation as long as they provide sufficient appropriate evidence. Detection risk depends on the quality of the evidence, not on which specific procedure produced it.
How does an auditor test the bank reconciliation?
Every cash account gets its own bank reconciliation, and the auditor does not simply review the client's version. They reperform it from source documents to independently verify the ending book balance.
Why the bank balance and the book balance differ, and what the auditor checks when reperforming the reconciliation.
The reconciliation starts at the bank statement's ending balance and adjusts for two kinds of timing differences:
Deposits in transit are checks the company has already recorded but the bank has not yet processed. They get added to the bank balance. Outstanding checks are checks the company has written and recorded but the payee has not yet cashed. They get deducted from the bank balance.
+ Deposits in transit
− Outstanding checks
= Adjusted (book) balance
The four things the auditor actually checks
- Agree the bank statement balance to the year-end statement. If the starting number on the reconciliation does not tie to the real statement, the whole reconciliation is suspect.
- Test deposits in transit against the subsequent bank statement. A deposit in transit that never clears in the following weeks may be fictitious.
- Screen outstanding checks for stale ones. A stale check is outstanding so long it is unlikely to ever be cashed. Leaving it on the list understates the calculated book balance, which can mask a real misstatement.
- Agree the book balance to the trial balance. This confirms the reconciliation actually connects to the financial statements.
Annotated exhibit
A reconciliation for Bank of America checking account #102-10 as of 12/31/21, with the auditor's tick marks shown as comments.
| Bank statement ending balance | $2,000.00 | Agrees to 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 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, investigate whether it's stale. |
| Check #440, issued 12/27/21 | ($125.00) | |
| Check #450, issued 12/30/21 | ($250.00) | |
| Total outstanding checks | ($875.00) | |
| Balance per calculation | $1,635.00 | Recalculated, no issues noted. |
| Balance per general ledger | $1,800.00 | Agrees to the 12/31/21 trial balance. |
| Variance | ($165.00) | Below the $1,000 misstatement threshold; no further work needed. |
Reading the exhibit. Check #434 was issued six months before year-end, which is the signal of a stale check. If it truly is stale, removing it from the outstanding list would reduce the deduction and raise the calculated balance, closing part of the $165 gap. That gap sits below the $1,000 threshold in this example, which is why it gets noted rather than chased further.
How do you catch kiting with a transfer schedule?
A bank transfer schedule lists every inter-account transfer around year-end and tracks both sides of it: the date the transfer was initiated, the amount, which account sent it, when the sending bank actually debited it, which account received it, and when the receiving bank credited it.
A transfer recorded correctly shows the debit and credit on the same date, cleared by the bank in the same period. Kiting shows up as an asymmetry: the receiving account books a deposit in transit before year-end, while the sending account's balance has not yet been reduced because its debit does not clear until after year-end. The same dollars are sitting in both places at once.
The transfer schedule is the answer whenever AUD asks how to detect kiting. A bank confirmation will not catch it, because each bank only confirms the balance in its own account. Kiting only becomes visible when you look at both sides of the same transfer side by side, which is exactly what a transfer schedule does and a confirmation cannot.
How do the cash procedures fit together?
| Procedure | Assertions tested | What it catches |
|---|---|---|
| Bank confirmation | Existence, rights, valuation, completeness | Fictitious balances, undisclosed accounts, unknown loan obligations |
| Bank reconciliation (reperformed) | Valuation, accuracy, cutoff | Reconciling errors, stale checks, unrecorded bank charges |
| Bank transfer schedule | Existence, cutoff | Kiting, meaning double-counted transfers at year-end |
Frequently asked questions
Why is existence the most important assertion for cash?
Directional risk: companies tend to overstate assets, cash is an asset, and existence is the assertion that directly asks whether the reported balance is real. Every major cash procedure (confirmations, reconciliations, transfer schedules) is built primarily to address existence.
What is the difference between lapping and kiting?
Lapping is misappropriation of assets: an employee steals a customer payment and covers it with the next customer's payment. It involves accounts receivable. Kiting is fraudulent financial reporting: the same funds appear in two bank accounts at once to inflate the reported cash balance, and a bank transfer schedule is the procedure that catches it.
Do alternative procedures increase detection risk when a bank does not respond?
No. Alternative procedures are a fully acceptable substitute for a confirmation and do not raise detection risk as long as they provide sufficient appropriate evidence. A scope limitation only arises if the auditor cannot perform alternative procedures at all.
What is a stale check and why does it matter?
A stale check is an outstanding check old enough that it is unlikely to ever be cashed. Leaving it on the outstanding list understates the calculated book balance, since you are deducting a check that will never clear. The auditor identifies and removes stale checks, which requires an adjustment to the company's own books.
What does a bank confirmation reveal beyond the cash balance?
It also discloses loan balances, lines of credit, or other liabilities the company holds at that bank, which serves the completeness assertion for liabilities. An auditor who sees a confirmed $22,500 line of credit still has to verify that amount is recorded correctly on the company's own books.
Studying AUD and want the framework for the whole exam?
Cash is one piece of substantive testing. Seeing how it connects to risk assessment, materiality, and the audit report is what separates an 80s score from a 60s score. My free CPA 101 course walks through that framework using the same approach I used to score a 90 on AUD.
Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 95 on FAR. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.
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