## **Learning Outcomes**

After reading this article, you will be able to describe bank reconciliation procedures and explain their importance in detecting errors and fraud. You will understand how to obtain, interpret, and assess external bank confirmations and link these to audit assertions. You will also identify substantive procedures for cash, bank, and payroll as they relate to audit evidence. You should be able to apply these techniques in common ACCA exam scenarios.

## **ACCA Audit and Assurance (AA) Syllabus**

For ACCA Audit and Assurance (AA), you are required to understand the procedures for auditing cash, bank, and payroll balances. Key areas in this article include:

- The objectives of bank reconciliations and how they provide audit evidence.
- The process and significance of obtaining external bank confirmations.
- Substantive procedures relating to cash balances and payroll transactions.
- Application of assertions (existence, completeness, accuracy) to cash, bank, and payroll systems.
- Common control activities and deficiencies in the cash, bank, and payroll cycle.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is the primary purpose of a bank reconciliation from an audit standpoint?
2. When would an external bank confirmation provide more reliable evidence than a client’s own bank statement? Briefly explain.
3. List three common errors or issues that a bank reconciliation can help detect.
4. Identify one direct control and an appropriate test of control over payroll disbursement.

## **Introduction**

Cash and bank balances represent high-risk audit areas because they are liquid, easily transferable, and often subject to error or misappropriation. Accordingly, auditors must gather sufficient high-quality evidence to confirm the existence and accuracy of these balances. Payroll expenditure is also a key audit risk area due to its potential size and susceptibility to fraud or inadvertent errors. Core procedures include performing bank reconciliations, obtaining external confirmations from banks, and executing substantive and controls testing over payroll.

> **Key Term: bank reconciliation**
> A process that matches the bank statement balance to the company’s accounting records, identifying and explaining any timing differences or errors.

## Why Bank Reconciliations are Important

Bank reconciliations help demonstrate that recorded cash and bank balances are accurate and complete. By comparing the entity’s ledger with statements issued by independent banks, discrepancies arising from timing, errors, omissions, or fraudulent activity can be detected. Weaknesses in performing regular reconciliations can result in undetected errors or misstatements in the financial statements.

> **Key Term: external bank confirmation**
> Written evidence obtained directly by the auditor from a financial institution, confirming details such as balances, loans, and other arrangements at a specific date.

## The Bank Reconciliation Process

A typical bank reconciliation includes:

- Starting with the cashbook balance at period end.
- Adding deposits recorded by the company but not cleared by the bank (outstanding lodgements).
- Deducting cheques issued but not yet presented (unpresented cheques).
- Adjusting for direct credits, bank charges, interest, or errors not yet recorded in the cashbook.
- Reconciling to the balance as per the bank statement.

### **Worked Example 1.1**

Minto Ltd shows a cashbook overdraft of £2,000 at 31 December. The bank statement shows an overdrawn balance of £1,200. Outstanding lodgements of £1,500 and unpresented cheques of £700 exist.

**Question:** What is the reconciled balance, and what does the difference represent?

> **Answer:**  
> Cashbook (£2,000) + outstanding lodgements (£1,500) - unpresented cheques (£700) = (£1,200), matching the bank statement. The reconciliation accounts for timing differences.

## Obtaining and Interpreting Bank Confirmations

External confirmations provide direct written evidence from a third party and are more reliable than client-generated documentation. They are critical where there is higher risk of error or suspected management override.

Key features include:

- Confirmation of current account balances.
- Details of loans, overdrafts, security, and contingent liabilities.
- Information on unused facilities, guarantees, or legal disputes.

> **Key Term: substantive procedure**
> An audit test designed to detect material misstatements at the assertion level, such as inspection, recalculation, or confirmation.
>
> **Key Term: control activity**
> A policy or procedure implemented by management to prevent, detect, or correct errors and fraud in day-to-day operations.

### **Worked Example 1.2**

You send a bank confirmation request to GoldBank for the audit of Jardine Co. The confirmation received shows an overdraft of £20,000, but the client’s ledger shows nil balance.

**Question:** What audit action should you take?

> **Answer:**  
> Investigate the discrepancy immediately. Re-examine postings, review subsequent transactions, and discuss with management. If the difference is unresolved, consider the impact on the financial statements and your report.

### **Exam Warning**

> Failure to request a bank confirmation or accept client copies without proper verification is a frequent cause of audit failure. Always ensure confirmations are sent and returned directly to the auditor.

## Substantive Procedures Over Bank

Substantive audit procedures for cash and bank balances often include:

- Agreeing the closing bank balance per the bank reconciliation to the bank confirmation and final bank statement.
- Reviewing the bank reconciliation for mathematical accuracy.
- Tracing outstanding lodgements to pre-year-end cashbook entries and to post-year-end bank statements.
- Vouching unpresented cheques to the cashbook, and verifying subsequent clearing in bank statements.
- Inspecting bank statements after year end for unusual large transfers.

When cash is held physically (petty cash), auditors may count the balance unannounced and reconcile it to the ledger.

## Payroll: Audit Approach and Key Controls

Payroll is at risk from overstatement (e.g., fictitious employees), understatement (unpaid liabilities), or error (incorrect rates or calculations). Effective controls reduce these risks.

Common payroll controls include:

- Segregating duties between HR, payroll preparation, and payment authorization.
- Authorizing changes to pay rates and employee records.
- Reconciling total payroll per records to bank payments.
- Use of exception reports for overtime or unusual payments.

### **Worked Example 1.3**

Maple Ltd’s payroll process requires the payroll manager to review the monthly payroll listing before authorizing payment.

**Question:** How would you test the effectiveness of this control, and what assertion does it support?

> **Answer:**  
> Inspect a sample of payroll listings for evidence of review and authorization. This control addresses the accuracy and occurrence of payroll expenses.

## Common Pitfalls and Control Deficiencies

- Omitting regular bank reconciliations increases risk of undetected fraud or errors.
- Not independently reviewing the bank reconciliation weakens oversight.
- Allowing one person to control payroll setup, processing, and payment enables fraud.
- Relying solely on client-issued bank statements without third-party confirmation is insufficient.

### **Revision Tip**

> If bank reconciliations cannot be fully explained or do not balance, query the differences until satisfactorily resolved before drawing conclusions.

## **Summary**

A robust audit of cash, bank, and payroll covers both control and substantive procedures. Reliable evidence is obtained through complete bank reconciliations and direct external confirmations. Frequent bank reconciliations and control activities over payroll minimize the risk of misstatement. Weaknesses in performing these procedures may result in errors going undetected and increased audit risk.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain why bank reconciliations are a key audit control and how they provide evidence for existence, accuracy, and completeness assertions.
- Describe the process for obtaining and assessing external bank confirmations.
- List principal substantive procedures over cash, bank, and petty cash balances.
- Identify common payroll controls, potential deficiencies, and control tests.
- Recognize the importance of timely and independent review of reconciliations.
- Understand frequent errors in cash, bank, and payroll audits and remedial audit actions.

## **Key Terms and Concepts**

- bank reconciliation
- external bank confirmation
- substantive procedure
- control activity

Cash, bank, and payroll - Bank reconciliations and confirmations