Statutory Audit of Cash and Cash Equivalents in Indian Companies [Company Law]

written by ADMIN | March 17, 2025

Introduction

Cash and cash equivalents (CCE) are among the most critical items in a company’s balance sheet due to their high liquidity and vulnerability to fraud. This category includes cash in hand, bank balances, and highly liquid short-term investments that can be quickly converted into cash within three months. Because of the ease with which cash can be manipulated, auditors must apply stringent procedures to ensure that reported balances are accurate and free from misstatement.

This guide provides a comprehensive approach to auditing cash and cash equivalents under Indian laws, addressing key queries, potential risks, a detailed legal framework, and practical case studies to enhance understanding.

 

Objectives of Auditing Cash and Cash Equivalents

The primary objectives of auditing CCE include:

  1. Existence: Confirm that cash and bank balances actually exist as reported.
  2. Valuation: Ensure that the balances are accurately recorded and classified.
  3. Completeness: Verify that all transactions related to CCE are properly accounted for.
  4. Presentation & Disclosure: Ensure compliance with Schedule III of the Companies Act, 2013, and applicable accounting standards.
  5. Fraud Detection: Identify any misappropriation, unauthorized transactions, or unrecorded cash movements.

 

Audit Methodology

1. Understanding the Business & Risk Assessment

  • Evaluate the company’s internal controls over cash handling and bank transactions.
  • Identify risks like unauthorized withdrawals, fictitious cash balances, or fraudulent transactions.
  • Assess compliance with banking regulations, including RBI guidelines and tax laws.

 

2. Substantive Audit Procedures

Physical Verification of Cash in Hand

  • Conduct surprise cash counts at different locations to verify reported balances.
  • Compare the actual cash on hand with the book balance and investigate any discrepancies.
  • Review cash expenditure records to check for unauthorized payments or misstatements.

Bank Balance Verification

  • Obtain direct bank confirmations to verify balances, outstanding loans, or overdrafts.
  • Review bank reconciliations for long-unreconciled transactions.
  • Examine high-value transactions near the year-end for potential misclassification or fraudulent transfers.

Verification of Fixed Deposits (FDs) & Short-Term Investments

  • Ensure that fixed deposits with maturity beyond three months are not classified as cash equivalents.
  • Verify interest income recognition and ensure that deposits are properly disclosed in financial statements.

Cut-off Testing

  • Verify transactions recorded near the year-end to check for back-dated entries or missing adjustments.

Reconciliation of Cash & Bank Balances

  • Review cheques in transit, uncredited deposits, and unpresented cheques.
  • Investigate stale or duplicate entries that could indicate fraud.

Testing for Unauthorized Transactions

  • Examine large cash withdrawals, unusual bank transfers, and unauthorized payments.

Assessing Internal Controls over Cash Handling

  • Verify dual authorization for cash transactions.
  • Check segregation of duties to prevent misappropriation.

Examination of Foreign Currency Transactions

  • Ensure compliance with RBI guidelines and foreign exchange accounting standards.

 

Legal Framework

1. Companies Act, 2013

  • Section 128: Requires companies to maintain proper books of accounts, including cash and bank records.
  • Section 129: Ensures that financial statements present a true and fair view, including accurate cash balances.
  • Schedule III: Mandates classification and disclosure of cash and cash equivalents.

2. Accounting Standards & Ind AS

  • AS 3 (Cash Flow Statement): Defines cash and cash equivalents.
  • Ind AS 7 (Statement of Cash Flows): Provides guidelines for classification and reporting.

3. Standards on Auditing (SAs)

  • SA 500 (Audit Evidence): Guides the collection of sufficient audit evidence.
  • SA 505 (External Confirmations): Governs bank balance confirmations.
  • SA 530 (Audit Sampling): Helps in verifying cash transactions and reconciliations.

4. Income Tax Act, 1961

  • Section 40A(3): Disallows cash payments exceeding ₹10,000 for business expenses.
  • Section 269ST: Prohibits cash receipts exceeding ₹2 lakh from a single party in a day.

5. Goods and Services Tax (GST) Compliance

  • Ensure cash payments are not being used to bypass GST compliance.

 

Practical Examples

Example 1: Cash Shortage

  • Scenario: During a surprise cash count, ₹1 lakh is missing from the reported balance.
  • Audit Approach: Verify cash expense records, interview cash handlers, and review security footage if available.
  • Insight: Cash shortages often indicate fraud, unrecorded expenses, or mismanagement.

Example 2: Unreconciled Bank Entries

  • Scenario: A ₹3 lakh cheque deposited two months ago still doesn’t appear in the bank statement.
  • Audit Approach: Review bank reconciliation statements and inquire with the bank.
  • Insight: Long-pending reconciliation items can indicate fictitious transactions or fraud.

Example 3: Unusual Cash Withdrawals

  • Scenario: A company withdraws ₹25 lakh in cash with no clear justification.
  • Audit Approach: Scrutinize withdrawal records, verify supporting documents, and interview finance personnel.
  • Insight: Large cash withdrawals may indicate fraud or tax evasion.

Example 4: Misclassification of Fixed Deposits

  • Scenario: ₹10 crore in FDs classified as cash equivalents.
  • Audit Approach: Check maturity dates and liquidity conditions.
  • Insight: Incorrect classification distorts financial ratios and liquidity analysis.

Example 5: Unrecorded Bank Charges

  • Scenario: Bank charges of ₹1 lakh are missing from the books.
  • Audit Approach: Reconcile bank statements and adjust records.
  • Insight: Unrecorded charges understate expenses and overstate profits.

Example 6: Unauthorized Bank Signatories

  • Scenario: A former CFO still has bank signing authority.
  • Audit Approach: Verify authorized signatory lists and ensure timely updates.
  • Insight: Unauthorized signatories pose a high fraud risk.

Example 7: Manipulation of Cash Flows

  • Scenario: Large inflows just before year-end, reversed in the next period.
  • Audit Approach: Investigate transaction authenticity and rationale.
  • Insight: Such transactions may be used to inflate financial statements.

Example 8: Foreign Currency Transactions Not Recorded Properly

  • Scenario: A company’s USD deposits are not adjusted for forex gains/losses.
  • Audit Approach: Verify exchange rates and ensure compliance with forex regulations.
  • Insight: Non-compliance can result in penalties and misstated profits.

 

Conclusion

Auditing cash and cash equivalents is crucial due to their susceptibility to fraud and manipulation. A well-structured audit approach, incorporating surprise cash counts, bank confirmations, and analytical procedures, ensures financial integrity and regulatory compliance. Given the high risks associated with cash transactions, auditors must exercise due diligence to detect irregularities and ensure the reliability of financial statements.

 

Author

 

 

 

 

 

CA Sourabh Kothari (C.A., B.Com)
He is currently working as Partner – Risk and Transaction advisory with a renowned firm in Jaipur having experience in Internal Audit, IFC Audit, Business consultancy, Due Diligence and Management consultancy.
E-mail: Sourabh.kothari@jainshrimal.in | LinkedIn: Sourabh Kothari

 

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