Chapter 22 Cash

You are auditing the financial statements of Fine Food Limited (“FFL”) for the year ended 31
December 2016. Included in FFL’s 2016 financial statements, bank balances of HK$28,000,000 and a
time deposit of HK$500,000,000 were recorded.
The following are the bank reconciliations prepared by FFL

Notes:
During the course of the audit, the financial controller of FFL gave you further information:
(a) The rejected cheque was due to inadequate funds in the customer’s bank account.
(b) The loan of HK$2,000,000 was made to a director of FFL on 31 December 2016 which was not
recorded in the financial statements.
Time deposit:
The financial controller of FFL provided you with a time deposit slip issued by Easy Bank (A bank
located in Scotland) on 1 September 2013 when the time deposit was initially made. Its respective
terms are as follows:
Principal amount: HK$500,000,000
Term: Not specified, withdrawal of the time deposit is permitted at any time
Interest rate: 3% per annum payable on a quarterly basis
Required:
(a) For reconciling item (i), explain the possible causes of this incidence. Propose adjustment(s) to
correct the misstatements that may exist in FFL’s 2016 financial statements. (4 marks)
This long outstanding unpresented cheque may be caused by the delay in presenting the
cheque by the supplier. As cheques typically become invalid 6 months after the issue
date, FFL now owes the supplier HK$5,000,000. Therefore, an adjustment should be made
to increase the cash balances and the trade payables by HK$5,000,000 in FFL’s 2016
financial statements.

Dr: Cash 5M; Cr: AP 5M

(b) For reconciling item (ii), propose adjustment(s) to correct the misstatements and advise the
implications that may exist in FFL’s 2016 financial statements. (4 marks)
The audit team should propose an adjustment to increase the trade receivable balance and to
decrease the bank balance by HK$4,000,000.

Dr: AR 4M; Cr: Cash 4M

(Below are practical considerations but are not required by this course)
The presentation on the statement of financial position may also be wrong because the
balance should have been presented as “bank overdraft” in the current liabilities instead
of bank balances in the current assets.
The rejected cheque due to inadequate funds in the customer’s bank account may
indicate that the customer has financial difficulty which may cause FFL to reconsider
impairment provision.
Inadequate impairment provision would cause an understatement of expenses.

(c) For reconciling item (iii), propose adjustment(s) to correct the misstatements that exist in FFL’s
2016 financial statements. (4 marks)
An advance to a director before the year-end date not recorded would result in bank
balances being overstated and an omission of the loan to a director. Accordingly, the
proposed adjustment to correct this misstatement is to record the “Loan to a director” of
HK$2,000,000 and decrease the bank balances by the same amount in FFL’s 2016 financial
statements.

Dr: Loan to a director (other receivables) 2M; Cr: Cash 2M

(Below are practical considerations but are not required by this course)
The loan to a director would also be required to be disclosed in FFL’s financial statements
because the director is a related party of FFL who is subject to additional disclosure.
(d) With respect to the time deposit, the financial controller of FFL considers that it may take too long
for Easy Bank to reply regarding the bank confirmation. He asks you to rely on the time deposit slip
instead of sending a bank confirmation request to Easy Bank. Advise and explain whether you would
rely only on the time deposit slip as audit evidence to confirm its existence. (3 marks)
I would not rely only on the time deposit slip as audit evidence to confirm its existence. The time
deposit slip is not adequate to prove its existence at the year-end date because FFL could have
withdrawn the time deposit subsequent to 1 September 2013 and such withdrawal could not be
reflected in this time deposit slip.
Bank confirmation is considered as a more relevant and reliable audit evidence to confirm the
existence of the time deposit at the year-end date.
In addition, bank confirmations allow the auditor to obtain information of other matters such as loans,
notes payables, factoring, or the use of assets as collaterals.