The audit of cash flow statements is an area that offers opportunities for improvement, as regulators such as the Financial Reporting Council (FRC) repeatedly find that this primary financial statement is not given sufficient focus, leading to errors and weaknesses that go unnoticed by preparers and auditors. 

The following questions consider a few of the issues that were on the minds of auditors who attended the faculty webinar, Tips and common pitfalls in preparing and auditing cash flow statements, which is available as a recording with slides and other support resources.

How can you improve the audit of cash flow statements?

There are many potential answers to this question. If you are responsible for auditing the cash flow statement, then reading this article and watching the faculty webinar should help. Among other things, the webinar highlights some of the common root causes that can result in preparer and auditor errors relating to the cash flow statement, which can help you to understand what may be going wrong and take steps to avoid and/or address such issues.

As the entire audit team have a collective responsibility to get the audit of the cash flow statement right, they can assist by, for example, considering not just how the elements they are responsible for are audited but also how they should be reflected in the cash flow statement and disclosures, and communicating this to a team member who is responsible for auditing the cash flow statement. It is particularly important because accounting entries relating to significant risks can also have a cash flow statement impact. Of course, these are just some of the possibilities.

What is the first thing you do when auditing a cash flow statement?

Before any audit work is done on the cash flow statement, it’s a good idea to make sure that the right person will be doing this. Do they have sufficient experience and seniority? Have they been briefed? Did they attend the planning meeting? Do they know enough about the audit client? Do they have a good overview of the client’s activities and how those activities impact the cash flow statement? Are they aware of developments that have happened over the year?

Then the most important starting point is making sure that you have got the balances right for cash and cash-equivalents. 

You must do your normal bank confirmation processes to get the cash number right, because if you’re not reconciling the right number with your cash flow statement you’ll be in real trouble. Then, I would talk to members of the audit team about areas that they are working on, trying to draw out where there have been movements, building an expectation of what I would expect to see in the cash flow statement. 

Only then would I go on to do the work – and that would be quite detailed. 

Obtaining the opening and closing balance sheets and drawing out movements, breaking those down into their individual components, then relaying that back to my knowledge about the cash flow statement and the movements during the year. Looking to see, for example, whether anything is missing, whether there is anything I need more information about. That’s where I’d start.

Preparing the cash flow statement is the responsibility of the audit entity, but sometimes auditors get pulled into this. What do auditors need to remember about the self-review threat?

Auditors must be careful not to lose their independence by being drawn into preparing the cash flow statement for the client. The fundamental rule applies: you can’t audit your own work. 

Many auditors will have experience of cash flow statements that are incomplete or contain lots of errors and as auditors we can provide the client with feedback on that and ask questions about numbers, particularly where they do not make sense, but we should not do accounting work for the client. Making that distinction is important. 

Can the cash flow statement be audited in isolation?

This is dangerous. What is happening in the rest of the financial statements is integral to the audit of the cash flow statement. If the cash flow statement is audited in isolation, something may be missed. There could be significant cash flows in other areas and if there are, you need to capture this information.

Those responsible for auditing the cash flow statement should ask questions of other team members who are responsible for the other financial statement areas, to identify whether the cash and non-cash transactions have been appropriately included or excluded from the cash flow statement and, where appropriate, disclosed in the financial statements.

It’s also important to read the ‘other information’ to check that transactions and arrangements disclosed in the front end, for example, in relation to an acquisition or issue of equity, are reflected in the cash flow statement. The cash flow auditor needs to make sure that the cash flow statement is telling the same story that’s in the rest of the financial statements.

What audit evidence should I expect to see on file for the audit of a cash flow statement?

This can vary depending on circumstances. Where a firm has developed audit programmes to document the audit of a cash flow statement, I would expect to see that information on the audit file. If a firm uses an accounts disclosure checklist, I would expect to see this filled out and completed on the file, including a section on the cash flow statement. 

In response to an earlier question, I mentioned the detailed audit work that’s needed on the opening and closing balance sheets, and the differences between those two balance sheets being broken down into the components – and I would expect the file to show how each one of the movements has been audited. 

Obviously, they might be audited in a number of different places within the file, but I would expect the cash flow statement analysis to signpost to where such things have been audited. If they have not been audited, I would expect them to get audited in some way. That’s very important. 

All sorts of firms will have different ways of doing this. An audit programme, for example. A spreadsheet noting differences and how those have been investigated – this is the basic sort of information I would expect to see, as well as the information about cash and cash-equivalents and the bank letters that have been sent out to make sure that those balances are correct.

Do I always need to get a bank confirmation or can I just use the bank statement?

In my view you do always need to get a bank confirmation. Others may not agree and ISA 505 does not mandate it, but I think that relying on bank statements is a very risky thing to do. Consider what has happened with recent high-profile cases and problems there around bank accounts and bank confirmations. I think that a bank confirmation is one of the best pieces of audit evidence we can get.

If something goes wrong everyone focuses on the cash and one of the first questions a regulator will ask is whether you obtained a bank confirmation and if not, why not. I would be very reluctant to normalise accepting alternative procedures, particularly if we are only doing so because we have run out of time. 

As auditors, if we plan ahead we should always be able to get a bank confirmation. Often, the ones that are most difficult to get are the ones that you really want to get and we should start the process early if we know there will be difficulties.

Hugh Morgan, Technical Director, RSM UK, and Chair of ICAEW’s Technical and Practical Auditing Committee.