How do you audit and verify the cash flow statement using the direct method? (2024)

Last updated on Feb 15, 2024

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1

Review the cash receipts and payments

2

Reconcile the cash balances

3

Trace the cash flows to the income statement and the balance sheet

4

Evaluate the reasonableness and completeness of the cash flows

5

Test the mathematical accuracy and presentation of the cash flow statement

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Here’s what else to consider

The cash flow statement is one of the most important financial reports for any business. It shows how much cash is generated and used by the operating, investing, and financing activities of the company. The direct method of preparing the cash flow statement is preferred by many users because it provides more detailed information about the sources and uses of cash. However, it also requires more data and analysis than the indirect method, which starts from the net income and adjusts it for non-cash items. How do you audit and verify the cash flow statement using the direct method? Here are some steps you can follow to ensure the accuracy and completeness of the cash flow statement.

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How do you audit and verify the cash flow statement using the direct method? (10) How do you audit and verify the cash flow statement using the direct method? (11) How do you audit and verify the cash flow statement using the direct method? (12)

1 Review the cash receipts and payments

The first step is to review the cash receipts and payments recorded in the cash book or the general ledger. You need to check that they are classified correctly into operating, investing, and financing activities, and that they are consistent with the bank statements and other supporting documents. You also need to identify any non-cash transactions, such as depreciation, amortization, stock-based compensation, or exchange rate differences, and exclude them from the cash flow statement.

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2 Reconcile the cash balances

The next step is to reconcile the cash balances at the beginning and end of the period. You need to compare the cash balances reported in the cash flow statement with the cash balances shown in the balance sheet and the bank reconciliation statement. You need to explain any differences or discrepancies, such as outstanding checks, deposits in transit, bank errors, or adjustments for reconciling items.

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  • Reconciling Cash Balances with Precision:Proceed by meticulously reconciling the cash balances appearing at the beginning and end of the designated period.Conduct a critical comparison between the cash balances presented in your cash flow statement, balance sheet, and bank reconciliation statement, ensuring utmost accuracy.Investigate and provide clear explanations for any discrepancies or variances identified, such as outstanding checks, deposits in transit, potential bank errors, or necessary adjustments for reconciling items.Maintain meticulous documentation throughout the reconciliation process, ensuring transparency and auditability.

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3 Trace the cash flows to the income statement and the balance sheet

The third step is to trace the cash flows from the operating, investing, and financing activities to the income statement and the balance sheet. You need to verify that the cash flows are derived from the changes in the relevant accounts, such as accounts receivable, inventory, accounts payable, fixed assets, long-term debt, or equity. You also need to check that the cash flows are consistent with the accounting policies, standards, and principles applied by the company.

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  • Seamless Integration: Cash Flows & Financial Statements:Establish a clear path by meticulously tracing the cash flows from each activity (operating, investing, financing) to their corresponding accounts within the income statement and balance sheet.Verify meticulous alignment between the cash flow movements and the changes observed in relevant accounts, such as accounts receivable, inventory, accounts payable, fixed assets, long-term debt, or equity.Ensure strict adherence to the established accounting policies, standards, and principles adopted by the company throughout the tracing process.Employ a meticulous and documented approach to guarantee the accuracy and integrity of the traced cash flows.

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4 Evaluate the reasonableness and completeness of the cash flows

The fourth step is to evaluate the reasonableness and completeness of the cash flows reported in the cash flow statement. You need to assess whether the cash flows reflect the nature and performance of the business, and whether they are in line with the industry trends, benchmarks, and expectations. You also need to look for any unusual or significant cash flows, such as large or frequent transactions, related party transactions, or transactions with tax implications, and obtain sufficient audit evidence and explanations for them.

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  • Testing for reasonableness is definitely important. In addition to the steps mentioned, as a means of testing the reasonableness of the calculated cash flows, we can: ✅Compare the cash flows from each section (from operating activities, financing activities, and investing activities) over multiple periods and question the reason(s) for any significant variances; ✅Compare the cash flows from investing activities to the changes in balances of relevant accounts on the balance sheet (e.g. fixed assets, investments);✅Similarly compare the changes to financing activities with the changes in relevant accounts on the balance sheet (e.g. loan payable, equity accounts).Zoom out and evaluate the numbers in the context of the bigger picture.

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  • Scrutinizing Cash Flows for Reasonableness and Completeness:Conduct a thorough assessment to determine if the reported cash flows accurately reflect the business's nature, performance, and overall financial health.Compare the cash flows to industry benchmarks, trends, and expectations to identify any potential discrepancies or anomalies.Scrutinize any unusual or significant cash flows, including large/frequent transactions, related party dealings, or tax-related transactions, seeking sufficient audit evidence and clear explanations.Maintain a skeptical mindset and document your findings and conclusions thoroughly.

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5 Test the mathematical accuracy and presentation of the cash flow statement

The final step is to test the mathematical accuracy and presentation of the cash flow statement. You need to check that the cash flows are added and subtracted correctly, and that the net increase or decrease in cash equals the difference between the cash balances at the beginning and end of the period. You also need to check that the cash flow statement is properly formatted, labeled, and disclosed, and that it complies with the relevant accounting standards and regulations.

By following these steps, you can audit and verify the cash flow statement using the direct method and provide an independent opinion on the reliability and fairness of the financial information.

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  • Meticulous Finishing Touches: Accuracy & Presentation:Conclude by rigorously verifying the mathematical accuracy of the cash flow statement. Ensure every addition, subtraction, and calculation yields precise results.Reconcile the net increase or decrease in cash with the difference between the beginning and ending cash balances, guaranteeing alignment.Scrutinize the statement's presentation, meticulously assessing formatting, labeling, and disclosures for clarity and adherence to established accounting standards and regulations.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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  • The cashflow statement should agree with the balance sheet as well as the profit and loss statement or income statement. The cashflow statement shows transactions which affect both balance sheet and profit and loss /income statement.

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