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Audit & Beyond

Strengthening the audit of cash flow statements

Author: ICAEW

Published: 12 Jan 2024

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All firms may find opportunities to enhance their audit of cash flow statements.

Cash flow statements are an area where regulators, such as the UK’s Financial Reporting Council (FRC), repeatedly find errors during reviews and inspections of financial statements and their audit. Over recent years the FRC has shared its findings in a thematic review of cash flow and liquidity disclosures (2020), a thematic briefing on the audit of cash flow statements (2021), its annual audit firm specific reports for 2023 and previous years and in other official outputs.

The FRC has identified cash flow statements as an area of supervisory focus during its 2024/25 programme of audit quality inspections and corporate reporting reviews.

This article highlights common and significant errors and weaknesses the FRC finds in cash flow statements and their audit, offers insights into some root causes, and shares examples of how some firms have strengthened the audit of cash flow statements.

All audit firms should look carefully at how they undertake the audit of cash flow statements

Basic disclosure errors

Basic errors in cash flow statements are not unusual. In its thematic review of cash flow and liquidity disclosures, the FRC notes that most of the errors it finds could have been avoided if the company had a robust pre-issuance review built into its financial statement close process. Basic errors often become evident during a desktop review of accounts by the FRC. 

Many such errors relate to missing cash flows or misclassification of cash flows between operating, investing, and financing activities. The FRC also sees inconsistencies in how accounting policies are applied for similar items, such as interest payments on leases and interest on borrowings, and inconsistencies between amounts presented in the cash flow statement and amounts disclosed elsewhere in the financial statements. The FRC highlights several areas of improvement in the disclosure of accounting policies. 

The disclosures thematic also offers examples of better disclosure. Three years on, in its 2023 Annual Review of Corporate Reporting the FRC notes that it continues to find, through its desktop reviews, a significant number of issues with cash flow statements. There are, it reports, fewer routine errors, although basic consistency checks are still lacking, and many errors are still being identified with netting and reporting non-cash movements within the cash flow statement.

The 2023 review of corporate reporting also offers a reminder that companies need to carefully consider how current economic conditions, such as high inflation and rising interest rates, may impact on cash flows – and outlines its disclosure expectations for 2023/24.

Actions for auditors

Although the cash flow statement is a primary statement, the FRC finds that it does not always get the necessary amount of audit input. According to the FRC’s 2023 Audit Quality Inspection and Supervision Report, there were increased findings in areas relating to cash and cash equivalents and, although these examples were identified in audits conducted by the largest UK firms, smaller firms should not be complacent.

It’s important to remember that all auditors must obtain sufficient and appropriate audit evidence to assess whether cash and cash equivalents are accurately recognised in the financial statements. This includes ensuring that the cash flow statement is accurately presented.

The 2023 audit inspection and supervision report found, for example, instances where audit teams had not adequately tested the cash and cash equivalents balance or the cash flow statement. Audit teams did not identify material errors in the classification of cash flows in the cash flow statement, did not identify inappropriate netting of cash and overdraft balances on the face of the balance sheet, conducted insufficient confirmation procedures over cash and cash equivalent balances (including short-term deposits), and did not perform adequate alternative procedures.

Firms often have well-established policies and procedures around the audit of cash and cash flow statements, but they may benefit from being reviewed and enhanced. The FRC recommends that firms do more to update them, to reflect internal and external inspection findings and the findings of its 2020 thematic review on cash flow and liquidity disclosures. 

Firms need to update policies and procedures around the audit of cash and cash flow statements

The FRC’s 2021 thematic on the audit of cash flow statements recommends that all audit firms should look carefully at how they undertake the audit of cash flow statements.

As cash flow statement movements are linked to other audited primary financial statements, the amount of audit work on this must be sufficient to reach an appropriate audit opinion or to identify matters that should be corrected/reported to those charged with governance. 

Root causes

Common root causes of inadequacies the FRC has identified in the audit of cash and cash flow statements include:

  • internal consistency checks by the audit team across the financial statements not picking up basic errors in the cash flow statement;
  • the audit team not always adequately challenging management on the accounting policies applied and disclosures made affecting the cash flow statement;
  • guidance available to the audit team to deal with technical and complex judgements was not always sufficient or embedded through staff awareness, methods, and training;
  • the review process did not always identify and adequately respond to matters identified in the audit; and
  • use of spreadsheets and the manual nature of cash flow workings by companies increased the complexity of auditing the consolidated cash flow statement. 

Ways in which audit firms are addressing such issues include:

  • assigning cash flow statement audit work to more senior members of the audit team;
  • increasing the emphasis on audit evidence recorded;
  • enhancing internal supervision and review of cash flow statement audit work;
  • briefings and training for audit staff;
  • changing audit templates/audit programme to reinforce existing methodology or introduce new procedures;
  • discussing the cash flow statement approach at planning/ team meetings; and
  • reporting to those charged with governance on capacity/capability of the finance team and controls/process recommendations.

Such steps can lead to various benefits. 

Considering the audit of cash flow statements during the planning phase offers an opportunity to address factors affecting other primary statements, such as the complexity of the group structure, change events, audit team staff mix, and quality of the audit entity’s procedures and systems. 

Performing a thorough review of audit procedures performed can reduce the risk of less experienced staff (who may not understand the entity) not identifying errors from change events and internal consistency errors. Late changes to the financial statements can also be addressed.

Appendix 1 to the thematic on the audit of cash flows also offers information and insights that auditors may find useful. It lists 10 errors in cash flow statements (taken from the FRC’s cash flow disclosures thematic) and identifies if and how those errors would impact cash flows for operating, investing, and financing. 

Enhancing the audit of cash and cash flow statements can also reduce errors and minimise the need for restatements.

So, there are plenty of opportunities for auditors to strengthen their audit of cash and cash flow statements, and plenty of reasons why all audit firms should do so.

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