There are numerous reasons to analyze BRS prepared by an entity. One major reason why should an auditor has to be vigilant while performing BRS audit is discussed below.
BRS is a statement prepared to reconcile or tally the balance shown in cash book of an entity with that of bank statement. There could be certain reasons for the difference. Out of which one is cheque issued by the entity for payment but not presented by vendor.
Q1: Let's examine how fraudsters take advantage of this opportunity?
Fraudsters prepare cheques but not hand over to the vendors (i.e. in actual no payment will be made to the payee which results in creation of fictitious payment) and cheques are kept in the custody of issuer.
Since no cheque is presented by vendor, balance as per cash book is reduced through such payments, however, corresponding funds remain in bank (in actual no flow of funds from the bank account). Such funds are called Secret Reserves, which are used illicitly for other purposes.
Secret reserve could be created for tax evasion, or for future utilization as and when opportunities arise for fraud.
Q2: Why such situation will arise that payee will not ask for the payment?
Sometimes fraudster gets an opportunity where vendors or payee are not aware that they are entitled to any such payment or where account has been settled in some other manner by vendors.
For example: donations made may not be even known to donee organizations. This happened in case where an amount of Rs.12 lakhs was generously donated by workers, which was deducted from their wages in a company to donate to Gujarat Earthquake Relief Fund (GERF). This cheque in favor of GERF was prepared, accounted for in the books and even signed by the company, but never was delivered to GERF. Instead the funds were kept as a secret reserve for the company for its use in future.
Another example, where to reduce Profit, Company accounts fake expenses. In this case no real creditor exists but company has to show the payment against those increased expenses. So cheques and vouchers are entered in books but no actual fund flows out of the bank account, thus it results in creating Secret reserves.
Similarly, cheque deposited but not cleared may reveal existence of 'teeming & lading' or lapping process where credit of payment received from one party temporarily diverted to benefit another party.
Q3: How one can check such kind of transactions?
Take immediate 3 months subsequent bank statement after financial year end to trace the reconciling item.
Check whether all the cheques issued but not presented appearing in BRS get clear within 3 months of its issue. Since cheque only remain valid for 3 months after its issuance, therefore, if not presented within stipulated time, gets expire and is not encashable, same should get reversed in books that will ultimately increase the bank balance.
Similar exercise should be done for cheque deposited but not cleared.