Kiting is where, in the bank account of one entity within a group of companies, a cheque is drawn on balance date payable to another entity within the group but is recorded in the general ledger of the first entity as a disbursement that occurred after balance date. The cheque is then recorded as a deposit in the bank account of the second entity on balance date and appears as an outstanding deposit in the reconciliation of that entity's general ledger "cash at bank" account with the bank statement. Kiting may also take place within the one entity, where the entity has more than one bank account.
For example, consider the general ledger bank accounts of a group comprising entity A and entity B with a balance date of December 31. The same employee is responsible for drawing cheques on the bank accounts of both entities, and is also responsible for the reconciliation of the balance in the bank accounts in the general ledger with the balance on the bank statements. On December 31, a cheque is drawn on A's bank account payable to B for an amount of 60 but is recorded in the general ledger of A as a disbursement that occurred after balance date. The cheque is treated by B as an outstanding deposit as at December 31, and deposited into B's bank on January 1. The general ledger accounts for cash at bank would appear as follows:
| Entity A - Cash at bank | Entity B - Cash at bank | |||||
|---|---|---|---|---|---|---|
| Dec 30 | Balance | 100 | Dec 30 | Balance | 100 | |
| Dec 31 | Dec 31 | Deposit from A | 60 | |||
| Dec 31 | Balance | 100 | Dec 31 | Balance | 160 | |
| Jan 1 | Cheque to B | 60 | Jan 1 | |||
| Jan 2 | Balance | 40 | Jan 2 | Balance | 160 | |
The group financial statements based on the above recorded values will show total cash at bank of 260 at year end, whereas the correct amount is 200. Note that the same principle applies to one entity that has more than one bank account.
The auditor can detect this form of kiting by ensuring any outstanding deposit appearing on a bank reconciliation at balance date that arises from an inter-entity cheque (in the example, the deposit from A of 60) is also recorded by the paying entity as a cheque drawn prior to balance date (and not, as shown above, as a cheque drawn after balance date).
Clients can reduce the risk of this type of fraud by ensuring that persons responsible for authorizing or signing cheques are not also responsible for the preparation of the reconciliation of the general ledger "cash at bank" account with the bank statement (in other words, by ensuring organizational independence).
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