Auditing Chapter 6

Which of the following control activities would best protect against the preparation of improper or inaccurate cash disbursements? a. All checks must be signed by an officer designated by the board of directors. b. All signed checks must be reviewed and compared with supporting documentation by the treasurer before mailing. c. All checks must be sequentially numbered and accounted for by internal auditors. d. All checks must be perforated or otherwise effectively canceled when they are returned with the bank statement.

b. Correct A final review by the treasurer can catch mistakes made in the processing of the payment. This also involves a review of the supporting documentation, an important consideration as well.

Immediately upon receipt of cash, a responsible employee should a. Record the amount in the cash receipts journal. b. Prepare a remittance listing. c. Update the subsidiary accounts receivable records. d. Prepare a deposit slip in triplicate.

b. Correct Effective control of cash requires that receipts be recorded promptly. For mail receipts, a listing of remittance advices by an employee not performing incompatible functions is a standard control activity. If the customer does not return the remittance advice, one should be prepared at the time the mail is opened. If remittance advices are not used, a list of receipts should still be made when the mail is opened.

Each morning the controller gets the prior day's list of remittances, a copy of the payment report, and a copy of the deposit slip returned from the bank. When comparing these items, the controller would be able to determine that a. No checks were returned for insufficient funds. b. The cash received and remittance advice received were maintained in a single batch. c. The accounts receivable system has controls over unauthorized access. d. The assistant controller does not also reconcile the subsidiary accounts payable.

b. Correct If the cash received was not deposited intact or remittances were not posted, the deposit slip amount would not match the remittances or the payments recorded.

Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? a. Understating the sales journal. b. Overstating the accounts receivable control account. c. Overstating the accounts receivable subsidiary ledger. d. Overstating the sales journal.

a. Correct Not recording sales on account in the books of original entry is the most effective way to conceal a subsequent theft of cash receipts. The accounts will be incomplete but balanced, and procedures applied to the accounting records will not detect the defalcation.

A good fraud prevention program should address employees' motivation to steal from the company. The best method for doing this is to a. Establish employee assistance programs. b. Require a fidelity bond on all employees. c. Require reconciliations of all accounts to be reviewed by a supervisor. d. Ensure that all accounts with high inherent risk of fraud are audited.

a. Correct Problems due to debt, addictions, or family problems motivate employees to commit frauds. Establishing an employee assistance program addresses these issues and ultimately may reduce the motivation to commit fraud for some employees.

When auditing with "fraud awareness," auditors should especially notice and follow up employee activities under which of these conditions? a. The company always estimates the inventory but never takes a complete physical count. b. The petty cash box is always locked in the desk of the custodian. c. Management has published a company code of ethics and sends frequent communication newsletters about it. d. The board of directors reviews and approves all investment transactions.

a. Correct Risk is high when the company always estimates the inventory but never takes a complete physical count.

During an audit of cash, the auditor is most concerned with the management assertion of a. Existence. b. Rights and obligations. c. Valuation or allocation. d. Occurrence.

a. Correct The existence of cash is always a relevant assertion for cash because an overstatement of cash might indicate that fraudulent revenue was recorded.

Which of these arrangements of duties could most likely lead to an embezzlement or theft? a. The inventory warehouse manager has responsibility for making the physical inventory observation and reconciling discrepancies to the perpetual inventory records. b. The cashier prepared the bank deposit, endorsed the checks with a company stamp, and delivered the cash and checks to the bank for deposit (no other bookkeeping duties). c. The accounts receivable clerk received a list of payments received by the cashier so he could make entries in the customers' accounts receivable subsidiary accounts. d. The financial vice president received checks made out to suppliers and the supporting invoices, signed the checks, and mailed the checks.

a. Correct The inventory warehouse manager could steal inventory and then manipulate the records to cover up the theft. This arrangement would violate proper segregation of duties because the manager has custody of assets and access to the records. The manager can steal and then conceal!

Which of the following combinations is a good way to conceal employee fraud but an ineffective means of perpetrating management (financial reporting) fraud? a. Overstating sales revenue and overstating customer accounts receivable balances. b. Overstating sales revenue and overstating bad debt expense. c. Understating interest expense and understating accrued interest payable. d. Omitting the disclosure information about related-party sales to the president's relatives at below-market prices.

b. Correct Overstating sales revenue and overstating bad debt expense by the same amount does not overstate net income or total assets (which is often a goal of financial reporting fraud). However, this action would help to hide a manager's theft of assets (i.e., embezzlement).

Which of the following is least indicative of fraudulent activity a. Numerous cash refunds have been made to different people at the same post office box address. b. Internal auditors cannot locate several credit memos to support reductions of customers' balances. c. Bank reconciliation has no outstanding checks or deposits older than 15 days. d. Three people were absent the day the auditors handed out the paychecks and have not picked them up four weeks later.

c. Correct Bank reconciliations that do not have outstanding checks or deposits older than 15 days are generally positive signs and are not indicative of fraudulent activity.

In preparing for the audit of cash, the auditors perform analytical procedures concerning cash balances. Which of the following would be the best source of information for use in the estimate of cash? a. Prior-years' balances. b. Management inquiry. c. Cash budgets. d. Aged accounts receivable reports.

c. Correct Budgets provided by management provide the best management estimates for the sources and uses of cash. Where cash receipts or cash expenditures vary from the budget by a material amount, a higher level of risk may be assessed.

Allison Everhart, an employee in accounts payable, believes she can run a fictitious invoice through the accounts payable system and collect the money. She knows payments are subject to an audit. Which account would be the best place to hide the fraud? a. Inventory. b. Wage expense. c. Consulting service expense. d. Property tax expense.

c. Correct Expense accounts are often good places to hide fraud because accounts are closed at the end of the year. Consulting expense is a particularly good place to hide a fraud because it provides no actual product that may be counted or compared to the expense.

Which of the following is an effective audit procedure that an auditor might use to detect kiting between intercompany banks? a. Review the composition of authenticated deposit slips. b. Review subsequent bank statements. c. Prepare a schedule of the bank transfers. d. Prepare a year-end bank reconciliation.

c. Correct Kiting involves a mismatching of dates of recording cash transactions around year end, and the schedule of bank transfers is designed to show all the relevant dates so the auditor can see that the entries were made in the proper periods.

If the auditor believes that a misstatement is or might be intentional and the effect on the financial statements could be material or cannot be readily determined, the auditor should do which of the following? a. Inquire of management as to the possibility of fraud. b. Discuss with the audit committee what should be done to prevent possible future misstatements. c. Perform procedures to obtain additional audit evidence to determine whether fraud has occurred or is likely to have occurred. d. Both a and b are correct. e. None of these is correct.

c. Correct Since the auditor believes that a discovered misstatement is or might be intentional, he/she should first perform additional procedures to obtain additional evidence to determine whether fraud has actually occurred.

Which of the following would the auditor consider to be an incompatible operation if the cashier receives remittances? a. The cashier prepares the daily deposit. b. The cashier makes the daily deposit at a local bank. c. The cashier posts the receipts to the accounts receivable subsidiary ledger cards. d. The cashier endorses the checks.

c. Correct The auditor would consider it incompatible because the cashier would have both custody of cash and record-keeping responsibility and, hence, could steal money and fix the records without interference by anyone else. The cashier could steal and then conceal!

Upon receipt of customers' checks in the mail room, a responsible employee should prepare a remittance list that is forwarded to the cashier. A copy of the list should be sent to the a. Internal auditor to investigate the list for unusual transactions. b. Treasurer to compare the list with the monthly bank statement. c. Accounts receivable bookkeeper to update the subsidiary accounts receivable records. d. Entity's bank to compare the list with the cashier's deposit slip.

c. Correct The individuals with record-keeping responsibility should not have custody of cash. Hence, those individuals should use either the remittance advices or a list of the remittances to make entries to the cash and accounts receivable control account and to the subsidiary accounts receivable records. Indeed, having different people make entries in the control account and in the subsidiary records is an effective control.

A code of ethics is an important element of a fraud prevention program. Which of the following would diminish the effectiveness of a company's code of conduct? a. The establishment of a chief ethics officer. b. The establishment of a hotline for reporting unethical behavior. c. The violation of the code of ethics by senior management. d. The posting of the code of ethics in the company workplace.

c. Correct The violation of the code of ethics by senior management would reduce the effectiveness of the code of ethics because the tone at the top would send the wrong message to employees that the code of ethics was not important.

In what way can audit procedures be modified to address assessed fraud risks? a. Obtain more reliable information. b. Perform procedures close to year-end. c. Apply computer-assisted techniques to all items. d. All of these are valid modifications.

d. Correct All three responses reflected in (a-c) would be appropriate modifications to address assessed fraud risks. As a result, this is the correct response.

Which of the following control activities could prevent a paid disbursement voucher from being presented for payment a second time? a. Vouchers should be prepared by individuals who are responsible for signing disbursement checks. b. Disbursement vouchers should be approved by at least two responsible management officials. c. The date on a disbursement voucher should be within a few days of the date the voucher is presented for payment. d. The official signing the check should compare it with the voucher and should stamp "paid" on the voucher documents.

d. Correct Cancellation of vouchers by stamping them PAID prevents the voucher from mistakenly being paid a second time.

Incorporating elements of unpredictability in the selection of audit procedures to be performed by auditors include all of the following except a. Varying the timing of the audit procedures. b. Selecting items for testing that have lower amounts or are otherwise outside customary selection parameters. c. Performing audit procedures on an unannounced basis. d. Sending attorney letters to every attorney listed under the legal expense account. e. None of these is correct.

d. Correct Sending attorney letters to every attorney listed under the legal expense account is common as it is important for auditors to inquire about any possible loss contingency. Since it is a customary procedure, this would not be an example of incorporating unpredictability into the selection of auditing procedures and would be the correct answer.

The best way to enact a broad fraud prevention program is to a. Install airtight control systems of checks and supervision. b. Name an "ethics officer" who is responsible for receiving and acting on fraud tips. c. Place dedicated hotline telephones on walls around the workplace with direct communication to the company ethics officer. d. Practice management "of the people and for the people" to help them share personal and professional problems.

d. Correct Since "people" are essential to a fraud prevention program, Practice management "of the people and for the people" to help them share personal and professional problems is the best long run way to stop fraud.

Fraud risk factors are events or conditions that indicate which of the following: a. An opportunity to carry out a fraud. b. An attitude or rationalization that justifies a fraudulent action. c. An incentive or pressure to perpetrate fraud. d. All of these are correct.

d. Correct The three factors that are likely to be present when fraud occurs are opportunity, motive, and the rationalization, which are reflected in responses (a-c).

Embezzlement is a type of fraud that involves a. An employee's misappropriating an employer's money or property not entrusted to him or her. b. A manager's falsification of financial statements for the purpose of misleading investors and creditors. c. An employee's mistaken representation of opinion that causes incorrect accounting entries. d. An employee misappropriating an employer's money or property entrusted to the employee's control in the employee's normal job.

d. Correct This statement is the textbook and criminological definition of embezzlement.

Fraud risk factors are events or conditions that indicate I. An incentive or pressure to perpetrate fraud. II. An opportunity to carry out the fraud. III. An attitude or rationalization that justifies the fraudulent action. Which of the following statements is true? a. I is a fraud risk factor. b. I and II are fraud risk factors. c. II and III are fraud risk factors. d. None of these is a fraud risk factor. e. I, II, and III are fraud risk factors.

e. Correct An incentive or pressure to perpetrate fraud is a correct response. In addition, an opportunity to carry out the fraud is a correct response. Finally, an attitude or rationalization that justifies the fraudulent action is a correct response. As a result, this answer is correct.