Chapter 10 Revenue Cycle: Cash and Financial Investments

(a) Which of the following controls would most likely reduce the risk of diversion of customer receipts by a client's employees? 1. A bank lockbox system. 2. Prenumbered remittance advises. 3. Monthly bank reconciliations. 4. Daily deposit of cash receipts.

1. A bank lockbox system.

What are cash equivalents?

Can be converted to cash on short notice such as money market funds, CDs, and other types of deposits.

Explain how a lockbox system contributes to internal control over cash receipts.

Lockboxes hasten the deposits of cash receipts. The lockboxes are controlled by the companies bank and is checked several times a day, the cash deposits are credited to the company's account and remittances are sent to the company. The bank does not have any control over the company's accounting records.

What is the "acronym" for the objectives of the cash audit?

P - presentation and disclosure E - existence R - rights C - completeness I - inherent risks related to cash, including fraud risks I - internal control over cash transactions

Management Assertions: Explain the P in PERCV.

Presentation and Disclosure - Accounts are described and classified in the financial statements in accordance with GAAP, and all material disclosures are provided.

What is inherent risk?

Risk of a material misstatement occurring in an assertion assuming no related internal controls.

Who requests the cutoff bank statement?

The client will request the cutoff bank statement from the bank and mail it directly to the auditors.

What is a control listing?

The control listing shows the amount received from each customer and identifies the customer by name or by account number.

During your reconciliation of bank accounts in an audit, you find that a number of checks for small amounts have been outstanding for more than a year. Does this situation call for any action by the auditor? Explain.

The old outstanding checks should be eliminated as they cause unnecessary clerical work in each bank reconciliation and also represent a threat to good internal control. A dishonest employee may conceal a cash shortage merely by omitting old outstanding checks from the bank reconciliation. The auditor should prepare a list of the old checks and ask the client to contact the payees and request them to present the checks for payment. If this is not feasible, the checks should be eliminated by restoring the appropriate amount to the cash balance and setting up a special liability account.

What is audit risk?

The risk that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated. Formula: risk of material misstatement (IR & CR) x risk that the auditors fail to the misstatement (DR)

What is a compensating balance?

Under the terms of a bank loan agreement, the cash in a company's general account sometimes must be maintained at a specified minimum balance, referred to as a compensating balance.

What information do CPAs request from a financial institution on the standard confirmation form?

amounts on deposit, whether accounts are interest-bearing and/or subject to withdrawal, and direct liabilities (loans) of the client from the financial institution.

What is detection risk?

Risk that the auditors' procedures will lead them to conclude that a material misstatement does not exist in an assertion when in fact such misstatement does exist.

Management Assertions: Explain the R in PERCV.

Rights and Obligations - The client has rights to assets and obligations to pay liabilities that are included in the financial statements.

What is control risk?

Risk that a material misstatement in an assertion will not be prevented or detected on a timely basis by the company's internal control.

What are two reasons auditors use a cutoff bank statement?

1. To determine that checks issued on or before the balance sheet date and paid during the cutoff period were listed as outstanding on the year-end bank reconciliation. 2. To determine that reconciling items shown on the year-end bank reconciliation have cleared the bank within a reasonable amount of time.

What information should be noted by the auditors during their inspection of securities on hand?

(a) name of issuing company, (b) face amount, (c) serial number, (d) maturity date, (e) date and rate of interest or dividends, (f) presence of all future interest coupons, and (g) name in which registered.

What is a cutoff bank statement?

A statement covering a specified number of business days (usually 7 to 10) following the end of the client's FY.

(e) You have been assigned to the year-end audit of a financial institution and are planning the timing of audit procedures relating to cash. You decide that it would be preferable to: 1. Count the cash in advance of the balance sheet date in order to disclose any kiting operations at year-end. 2. Coordinate the count of cash with the cutoff of accounts payable. 3. Coordinate the count of cash with the count of marketable securities and other negotiable assets. 4. Count the cash immediately upon the return of the confirmation letters from the financial institution.

.3. Coordinate the count of cash with the count of marketable securities and other negotiable assets.

(l) The best way to verify the amounts of dividend revenue received during the year is: 1. recomputation. 2. verification by reference to dividend record books. 3. confirmation with dividend-paying companies. 4. examination of cash disbursements records.

2. verification by reference to dividend record books. Comparing the recorded amount of dividend revenue with dividend record books (published by investment advisory services) provides evidence of the amount of dividend revenue that should have been received during the year. It is virtually impossible to confirm the receipt of dividends with the company paying those dividends.

(b) To provide assurance that each voucher is submitted and paid only once, the auditors most likely would examine a sample of paid vouchers and determine whether each voucher is: 1. Supported by a vendor's invoice. 2. Stamped "paid" by the check signer. 3. Prenumbered and accounted for. 4. Approved for authorized purchases.

2. Stamped "paid" by the check signer.

Management Assertions: Explain the C in PERCV.

Completeness - All transactions, assets, liabilities, and elements of owners' equity that should be presented in the financial statements are included.

(j) Hall Company had large amounts of funds to invest on a temporary basis. The board of directors decided to purchase securities and derivatives and assigned the future purchase and sale decisions to a responsible financial executive. The best person or persons to make periodic reviews of the investment activity would be: 1. An investment committee of the board of directors. 2. The COO. 3. The corporate controller. 4. The treasurer.

1. An investment committee of the board of directors.

Management Assertions: Explain the E in PERCV.

Existence or Occurrence - Assets, liabilities, and owners' equity accounts reflected in the financial statements exist; the recorded transactions have occurred.

(h) The auditors suspect that a client's cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditors most likely would compare the: 1. Details of bank deposit slips with details of credits to customer accounts. 2. Daily cash summaries with the sums of the cash receipts journal entries. 3. Individual bank deposit slips with the details of the monthly bank statements. 4. Dates uncollectible accounts are authorized to be written off with the dates the write-offs are actually recorded.

1. Details of bank deposit slips with details of credits to customer accounts. Lapping will result in a delay in the recording of specific remittance credits in the financial records, but the checks will be deposited in the bank as they are received. Therefore, a comparison of the checks deposited to the credits to customer accounts will likely uncover the scheme.

(f) Which of the following procedures would the auditors most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet? 1. Observe the consistency of the employees' use of cash registers and tapes. 2. Inquire about employees' access to recorded but undeposited cash. 3. Trace deposits in the cash receipts journal to the cash balance in the GL. 4. Compare the cash balance in the GL with the bank confirmation request.

1. Observe the consistency of the employees' use of cash registers and tapes. The use of cash registers and tapes helps assure that all sales of a retail store are recorded.

(g) Reconciliation of the bank account should not be performed by an individual who also: 1. Processes cash disbursements. 2. Has custody of securities. 3. Prepares the cash budget. 4. Reviews inventory reports.

1. Processes cash disbursements. The individual who reconciles the bank account should not be involved in the processing of cash receipts or disbursements.

(k) The auditors who physically examine securities should insist that a client representative be present in order to: 1. detect fraudulent securities. 2. lend authority to the auditors' directives. 3. acknowledge the receipt of securities returned. 4. coordinate the return of securities to the proper locations.

3. acknowledge the receipt of securities returned.

(d) To gather evidence regarding the balance per bank in a bank reconciliation, the auditors would examine any of the following except: 1. cutoff bank statement. 2. Year-end bank statement. 3. Bank confirmation. 4. General ledger.

4. General ledger. The general ledger will not have information on the balance per bank. The cutoff bank statement, year-end bank statement and bank confirmation will all include information on the balance per bank.

(c) In testing controls over cash disbursements, the auditors most likely would determine that the person who signs checks also: 1. Reviews the monthly bank reconciliation. 2. Returns the checks to accounts payable. 3. Is denied access to the supporting documents. 4. Is responsible for mailing the checks.

4. Is responsible for mailing the checks.

Explain the objectives of each of the following audit procedures for cash: A. Obtain a cutoff bank statement subsequent to the balance sheet date. B. Compare paid checks returned with the bank statement to the list of outstanding checks in the previous reconciliation.

A. Obtaining a cutoff bank statement permits the examination of many checks listed as outstanding in the bank reconciliation and establishes the collectibility of customers' checks included in undeposited receipts on the balance sheet date. Any unrecorded outstanding checks at year-end will also be disclosed by the cutoff statement. B. the auditors obtain assurance that the cash cutoff at the beginning of the bank reconciliation period is accurate, and that cash shortages are not being obscured by manipulation of the outstanding checks list.

(i) In order to guard against the misappropriation of company-owned marketable securities, which of the following is the best course of action that can be taken by a company with a large portfolio of marketable securities? 1. Require that one trustworthy and bonded employee be responsible for access to the safekeeping area where securities are kept. 2. Require that employees who enter and leave the safekeeping area sign and record in a log the exact reason for their access. 3. Require that employees involved in the safekeeping function maintain a subsidiary control ledger for securities on a current basis. 4. Require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent.

4. Require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent

What is a voucher?

A document authorizing a cash disbursement. A voucher usually provides space for employees to initial after they have performed approval functions.

What is a lockbox?

A post office box controlled by a company's bank at which cash remittances from customers are received. The bank picks up the remittances, immediately credits the cash to the company's bank account, and forwards the remittance advices to the company.

Among the departments of JR Co. are a purchasing dept, receiving dept, acctg dept, and finance dept. If you were preparing a flowchart of a voucher system to be installed by the company, in which department would you show: A. The assembling of the PO, RR, and vendor's invoice to determine that these documents are in agreement? B. The preparation of a check? C. The signing of a check? D. The mailing of a check to the payee? E. The perforation of the voucher and supporting documents?

A. Accounting B. Accounting C. Finance D. Finance E. FINANCE

How might the term window dressing be related to the making of loans by a corporation to one or more of its executives?

Another example of window dressing occurs when a corporate officer who has borrowed money from the corporation repays the loan just before the balance sheet date and then promptly obtains a new loan shortly after the balance sheet date.

How can auditors detect kiting?

By preparing a schedule of bank transfers for a few days before and after balance sheet date.

Explain the objectives of each of the following audit procedures for cash: C. Trace all bank transfers during the last week of the audit year and the first week of the following year. D. Investigate any checks representing large or unusual payments to related parties.

C. Tracing all bank transfers for a short period before and after the end of the year is designed to disclose "kiting," whereby a check drawn on one bank is not recorded as a disbursement as of the balance sheet date, although the deposit of the check in another bank is properly recorded. D. The purpose of investigating checks representing large or unusual payments to related parties is to determine that the transactions (a) were properly authorized and recorded and (b) are adequately disclosed in the financial statements.

State one broad general objective of internal control over each of the following: cash receipts, cash disbursements, and cash balances.

Cash receipts: match receipts to deposits and recorded promptly and accurately. Cash disbursements: match vendor balances to payments. Cash balances: reconcile bank statements monthly to ensure balances are correct. The need for obtaining loans or for investing excess cash is thus made known on a timely basis.

What is EDI?

EDI (Electronic data interchange) is a computer network between companies that allows the interchange of data from one company's computer to the other's (e.g., allows purchases and sales between two firms to be processed electronically).

The auditors' work on cash may include preparing a description of controls and performing tests of controls. Which of these two steps should be performed first? What is the purpose of tests of controls?

First you prepare of description of controls then perform tests of controls. To verify what they are telling you is actually correct.

If a security or derivative is not marketable, how do the auditors typically obtain evidence about the fair value of the instrument?

If a security or derivative is not marketable (has no active market); management may obtain an appraisal of fair value from a securities valuation firm (a specialist). In such cases, the auditors should refer to AICPA AU-C 620 (PCAOB 336) which requires that they consider the professional qualifications and reputation of the appraiser and obtain an understanding of the methods and assumptions used. When a valuation model, such as an option-pricing model, is used, the auditors should assess the reasonableness and appropriateness of the model and evaluate the reasonableness of the underlying assumptions. The auditors should make sure that the model considers all aspects of risk, such as counterparty credit risk, risk of adverse changes in market factors, and risk of losses from legal or regulatory action. In addition, the auditors should evaluate the relevance, completeness, and accuracy of any significant information provided to the specialist by the client to be used in appraising the options.

What is kiting?

Manipulations causing an amount of cash to be included simultaneously in the balance of two or more bank accounts. Kiting schemes are based on the float period - the time necessary for a check deposited in one bank to clear the bank on which it was drawn.

What is the meaning of the term window dressing when used in connection with year-end financial statements?

The term "window dressing" refers to actions taken shortly before the balance sheet date which are designed specifically to improve the cash position or in other ways to create an improved financial picture of the company. Some forms of window dressing are legitimate (such as making all possible shipments and billings to customers at year-end). Other methods of window dressing (such as holding the cash journals open) constitute misrepresentation.

Describe the purpose of a bank transfer schedule.

To trace bank transfers to disclose overstatement of cash balances resulting from kiting. When a check drawn on one bank is deposited in another, several days (called the float period) usually pass before the check clears the bank on which it is drawn. During this period, the amount of the check is included in the balance on deposit at both banks. Kiting refers to the manipulations that utilize such temporarily overstated bank balances to conceal a cash shortage or meet short-term cash needs.

Explain two procedures by which auditors may verify the client's cutoff of cash receipts.

To verify the client's cutoff of cash receipts, the auditors may either (1) be on hand to count the undeposited cash receipts on the last business day of the period, or (2) examine the cutoff bank statement to determine that deposits reported as being in transit at year-end were received by the bank on the following business day. When a client has numerous branches, the auditors usually employ a combination of these procedures in verifying the cutoff at the various locations.

Management Assertions: Explain the V in PERCV.

Valuation or Allocation - Assets, liabilities, owners' equity, revenues, and expenses are presented at amounts that are determined in accordance with GAAP.