Audit: Chapter 23
Business risks associated with financial instruments are the same for all companies.
FALSE
Examples of cash equivalents include, time deposits, certificates of deposit, and marketable securities. True or False
FALSE
The auditor needs to have an understanding of the clients internal controls over determining fair value estimates.
TRUE
What should be audited on an interbank transfer schedule?
1.) The accuracy of the information on the interbank transfer schedule should be verified. 2.) The interbank transfers must be recorded in both receiving and disbursing banks. 3.) he date of the recording of the disbursements and receipts for each transfer must be in the same fiscal year. 4.) Disbursements on the interbank transfer schedule should be correctly included in or excluded from year end bank reconciliations as outstanding checks. 5.) Receipts on the interbank transfer schedule should be correctly included in or excluded from year end reconciliations as deposits in transit.
standard bank confirmation form
A form approved by the AICPA and American bankers Association through which the bank responds to the auditor about bank balance and loan information.
The starting point for the verification of the balance in the general bank account is to obtain:
A.) A bank reconciliation from the client.
The test of details of balances procedure that requires the auditor to trace the book balance on the reconciliation to the general ledger is an attempt to satisfy the audit objective of:
A.) Detail - Tie - in
Which of the following balance-related audit objectives typically is assessed as having high inherent risk for cash?
A.) Existence
The process of transferring money from one bank account to another and improperly recording the transaction is referred to as:
A.) Kiting
__________ is an automated fraud detection tool offered by most banks.
A.) Positive pay
The auditor uses a proof of cash to determine whether: All recorded cash disbursements were paid by the bank All amts paid by the bank were recorded A) YY B) NN C) YN D) NY
All recorded cash disbursements were paid by the bank: YES All amounts paid by the bank were recorded: YES
Imprest Payroll Account
As a means of improving internal control, many companies establish a separate imprest bank account for making payroll payments to employees. A fixed balance, such as $1,000, is maintained in the account at all times. Immediately before each pay period, one check is drawn on the general cash account t deposit the total amount of the next payroll in the imprest payroll account.
The auditors test the clients monthly bank reconciliation to verify whether the clients recorded bank balance is the same amount as the actual cash in the bank. Which of the following would not explain a difference between the company's cash balance and the banks balance for the client?
B.) Checks are written by the client in the same month the checks clear the bank.
The reason for testing the client's bank reconciliation is to verify whether the client's recorded bank balance is the same amount as the actual cash in bank, except for deposits in transit, checks outstanding, and other reconciling items. The information needed to complete the tests of the reconciliation are provided by the: A) client's records and ledgers for the year under audit. B) cutoff bank statement. C) client's records and ledgers for the subsequent year. D) canceled checks for the year under audit.
B.) Cutoff bank statement
Which of the following verifications would generally not be performed by the auditor in the month subsequent to the balance sheet date?
C.) Verify the book statement balances tied to the cash receipts and disbursement journals for the year under audit.
Which of the following statements is correct?
D.) Auditing standards do not require bank confirmations.
A proof of cash is effective at identifying which of the following misstatements?
D.) Checks recorded in the books for amount different from that on the check.
When the auditor believes the year end bank reconciliation may be intentionally misstated, it is appropriate to perform extended tests of the year-end bank reconciliation. Assuming the client has a October 31 year end, these extended tests would not include:
Determining that all outstanding checks had cleared by the date of the bank cutoff statement.
Cash equivalents
Excess cash invested in short term, highly liquid investments such as time deposits, certificates of deposit, and money market funds.
A proof of cash includes a reconciliation of cash receipts deposited in the bank with the cash disbursements records for a given period.
FALSE
The majority of financial instruments are values at the lower of cost or market.
FALSE
The majority of financial instruments are valued using:
Fair value estimates
As part of their internal control procedures, management needs to have procedures in place to properly classify financial instruments as trading, available-for-sale, or held to maturity, based on:
Intent
Prices in an active market for identical assets is a level _________ fair value estimate
Level 1
Level ______ estimates use observable inputs other than quoted prices
Level 2
The use of unobservable inputs such as a pricing model or discounted cash flow is an example of a level_________ estimate.
Level 3
The auditor is testing for balance-related audit objectives of detail tie-in when they:
Prove the schedule of investment activity as to additions and subtractions
Which of the following should be audited on the interbank transfer schedule?
Receipts on the interbank transfer schedule should be correctly included in or excluded from year-end bank reconciliations as deposits in transit
A factor that increases inherent risk for financial instruments is the complexity of the relevant accounting standards.
TRUE
A proof of cash involved a combination of substantive tests of transactions and tests of details of balances.
TRUE
Tests related to realizable value will vary according to the type of security and the associated standard
TRUE
The auditor is generally concerned about the realizable value and the rights to cash. A) True B) False LO 23-3
TRUE
The auditor must extend the audit process in the audit of year-end cash when there are inadequate controls.
TRUE
The bank reconciliation control is enhanced when a qualified employee reviews the monthly reconciliation as soon as possible after its completion: True or False
TRUE
When auditing financial instruments, interest income and dividends can be recomputed can compared to a public source.
TRUE
When auditing financial instruments:
The auditor relies on statements and brokers' advices from investment managers to test purchases and sales as long as controls were deemed effective.
Factors that impact risk of financial instruments DO NOT include:
The cost of securities
bank reconciliation
The document usually prepared by client personnel of the differences between the cash balance recorded in the general ledger and the amount in the bank account
General cash account
The primary bank account for most organizations
General Cash Account
This is the focal point of cash for most organizations because virtually all cash receipts and disbursements flow through this account.
When auditing financial instruments, analytical procedures can be sued to:
test the reasonableness of interest and dividend income
Auditors will often prepare a proof of cash when the client has material internal control weaknesses in cash receipts and cash disbursements. The purpose of the proof of cash is to determine if the clients accounting records for cash are reliable. List below the four requirements the proof of cash is designed to provide for the auditor:
1.) All recorded cash receipts were deposited 2.) All deposits in the bank were recorded in the accounting records. 3.) All recorded cash disbursements were paid by the bank 4.) All amounts that were paid by the bank were recorded
"Failure to bill a customer" is an exampled of an error that results in the failure to receive cash, but would not be discovered as part of the audit of the bank reconciliation. State three other examples of error or irregularities that result in the improper payments of or failure to receive, cash, but that would not be discovered during the audit of the bank reconciliation. How are these types of misstatements usually uncovered in the audit.
1.) An embezzlement of cash by interception of cash receipts from customers before they are recorded with the account charged off as a bad debt. 2.) Duplicate payment of a vendors invoice 3.) Improper payments of of officers personal expenditures 4.) Payment for raw materials that were not received 5.) Payment to an employee for more hours than he or she worked 6.) Payment of interest to a related party for an amount in excess of the going rate. If these misstatements are to be uncovered in the audit, their discover must occur through tests of controls and substantive tests of transactions.
Internal controls over year-end cash balances in the general account can be divided into two categories:
1.) Controls over transactions cycle affecting the recording of cash receipts and cash disbursements 2.) Independent bank reconciliations
Bank reconciliation audit tests are designed to detect misstatements other than through the improper payment of cash or failure to receive cash normally would not be detected as part of the tests of the bank reconciliation. List THREE misstatements that are designed to be detected by bank reconciliations.
1.) Failure to include a check that has not cleared the bank on the outstanding checklist, even though it has been recorded on the cash disbursement journal. 2.) Cash received by the client subsequent to the balance sheet date, but recorded as cash receipts in the current year. 3.) Deposits recorded as cash receipts near the end of the year, deposited in the bank in the same month, and included in the bank reconciliation as a deposit in transit.
A proof of cash includes four reconciliation tasks. List them below:
1.) Reconcile the balance on the bank statement with the general ledger balance at the beginning of the proof-of-cash period 2.) Reconcile cash receipts deposited per bank with the receipts recorded in the cash receipts journal for a given period. 3.) Reconcile electronic payments and cancelled checks clearing the bank with those recorded in the cash disbursements journal for a given period. 4.) Reconcile the balance on the bank statement with the general ledger balance at the end of the proof-of-cash period.
List two common tests of details of balances procedures the auditor would perform when testing for the balance-related audit objective of realizable value:
1.) Verify quoted market prices 2.) Test managements classifications 3.) Test managements assumptions related to valuation 4.) consider using a specialist for testing fair value estimates 5.)Consider whether an impairment loss is required
Explain what is meant by a "cutoff bank statement", and discuss the purpose of it in the audit of cash.
A cutoff bank statement is a partial period bank statement and the related copies of canceled checks, duplicate deposit slips, and other documents included in the bank statements, mailed by the bank directly to the CPA firms office. The purpose of the cutoff bank statements is to verify the reconciling items on the clients year-end bank reconciliation with evidence that is not accessible to the client.
Imprest petty cash fund:
A fund of cash maintained within the company for small cash acquisitions, expenses, or to cash employees checks
Listing all bank transfers made a few days before and after the balance sheet date and tracing each to the accounting records for proper recording is a useful approach to test for:
A. Kiting
Auditors are likely to prepare a proof of cash when the client has: A) material control weaknesses in cash receipts and cash disbursements. B) material control weaknesses in accounts receivable and revenue. C) material control weaknesses in accounts payable and inventory. D) material control weaknesses in payroll.
A.) Material control weaknesses in cash receipts and cash disbursements
In addition to confirming bank balances of your audit client, a bank confirmation would normally contain: A) the client's bank loans with due date, interest rate, and collateral requested. B) the client's credit history as regards to paying back loans. C) the client's managements bank account information. D) the client's business prospects
A.) The clients bank loans with due date, interest rate, and collateral requested.
The general cash account is considered a significant account in almost all audits:
B.) Even when the ending balance is immaterial.
Which of the following would normally be discovered as part of the audit of the bank reconciliation?
B.) Failure to include a deposit in transit on the bank reconciliation.
Because cash is the most desirable asset for people to steal, it has a higher: A) control risk. B) inherent risk. C) detection risk. D) liquidity risk.
B.) Inherent Risk
Which of the following cycles does not affect cash in the bank?
B.) Inventory and warehousing
An imprest petty cash fund would least likely be used to pay for which of the following items? A) Minor office supplies B) Monthly interest expense C) Stamps for small mailings D) Small contributions to a local charity
B.) Monthly Interest Expense
The audit and accounting concern addressed in a monthly proof of cash is with: A) adjusting account balances. B) reconciling the amounts recorded in the books with the amounts included in the bank statement. C) determining the month-end balance. D) identifying cash transfers
B.) Reconciling the amounts recorded in the books with the amounts included in the bank statement
The bank reconciliation:
B.) Should be performed by someone independent of the handling or recording of cash receipts.
A partial period bank statement and related canceled check, duplicate deposit slips and other documents included in bank statements, mailed by the bank directly to the CPA firm, is called:
C.) A cutoff bank statement
A proof of cash represents: A) a test of controls and substantive test of transactions. B) a substantive test of transactions. C) a substantive test of transactions and test of details of balances. D) a test of details of balances.
C.) A substantive test of transactions and test of details of balances
Which of the following statements is correct?
C.) Bank personnel are not responsible for searching their records for bank balances or loans beyond those included on the bank confirmation.
Which of the following is likely to be detected as part of the audit of the bank reconciliation?
C.) Cash received by the client after year end, but included in cash receipts in the current year.
The test of details of balances procedure that requires the auditor to foot the outstanding check list and deposits in transit is an attempt to satisfy which audit objective?
C.) Detail-tie-in
Which of the following misstatements is most likely to be uncovered during an audit of a clients bank reconciliation?
C.) Failure to record a collection of a note receivable by the bank on the clients behalf
The audit objective of determining that cash in bank, as stated on the reconciliation, foots correctly and agrees with the general ledger can be tested by which of the following procedures?
C.) Footing the outstanding checks list and the list of deposits in transit.
Which of the following is a correct statement? A.) The prof of cash receipts is a test of the balance in the cash account at a point in time B.) The proof of cash disbursements is effective for discovering a check written for the incorrect amount for which the dollar amount in cash disbursements is also incorrect C.) It is extremely difficult for an auditor to detect thefts of cash, especially omitted transactions and account balances D.) Segregation of duties is not an important control procedure for cash in a small business
C.) It is extremely difficult for an auditor to detect thefts of cash, especially omitted transactions and account balances
Which of the following items would not normally appear on bank reconciliations?
C.) Outstanding deposits
All of the following would not be uncovered by a bank reconciliation except for:
C.) Payments on notes payable debited directly to the bank account by the bank but not recorded on the books.
In an effort to satisfy the completeness objective, the auditor could perform which of the following test of details of balance procedures? A) Trace the book balance on the reconciliation to the general ledger. B) Trace outstanding checks to subsequent period bank statements. C) Perform a four-column proof of cash. D) Review financial statements to make sure that material savings accounts and certificates of deposit are disclosed separately.
C.) Perform a four-column proof of cash.
The direct receipt of a confirmation from every bank with which the client does business is:
C.) Recommended for every audit except when there an unusually large number of active accounts.
Procedures that may uncover fraud in the cash receipts area include:
C.) Tests performed to detect lapping
Which is NOT an important objective for financial instruments
Cutoff
The standard bank confirmation form has been agreed upon by the:
D.) AICPA and the American Bankers Association
The audit procedure which requires the auditor to record the last check number used on the last day of the year and subsequently trace to the outstanding checks and the cash disbursements records is performed to satisfy the audit objective of:
D.) Cutoff
An imprest petty cash fund: A) Is a bank account B) Is used for large unusual purchases C) Is usually reimbursed at least once a week for good internal control D) Is being replace by pre-approved pruchase cards in many companies
D.) Imprest Petty cash fund is being replaced by pre-approved purchase cards in many companies.
A major consideration in the audit of the general cash balances is the possibility of fraud. The auditor must extend his or her procedures in the audit of year-end cash to determine the possibility of a material fraud when they are:
D.) Inadequate internal controls.
If an auditor waits until the subsequent period bank statement is available to verify reconciling items, it is primarily a test for: A) errors. B) omissions. C) kiting. D) intentional misstatements.
D.) Intentional misstatements
Which of the following is not a "cash equivalent"? A) Time deposits B) Certificantes of deposit C) Money Market funds D) Marketable Securities
D.) Marketable Securities is not a "cash equivalent".
The most important balance-related audit objectives in the audit of cash include all but which of the following?
D.) Occurrence, Existence, Accuracy, and Completeness would all be included.
A proof of cash is not an effective procedure for identifying which of the following types of misstatements : A.) All recorded disbursements were paid by the bank B.)All recorded cash receipts were deposited C.) All amounts that were paid by the bank were recorded D.) Some checks were written for incorrect amounts
D.) Some checks were written for incorrect amounts
On the last day of the fiscal year, the cash disbursements clerk drew a company check on bank A and deposited the check in the company account in bank B to cover a previous theft of cash. the disbursement has NOT been recorded. the auditor will best detect this form of kiting by:
Examining paid checks returned with the bank statement of the next account period after year-end.
Cash Equivalents
Excess cash accumulated during certain parts of the operating cycle that will be needed in the reasonably near future is often invested in short-term, highly liquid cash equivalents such a time deposits, certificates of deposit, and money market funds.
When the auditor send a confirmation to the broker-dealer, they are testing the balance related audit objective of:
Existence
Analytical procedures may be used to assess the year-end balances for financial instruments
FALSE
Auditors usually design bank confirmation that address the clients specific circumstances. True or False
FALSE
Level 1 estimates require more management judgement than level 2 or level 3 estimates
FALSE
Many of the auditor's audit procedures in the audit of cash center around the client's bank confirmations. A) True B) False LO 23-3
FALSE
Only tests of details of cash balances are useful when auditors are specifically testing for fraud.
FALSE
Tests for kiting are performed using only a schedule of intrabank transfers.
FALSE
The client may mail the bank confirmation requests if the auditor believes doing so will increase the likelihood that the confirmation will be returned promptly. A) True B) False LO 23-3
FALSE
The most important objectives for financial instruments are existence and consistency
FALSE
The starting point for testing the ending balance of financial instruments accounts is to obtain a gain or loss schedule for the year.
FALSE
The starting point for the verification of the balance in the general bank account is to obtain a bank cutoff statement. True or False
FALSE
The three most important audit objectives for cash are accuracy, existence, and classification. True or False
FALSE
To test the client's list of outstanding checks on the bank reconciliation for completeness, the auditor should trace from the list to the checks included with the cutoff bank statement. A) True B) False LO 23-3
FALSE
When an auditor is verifying quoted market prices, they are concerned about the balance related audit objective of accuracy
FALSE
When auditing financial instruments, the most difficult objective to test is existence.
FALSE
When auditing the general cash account, receipt of a standard bank confirmation is the starting point for verifying the company's general cash account balance. A) True B) False LO 23-3
FALSE
Which of the following is not a correct statement regarding business risk and financial instruments
Financial services firms are exposed to very little risk with their financial instruments.
Branch Bank Account
For a company operating in multiple locations, it is often desirable to have a serape bank balance at each location. Branch bank accounts are useful for building public relations in local communities and permitting the centralization of operations at the branch level.
If a bank does not respond to a bank confirmation request the auditor would most likely:
Perform alternative procedures: NO Send a second request: YES Ask the client to communicate with the bank to as them to complete and return the confirmation: YES
An auditor is reviewing the minutes of board meetings to determine whether any securities are pledged as collateral. This test of the detail of balances related to the audit objectives of:
RIGHTS
Determining if the financial instruments included in the schedule of investments activity at year-end are stated at appropriate amounts in accordance with accounting standards is the balance related audit objective of:
Realizable Value
When dealing with financial instruments, the most difficult balance-related audit objective to test is:
Realizable Value
Which of the following balance-related objectives applies to auditing the general cash account?
Rights: NO Classification: NO Realizable Value: NO
A proof of cash disbursements is NOT effective for discovering checks written for an improper amount, fraudulent checks, or misstatements in which the dollar amount appearing in the cash disbursements records is incorrect.
TRUE
A proof of cash receipts is NOT useful for uncovering the theft of cash receipts or the recording and deposit of an improper amount of cash
TRUE
Assessing internal controls to financial instruments may be necessary in order to reduce audit risk to an acceptable level
TRUE
Auditing guidance is provided for accounting estimates specifically for fair values estimates as considerable auditor judgement is involved.
TRUE
Auditors are not always required to obtain bank confirmations: True or False
TRUE
Companies may purchase marketable securities as a way to temporarily invest excess cash. True or False
TRUE
Completeness is an important objective for derivative financial instruments
TRUE
Cutoff is more important in testing transactions as a client may want to record a gain or a loss on sale at the end of the year.
TRUE
Ordinarily, all deposits-in-transit listed on the year-end bank reconciliation should appear as deposits on the cutoff bank statement. A) True B) False LO 23-3
TRUE
Presentation and disclosure objectives are important when auditing financial instruments
TRUE
Securities and contracts will typically be help by the broker-dealer
TRUE
The transfer of money from one bank to another and improperly recording the transfer so the amount is recorded is an asset is referred to kiting.
TRUE
There is significant potential for misstatements and misclassifications of financial instruments.
TRUE
Tracing outstanding checks to subsequent period bank statements tests the cutoff audit objective. A) True B) False LO 23-3
TRUE
When auditing the year-end cash balance, one of the areas of focus is on the accuracy objective. A) True B) False LO 23-3
TRUE
When an audit client uses a service organization to manage their investment activity:
The auditor can rely on the internal controls of the service organization if the service organizations auditor issues a report on their internal control.
Explain the purpose of testing the clients bank reconciliation, and discuss the major audit procedures involved.
The purpose of testing the clients reconciliation is to verify whether the clients recorded bank balance is the same amount as the actual cash in the bank. Procedures include: 1.) verify that the clients bank reconciliation is mathematically accurate 2.) Trace the balance on the bank confirmation and/or the beginning balance on the current statement to the balance per bank on the bank reconciliation to make sure they are the same. 3.) Investigate all significant checks included on the outstanding checklist that have not cleared the bank on the cutoff statement. 4.) Trace deposits in transit to the cutoff bank statement 5.) Account for other reconciling items on the bank statement and bank reconciliation.
Kiting
The transfer of money from one bank account to another and impoperly recording the transfer so that the amount is recorded as an asset in both accounts.
imprest petty cash fund
This fund is used for small cash acquisitions that can be paid more conveniently and quickly by cash than by check, or for the convenience of employees in cashing personal or payroll checks.
When auditing financial instruments, a confirmation is sent to the broker-dealer:
To confirm year-end holdings
