Chapter 10

True or false: A compensating balance agreement generally requires that cash be reclassified as a noncurrent asset.

False

True or false: A proof of cash is an audit procedure that is performed on almost every engagement.

False

True or false: Confirmations for cash balances should be mailed only to the financial institutions with which the client has a cash balance at year-end.

False

True or false: For investments in securities accounted for by the equity method, the auditors are primarily concerned with verifying the market value of the investments.

False

True or false: Lapping of accounts receivable by an employee is not possible when there is adequate segregation of duties with respect to cash disbursements.

False

True or false: Mailroom personnel of a company should prepare a control listing of incoming cash receipts and deposit them intact daily.

False

True or false: Signed checks should be returned to the cash disbursements clerk for mailing.

False

True or false: The auditors should count small petty cash funds at year-end to make sure that balance is not understated on the financial statements.

False

True or false: Control over the receipt of cash sales is best achieved when two or more employees participate in each transaction.

True

True or false: Verification of cash and other liquid assets be verified on the same date may prevent substitution of one form of asset for another.

True

Which of the following controls would be most likely to reduce the risk of diversion of customer receipts by a company's employees? a) A bank lockbox system b) Approval of all disbursements by an individual independent of cash receipts c) Monthly bank cutoff statements d) Prenumbered remittance advices

a) A bank lockbox system

Which of the following controls would most likely reduce the risk of diversion of customer receipts by a client's employee? a) A bank lockbox system b) Prenumbered remittance advices c) Monthly bank reconciliations d) Daily deposit of cash receipts

a) A bank lockbox system

An auditor may obtain information on the December 31 month end balance per bank in which of the following? a) Both standard confirmation form and January 1-10 cutoff statement b) Standard confirmation form, but not January 1-10 cutoff statement c) January 1-10 cutoff statement, but not standard confirmation form d) Neither standard confirmation form nor January 1-10 cutoff statement

a) Both standard confirmation form and January 1-10 cutoff statement

Banks may process electronic "substitute checks" in place of customer written hard copy checks due to the: a) Check Clearing for the 21st Century Act b) Public Company Accounting Oversight Board's Standard No. 2 c) Foreign Corrupt Practices Act d) Sarbanes-Oxley Act

a) Check Clearing for the 21st Century Act

Which of the following is the best audit procedure for the detection of lapping? a) Comparison of postings of cash receipts to accounts with the details of cash deposits b) Confirmation of the cash balance c) Reconciliation the cash account balance d) Preparing a proof of cash

a) Comparison of postings of cash receipts to accounts with the details of cash deposits

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? a) Observe the consistency of the employees' use of cash registers and tapes b) Inquire about employees' access to recorded but undeposited cash c) Trace deposits in the cash receipts journal to the cash balance in the general ledger d) Compare the cash balance in the general ledger with the bank confirmation request

a) Observe the consistency of the employees' use of cash registers and tapes

Which of the following is not a universal rule for achieving internal control over cash? a) Separate recordkeeping from accounting for cash to the extent possible b) Deposit each day's cash receipts intact c) Separate cash handling from recordkeeping d) Have monthly bank reconciliations prepared by employees not responsible for the issuance of checks

a) Separate recordkeeping from accounting for cash to the extent possible

Which of the following manipulations of cash transactions would overstate the cash balance on the financial statements? a) Understatement of outstanding checks b) Overstatement of outstanding checks c) Understatement of deposits in transit d) Overstatement of bank services charges

a) Understatement of outstanding checks

The Parmalat fraud case apparently involved: a) a fraudulent cash confirmation b) kiting of funds between banks in India and banks in Pakistan c) a bank reconciliation performed by the client that systematically understated cash d) major unrecorded disbursements for equipment

a) a fraudulent cash confirmation

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: a) an investment committee of the board of directors b) the chief operating officer c) the corporate controller d) the treasurer

a) an investment committee of the board of directors

By preparing a four-column bank reconciliation ("proof of cash") for the last month of the year, an auditor will generally be able to detect: a) an unrecorded check written at the beginning of the month which was cashed during the period covered by the reconciliation b) a cash sale which was not recorded on the books and was stolen by a bookkeeper c) an embezzlement of unrecorded cash receipts on receivables before they had been deposited into the bank d) a credit sale which has been recorded twice in the sales journal

a) an unrecorded check written at the beginning of the month which was cashed during the period covered by the reconciliation

By preparing a four-column bank reconciliation ("proof of cash") at year-end, an auditor will generally be able to detect: a) an unrecorded deposit made at the bank at the end of the month b) a second payment of an account payable which had already been paid in full two months earlier c) an embezzlement of cash receipts not recorded in the cash receipts journal before they had been deposited into the bank d) a receivable collected that had previously been written off as uncollectible

a) an unrecorded deposit made at the bank at the end of the month

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: a) details of bank deposit slips with details of credits to customer accounts b) daily cash summaries with the sums of the cash receipts journal entries c) individual bank deposit slips with the details of the monthly bank statements d) dates uncollectible accounts are authorized to be written off with the dates the write-offs are actually recorded

a) details of bank deposit slips with details of credits to customer accounts

When a client engages in transactions involving derivatives, the auditor should: a) develop an understanding of the economic substance of each derivative b) confirm with the client's broker whether the derivatives are for trading purposes c) notify the audit committee about the risks involved in derivative transactions d) add an explanatory paragraph to the auditor's report describing the risks associated with each derivative

a) develop an understanding of the economic substance of each derivative

Reconciliation of the bank account should not be performed by an individual who also: a) processes cash disbursements b) has custody of securities c) prepares the cash budget d) reviews inventory reports

a) processes cash disbursements

Which of the following procedures in the cash disbursements cycle should not be performed by the accounts payable department? a) Comparing the vendor's invoice with the receiving report b) Cancelling supporting documentation after payment c) Verifying the mathematical accuracy of the vendor's invoice d) Preparing the check for signature by an authorized person

b) Cancelling supporting documentation after payment

An auditor may obtain information on the December 31 month end balance per bank in which of the following? a) Both December 31 bank statement and schedule of bank (cash) transfers b) December 31 bank statement, but not schedule of bank (cash) transfers C) Schedule of bank (cash) transfers, but not December 31 bank statement d) Neither December 31 bank statement nor schedule of bank (cash) transfers

b) December 31 bank statement, but not schedule of bank (cash) transfers

Which procedure is an auditor most likely to use to detect a check outstanding at year-end that was not recorded as outstanding on the year-end bank reconciliation? a) Prepare a bank transfer schedule using the client's cash receipts and cash disbursements journal b) Receive a cutoff statement directly from the client's bank c) Prepare a four-column bank reconciliation using the year-end bank statement d) Confirm the year end balance using the standard form to confirm account balance information with financial institutions

b) Receive a cutoff statement directly from the client's bank

In October, three months before year-end, the bookkeeper erroneously recorded the receipt of a one year bank loan with a debit to cash and a credit to miscellaneous revenue. Select the most effective method for detecting this type of error. a) Foot the cash receipts journal for October b) Send a bank confirmation as of year-end c) Prepare a bank reconciliation as of year-end d) Prepare a bank transfer schedule as of year-end

b) Send a bank confirmation as of year-end

Which of the following is not a control that generally is established over cash receipts? a) To prevent abstraction of cash, a control listing of cash receipts should be prepared by mailroom personnel b) To insure accurate posting, the accounts receivable clerk should post the customers' receipts from customers' checks c) To insure accuracy of the accounts receivable records, the records should be reconciled monthly to the accounts receivable controlling account d) To prevent theft of cash, receipts should be deposited daily

b) To insure accurate posting, the accounts receivable clerk should post the customers' receipts from customers' checks

By preparing a four-column bank reconciliation ("proof of cash") at year-end, an auditor will generally not be able to detect: a) an unrecorded deposit made at the bank at the end of the month b) a second payment of an account payable which had already been paid in full two months earlier c) an unrecorded check cashed during that month d) a bank charge during the month not recorded on the books

b) a second payment of an account payable which had already been paid in full two months earlier

On receiving the bank cutoff statement, the auditor should trace: a) deposits in transit on the year-end bank reconciliation to deposits in the cash receipts journal b) checks dated prior to year end to the outstanding checks listed on the year-end bank reconciliation c) deposits listed on the cutoff statement to deposits in the cash receipts journal d) checks dated subsequent to year end to the outstanding checks listed on the year-end bank reconciliation

b) checks dated prior to year end to the outstanding checks listed on the year-end bank reconciliation

The auditors use a bank cutoff statement to compare: a) deposits in transit on the year-end cash general ledger account to deposits in the cash receipts journal b) checks dated prior to year-end to the outstanding checks listed on the year-end bank reconciliation c) deposits listed on the cutoff statement to disbursements in the cash disbursements journal d) checks dated subsequent to year-end to the outstanding checks listed on the year-end bank statement

b) checks dated prior to year-end to the outstanding checks listed on the year-end bank reconciliation

Kiting would least likely be detected by: a) analyzing details of large cash deposits around year end b) comparing customer remittance advices with recorded disbursements in the cash disbursements journal c) preparing a four-column bank reconciliation for all major cash accounts d) preparing a schedule of interbank transfers by using the client's records and bank statements around year end

b) comparing customer remittance advices with recorded disbursements in the cash disbursements journal

A practical and effective audit procedure for the detection of lapping is: a) preparing an interbank transfer schedule b) comparing recorded cash receipts in detail against items making up the bank deposit as shown on duplicate deposit slips validated by the bank c) tracing recorded cash receipts to postings in customers' ledger cards d) preparing a proof of cash

b) comparing recorded cash receipts in detail against items making up the bank deposit as shown on duplicate deposit slips validated by the bank

Jones embezzled $10,000 from his company's account in Bank A. At year-end he hid the shortage by making a deposit on December 31 in Bank A, drawn on Bank B. He has not recorded the transaction on the books. This is an example of: a) lapping b) kiting c) effective cash management d) related party transactions

b) kiting

Tracing recorded sales transactions in the sales journal to the shipping documents (bills of lading) provides evidence about the: a) completeness of recording of sales transactions b) occurrence of sales transactions c) billing of all sales transactions d) presentation of payables

b) occurrence of sales transactions

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: a) supported by a vendor's invoice b) stamped "paid" by the check signer c) prenumbered and accounted for d) approved for authorized purchases

b) stamped "paid" by the check signer

The Standard Form to Confirm Account Balances with Financial Institutions includes information on all of the following except: a) date dur of a direct liability b) the principal amount paid on a direct liability c) description of collateral for a direct liability d) the interest rate of a direct liability

b) the principal amount paid on a direct liability

Contact with banks for the purpose of opening company bank accounts should normally be the responsibility of the corporate: a) board of directors b) treasurer c) controller d) executive committee

b) treasurer

An auditor compares annual revenues and expenses with similar amounts from the prior year and investigates all changes exceeding 10%. This procedure most likely could indicate that: a) fourth quarter payroll taxes were properly accrued and recorded, but were not paid until early in the subsequent year b) unrealized gains from increases in the value of available-for-sale securities were recorded in the income account for trading securities c) the annual provision for uncollectible accounts expense was inadequate because of worsening economic conditions d) notice of an increase in property tax rates was received by management, but was not recorded until early in the subsequent year

b) unrealized gains from increases in the value of available-for-sale securities were recorded in the income account for trading securities

The best way to verify the amounts of dividend revenue received during the year is: a) recomputation b) verification by reference to dividend record books c) confirmation with dividend-paying companies d) examination of cash disbursements records

b) verification by reference to dividend record books

Jones embezzled $10,000 from his company's account in Bank A. At year-end he hid the shortage by making a deposit on December 31 in Bank A, drawn on Bank B. He has not recorded the transaction on the books. Which of the following is most likely to be effective in detecting this fraud? a) Bank confirmation b) Bank transfer schedule prepared using only the cash receipts and cash disbursements journals c) Comparison of bank cutoff statement to the cash receipts and disbursements records d) Receivable confirmation

c) Comparison of bank cutoff statement to the cash receipts and disbursements records

Which of the following statements is not correct? a) Cash is important to the audit process balance because of its vulnerability to misappropriation, despite the fact that the balance at the balance sheet date may be immaterial b) Payroll cash account balances kept on an imprest basis are more easily controlled than others not so kept c) Confirmation of cash should only be performed as of the balance statement date because the auditor expresses an opinion as of that date d) Reviewing interbank transfers is important to the auditor because of the possibility that the client may be engaged in kiting

c) Confirmation of cash should only be performed as of the balance statement date because the auditor expresses as an opinion as of that date

Which of the following is not a control over cash disbursements? a) Disbursements should be made by check b) A check protecting machine should be used c) Documents supporting the payment of a disbursement should be cancelled by the person preparing the check to prevent reuse d) Voided checks should be defaced and filed with paid checks

c) Documents supporting the payment of a disbursement should be cancelled by the person preparing the check to prevent reuse

Which of the following is one of the better auditing techniques that might be used by an auditor to detect kiting? a) Review composition of authenticated deposit slips b) Review subsequent bank statements and cancelled checks received directly from the banks c) Prepare a schedule of bank transfers d) Prepare year-end bank reconciliations

c) Prepare a schedule of bank transfers

Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom? 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 d) The cashier endorses the checks

c) The cashier posts the receipts to the accounts receivable subsidiary ledger

As one of the year-end audit procedures, the auditor instructed the client's personnel to prepare a confirmation request for a bank account that had been closed during the year. After the client's treasurer has signed the request, it was mailed by the assistant treasurer. What is the major flaw in this audit procedure? a) The confirmation request was signed by the treasurer b) Sending the request was meaningless because the account was closed before the year end c) The request was mailed by the assistant treasurer d) The CPA did not sign the confirmation request before it was mailed

c) The request was mailed by the assistant treasurer

The auditors who physically examine securities should insist that a client representative be present in order to: a) detect fraudulent securities b) lend authority to the auditors' directives c) acknowledge the receipt of securities returned d) coordinate the return of securities to the proper locations

c) acknowledge the receipt of securities returned

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: a) count the cash in advance of the balance sheet date in order to disclose any kiting operations at year-end b) coordinate the count of cash with the cutoff of accounts payable c) coordinate the count of cash with the count of marketable securities and other negotiable assets d) count the cash immediately upon the return of the confirmation letters from the financial institution

c) coordinate the count of cash with the count of marketable securities and other negotiable assets

The auditors' count of the client's cash should be coordinated to coincide with the: a) consideration of the internal controls with respect to cash b) close of business on the balance sheet date c) count of investment securities d) count of inventories

c) count of investment securities

Jones was engaged to audit the financial statements of Gamma Corporation for the year ended June 30, 200X. Having completed an examination of the investment securities, which of the following is the best method of verifying the accuracy of recorded dividend income? a) Tracing recorded dividend income to cash receipts records and validated deposit slips b) Utilizing analytical techniques and statistical sampling c) Comparing recorded dividends with amounts appearing on federal information form 1099s d) Comparing recorded dividends with a standard financial reporting service's record of dividends

d) Comparing recorded dividends with a standard financial reporting service's record of dividends

In a manufacturing company which one of the following audit procedures would give the least assurance of the existence of the assets in the general ledger balance of investment in stocks and bonds at the audit date? a) Confirmation from the broker b) Inspection of year-end brokers' statements c) Vouching all changes during the year to brokers' advises and statements d) Examination of paid checks issued in payment of securities purchased

d) Examination of paid checks issued in payment of securities purchased

Which of the following is correct concerning "window dressing" for cash? a) A segregation of duties within the cash function effectively eliminates its occurrence b) It generally involves manipulation of inventory c) It is illegal, and an audit is designed to provide reasonable assurance of its detection d) Many forms of it require no action by the auditors

d) Many forms of it require no action by the auditors

Your client left the cash receipts journal open after year-end for an extra day and included January 1 cash receipts in the 12/31/XX totals. All of those cash receipts were due to cash sales. Assuming the client uses a periodic inventory system with a 12/31/XX count of the physical inventory, which of the following is most likely to be true relating to the year XX financial statements? a) Sales are understated b) Accounts receivable are understated c) Inventory is overstated d) Net income is overstated

d) Net income is overstated

Which of the following is not a control that generally is established over cash transactions? a) Separating cash handling from recordkeeping b) Centralizing the receipt of cash c) Depositing each day's receipts intact d) Obtaining a receipt for every disbursement

d) Obtaining a receipt for every disbursement

A company's decision to use the fair value option for valuation of marketable securities is most likely to affects which of the following assertions the most? a) Completeness b) Existence c) Fairness d) Presentation and disclosure

d) Presentation and disclosure

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? a) Require that one trustworthy and bonded employee be responsible for access to the safekeeping area where securities are kept b) Require that employees who enter and leave the safekeeping area sign and record in a log the exact reason for their access c) Require that employees involved in the safekeeping function maintain a subsidiary control ledger for securities on a current basis d) Require that the safekeeping function for securities be assigned to a bank or stock broker that will act as a custodial agent

d) Require that the safekeeping function for securities be assigned to a bank or stock broker that will act as a custodial agent

Internal control over marketable securities is enhanced when: a) Securities are held by the cashier b) Securities are registered in the name of the custodian c) Detailed records of securities are maintained by the custodian of the securities d) Securities are held under joint control of two or more officials

d) Securities are held under joint control of two or more officials

Which of the following is not confirmed on the standard form used for cash balances at financial institutions? a) Cash checking account balances b) Cash savings account balances c) Loans payable d) Securities held for the client by the financial institution

d) Securities held for the client by the financial institution

An internal control questionnaire indicates that an approved receiving report is required to accompany every check request for payment of merchandise. Which of the following procedures provides the best evidence on operating effectiveness? a) Select and examine receiving reports and test whether the related cancelled checks are dated no earlier than the receiving reports b) Select and examine receiving reports and test whether the related cancelled checks are dated not later than the receiving reports c) Select and examine cancelled checks and test whether the related receiving reports are dated no earlier than the checks d) Select and examine cancelled checks and test whether the related receiving reports are dated no later than the checks

d) Select and examine cancelled and test whether the related receiving reports are dated no later than the checks

An auditor's analytical procedures have revealed that the accounts receivable of a client have doubled since the end of the prior year. However, the allowance for doubtful accounts, as a percentage of accounts receivable remained about the same. Which of the following client explanations most likely would satisfy the auditor? a) Credit standards were liberalized in the current year b) Twice as many accounts receivable were written off in the prior year as compared to this year c) A greater percentage of accounts were currently listed in the "more than 90 days overdue" category than the prior year d) The client opened a second retail outlet in the current year and its credit sales approximately equaled the older, established outlet

d) The client opened a second retail outlet in the current year and its credit sales approximately equaled the older, established outlet

The auditors should insist that a representative of the client be present during the physical examination of securities in order to: a) lend authority of the auditor's directives b) detect forged securities c) coordinate the return of all securities to proper locations d) acknowledge the receipt of securities returned

d) acknowledge the receipt of securities returned

To gather evidence regarding the balance per bank in a bank reconciliation, an auditor could examine all of the following except: a) cutoff bank statement b) year-end bank statement c) bank confirmation d) general ledger

d) general ledger

To gather evidence regarding the balance per bank in a bank reconciliation, the auditors would examine any of the following except: a) cutoff bank statement b) year-end bank statement c) bank confirmation d) general ledger

d) general ledger

In testing controls over cash disbursements, the auditors most likely would determine that the person who signs checks also: a) reviews the monthly bank reconciliation b) returns the checks to accounts payable c) is denied access to the supporting documents d) is responsible for mailing the checks

d) is responsible for mailing the checks

The auditors compare information on canceled checks with information contained in the cash disbursement journal. The objective of this test is to determine that: a) recorded cash disbursement transactions are properly authorized b) proper cash purchase discounts have been recorded c) cash disbursements are for goods and services actually received d) no discrepancies exist between the data on the checks and the data in the journal

d) no discrepancies exist between the data on the checks and the data in the journal

Properly designed internal control will permit the same employee to: a) receive and deposit checks, and also approve write-offs of customer accounts b) approve vouchers for payments, and also receive and deposit cash c) reconcile the bank statements, and also receive and deposit cash d) sign checks, and also cancel supporting documents

d) sign checks, and also cancel supporting documents