Chapter 16

An auditor should trace interbank transfers for the last part of the audit period and first part of the subsequent period to detect whether

Cash balances were overstated because of kiting.

All of the following can assist the auditor in testing the existence assertion for investment securities except:

Comparing fair value to cost.

To gather evidence regarding the balance per bank in a bank reconciliation, an auditor would examine all of the following except the:

General ledger.

Examining brokers' advices for a sample of securities purchased during the year is a test for the assertion of

Rights and obligations.

It is generally more efficient to follow a substantive strategy for auditing investments.

TRUE

The auditor's use of analytical procedures for auditing cash is limited.

TRUE

The cash account is affected by all of the entity's business processes.

TRUE

The auditor should ordinarily mail confirmation requests to all banks with which the entity has conducted any business during the year, regardless of the year-end balance, since

The confirmation form also seeks information about indebtedness to the bank.

Which of the following control activities would an entity most likely use to assist in satisfying the completeness assertion related to long-term investments?

The internal auditor compares the securities in the bank safe-deposit box with recorded investments.

A company holds bearer bonds as a short-term investment. Responsibility for custody of these bonds and submission of coupons for collections of periodic interest probably should be delegated to the

Treasurer.

When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud most likely would be reduced if the

Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.

Which of the following controls would a company most likely use to safeguard marketable securities when an independent trust agent is not employed?

Two company officials must be present to access marketable securities, which are kept in a bank safe-deposit box.

Which of the following internal controls most likely would reduce the risk of diversion of customer receipts by an entity's employees?

A bank lockbox system.

Which of the following procedures most likely would give the greatest assurance that securities held as investments are safeguarded?

Access to securities requires the presence of two designated officials.

The auditor should insist that a representative of the entity be present during the physical examination of securities in order to

Acknowledge the receipt of securities returned.

Which of the following controls would an entity most likely use in safeguarding against the loss of marketable securities?

An independent trust company that has no direct contact with the employees who have recordkeeping responsibilities has possession of the securities.

Examining a sample of cancelled checks for an authorized signature tests which of the following assertions for cash?

Authorization.

The least crucial element of internal control over cash is

Batch processing of checks.

The primary purpose of sending a standard confirmation request to financial institutions with which the entity has done business during the year is to

Corroborate information regarding deposit and loan balances.

An unrecorded check issued during the last week of the year would most likely be discovered by the auditor when the

Cutoff bank statement is reconciled.

Which of the following procedures would be most important in the audit of an investment valued at fair value?

Develop an independent estimate of the fair value measurement.

An auditor usually tests the reasonableness of dividend income from investments in stock of public companies by computing the amounts that should have been received by referring to

Dividend record books produced by investment advisory services.

In a manufacturing company, which one of the following audit procedures would give the least assurance for the existence of the general ledger balance of investment in stocks and bonds at the audit date?

Examination of canceled checks issued in payment of securities purchased.

To satisfy the valuation assertion when auditing an investment accounted for by the equity method, an auditor most likely would

Examine the audited financial statements of the investee company.

Level 1 inputs are more risky and difficult to audit than Level 3 inputs to a valuation model.

FALSE

The general cash account is normally the principal account used to disburse payroll.

FALSE

Auditors will need to perform more substantive tests than normal to obtain sufficient appropriate evidence that a financial instrument is fairly stated if which of the following conditions exist?

Management's key assumptions are subject to volatility.

Which of the following pairs of accounts would an auditor most likely analyze on the same working paper?

Notes receivable and interest income.

Which of the following is one of the better auditing techniques that might be used by an auditor to detect kiting between intercompany banks?

Prepare a schedule of bank transfers.

An auditor ordinarily should send a standard confirmation request to all banks with which the entity has done business during the year under audit, regardless of the year-end balance, because this procedure

Seeks information about indebtedness to the bank.

A cutoff bank statement is used to verify the propriety of the reconciling items shown on the bank reconciliation.

TRUE

An imprest cash account is used for specific purposes and generally maintains a very small balance.

TRUE

If the entity maintains custody of its investments, the auditor normally examines the actual securities.

TRUE

The first step in auditing petty cash is to gain an understanding of the entity's controls over petty cash. Describe some important controls an entity should have over its petty cash fund.

1. The petty cash fund should be maintained by an independent custodian. If this custodian is involved in other cash functions, the petty cash activity should be reviewed by another person. 2. Prenumbered vouchers should be used for withdrawing from the fund. 3. A limit should be placed on the size of reimbursements made to petty cash. 4. An additional person should conduct surprise counts of the fund.

For each test of transactions and each test of account balances for investments listed below, identify the assertion for which the test provides evidence. 1. Determine whether there has been any permanent impairment in the value of the cost basis of an individual security. 2. Inspect securities if they are maintained by the entity or obtain a confirmation from an independent custodian. 3. Search for purchases of securities by examining transactions for a few days after year-end. 4. Examine brokers' advices for a sample of securities purchased during the year.

1. Valuation and allocation. 2. Existence. 3. Completeness. 4. Rights and obligations.

Match the segregation of duties for investments with the misstatement (due to error or fraud) it can help prevent. 1. The valuation-monitoring function is separate from the acquisition function 2. Custody of the securities is separate from accounting for the securities 3. The initiation function is separate from the final approval function 4. The maintenance of the securities ledger is separate from that of the general ledger

An individual can make fictitious transactions 3 An individual can improperly record securities values or not report the values to management 1 An individual can conceal a theft of securities 2 An individual can conceal any defalcation that would normally be detected by reconciliation of subsidiary records with general ledger control accounts 4

A company has additional temporary funds to invest. The Board of Directors decided to purchase marketable securities and assigned the future purchase and sale decisions to a responsible financial executive. The best person(s) to make periodic reviews of the investment activity authorized by that executive should be

An investment committee of the Board of Directors.

Which of the following would provide the best form of evidential matter pertaining to the annual valuation of a long-term investment in which the entity owns a 45 percent voting interest?

Audited financial statements of the investee company.

Jones was engaged to examine the financial statements of Virginia Corporation for the year ended June 30. Having completed an examination of the investment securities, which of the following is the best method of verifying the accuracy of recorded dividend income?

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

An auditor testing long-term investments would ordinarily use substantive analytical procedures as the primary audit evidence to support the reasonableness of the

Completeness of recorded investment income.

Tracing a sample of remittance advices to entries in the cash receipts journal tests which of the following assertions for cash?

Completeness.

When an auditor is unable to inspect and count an entity's investment securities until after the balance sheet date, the bank where the securities are held in a safe-deposit box should be notified on or before the balance sheet date that it will be asked to

Confirm that there has been no access to the box between the balance sheet date and the security-count date.

In establishing the existence and ownership of a long-term investment in stock of a publicly traded company, an auditor should inspect the securities or

Confirm the number of shares owned that are held by an independent custodian.

A primary purpose of the proof of cash is to

Ensure that all cash receipts recorded in the cash receipts journal were deposited in the bank account.

In confirming with an outside agent, such as a financial institution, that the agent is holding investment securities in the entity's name, an auditor most likely gathers evidence in support of management's financial statement assertions regarding

Existence. Rights and obligations. Completeness.

A major control that directly affects the audit of cash is the bank reconciliation prepared by the auditor.

FALSE

Kiting is an audit procedure used to test the accuracy of the cash receipts.

FALSE

If fraud is suspected, auditors may complete all of the following procedures except:

Footing the bank reconciliation and the outstanding checks listing.

Match the type of bank account with its definition: 1. This account is the principal cash account of an entity 2. This account contains a stipulated amount of cash and is used for limited purposes 3. This account is typically immaterial in amount and is used for paying certain types of expenses and transactions 4. This account is a separate cash account maintained at the local bank of the entity

General cash account 1 Branch account 4 Imprest cash account 2 Petty cash account 3

An imprest cash account is

One that contains a stipulated amount of money and is used for limited purposes.

The cashier of Brooke Company covered a shortage in the cash working fund with cash obtained on December 31 from a local bank by cashing, but not recording, a check drawn on the company's out-of-town bank. How would the auditor discover this manipulation?

Preparing and detail testing a bank transfer schedule.

Which of the following audit procedures is the most appropriate when internal control over cash is weak or when an entity requests an investigation of cash transactions?

Proof of cash.

Of the following, which is the most efficient audit procedure for verification of interest earned on bond investments?

Recomputing interest earned using the interest rate and bond amount.

Under which of the following circumstances would an auditor be most likely to intensify an examination of a $1,000 petty cash fund maintained on an imprest basis?

Reimbursement of the fund from the general cash account occurs twice or more each week.

An entity has a large and active investment portfolio that is kept in a bank safe-deposit box. If the auditor is unable to examine and count the securities at the balance sheet date but will examine and count the securities shortly thereafter, the auditor most likely will

Request that the entity have the bank seal the safe-deposit box until the auditor can count the securities at a subsequent date.

Explain how cash plays a role in all business processes. Cash is received by the entity through the revenue process, as well as from the sale of property, plant, and equipment, and proceeds from the issuance of long-term debt or capital stock. Cash is disbursed through the purchasing process when buying inventory, materials, and equipment and through the human resource process through payroll. Cash is also disbursed in the financing process when the entity pays off long-term debt or buys back its stock (treasury stock). For each assertion about cash listed below, give an example of a test of transactions for (1) cash receipts and (2) cash disbursements. a. Classification. b. Occurrence. c. Authorization. d. Completeness.

Student answers will vary: a.1. Cash receipts-Examine a sample of remittance advices for proper account classification. a.2. Cash disbursements-Examine a sample of canceled checks for proper account classification. b.1. Cash receipts-Trace a sample of entries in the cash receipts journal to remittance advices, daily deposit slips, and the bank statement. b.2. Cash disbursements-Trace a sample of entries in the cash disbursements journal to canceled checks, the voucher packet, and the bank statement. c.1. Cash receipts-For a sample of days, examine the signature on the deposit slip and the check endorsements for proper authorization. c.2. Cash disbursements-Examine a sample of canceled checks for authorized signature and proper endorsement. d.1. Cash receipts-Trace a sample of remittance advices to the cash receipts journal and, if necessary, to deposit slips. d.2. Cash disbursements-Trace a sample of canceled checks to the cash disbursements journal.

When there is a large number of negotiable securities in multiple locations, careful planning of the physical inspection and count of the securities by the auditor is necessary to guard against

Substitution of securities already counted at one location for other securities that should be on hand at a different location but are not.

What are the factors that must be considered to determine if a permanent decline in the value of an investment security has occurred?

The auditor must determine if there has been any permanent decline in the value of an investment security. Auditing standards provide guidance for determining whether a decline in value below amortized cost is other than temporary. The following factors are cited as indicating other than temporary impairments: 1. Fair value is significantly below cost. 2. The decline in fair value is attributable to specific adverse conditions affecting a particular investment. 3. The decline in fair value is attributable to specific conditions, such as conditions in an industry or in geographic areas. 4. Management does not possess both the intent and the ability to hold the investment long enough to allow for any anticipated recovery in fair value. 5. The decline in fair value has existed for an extended period. 6. A debt security has been downgraded by a rating agency. 7. The financial condition of the issuer has deteriorated. 8. Dividends have been reduced or eliminated, or scheduled interest payments on debt securities have not been made. If the investment value is determined to be permanently impaired, the security should be written down and a new carrying amount established. In addition, the auditor should examine the sale of any security to ensure that proper values were used to record the sale and any realized gain or loss.

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

The cashier posts the receipts to the accounts receivable subsidiary ledger cards.

As one of the year-end audit procedures, the auditor instructed the entity's personnel to prepare a standard bank confirmation request for a bank account that had been closed during the year. After the entity's treasurer had signed the request, it was mailed to the bank by the assistant treasurer. What is the major flaw in this audit procedure?

The request was mailed by the assistant treasurer.

You are auditing cash for Moonbeam, Inc. In meeting with the CFO during the planning stages of the audit, she indicated that there was a high risk of misstatement due to fraud in the cash account, given the lack of proper segregation of duties. As the auditor, what tests could you perform to detect fraudulent activities in the cash account?

There are three tests used for detecting fraud in the cash accounts. The first is extended bank reconciliation procedures. The auditor examines disposition of the reconciling items included on the prior months' reconciliations and the reconciling items included in the current bank reconciliation. These procedures can locate a fraud that used reconciling items to cover a cash defalcation. A second test is a proof of cash. A proof of cash reconciles the cash receipts and disbursements recorded on the entity's books with the cash deposited into and disbursed from the entity's bank account for a specific time period. Its primary purpose is to ensure that all cash receipts recorded in the entity's cash receipts journal were deposited in the entity's bank account, to ensure that all cash disbursements recorded in the cash disbursements journal have cleared the bank account, and to ensure that no bank transactions have been omitted from the entity's accounting records. It can detect cash stolen after being recorded on the entity's books. A third test is a test for kiting. Kiting is the process of covering a cash shortage by transferring money from one bank account to another and recording the transactions improperly on the entity's books. A test for kiting is completed through the use of an intertransfer schedule that lists all the transfers made between cash accounts. Each transfer is followed through from one account to another, noting the dates recorded on the entity's book and the dates on the bank statements.

Which of the following is not one of the auditor's primary objectives in an examination of marketable securities?

To determine whether securities are authentic.

An auditor who is engaged to examine the financial statements of a business enterprise will request a cutoff bank statement primarily to

Verify reconciling items on the entity's bank reconciliation.

Explain the importance of the bank reconciliation to the audit and list some of the items found on the reconciliation. The completion of a monthly bank reconciliation is an important control that affects the audit of the cash. The reconciliation ensures that the entity's books reflect the same amount of cash as the bank's after the consideration of reconciling items. A proper reconciliation can reduce the amount of audit time spent on cash. The reconciliation contains the balance per the entity's books and the balance per the bank, as well as reconciling items such as outstanding checks and deposits in transit. It may also include bank service charges and checks returned because the customer did not have sufficient cash in his account to cover the payment of the check. Identify 3 of the 6 tests an auditor uses on the bank reconciliation. (Only 3 are required for the student's answer)

• Test the mathematical accuracy of the bank reconciliation working paper and agree the adjusted balance per the books to the general ledger. • Agree the bank balance on the bank reconciliation with the balance shown on the standard bank confirmation. • Trace the deposits in transit on the bank reconciliation to the cutoff bank statement. • Compare the outstanding checks on the bank reconciliation working paper with the canceled checks contained in the cutoff bank statement for proper payee, amount, and endorsement. • Agree any charges included on the bank statement to the bank reconciliation. • Agree the adjusted book balance to the cash account lead schedule.