Test bank principles of auditing and other assurance principles chapter 10 cash and financial investments

The auditors should count small petty cash funds at year-end to make sure that balance is not understated on the financial statements.. Prepare a bank transfer schedule using the client'

Cash and Financial Investments

True / False Questions

1 The auditors should count small petty cash funds at year-end to make sure that balance is

not understated on the financial statements

True False

2 Control over the receipt of cash sales is best achieved when two or more employees

participate in each transaction

True False

3 Mailroom personnel of a company should prepare a control listing of incoming cash

receipts and deposit them intact daily

True False

4 Signed checks should be returned to the cash disbursements clerk for mailing

True False

5 Lapping of accounts receivable by an employee is not possible when there is adequate

segregation of duties with respect to cash disbursements

8 A compensating balance agreement generally requires that cash be reclassified as a

noncurrent asset

True False

9 Verification of cash and other liquid assets be verified on the same date may prevent

substitution of one form of asset for another

True False

10 For investments in securities accounted for by the equity method, the auditors are

primarily concerned with verifying the market value of the investments

True False

Multiple Choice Questions

11 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 in 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

12 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

13 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

14 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

15 An internal control questionnaire indicates that an approved receiving report is required toaccompany 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 canceled checks are dated no earlier than the receiving reports

B Select and examine receiving reports and test whether the related canceled checks are dated

no later than the receiving reports

C Select and examine canceled checks and test whether the related receiving reports are dated

no earlier than the checks

D Select and examine canceled checks and test whether the related receiving reports are dated no later than the checks

16 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

17 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

18 An auditor may obtain information on the December 31 month end balance per bank in which of the following?

20 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

21 Which of the following statements is not correct?

A Cash is important to the audit process 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

22 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

23 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

24 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

25 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

26 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

27 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

28 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

29 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

30 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

31 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?

32 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

33 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 canceled by the person preparing the check to prevent reuse

D Voided checks should be defaced and filed with paid checks

34 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 of the cash account balances

D Preparing a proof of cash

35 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

36 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

37 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

38 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

39 The Standard Form to Confirm Account Balances with Financial Institutions includes

information on all of the following except:

A Date due 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

40 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

41 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

42 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

43 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

44 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 canceled checks received directly from the banks

C Prepare a schedule of bank transfers

D Prepare year-end bank reconciliations

45 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

46 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

47 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

48 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

49 Which of the following cash transfers is most likely to result in a misstatement of cash at December 31, 19X7?

50 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

51 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 payment, 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

52 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 Canceling supporting documentation after payment

C Verifying the mathematical accuracy of the vendor's invoice

D Preparing the check for signature by an authorized person

53 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

54 Banks may process electronic "substitute checks" in place of customer written hard copy checks due to the:

A Check Clearing for the 21stCentury Act

B Public Company Accounting Oversight Board's Standard No 2

C Foreign Corrupt Practices Act

D Sarbanes-Oxley Act

55 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

56 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?

57 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

Essay Questions

58 In the audit of a client's financial statements, the auditors must be concerned with the possibility that client personnel might be engaged in kiting or lapping

a Define lapping and describe an audit procedure that might detect lapping

b Define kiting and describe an audit procedure that might detect kiting

59 Since financial investments are assets with a high degree of inherent risk, companies must establish effective internal control over their investments

a Describe the functions that should be segregated to provide good internal control over financial investments

b Describe two other internal control policies that should be established for financial

investments

60 Listed below are four interbank cash transfers, indicated by the letters a, b, c and d, of a client for late December 20X1, and early January 20X2 Your answer choice for the next two questions should be selected from this list.

For each of transfers a through d indicate whether cash is understated, unaffected, or

overstated by the transfer and provide a brief example of what could cause the situation in which cash is either understated or overstated

61 In many financial statements audits, auditing financial investments involves complex tasksrequiring specialized skill and knowledge

a List three audit tasks related to the audit of financial investments that may require

specialized skill or knowledge

b Define the term "financial derivative."

c List the two general purposes that a client might acquire a financial derivative

Chapter 10 Cash and Financial Investments Answer Key

True / False Questions

1 The auditors should count small petty cash funds at year-end to make sure that balance is

not understated on the financial statements

5 Lapping of accounts receivable by an employee is not possible when there is adequate

segregation of duties with respect to cash disbursements