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Chapter 10 - Cash and Financial Investments

Chapter 10
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

. !ailroom personnel of a company should prepare a control listin" of incomin" cash
receipts and deposit them intact daily.
True False

#. $i"ned checks should be returned to the cash disbursements clerk for mailin".
True False

%. &appin" of accounts receivable by an employee is not possible when there is ade'uate
se"re"ation of duties with respect to cash disbursements.
True False

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

). * proof of cash is an audit procedure that is performed on almost every en"a"ement.
True False

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Chapter 10 - Cash and Financial Investments
+. * compensatin" balance a"reement "enerally re'uires that cash be reclassified as a
noncurrent asset.
True False

,. -erification of cash and other li'uid 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 e'uity method. the auditors are
primarily concerned with verifyin" the market value of the investments.
True False


Multiple Choice Questions

11. *n auditor/s analytical procedures have revealed that the accounts receivable of a client
have doubled since the end of the prior year. 0owever. the allowance for doubtful accounts. as
a percenta"e of accounts receivable remained about the same. 1hich of the followin" client
e2planations most likely would satisfy the auditor3
*. Credit standards were liberali4ed in the current year.
5. Twice as many accounts receivable were written off in the prior year as compared to this
year.
C. * "reater percenta"e of accounts were currently listed in the 6more than ,0 days overdue6
cate"ory than in the prior year.
7. The client opened a second retail outlet in the current year and its credit sales
appro2imately e'ualed the older. established outlet.

12. 5y preparin" a four-column bank reconciliation 86proof of cash69 at year-end. an auditor
will "enerally be able to detect:
*. *n unrecorded deposit made at the bank at the end of the month.
5. * second payment of an account payable which had already been paid in full two months
earlier.
C. *n embe44lement of cash receipts not recorded in the cash receipts journal before they
had been deposited into the bank.
7. * receivable collected that had previously been written off as uncollectible.

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Chapter 10 - Cash and Financial Investments
1. ;itin" would least likely be detected by:
*. *naly4in" details of lar"e cash deposits around year end.
5. Comparin" customer remittance advices with recorded disbursements in the cash
disbursements <ournal.
C. =reparin" a four-column bank reconciliation for all ma<or cash accounts.
7. =reparin" a schedule of interbank transfers by usin" the client/s records and bank
statements around year end.

1#. >our client left the cash receipts <ournal open after year-end for an e2tra day and included
?anuary 1 cash receipts in the 12@1@AA totals. *ll of those cash receipts were due to cash
sales. *ssumin" the client uses a periodic inventory system with a 12@1@AA count of the
physical inventory. which of the followin" is most likely to be true relatin" to the year AA
financial statements3
*. $ales are understated.
5. *ccounts receivable are understated.
C. Inventory is overstated.
7. Bet income is overstated.

1%. *n internal control 'uestionnaire indicates that an approved receivin" report is re'uired to
accompany every check re'uest for payment of merchandise. 1hich of the followin"
procedures provides the best evidence on operatin" effectiveness3
*. $elect and e2amine receivin" reports and test whether the related canceled checks are
dated no earlier than the receivin" reports.
5. $elect and e2amine receivin" reports and test whether the related canceled checks are dated
no later than the receivin" reports.
C. $elect and e2amine canceled checks and test whether the related receivin" reports are dated
no earlier than the checks.
7. $elect and e2amine canceled checks and test whether the related receivin" reports are
dated no later than the checks.

1(. 5y preparin" a four-column bank reconciliation 86proof of cash69 at year-end. an auditor
will "enerally not be able to detect:
*. *n unrecorded deposit made at the bank at the end of the month.
5. * second payment of an account payable which had already been paid in full two months
earlier.
C. *n unrecorded check cashed durin" that month.
7. * bank char"e durin" the month not recorded on the books.

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Chapter 10 - Cash and Financial Investments
1). 1hich procedure is an auditor most likely to use to detect a check outstandin" at year-end
that was not recorded as outstandin" on the year-end bank reconciliation3
*. =repare a bank transfer schedule usin" the client/s cash receipts and cash disbursements
<ournal.
5. Ceceive a cutoff statement directly from the client/s bank.
C. =repare a four column bank reconciliation usin" the year-end bank statement.
7. Confirm the year end balance usin" the standard form to confirm account balance
information with financial institutions.

1+. *n auditor may obtain information on the 7ecember 1 month end balance per bank in
which of the followin"3

*. Dption *
5. Dption 5
C. Dption C
7. Dption 7

1,. *n auditor may obtain information on the 7ecember 1 month end balance per bank in
which of the followin"3

*. Dption *
5. Dption 5
C. Dption C
7. Dption 7

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Chapter 10 - Cash and Financial Investments
20. 1hich of the followin" is correct concernin" 6window dressin"6 for cash3
*. * se"re"ation of duties within the cash function effectively eliminates its occurrence.
5. It "enerally involves manipulation of inventory.
C. It is ille"al. and an audit is desi"ned to provide reasonable assurance of its detection.
7. !any forms of it re'uire no action by the auditors.

21. 1hich of the followin" statements is not correct3
*. 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.
5. =ayroll 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 e2presses an opinion as of that date.
7. Ceviewin" interbank transfers is important to the auditor because of the possibility that the
client may be en"a"ed in kitin".

22. The auditors use a bank cutoff statement to compare:
*. 7eposits in transit on the year-end cash "eneral led"er account to deposits in the cash
receipts <ournal.
5. Checks dated prior to year-end to the outstandin" checks listed on the year-end bank
reconciliation.
C. 7eposits listed on the cutoff statement to disbursements in the cash disbursements <ournal.
7. Checks dated subse'uent to year-end to the outstandin" checks listed on the year-end bank
statement.

2. * practical and effective audit procedure for the detection of lappin" is:
*. =reparin" an interbank transfer schedule.
5. Comparin" recorded cash receipts in detail a"ainst items makin" up the bank deposit as
shown on duplicate deposit slips validated by the bank.
C. Tracin" recorded cash receipts to postin"s in customers/ led"er cards.
7. =reparin" a proof of cash.

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Chapter 10 - Cash and Financial Investments
2#. 1hich of the followin" is not a control that "enerally is established over cash
transactions3
*. $eparatin" cash handlin" from recordkeepin".
5. Centrali4in" the receipt of cash.
C. 7epositin" each day/s receipts intact.
7. Dbtainin" a receipt for every disbursement.

2%. 1hich of the followin" controls would be most likely to reduce the risk of diversion of
customer receipts by a company/s employees3
*. * bank lockbo2 system.
5. *pproval of all disbursements by an individual independent of cash receipts.
C. !onthly bank cutoff statements.
7. =renumbered remittance advices.

2(. 1hich of the followin" is not a control that "enerally is established over cash receipts3
*. To prevent abstraction of cash. a control listin" of cash receipts should be prepared by
mailroom personnel.
5. To insure accurate postin". 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 controllin" account.
7. To prevent theft of cash. receipts should be deposited daily.

2). Tracin" recorded sales transactions in the sales <ournal to the shippin" documents 8bills of
ladin"9 provides evidence about the:
*. Completeness of recordin" of sales transactions.
5. Dccurrence of sales transactions.
C. 5illin" of all sales transactions.
7. =resentation of payables.

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Chapter 10 - Cash and Financial Investments
2+. 5y preparin" a four-column bank reconciliation 86proof of cash69 for the last month of the
year. an auditor will "enerally be able to detect:
*. *n unrecorded check written at the be"innin" of the month which was cashed durin" the
period covered by the reconciliation.
5. * cash sale which was not recorded on the books and was stolen by a bookkeeper.
C. *n embe44lement of unrecorded cash receipts on receivables before they had been
deposited into the bank.
7. * credit sale which has been recorded twice in the sales <ournal.

2,. In Dctober. 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. $elect the
most effective method for detectin" this type of error.
*. Foot the cash receipts <ournal for Dctober.
5. $end a bank confirmation as of year-end.
C. =repare a bank reconciliation as of year-end.
7. =repare a bank transfer schedule as of year-end.

0. ?ones embe44led E10.000 from his company/s account in 5ank *. *t year-end he hid the
shorta"e by makin" a deposit on 7ecember 1 in 5ank *. drawn on 5ank 5. 0e has not
recorded the transaction on the books. This is an e2ample of:
*. &appin".
5. ;itin".
C. Fffective cash mana"ement.
7. Celated party transactions.

1. ?ones embe44led E10.000 from his company/s account in 5ank *. *t year-end he hid the
shorta"e by makin" a deposit on 7ecember 1 in 5ank *. drawn on 5ank 5. 0e has not
recorded the transaction on the books. 1hich of the followin" is most likely to be effective in
detectin" this fraud3
*. 5ank confirmation.
5. 5ank transfer schedule prepared usin" only the cash receipts and cash disbursements
<ournals.
C. Comparison of bank cutoff statement to the cash receipts and disbursements records.
7. Ceceivable confirmation.

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Chapter 10 - Cash and Financial Investments
2. 1hich of the followin" is not a universal rule for achievin" internal control over cash3
*. $eparate recordkeepin" from accountin" for cash to the e2tent possible.
5. 7eposit each day/s cash receipts intact.
C. $eparate cash handlin" from recordkeepin".
7. 0ave monthly bank reconciliations prepared by employees not responsible for the issuance
of checks.

. 1hich of the followin" is not a control over cash disbursements3
*. 7isbursements should be made by check.
5. * check protectin" machine should be used.
C. 7ocuments supportin" the payment of a disbursement should be canceled by the person
preparin" the check to prevent reuse.
7. -oided checks should be defaced and filed with paid checks.

#. 1hich of the followin" is the best audit procedure for the detection of lappin"3
*. Comparison of postin"s of cash receipts to accounts with the details of cash deposits.
5. Confirmation of the cash balance.
C. Ceconciliation of the cash account balances.
7. =reparin" a proof of cash.

%. 1hich of the followin" manipulations of cash transactions would overstate the cash
balance on the financial statements3
*. Gnderstatement of outstandin" checks.
5. Dverstatement of outstandin" checks.
C. Gnderstatement of deposits in transit.
7. Dverstatement of bank services char"es.

(. 1hich of the followin" is not confirmed on the standard form used for cash balances at
financial institutions3
*. Cash checkin" account balances.
5. Cash savin"s account balances.
C. &oans payable.
7. $ecurities held for the client by the financial institution.

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Chapter 10 - Cash and Financial Investments
). Internal control over marketable securities is enhanced when:
*. $ecurities are held by the cashier.
5. $ecurities are re"istered in the name of the custodian.
C. 7etailed records of securities are maintained by the custodian of the securities.
7. $ecurities are held under <oint control of two or more officials.

+. In a manufacturin" company which one of the followin" audit procedures would "ive the
least assurance of the e2istence of the assets in the "eneral led"er balance of investment in
stocks and bonds at the audit date3
*. Confirmation from the broker.
5. Inspection of year-end brokers/ statements.
C. -ouchin" all chan"es durin" the year to brokers/ advises and statements.
7. F2amination of paid checks issued in payment of securities purchased.

,. The $tandard Form to Confirm *ccount 5alances with Financial Institutions includes
information on all of the followin" except:
*. 7ate due of a direct liability.
5. The principal amount paid on a direct liability.
C. 7escription of collateral for a direct liability.
7. The interest rate of a direct liability.

#0. The auditors should insist that a representative of the client be present durin" the physical
e2amination of securities in order to:
*. &end authority of the auditor/s directives.
5. 7etect for"ed securities.
C. Coordinate the return of all securities to proper locations.
7. *cknowled"e the receipt of securities returned.

#1. The auditors/ count of the client/s cash should be coordinated to coincide with the:
*. Consideration of the internal controls with respect to cash.
5. Close of business on the balance sheet date.
C. Count of investment securities.
7. Count of inventories.

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Chapter 10 - Cash and Financial Investments
#2. The auditors compare information on canceled checks with information contained in the
cash disbursement <ournal. The ob<ective of this test is to determine that:
*. Cecorded cash disbursement transactions are properly authori4ed.
5. =roper cash purchase discounts have been recorded.
C. Cash disbursements are for "oods and services actually received.
7. Bo discrepancies e2ist between the data on the checks and the data in the <ournal.

#. ?ones was en"a"ed to audit the financial statements of Hamma Corporation for the year
ended ?une 0. 200A. 0avin" completed an e2amination of the investment securities. which
of the followin" is the best method of verifyin" the accuracy of recorded dividend income3
*. Tracin" recorded dividend income to cash receipts records and validated deposit slips.
5. Gtili4in" analytical techni'ues and statistical samplin".
C. Comparin" recorded dividends with amounts appearin" on federal information form 10,,s.
7. Comparin" recorded dividends with a standard financial reportin" service/s record of
dividends.

##. 1hich of the followin" is one of the better auditin" techni'ues that mi"ht be used by an
auditor to detect kitin"3
*. Ceview composition of authenticated deposit slips.
5. Ceview subse'uent bank statements and canceled checks received directly from the banks.
C. =repare a schedule of bank transfers.
7. =repare year-end bank reconciliations.

#%. 1hich one of the followin" would the auditor consider to be an incompatible operation if
the cashier receives remittances from the mailroom3
*. The cashier prepares the daily deposit.
5. The cashier makes the daily deposit at a local bank.
C. The cashier posts the receipts to the accounts receivable subsidiary led"er.
7. The cashier endorses the checks.

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Chapter 10 - Cash and Financial Investments
#(. *s one of the year-end audit procedures. the auditor instructed the client/s personnel to
prepare a confirmation re'uest for a bank account that had been closed durin" the year. *fter
the client/s treasurer has si"ned the re'uest. it was mailed by the assistant treasurer. 1hat is
the ma<or flaw in this audit procedure3
*. The confirmation re'uest was si"ned by the treasurer.
5. $endin" the re'uest was meanin"less because the account was closed before the year end.
C. The re'uest was mailed by the assistant treasurer.
7. The C=* did not si"n the confirmation re'uest before it was mailed.

#). Dn receivin" the bank cutoff statement. the auditor should trace:
*. 7eposits in transit on the year-end bank reconciliation to deposits in the cash receipts
<ournal.
5. Checks dated prior to year end to the outstandin" checks listed on the year-end bank
reconciliation.
C. 7eposits listed on the cutoff statement to deposits in the cash receipts <ournal.
7. Checks dated subse'uent to year end to the outstandin" checks listed on the year-end bank
reconciliation.

#+. To "ather evidence re"ardin" the balance per bank in a bank reconciliation. an auditor
could e2amine all of the followin" except
*. Cutoff bank statement.
5. >ear-end bank statement.
C. 5ank confirmation.
7. Heneral led"er.

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Chapter 10 - Cash and Financial Investments
#,. 1hich of the followin" cash transfers is most likely to result in a misstatement of cash at
7ecember 1. 1,A)3

*. Transfer *
5. Transfer 5
C. Transfer C
7. Transfer 7

%0. Contact with banks for the purpose of openin" company bank accounts should normally
be the responsibility of the corporate:
*. 5oard of 7irectors.
5. Treasurer.
C. Controller.
7. F2ecutive Committee.

%1. =roperly desi"ned internal control will permit the same employee to:
*. Ceceive and deposit checks. and also approve write-offs of customer accounts.
5. *pprove vouchers for payment. and also receive and deposit cash.
C. Ceconcile the bank statements. and also receive and deposit cash.
7. $i"n checks. and also cancel supportin" documents.

%2. 1hich of the followin" procedures in the cash disbursements cycle should not be
performed by the accounts payable department3
*. Comparin" the vendor/s invoice with the receivin" report.
5. Cancelin" supportin" documentation after payment.
C. -erifyin" the mathematical accuracy of the vendor/s invoice.
7. =reparin" the check for si"nature by an authori4ed person.

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Chapter 10 - Cash and Financial Investments
%. The =armalat fraud case apparently involved
*. * fraudulent cash confirmation.
5. ;itin" of funds between banks in India and banks in =akistan.
C. * bank reconciliation performed by the client that systematically understated cash.
7. !a<or unrecorded disbursements for e'uipment.

%#. 5anks may process electronic 6substitute checks6 in place of customer written hard copy
checks due to the:
*. Check Clearin" for the 21stCentury *ct
5. =ublic Company *ccountin" Dversi"ht 5oard/s $tandard Bo. 2.
C. Forei"n Corrupt =ractices *ct.
7. $arbanes-D2ley *ct

%%. 1hen a client en"a"es in transactions involvin" derivatives. the auditor should
*. 7evelop an understandin" of the economic substance of each derivative.
5. Confirm with the client/s broker whether the derivatives are for tradin" purposes.
C. Botify the audit committee about the risks involved in derivative transactions.
7. *dd an e2planatory para"raph to the auditor/s report describin" the risks associated with
each derivative.

%(. * company/s decision to use the fair value option for valuation of marketable securities is
most likely to affects which of the followin" assertions the most3
*. Completeness.
5. F2istence.
C. Fairness.
7. =resentation and 7isclosure

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Chapter 10 - Cash and Financial Investments
%). *n auditor compares annual revenues and e2penses with similar amounts from the prior
year and investi"ates all chan"es e2ceedin" 10I. This procedure most likely could indicate
that
*. Fourth 'uarter payroll ta2es were properly accrued and recorded. but were not paid until
early in the subse'uent year.
5. Gnreali4ed "ains from increases in the value of available-for-sale securities were recorded
in the income account for tradin" securities.
C. The annual provision for uncollectible accounts e2pense was inade'uate because of
worsenin" economic conditions.
7. Botice of an increase in property ta2 rates was received by mana"ement. but was not
recorded until early in the subse'uent year.


Essay Questions

%+. In the audit of a client/s financial statements. the auditors must be concerned with the
possibility that client personnel mi"ht be en"a"ed in kitin" or lappin".
a. 7efine lappin" and describe an audit procedure that mi"ht detect lappin".
b. 7efine kitin" and describe an audit procedure that mi"ht detect kitin".




%,. $ince financial investments are assets with a hi"h de"ree of inherent risk. companies must
establish effective internal control over their investments.
a. 7escribe the functions that should be se"re"ated to provide "ood internal control over
financial investments.
b. 7escribe two other internal control policies that should be established for financial
investments.




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Chapter 10 - Cash and Financial Investments
(0. &isted below are four interbank cash transfers. indicated by the letters a. b. c and d. of a
client for late 7ecember 20A1. and early ?anuary 20A2. >our answer choice for the ne2t two
'uestions should be selected from this list.

For each of transfers a throu"h d indicate whether cash is understated. unaffected. or
overstated by the transfer and provide a brief e2ample of what could cause the situation in
which cash is either understated or overstated.




(1. In many financial statements audits. auditin" financial investments involves comple2 tasks
re'uirin" speciali4ed skill and knowled"e.
a. &ist three audit tasks related to the audit of financial investments that may re'uire
speciali4ed skill or knowled"e.
b. 7efine the term 6financial derivative.6
c. &ist the two "eneral purposes that a client mi"ht ac'uire a financial derivative.




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Chapter 10 - Cash and Financial Investments
Chapter 10 Cash and Financial Investments *nswer ;ey


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.
FALSE

Difficulty: Easy

2. Control over the receipt of cash sales is best achieved when two or more employees
participate in each transaction.
T!E

Difficulty: Easy

. !ailroom personnel of a company should prepare a control listin" of incomin" cash
receipts and deposit them intact daily.
FALSE

Difficulty: Medium

#. $i"ned checks should be returned to the cash disbursements clerk for mailin".
FALSE

Difficulty: Medium

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Chapter 10 - Cash and Financial Investments
%. &appin" of accounts receivable by an employee is not possible when there is ade'uate
se"re"ation of duties with respect to cash disbursements.
FALSE

Difficulty: Medium

(. Confirmations for cash balances should be mailed only to the financial institutions with
which the client has a cash balance at year-end.
FALSE

Difficulty: Hard

). * proof of cash is an audit procedure that is performed on almost every en"a"ement.
FALSE

Difficulty: Medium

+. * compensatin" balance a"reement "enerally re'uires that cash be reclassified as a
noncurrent asset.
FALSE

Difficulty: Medium

,. -erification of cash and other li'uid assets be verified on the same date may prevent
substitution of one form of asset for another.
T!E

Difficulty: Easy

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Chapter 10 - Cash and Financial Investments
10. For investments in securities accounted for by the e'uity method. the auditors are
primarily concerned with verifyin" the market value of the investments.
FALSE

Difficulty: Medium


Multiple Choice Questions

11. *n auditor/s analytical procedures have revealed that the accounts receivable of a client
have doubled since the end of the prior year. 0owever. the allowance for doubtful accounts. as
a percenta"e of accounts receivable remained about the same. 1hich of the followin" client
e2planations most likely would satisfy the auditor3
*. Credit standards were liberali4ed in the current year.
5. Twice as many accounts receivable were written off in the prior year as compared to this
year.
C. * "reater percenta"e of accounts were currently listed in the 6more than ,0 days overdue6
cate"ory than in the prior year.
"# The client opened a second retail outlet in the current year and its credit sales
appro2imately e'ualed the older. established outlet.

Difficulty: Medium
Source: AICPA

12. 5y preparin" a four-column bank reconciliation 86proof of cash69 at year-end. an auditor
will "enerally be able to detect:
A# *n unrecorded deposit made at the bank at the end of the month.
5. * second payment of an account payable which had already been paid in full two months
earlier.
C. *n embe44lement of cash receipts not recorded in the cash receipts journal before they
had been deposited into the bank.
7. * receivable collected that had previously been written off as uncollectible.

Difficulty: Hard

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Chapter 10 - Cash and Financial Investments
1. ;itin" would least likely be detected by:
*. *naly4in" details of lar"e cash deposits around year end.
$# Comparin" customer remittance advices with recorded disbursements in the cash
disbursements <ournal.
C. =reparin" a four-column bank reconciliation for all ma<or cash accounts.
7. =reparin" a schedule of interbank transfers by usin" the client/s records and bank
statements around year end.

Difficulty: Hard

1#. >our client left the cash receipts <ournal open after year-end for an e2tra day and included
?anuary 1 cash receipts in the 12@1@AA totals. *ll of those cash receipts were due to cash
sales. *ssumin" the client uses a periodic inventory system with a 12@1@AA count of the
physical inventory. which of the followin" is most likely to be true relatin" to the year AA
financial statements3
*. $ales are understated.
5. *ccounts receivable are understated.
C. Inventory is overstated.
"# Bet income is overstated.

Difficulty: Medium

1%. *n internal control 'uestionnaire indicates that an approved receivin" report is re'uired to
accompany every check re'uest for payment of merchandise. 1hich of the followin"
procedures provides the best evidence on operatin" effectiveness3
*. $elect and e2amine receivin" reports and test whether the related canceled checks are
dated no earlier than the receivin" reports.
5. $elect and e2amine receivin" reports and test whether the related canceled checks are dated
no later than the receivin" reports.
C. $elect and e2amine canceled checks and test whether the related receivin" reports are dated
no earlier than the checks.
"# $elect and e2amine canceled checks and test whether the related receivin" reports are
dated no later than the checks.

Difficulty: Hard

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Chapter 10 - Cash and Financial Investments
1(. 5y preparin" a four-column bank reconciliation 86proof of cash69 at year-end. an auditor
will "enerally not be able to detect:
*. *n unrecorded deposit made at the bank at the end of the month.
$# * second payment of an account payable which had already been paid in full two months
earlier.
C. *n unrecorded check cashed durin" that month.
7. * bank char"e durin" the month not recorded on the books.

Difficulty: Hard

1). 1hich procedure is an auditor most likely to use to detect a check outstandin" at year-end
that was not recorded as outstandin" on the year-end bank reconciliation3
*. =repare a bank transfer schedule usin" the client/s cash receipts and cash disbursements
<ournal.
$# Ceceive a cutoff statement directly from the client/s bank.
C. =repare a four column bank reconciliation usin" the year-end bank statement.
7. Confirm the year end balance usin" the standard form to confirm account balance
information with financial institutions.

Difficulty: Hard

1+. *n auditor may obtain information on the 7ecember 1 month end balance per bank in
which of the followin"3

A# Dption *
5. Dption 5
C. Dption C
7. Dption 7

Difficulty: Medium

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Chapter 10 - Cash and Financial Investments
1,. *n auditor may obtain information on the 7ecember 1 month end balance per bank in
which of the followin"3

*. Dption *
$# Dption 5
C. Dption C
7. Dption 7

Difficulty: Medium

20. 1hich of the followin" is correct concernin" 6window dressin"6 for cash3
*. * se"re"ation of duties within the cash function effectively eliminates its occurrence.
5. It "enerally involves manipulation of inventory.
C. It is ille"al. and an audit is desi"ned to provide reasonable assurance of its detection.
"# !any forms of it re'uire no action by the auditors.

Difficulty: Hard

21. 1hich of the followin" statements is not correct3
*. 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.
5. =ayroll 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 e2presses an opinion as of that date.
7. Ceviewin" interbank transfers is important to the auditor because of the possibility that the
client may be en"a"ed in kitin".

Difficulty: Hard

10-21
Chapter 10 - Cash and Financial Investments
22. The auditors use a bank cutoff statement to compare:
*. 7eposits in transit on the year-end cash "eneral led"er account to deposits in the cash
receipts <ournal.
$# Checks dated prior to year-end to the outstandin" checks listed on the year-end bank
reconciliation.
C. 7eposits listed on the cutoff statement to disbursements in the cash disbursements <ournal.
7. Checks dated subse'uent to year-end to the outstandin" checks listed on the year-end bank
statement.

Difficulty: Hard

2. * practical and effective audit procedure for the detection of lappin" is:
*. =reparin" an interbank transfer schedule.
$# Comparin" recorded cash receipts in detail a"ainst items makin" up the bank deposit as
shown on duplicate deposit slips validated by the bank.
C. Tracin" recorded cash receipts to postin"s in customers/ led"er cards.
7. =reparin" a proof of cash.

Difficulty: Hard

2#. 1hich of the followin" is not a control that "enerally is established over cash
transactions3
*. $eparatin" cash handlin" from recordkeepin".
5. Centrali4in" the receipt of cash.
C. 7epositin" each day/s receipts intact.
"# Dbtainin" a receipt for every disbursement.

Difficulty: Medium

2%. 1hich of the followin" controls would be most likely to reduce the risk of diversion of
customer receipts by a company/s employees3
A# * bank lockbo2 system.
5. *pproval of all disbursements by an individual independent of cash receipts.
C. !onthly bank cutoff statements.
7. =renumbered remittance advices.

Difficulty: Hard

10-22
Chapter 10 - Cash and Financial Investments
2(. 1hich of the followin" is not a control that "enerally is established over cash receipts3
*. To prevent abstraction of cash. a control listin" of cash receipts should be prepared by
mailroom personnel.
$# To insure accurate postin". 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 controllin" account.
7. To prevent theft of cash. receipts should be deposited daily.

Difficulty: Medium

2). Tracin" recorded sales transactions in the sales <ournal to the shippin" documents 8bills of
ladin"9 provides evidence about the:
*. Completeness of recordin" of sales transactions.
$# Dccurrence of sales transactions.
C. 5illin" of all sales transactions.
7. =resentation of payables.

Difficulty: Medium

2+. 5y preparin" a four-column bank reconciliation 86proof of cash69 for the last month of the
year. an auditor will "enerally be able to detect:
A# *n unrecorded check written at the be"innin" of the month which was cashed durin" the
period covered by the reconciliation.
5. * cash sale which was not recorded on the books and was stolen by a bookkeeper.
C. *n embe44lement of unrecorded cash receipts on receivables before they had been
deposited into the bank.
7. * credit sale which has been recorded twice in the sales <ournal.

Difficulty: Hard

10-2
Chapter 10 - Cash and Financial Investments
2,. In Dctober. 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. $elect the
most effective method for detectin" this type of error.
*. Foot the cash receipts <ournal for Dctober.
$# $end a bank confirmation as of year-end.
C. =repare a bank reconciliation as of year-end.
7. =repare a bank transfer schedule as of year-end.

Difficulty: Hard

0. ?ones embe44led E10.000 from his company/s account in 5ank *. *t year-end he hid the
shorta"e by makin" a deposit on 7ecember 1 in 5ank *. drawn on 5ank 5. 0e has not
recorded the transaction on the books. This is an e2ample of:
*. &appin".
$# ;itin".
C. Fffective cash mana"ement.
7. Celated party transactions.

Difficulty: Hard

1. ?ones embe44led E10.000 from his company/s account in 5ank *. *t year-end he hid the
shorta"e by makin" a deposit on 7ecember 1 in 5ank *. drawn on 5ank 5. 0e has not
recorded the transaction on the books. 1hich of the followin" is most likely to be effective in
detectin" this fraud3
*. 5ank confirmation.
5. 5ank transfer schedule prepared usin" only the cash receipts and cash disbursements
<ournals.
C# Comparison of bank cutoff statement to the cash receipts and disbursements records.
7. Ceceivable confirmation.

Difficulty: Hard

10-2#
Chapter 10 - Cash and Financial Investments
2. 1hich of the followin" is not a universal rule for achievin" internal control over cash3
A# $eparate recordkeepin" from accountin" for cash to the e2tent possible.
5. 7eposit each day/s cash receipts intact.
C. $eparate cash handlin" from recordkeepin".
7. 0ave monthly bank reconciliations prepared by employees not responsible for the issuance
of checks.

Difficulty: Medium

. 1hich of the followin" is not a control over cash disbursements3
*. 7isbursements should be made by check.
5. * check protectin" machine should be used.
C# 7ocuments supportin" the payment of a disbursement should be canceled by the person
preparin" the check to prevent reuse.
7. -oided checks should be defaced and filed with paid checks.

Difficulty: Medium

#. 1hich of the followin" is the best audit procedure for the detection of lappin"3
A# Comparison of postin"s of cash receipts to accounts with the details of cash deposits.
5. Confirmation of the cash balance.
C. Ceconciliation of the cash account balances.
7. =reparin" a proof of cash.

Difficulty: Hard

%. 1hich of the followin" manipulations of cash transactions would overstate the cash
balance on the financial statements3
A# Gnderstatement of outstandin" checks.
5. Dverstatement of outstandin" checks.
C. Gnderstatement of deposits in transit.
7. Dverstatement of bank services char"es.

Difficulty: Medium

10-2%
Chapter 10 - Cash and Financial Investments
(. 1hich of the followin" is not confirmed on the standard form used for cash balances at
financial institutions3
*. Cash checkin" account balances.
5. Cash savin"s account balances.
C. &oans payable.
"# $ecurities held for the client by the financial institution.

Difficulty: Medium

). Internal control over marketable securities is enhanced when:
*. $ecurities are held by the cashier.
5. $ecurities are re"istered in the name of the custodian.
C. 7etailed records of securities are maintained by the custodian of the securities.
"# $ecurities are held under <oint control of two or more officials.

Difficulty: Medium

+. In a manufacturin" company which one of the followin" audit procedures would "ive the
least assurance of the e2istence of the assets in the "eneral led"er balance of investment in
stocks and bonds at the audit date3
*. Confirmation from the broker.
5. Inspection of year-end brokers/ statements.
C. -ouchin" all chan"es durin" the year to brokers/ advises and statements.
"# F2amination of paid checks issued in payment of securities purchased.

Difficulty: Hard
Source: AICPA

,. The $tandard Form to Confirm *ccount 5alances with Financial Institutions includes
information on all of the followin" except:
*. 7ate due of a direct liability.
$# The principal amount paid on a direct liability.
C. 7escription of collateral for a direct liability.
7. The interest rate of a direct liability.

Difficulty: Hard
Source: AICPA

10-2(
Chapter 10 - Cash and Financial Investments
#0. The auditors should insist that a representative of the client be present durin" the physical
e2amination of securities in order to:
*. &end authority of the auditor/s directives.
5. 7etect for"ed securities.
C. Coordinate the return of all securities to proper locations.
"# *cknowled"e the receipt of securities returned.

Difficulty: Medium
Source: AICPA

#1. The auditors/ count of the client/s cash should be coordinated to coincide with the:
*. Consideration of the internal controls with respect to cash.
5. Close of business on the balance sheet date.
C# Count of investment securities.
7. Count of inventories.

Difficulty: Medium
Source: AICPA

#2. The auditors compare information on canceled checks with information contained in the
cash disbursement <ournal. The ob<ective of this test is to determine that:
*. Cecorded cash disbursement transactions are properly authori4ed.
5. =roper cash purchase discounts have been recorded.
C. Cash disbursements are for "oods and services actually received.
"# Bo discrepancies e2ist between the data on the checks and the data in the <ournal.

Difficulty: Easy
Source: AICPA

10-2)
Chapter 10 - Cash and Financial Investments
#. ?ones was en"a"ed to audit the financial statements of Hamma Corporation for the year
ended ?une 0. 200A. 0avin" completed an e2amination of the investment securities. which
of the followin" is the best method of verifyin" the accuracy of recorded dividend income3
*. Tracin" recorded dividend income to cash receipts records and validated deposit slips.
5. Gtili4in" analytical techni'ues and statistical samplin".
C. Comparin" recorded dividends with amounts appearin" on federal information form 10,,s.
"# Comparin" recorded dividends with a standard financial reportin" service/s record of
dividends.

Difficulty: Hard
Source: AICPA

##. 1hich of the followin" is one of the better auditin" techni'ues that mi"ht be used by an
auditor to detect kitin"3
*. Ceview composition of authenticated deposit slips.
5. Ceview subse'uent bank statements and canceled checks received directly from the banks.
C# =repare a schedule of bank transfers.
7. =repare year-end bank reconciliations.

Difficulty: Medium
Source: AICPA

#%. 1hich one of the followin" would the auditor consider to be an incompatible operation if
the cashier receives remittances from the mailroom3
*. The cashier prepares the daily deposit.
5. The cashier makes the daily deposit at a local bank.
C# The cashier posts the receipts to the accounts receivable subsidiary led"er.
7. The cashier endorses the checks.

Difficulty: Hard
Source: AICPA

10-2+
Chapter 10 - Cash and Financial Investments
#(. *s one of the year-end audit procedures. the auditor instructed the client/s personnel to
prepare a confirmation re'uest for a bank account that had been closed durin" the year. *fter
the client/s treasurer has si"ned the re'uest. it was mailed by the assistant treasurer. 1hat is
the ma<or flaw in this audit procedure3
*. The confirmation re'uest was si"ned by the treasurer.
5. $endin" the re'uest was meanin"less because the account was closed before the year end.
C# The re'uest was mailed by the assistant treasurer.
7. The C=* did not si"n the confirmation re'uest before it was mailed.

Difficulty: Easy
Source: AICPA

#). Dn receivin" the bank cutoff statement. the auditor should trace:
*. 7eposits in transit on the year-end bank reconciliation to deposits in the cash receipts
<ournal.
$# Checks dated prior to year end to the outstandin" checks listed on the year-end bank
reconciliation.
C. 7eposits listed on the cutoff statement to deposits in the cash receipts <ournal.
7. Checks dated subse'uent to year end to the outstandin" checks listed on the year-end bank
reconciliation.

Difficulty: Medium
Source: AICPA

#+. To "ather evidence re"ardin" the balance per bank in a bank reconciliation. an auditor
could e2amine all of the followin" except
*. Cutoff bank statement.
5. >ear-end bank statement.
C. 5ank confirmation.
"# Heneral led"er.

Difficulty: Medium
Source: AICPA

10-2,
Chapter 10 - Cash and Financial Investments
#,. 1hich of the followin" cash transfers is most likely to result in a misstatement of cash at
7ecember 1. 1,A)3

*. Transfer *
$# Transfer 5
C. Transfer C
7. Transfer 7

Difficulty: Medium
Source: AICPA

%0. Contact with banks for the purpose of openin" company bank accounts should normally
be the responsibility of the corporate:
*. 5oard of 7irectors.
$# Treasurer.
C. Controller.
7. F2ecutive Committee.

Difficulty: Hard
Source: AICPA

%1. =roperly desi"ned internal control will permit the same employee to:
*. Ceceive and deposit checks. and also approve write-offs of customer accounts.
5. *pprove vouchers for payment. and also receive and deposit cash.
C. Ceconcile the bank statements. and also receive and deposit cash.
"# $i"n checks. and also cancel supportin" documents.

Difficulty: Medium
Source: AICPA

10-0
Chapter 10 - Cash and Financial Investments
%2. 1hich of the followin" procedures in the cash disbursements cycle should not be
performed by the accounts payable department3
*. Comparin" the vendor/s invoice with the receivin" report.
$# Cancelin" supportin" documentation after payment.
C. -erifyin" the mathematical accuracy of the vendor/s invoice.
7. =reparin" the check for si"nature by an authori4ed person.

Difficulty: Medium
Source: AICPA

%. The =armalat fraud case apparently involved
A# * fraudulent cash confirmation.
5. ;itin" of funds between banks in India and banks in =akistan.
C. * bank reconciliation performed by the client that systematically understated cash.
7. !a<or unrecorded disbursements for e'uipment.

Difficulty: Medium

%#. 5anks may process electronic 6substitute checks6 in place of customer written hard copy
checks due to the:
A# Check Clearin" for the 21stCentury *ct
5. =ublic Company *ccountin" Dversi"ht 5oard/s $tandard Bo. 2.
C. Forei"n Corrupt =ractices *ct.
7. $arbanes-D2ley *ct

Difficulty: Easy

%%. 1hen a client en"a"es in transactions involvin" derivatives. the auditor should
A# 7evelop an understandin" of the economic substance of each derivative.
5. Confirm with the client/s broker whether the derivatives are for tradin" purposes.
C. Botify the audit committee about the risks involved in derivative transactions.
7. *dd an e2planatory para"raph to the auditor/s report describin" the risks associated with
each derivative.

Difficulty: Hard
Source: AICPA

10-1
Chapter 10 - Cash and Financial Investments
%(. * company/s decision to use the fair value option for valuation of marketable securities is
most likely to affects which of the followin" assertions the most3
*. Completeness.
5. F2istence.
C. Fairness.
"# =resentation and 7isclosure

Difficulty: Hard

%). *n auditor compares annual revenues and e2penses with similar amounts from the prior
year and investi"ates all chan"es e2ceedin" 10I. This procedure most likely could indicate
that
*. Fourth 'uarter payroll ta2es were properly accrued and recorded. but were not paid until
early in the subse'uent year.
$# Gnreali4ed "ains from increases in the value of available-for-sale securities were recorded
in the income account for tradin" securities.
C. The annual provision for uncollectible accounts e2pense was inade'uate because of
worsenin" economic conditions.
7. Botice of an increase in property ta2 rates was received by mana"ement. but was not
recorded until early in the subse'uent year.

Difficulty: Medium
Source: AICPA


Essay Questions

10-2
Chapter 10 - Cash and Financial Investments
%+. In the audit of a client/s financial statements. the auditors must be concerned with the
possibility that client personnel mi"ht be en"a"ed in kitin" or lappin".
a. 7efine lappin" and describe an audit procedure that mi"ht detect lappin".
b. 7efine kitin" and describe an audit procedure that mi"ht detect kitin".
a. &appin" is the concealment of a cash shorta"e by delayin" the recordin" of cash receipts. It
involves postin" receipts to the wron" account.
=rocedures for detectin" lappin" include 8only one re'uired9:
7etails of cash receipts may be compared to postin"s to the accounts receivable subsidiary
records. preferably on a surprise basis.
Confirmation of accounts receivable.
b. ;itin" is manipulation causin" an amount of cash to be included simultaneously in the
balance of two or more bank accounts.
To detect kitin" the auditors prepare and verify a schedule of bank transfers.

Difficulty: Medium

%,. $ince financial investments are assets with a hi"h de"ree of inherent risk. companies must
establish effective internal control over their investments.
a. 7escribe the functions that should be se"re"ated to provide "ood internal control over
financial investments.
b. 7escribe two other internal control policies that should be established for financial
investments.
a. The functions that should be se"re"ated with respect to financial investments are:
1. *uthori4ation of purchases and sales.
2. Custody of the securities. and
. !aintainin" records of investments.
b. Dther internal controls include 8only two re'uired9:
Fstablishin" formal investment policies.
!aintainin" a complete detailed record of investments and revenue from investments.
Ce"istration of securities in the name of the company.
=eriodic physical inspection.
?oint control over securities. or use of an independent custodian.
=reparation of a bud"et of investment revenue.
7etermination of appropriate accountin" by competent personnel.

Difficulty: Medium

10-
Chapter 10 - Cash and Financial Investments
(0. &isted below are four interbank cash transfers. indicated by the letters a. b. c and d. of a
client for late 7ecember 20A1. and early ?anuary 20A2. >our answer choice for the ne2t two
'uestions should be selected from this list.

For each of transfers a throu"h d indicate whether cash is understated. unaffected. or
overstated by the transfer and provide a brief e2ample of what could cause the situation in
which cash is either understated or overstated.
a. Gnaffected.
b. Gnaffected.
c. Gnderstated. *lthou"h there are a number of possible situations. one is that in which a
check is written on the disbursin" bank on the last day of 7ecember with a credit to cash. and
an associated debit to some e2pense account so as to decrease reported profits 8and ta2es9 for
the year.
d. Dverstated. Dne situation is that in which an employee has misappropriated funds durin"
the year. and draw a check transferrin" funds to the account with the shorta"e so as to cover
the shorta"e. *s of 7ecember 1. the shorta"e is replaced. with no reduction as yet recorded
in the account on which it is drawn.

Difficulty: Hard

10-#
Chapter 10 - Cash and Financial Investments
(1. In many financial statements audits. auditin" financial investments involves comple2 tasks
re'uirin" speciali4ed skill and knowled"e.
a. &ist three audit tasks related to the audit of financial investments that may re'uire
speciali4ed skill or knowled"e.
b. 7efine the term 6financial derivative.6
c. &ist the two "eneral purposes that a client mi"ht ac'uire a financial derivative.
a. *udit tasks re'uirin" speciali4ed skill or knowled"e 8only three re'uired9:
Identifyin" controls at service or"ani4ations that provide financial services for the client.
Dbtainin" an understandin" of information systems for securities and derivatives that are
hi"hly dependent on computer technolo"y.
*pplyin" comple2 accountin" principles.
Gnderstandin" the methods of determinin" fair values of financial investments/
*ssessin" inherent risk and control risk for assertions about derivatives used for hed"in".
b. 7erivatives are financial instruments that 6derive6 their value form other financial
instruments. underlyin" assets. or indices.
c. Clients en"a"e in financial derivative transactions for two ma<or purposes:
0ed"in"--to hed"e chan"es in value of an e2istin" asset or liability or of a prospective
future transaction.
$peculatin"--to bet on the chan"e in value of another financial instrument. an asset. or an
inde2.

Difficulty: Hard

10-%

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