Auditing and Assurance Services, 16e, Global Edition (Arens/Elder/Beasley)

Chapter 23 Audit of Cash and Financial Instruments

23.1 Learning Objective 23-1

1) Which of the following is not a "cash equivalent"?

A) time deposits
B) certificates of deposit
C) money market funds
D) marketable securities
Answer: D
Terms: Cash equivalent
Diff: Moderate
Objective: LO 23-1
AACSB: Reflective thinking

2) An imprest petty cash fund would least likely be used to pay for which of the following items?
A) minor office supplies
B) monthly interest expense
C) stamps for small mailings
D) small contributions to a local charity
Answer: B
Terms: Imprest petty cash fund
Diff: Moderate
Objective: LO 23-1
AACSB: Reflective thinking

3) An imprest petty cash fund

A) is a bank account.
B) is used for large, unusual purchases.
C) is usually reimbursed at least once a week for good internal control.
D) is being replaced by pre-approved purchase cards in many companies.
Answer: D
Terms: Examination of imprest petty cash fund
Diff: Moderate
Objective: LO 23-1
AACSB: Analytic thinking

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4) Financial instruments
A) include debt securities and money market funds.
B) such as derivatives can be used as a way of hedging.
C) must be classified as held-to-maturity securities.
D) All of the above are correct.
Answer: B
Terms: Financial instruments
Diff: Moderate
Objective: LO 23-1
AACSB: Reflective thinking

5) Describe each of the major types of cash accounts maintained by business entities.
Answer:
• General cash account. This is the focal point of cash for most organizations because virtually
all cash receipts and disbursements flow through this account.
• Imprest payroll account. As a means of improving internal control, many companies
establish a separate imprest bank account for making payroll payments to employees. In such an
account, a fixed balance, such as $1,000, is maintained. Immediately before each pay period, one
check or electronic transfer is drawn on the general cash account to deposit the total amount of
the net payroll in the imprest payroll account.
• Branch bank account. For a company operating in multiple locations, it is often desirable to
have a separate bank balance at each location. Branch bank accounts are useful for building
public relations in local communities and permitting the centralization of operations at the
branch level.
• Imprest petty cash fund. This fund is used for small cash acquisitions that can be paid more
conveniently and quickly by cash than by check, or for the convenience of employees in cashing
personal or payroll checks.
• Cash equivalents. Excess cash accumulated during certain parts of the operating cycle that
will be needed in the reasonably near future is often invested in short-term, highly liquid cash
equivalents such as time deposits, certificates of deposit, and money market funds.
Terms: Major types of cash accounts
Diff: Moderate
Objective: LO 23-1
AACSB: Reflective thinking

6) Companies may purchase marketable securities as a way to temporarily invest excess cash.
Answer: TRUE
Terms: Financial instruments
Diff: Moderate
Objective: LO 23-1
AACSB: Reflective thinking

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7) Examples of cash equivalents include time deposits, certificates of deposit, and marketable
securities.
Answer: FALSE
Terms: Cash equivalent
Diff: Moderate
Objective: LO 23-1
AACSB: Reflective thinking

8) Branch bank accounts are useful for building banking relations in local communities.
Answer: TRUE
Terms: Types of cash accounts
Diff: Easy
Objective: LO 23-1
AACSB: Reflective thinking

23.2 Learning Objective 23-2

1) Which of the following misstatements is most likely to be uncovered during an audit of a

client's bank reconciliation?
A) duplicate payment of a vendor's invoice
B) billing a customer at a lower price than indicated by company policy
C) failure to record a collection of a note receivable by the bank on the client's behalf
D) payment to an employee for more than the hours actually worked
Answer: C
Terms: Bank reconciliation
Diff: Easy
Objective: LO 23-2
AACSB: Reflective thinking

2) Which of the following is likely to be detected as part of the audit of the bank reconciliation?
A) failure to bill a customer
B) duplicate payment of a vendor invoice
C) cash received by the client after year-end, but included in cash receipts in the current year
D) an embezzlement of cash by intercepting cash receipts from customers before they are
recorded
Answer: C
Terms: Bank reconciliation
Diff: Easy
Objective: LO 23-2
AACSB: Reflective thinking

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3) Which of the following would normally be discovered as part of the audit of the bank
reconciliation?
A) failure to bill a customer
B) failure to include a deposit in transit on the bank reconciliation
C) duplicate payment of a vendor's invoice
D) payment to an employee for more hours than she worked
Answer: B
Terms: Bank reconciliation
Diff: Easy
Objective: LO 23-2
AACSB: Reflective thinking

4) The general cash account is considered a significant account in almost all audits
A) where the ending balance is material.
B) even when the ending balance is immaterial.
C) except those of not-for-profit organizations.
D) where either the beginning or ending balance is material.
Answer: B
Terms: General cash account
Diff: Moderate
Objective: LO 23-2
AACSB: Reflective thinking

5) Which of the following is an accurate statement regarding cash?

A) The amount of cash flowing into and out of the cash account is often larger than that for any
other account in the financial statements.
B) The susceptibility of cash to embezzlement is greater than that for other types of assets.
C) Auditors must verify whether recorded cash in the general ledger correctly reflects all cash
transactions that took place during the year.
D) All of the above are accurate statements.
Answer: D
Terms: Cash in bank
Diff: Moderate
Objective: LO 23-2
AACSB: Reflective thinking

6) Which of the following cycles does not affect cash in bank?

A) capital acquisitions cycle
B) inventory and warehousing
C) payroll and personnel cycle
D) acquisitions and disbursements
Answer: B
Terms: Cash in bank
Diff: Easy
Objective: LO 23-2
AACSB: Reflective thinking

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7) List at least three misstatements that are designed to be detected by a bank reconciliation.
Answer:
1. Failure to include a check that has not cleared the bank on the outstanding checklist, even
though it has been recorded on the cash disbursement journal
2. Cash received by the client subsequent to the balance sheet date, but recorded as cash receipts
in the current year
3. Deposits recorded as cash receipts near the end of the year, deposited in the bank in the same
month, and included in the bank reconciliation as a deposit in transit
4. Payments on notes payable debited directly to the bank balance by the bank but not entered in
the client's records
Terms: Bank reconciliation audit tests; Detected misstatements
Diff: Easy
Objective: LO 23-2
AACSB: Reflective thinking

8) "Failure to bill a customer" is an example of an error that results in the failure to receive cash,
but would not be discovered as part of the audit of the bank reconciliation. State three other
examples of errors or irregularities that result in the improper payment of, or failure to receive,
cash, but that would not be discovered during the audit of the bank reconciliation. How are these
types of misstatements normally uncovered in the audit?
Answer:
• An embezzlement of cash by intercepting cash receipts from customers before they are
recorded with the account charged off as a bad debt
• Duplicate payment of a vendor's invoice
• Improper payments of officers' personal expenditures
• Payment for raw materials that were not received
• Payment to an employee for more hours than he or she worked
• Payment of interest to a related party for an amount in excess of the going rate

If these misstatements are to be uncovered in the audit, their discovery must occur through tests
of controls and substantive tests of transactions.
Terms: Improper payment or failure to receive cash but not discovered during audit of bank
reconciliation
Diff: Challenging
Objective: LO 23-2
AACSB: Reflective thinking

9) The general cash account will not be audited if the ending balance is immaterial.
Answer: FALSE
Terms: Cash in bank
Diff: Easy
Objective: LO 23-2
AACSB: Reflective thinking

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23.3 Learning Objective 23-3

1) The test of details of balances procedure that requires the auditor to foot the outstanding check
and electronic payment list and deposits in transit is an attempt to satisfy which audit objective?
A) cutoff
B) presentation and disclosure
C) detail tie-in
D) completeness
Answer: C
Terms: Test of details of balances procedure
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

2) The audit objective of determining that cash in bank, as stated on the reconciliation, foots
correctly and agrees with the general ledger can be tested by which of the following procedures?
A) performing tests for kiting
B) receiving and testing a cutoff bank statement
C) proving the bank reconciliation as to additions and subtractions, including all reconciling
items
D) examining the minutes of the board of directors for restrictions on the use of cash
Answer: C
Terms: Audit objective; Cash in bank; Reconciliation
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

3) The test of details of balances procedure that requires the auditor to trace the book balance on
the reconciliation to the general ledger is an attempt to satisfy the audit objective of
A) detail tie-in.
B) existence.
C) completeness.
D) accuracy.
Answer: A
Terms: Test details of balances procedure; Reconciliation
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

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4) Which of the following statements is correct?
A) Auditors must obtain bank confirmations for audits of nonpublic entities.
B) Auditors are required to obtain bank confirmations under international auditing standards.
C) Auditing standards do not address specific requirements regarding bank confirmations.
D) Auditing standards do not require bank confirmations.
Answer: D
Terms: Bank confirmation
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

5) A partial-period bank statement and the related copies of or digital access to cancelled checks,
duplicate deposit slips, and other documents included in bank statements, mailed by the bank
directly to the CPA firm's office, is called
A) a four-column proof of cash.
B) a year-end bank statement.
C) a cutoff bank statement.
D) a short-period bank statement.
Answer: C
Terms: Partial-period bank statement
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

6) Which of the following statements is correct?

A) Bank personnel are responsible for providing reasonable assurance that a response to a bank
confirmation is accurate.
B) Bank personnel are responsible for providing complete assurance that a bank confirmation is
complete.
C) Bank personnel are not responsible for searching their records for bank balances or loans
beyond those included on the bank confirmation.
D) Bank personnel are not responsible for providing information related to interest on the bank
confirmation.
Answer: C
Terms: Bank confirmation
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

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7) In addition to confirming bank balances of your audit client, a bank confirmation would
normally contain
A) the client's bank loans with due date, interest rate, and collateral requested.
B) the client's credit history as regards to paying back loans.
C) the client's managements bank account information.
D) the client's business prospects.
Answer: A
Terms: Bank confirmation
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

8) Which of the following balance-related audit objectives typically is assessed as having high
inherent risk for cash?
A) existence
B) cutoff
C) detail tie-in
D) presentation and disclosure
Answer: A
Terms: Balance-related audit objectives; High inherent risk for cash
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

9) Because cash is the most desirable asset for people to steal, it has a higher
A) control risk.
B) inherent risk.
C) detection risk.
D) liquidity risk.
Answer: B
Terms: Cash; Risk
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

10) The starting point for the verification of the balance in the general bank account is to obtain
A) a bank reconciliation from the client.
B) the client's cash account from the general ledger.
C) a cutoff bank statement directly from the bank.
D) the client's year-end bank statement.
Answer: A
Terms: Verification of balance in the general bank account
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

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11) In an effort to satisfy the completeness objective, the auditor could perform which of the
following test of details of balance procedures?
A) Trace the book balance on the reconciliation to the general ledger.
B) Trace outstanding checks to subsequent period bank statements.
C) Perform a four-column proof of cash.
D) Review financial statements to make sure that material savings accounts and certificates of
deposit are disclosed separately.
Answer: C
Terms: Completeness objective; Test of details of balance procedures
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

12) The audit procedure which requires the auditor to record the last check number used on the
last day of the year and subsequently trace to the outstanding checks and the cash disbursements
records is performed to satisfy the audit objective of
A) detail tie-in.
B) existence.
C) completeness.
D) cutoff.
Answer: D
Terms: Audit procedure to record last check number used
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

13) The direct receipt of a confirmation from every bank with which the client does business is
A) required by auditing standards for every audit.
B) not necessary unless material fraud is suspected.
C) recommended but not required by auditing standards.
D) necessary for every audit except when there are an unusually large number of active accounts.
Answer: C
Terms: Direct receipt of confirmation from every bank
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

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14) The reason for testing the client's bank reconciliation is to verify whether the client's
recorded bank balance is the same amount as the actual cash in bank, except for deposits in
transit, checks outstanding, and other reconciling items. The information needed to complete the
tests of the reconciliation is provided by the
A) client's records and ledgers for the year under audit.
B) cutoff bank statement.
C) client's records and ledgers for the subsequent year.
D) canceled checks for the year under audit.
Answer: B
Terms: Bank reconciliation; Deposits in transit; Outstanding checks
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

15) Which of the following items would not normally appear on bank reconciliations?
A) balance per bank
B) list of deposits in transit
C) outstanding deposits
D) outstanding checks
Answer: C
Terms: Bank reconciliation
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

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16) If a bank does not respond to a bank confirmation request, the auditor would most likely
A)
Ask the client to
communicate with the bank
Perform alternative Send a second to ask them to complete and
procedures request return the confirmation
No Yes Yes

B)
Ask the client to
communicate with the bank
Perform alternative Send a second to ask them to complete and
procedures request return the confirmation
No No Yes

C)
Ask the client to
communicate with the bank
Perform alternative Send a second to ask them to complete and
procedures request return the confirmation
Yes No Yes

D)
Ask the client to
communicate with the bank
Perform alternative Send a second to ask them to complete and
procedures request return the confirmation
Yes Yes No

Answer: A
Terms: Bank confirmation request
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

17) The most important balance-related audit objectives in the audit of cash include all except
which of the following?
A) existence
B) accuracy
C) completeness
D) occurrence
Answer: D
Terms: Balance-related audit objectives in the audit of cash
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

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18) The bank reconciliation
A) must be done on a daily basis if the client uses electronic banking.
B) should be performed by someone independent of the handling or recording of cash receipts.
C) should be performed by someone who handles cash disbursements.
D) ensures that no cash has been embezzled.
Answer: B
Terms: Bank fraud protection tools
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

19) ________ is an automated fraud detection tool offered by most banks.

A) Positive pay
B) A bank confirmation
C) Fraud buster
D) Check matching
Answer: A
Terms: Bank reconciliation
Diff: Moderate
Objective: LO 23-3
AACSB: Analytic thinking

20) Which of the following balance-related objectives applies to auditing the general cash
account?
A)
Rights Classification Realizable value
Yes No Yes

B)
Rights Classification Realizable value
No Yes No

C)
Rights Classification Realizable value
Yes Yes Yes

D)
Rights Classification Realizable value
No No No

Answer: D
Terms: Balance-related objective applied to auditing the general cash account
Diff: Challenging
Objective: LO 23-3
AACSB: Reflective thinking

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21) The standard bank confirmation form has been agreed upon by the
A) SEC and FASB.
B) AICPA and the SEC.
C) SEC and the American Bankers' Association.
D) AICPA and the American Bankers' Association.
Answer: D
Terms: Standard bank confirmation
Diff: Challenging
Objective: LO 23-3
AACSB: Reflective thinking

22) The auditors test the client's monthly bank reconciliation to verify whether the client's
recorded bank balance is the same amount as the actual cash in the bank. Which of the following
would not explain a difference between the company's cash balance and the bank's balance for
the client?
A) deposits in transit
B) Checks are written by the client in the same month the checks clear the bank.
C) other reconciling items
D) outstanding checks
Answer: B
Terms: Bank reconciliation
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

23) If an auditor waits until the subsequent period bank statement is available to verify
reconciling items, it is primarily a test for
A) errors.
B) omissions.
C) kiting.
D) intentional misstatements.
Answer: D
Terms: Auditor proves the bank statement
Diff: Challenging
Objective: LO 23-3
AACSB: Reflective thinking

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24) Which of the following verifications would generally not be performed by the auditor in the
month subsequent to the balance sheet date?
A) Foot the lists of all canceled checks, debit memos, deposits, and credit memos.
B) Verify the bank statement balances when the footed totals are used.
C) Verify the book statement balances tie to the cash receipts and disbursements journals for the
year under audit.
D) Review the items included in the footings to make sure that they were cancelled by the bank.
Answer: C
Terms: Verifications performed in the month subsequent to balance sheet date
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

25) When assessing risks affecting cash,

A) if a business defers preparing bank reconciliations for long periods, the value of the control is
reduced and may affect the auditor's assessment of control risk for cash.
B) most companies are likely to have significant client business risks affecting their cash
balances.
C) there is a low inherent risk for the existence and completeness objectives for cash.
D) all of the above are accurate statements.
Answer: A
Terms: Cash; Risk
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

26) Internal controls over year-end cash balances in the general account can be divided into two
categories. List the two below.
Answer:
1. controls over the transaction cycles affecting the recording of cash receipts and cash
disbursements
2. independent bank reconciliations
Terms: Internal controls over year-end cash balances
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

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27) Explain what is meant by a cutoff bank statement, and discuss the purpose of the cutoff bank
statement in the audit of cash.
Answer: A cutoff bank statement is a partial-period bank statement and the related copies of or
digital access to cancelled checks, duplicate deposit slips, and other documents included in bank
statements, mailed by the bank directly to the CPA firm's office or through online access to the
bank's electronic records of the client's bank account information. The purpose of the cutoff bank
statement or electronic access to account information on the bank's system is to verify the
reconciling items on the client's year-end bank reconciliation with evidence that is maintained by
the bank, not the client.
Terms: Cutoff bank statement; Audit of cash
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

28) Explain the purpose of testing the client's bank reconciliation, and discuss the major audit
procedures involved.
Answer: Auditors test the bank reconciliation to determine whether client personnel have
carefully prepared the bank reconciliation and to verify whether the client's recorded bank
balance is the same amount as the actual cash in the bank except for deposits in transit,
outstanding checks, and other reconciling items. Procedures include:
• Verify that the client's bank reconciliation is mathematically accurate.
• Trace the balance on the bank confirmation and/or the beginning balance shown in online
client banking records or in the cutoff statement to the balance per bank on the bank
reconciliation to ensure they are the same.
• Trace checks written and recorded before year-end and included with the cutoff bank
statement to the list of outstanding checks on the bank reconciliation and to the cash
disbursements journal in the period or periods prior to the balance sheet date.
• Investigate all significant checks included on the outstanding check list that have not cleared
the bank on the cutoff statement.
• Trace deposits in transit to the cutoff bank statement.
• Account for other reconciling items on the bank statement and bank reconciliation.
Terms: Testing client's bank reconciliation and major audit procedures
Diff: Challenging
Objective: LO 23-3
AACSB: Reflective thinking

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29) Instead of receiving a cutoff bank statement or if online access to client bank account
information is not available to the auditor, auditors can wait until the subsequent period bank
statement is available to verify reconciling items. Discuss the purpose of reviewing the
subsequent period bank statement and list the verifications the auditor performs on this bank
statement.
Answer: The purpose of such a proof is to test whether the client's employees have omitted,
added, or altered any of the documents accompanying the statement. Obviously, this tests for
intentional misstatements. The audit procedures include footing the lists of all the cancelled
checks, debit memos, deposits, and credit memos; verifying that the bank statement balances
when the footed totals are used; and reviewing the items included in the footings to make sure
that they were cancelled by the bank in the proper period and do not include any erasures or
alterations.
Terms: Prove subsequent period bank statement and audit procedures
Diff: Challenging
Objective: LO 23-3
AACSB: Reflective thinking

30) The bank reconciliation control is enhanced when a qualified employee reviews the monthly
reconciliation as soon as possible after its completion.
Answer: TRUE
Terms: Bank reconciliation
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

31) Many of the auditor's audit procedures in the audit of cash center around the client's bank
confirmations.
Answer: FALSE
Terms: Audit of cash; Bank confirmations
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

32) Tracing outstanding checks to subsequent period bank statements tests the cutoff audit
objective.
Answer: TRUE
Terms: Tracing outstanding checks; Cutoff audit objective
Diff: Easy
Objective: LO 23-3
AACSB: Reflective thinking

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33) When auditing the year-end cash balance, one of the areas of focus is on the accuracy
objective.
Answer: TRUE
Terms: Auditing year-end cash balance; Accuracy objective
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

34) The three most important audit objectives for cash are accuracy, existence, and classification.
Answer: FALSE
Terms: Audit objectives for cash
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

35) The starting point for the verification of the balance in the general bank account is to obtain a
bank cut-off statement.
Answer: FALSE
Terms: General bank account; Bank cut-off statement
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

36) When auditing the general cash account, receipt of a standard bank confirmation is the
starting point for verifying the company's general cash account balance.
Answer: FALSE
Terms: General cash account; Standard bank confirmation
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

37) To test the client's list of outstanding checks on the bank reconciliation for completeness, the
auditor should trace from the list to the checks included with the cutoff bank statement.
Answer: FALSE
Terms: Outstanding checks on bank reconciliation for completeness; Cutoff bank statement
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

38) The client may mail the bank confirmation requests if the auditor believes doing so will
increase the likelihood that the confirmation will be returned promptly.
Answer: FALSE
Terms: Bank confirmation
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

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39) Auditors usually design bank confirmations that address the client's specific circumstances.
Answer: FALSE
Terms: Bank confirmation
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

40) Ordinarily, all deposits-in-transit listed on the year-end bank reconciliation should appear as
deposits on the cutoff bank statement.
Answer: TRUE
Terms: Deposits-in-transit; Year-end bank reconciliation; Cutoff bank statement
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

41) Auditors are not always required to obtain bank confirmations.

Answer: TRUE
Terms: Bank confirmation
Diff: Challenging
Objective: LO 23-3
AACSB: Reflective thinking

42) The auditor is generally concerned about the realizable value and the rights to cash.
Answer: FALSE
Terms: Audit of cash
Diff: Moderate
Objective: LO 23-3
AACSB: Reflective thinking

43) A statement near the bottom of the standard bank confirmation form requires the bank to
inform auditors of open lines of credit and compensating balance requirements.
Answer: FALSE
Terms: Bank confirmation
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking

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23.4 Learning Objective 23-4

1) Auditors are likely to prepare a proof of cash when the client has
A) material internal control weaknesses in cash.
B) material internal control weaknesses in accounts receivable and revenue.
C) material internal control weaknesses in accounts payable and inventory.
D) material internal control weaknesses in payroll.
Answer: A
Terms: Proof of cash
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

2) The auditor uses a proof of cash to determine whether

A)
All recorded cash disbursements All amounts that were paid by the
were paid by the bank. bank were recorded.
Yes Yes

B)
All recorded cash disbursements All amounts that were paid by the
were paid by the bank. bank were recorded.
No No

C)
All recorded cash disbursements All amounts that were paid by the
were paid by the bank. bank were recorded.
Yes No

D)
All recorded cash disbursements All amounts that were paid by the
were paid by the bank. bank were recorded.
No Yes

Answer: A
Terms: Proof of cash
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

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3) A proof of cash represents
A) a test of controls and substantive test of transactions.
B) a substantive test of transactions.
C) a substantive test of transactions and test of details of balances.
D) a test of details of balances.
Answer: C
Terms: Proof of cash
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

4) A major consideration in the audit of the general cash balance is the possibility of fraud. The
auditor must extend his or her procedures in the audit of year-end cash to determine the
possibility of a material fraud when there are
A) large cash balances at the end of the year.
B) large cash receipts and disbursements during the year.
C) no imprest accounts used for payroll.
D) inadequate internal controls.
Answer: D
Terms: Material fraud; Extend procedures in audit of year-end cash
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

5) The audit and accounting concern addressed in a monthly proof of cash is with
A) adjusting account balances.
B) reconciling the amounts recorded in the books with the amounts included in the bank
statement.
C) determining the month-end balance.
D) identifying cash transfers.
Answer: B
Terms: Monthly proof of cash
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

6) A proof of cash is effective at identifying which of the following misstatements?

A) checks written for an improper amount
B) checks issued to invalid vendors
C) fraudulent checks
D) checks recorded in the books for an amount different from that on the check
Answer: D
Terms: Proof of cash
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

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7) The process of transferring money from one bank account to another and improperly
recording the transaction is referred to as
A) kiting.
B) lapping.
C) scamming.
D) embezzling.
Answer: A
Terms: Transferring money from one bank account to another and improperly recording the
transaction
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

8) Which of the following is a correct statement?

A) The proof of cash receipts is a test of the balance in the cash account at a point in time.
B) The proof of cash disbursements is effective for discovering a check written for the incorrect
amount for which the dollar amount in cash disbursements is also incorrect.
C) It is extremely difficult for an auditor to detect thefts of cash, especially omitted transactions
and account balances.
D) Segregation of duties is not an important control procedure for cash in a small business.
Answer: C
Terms: Audit of cash
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

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The following information applies to the questions below:

Listed below are four interbank cash transfers, indicated by the numbers 1, 2, 3, and 4, of a client
for late December 2015 and early January 2016:

Bank Account One Bank Account Two

Disbursing Date Receiving Date
(Month/Day) (Month/Day)
Per Bank Per Books Per Bank Per Books
1. 12/31 12/30 12/31 12/30
2. 1/2 12/30 12/31 12/31
3. 1/3 12/31 1/2 1/2
4. 1/3 12/31 1/2 12/31

9) Based on the schedule of interbank transfers above, which of the cash transfers indicates an
error in cash cutoff at December 31, 2015?
A) 1
B) 2
C) 3
D) 4
Answer: C
Terms: Interbank cash transfers
Diff: Challenging
Objective: LO 23-4
AACSB: Analytic thinking

10) Based on the schedule of interbank transfers above, which of the cash transfers would appear
as a deposit in transit on the December 31, 2015 bank reconciliation?
A) 1
B) 2
C) 3
D) 4
Answer: D
Terms: Interbank cash transfers
Diff: Challenging
Objective: LO 23-4
AACSB: Analytic thinking

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11) Based on the schedule of interbank transfers above, which of the cash transfers would not
appear as an outstanding check on the December 31, 2015 bank reconciliation?
A) 1
B) 2
C) 3
D) 4
Answer: A
Terms: Interbank cash transfers
Diff: Challenging
Objective: LO 23-4
AACSB: Analytic thinking

12) A proof of cash is not an effective procedure for identifying which of the following types of
misstatements?
A) All recorded disbursements were paid by the bank.
B) All recorded cash receipts were deposited.
C) All amounts that were paid by the bank were recorded.
D) Some checks were written for incorrect amounts.
Answer: D
Terms: Proof of cash; Misstatements
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

13) Listing all bank transfers made a few days before and after the balance sheet date and tracing
each to the accounting records for proper recording is a useful approach to test for
A) kiting.
B) lapping.
C) income smoothing.
D) channel stuffing.
Answer: A
Terms: Bank transfers
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

14) Procedures that may uncover fraud in the cash receipts area include
A) confirmation of accounts payable.
B) comparison of purchase orders to invoices.
C) tests performed to detect lapping.
D) all of the above.
Answer: C
Terms: Fraud; Cash
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

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15) Which of the following should be audited on the interbank transfer schedule?
A) Receipts on the interbank transfer schedule should be correctly included in or excluded from
year-end bank reconciliations as deposits in transit.
B) Disbursements on the interbank transfer schedule must always be shown as outstanding
checks.
C) The interbank transfers cannot be recorded in both the receiving and disbursing banks.
D) All transfers that occurred for the month before and the month after the year-end must be
included on the interbank transfer schedule.
Answer: A
Terms: Interbank cash transfers
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

16) On the last day of the fiscal year, the cash disbursements clerk drew a company check on
bank A and deposited the check in the company account in bank B to cover a previous theft of
cash. The disbursement has not been recorded. The auditor will best detect this form of kiting by
A) examining the composition of deposits in both bank A and bank B subsequent to year-end.
B) examining paid checks returned with the bank statement of the next account period after year-
end.
C) preparing, from the cash disbursements records, a summary of bank transfers for one week
prior to and subsequent to year-end.
D) comparing the detail of cash receipts as shown by the client's cash receipts records with the
detail on the confirmed duplicate deposit tickets for three days prior to and subsequent to year-
end.
Answer: B
Terms: Cash disbursements; Kiting
Diff: Challenging
Objective: LO 23-4
AACSB: Analytic thinking

17) When the auditor believes the year-end bank reconciliation may be intentionally misstated, it
is appropriate to perform extended tests of the year-end bank reconciliation. Assuming the client
has a October 31 year-end, these extended tests would not include
A) comparing all September 30 reconciling items with canceled checks and other documents in
the October bank statement.
B) comparing all canceled checks and deposit slips in the October bank statement with the
October cash disbursements and receipts records.
C) carrying out all proper procedures subsequent to the end of the year with the use of the bank
cutoff statement.
D) determining that all outstanding checks had cleared by the date of the bank cutoff statement.
Answer: D
Terms: Bank reconciliation; Extended tests
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

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18) Auditors will often prepare a proof of cash when the client has material internal control
weaknesses in cash receipts and cash disbursements. The purpose of the proof of cash is to
determine the client's accounting records for cash are reliable. List below the four requirements
the proof of cash is designed to provide for the auditor.
Answer:
1. All recorded cash receipts were deposited.
2. All deposits in the bank were recorded in the accounting records.
3. All recorded cash disbursements were paid by the bank.
4. All amounts that were paid by the bank were recorded.
Terms: Proof of cash requirements
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

19) A proof of cash includes four reconciliation tasks. List below two of those tasks.
Answer:
1. Reconcile the balance on the bank statement with the general ledger balance at the beginning
of the proof-of-cash period.
2. Reconcile cash receipts deposited per the bank with the receipts recorded in the cash receipts
journal for a given period.
3. Reconcile electronic payments and cancelled checks clearing the bank with those recorded in
the cash disbursements journal for a given period.
4. Reconcile the balance on the bank statement with the general ledger balance at the end of the
proof-of-cash period.
Terms: Proof of cash requirements
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

20) What should be audited on an interbank transfer schedule?

Answer:
1. The accuracy of the information on the interbank transfer schedule should be verified.
2. The interbank transfers must be recorded in both the receiving and disbursing banks.
3. The date of the recording of the disbursements and receipts for each transfer must be in the
same fiscal year.
4. Disbursements on the interbank transfer schedule should be correctly included in or excluded
from year-end bank reconciliations as outstanding checks.
5. Receipts on the interbank transfer schedule should be correctly included in or excluded from
year-end bank reconciliations as deposits in transit.
Terms: Audit of interbank transfer schedule
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

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21) Explain kiting, and discuss how it is performed.
Answer: Kiting is the transfer of money from one bank to another and incorrectly recording the
transaction to cover a theft of cash. Near the balance sheet date, a check is drawn on one bank
account and immediately deposited in a second account for credit before the end of the
accounting period. In making this transfer, the embezzler is careful to make sure that the check is
deposited at a late enough date so that it does not clear the first bank until after the end of the
period. If the interbank transfer is not recorded until after the balance sheet date, the amount of
the transfer is recorded as an asset in both banks.
Terms: Kiting
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

26
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22) Match six of the terms (a-k) with the descriptions/definitions provided below (1-6):

a. bank reconciliation
b. branch cash account
c. cash equivalents
d. cutoff bank statement
e. general cash account
f. imprest payroll account
g. imprest petty cash fund
h. kiting
i. proof of cash
j. standard bank confirmation form
k. lapping

________ 1. a fund of cash maintained within the company for small cash acquisitions,
expenses, or to cash employees' checks

________ 2. a form approved by the AICPA and American Bankers' Association through which
the bank responds to the auditor about bank balance and loan information

________ 3. excess cash invested in short-term, highly liquid investments such as time deposits,
certificates of deposit, and money market funds

________ 4. the primary bank account for most organizations

________ 5. the transfer of money from one bank account to another and improperly recording
the transfer so that the amount is recorded as an asset in both accounts

________ 6. the document usually prepared by client personnel of the differences between the
cash balance recorded in the general ledger and the amount in the bank account
Answer:
1. g
2. j
3. c
4. e
5. h
6. a
Terms: Bank reconciliation; Cash equivalents; General cash account; Imprest petty cash fund;
Kiting; Standard bank confirmation form
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

27
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23) A proof of cash involves a combination of substantive tests of transactions and tests of
details of balances.
Answer: TRUE
Terms: Proof of cash; Substantive tests of transactions and tests of details of balances
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

24) A proof of cash includes a reconciliation of cash receipts deposited in the bank with the cash
disbursements records for a given period.
Answer: FALSE
Terms: Proof of cash; Reconciliation of cash receipts deposited in the bank with cash
disbursements
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

25) The transfer of money from one bank account to another and improperly recording the
transfer so that the amount is recorded as an asset in both banks is referred to as kiting.
Answer: TRUE
Terms: Kiting
Diff: Easy
Objective: LO 23-4
AACSB: Reflective thinking

26) Tests for kiting are performed using only a schedule of intrabank transfers.
Answer: FALSE
Terms: Tests for kiting
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

27) A proof of cash helps the auditor determine whether all recorded cash receipts were
deposited in the bank and whether all recorded cash disbursements were paid by the bank.
Answer: TRUE
Terms: Proof of cash
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

28) A proof of cash receipts is not useful for uncovering the theft of cash receipts or the
recording and deposit of an improper amount of cash.
Answer: TRUE
Terms: Proof of cash receipts; Theft of cash receipts
Diff: Challenging
Objective: LO 23-4
AACSB: Reflective thinking

28
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29) A proof of cash disbursements is not effective for discovering checks written for an
improper amount, fraudulent checks, or misstatements in which the dollar amount appearing in
the cash disbursements records is incorrect.
Answer: TRUE
Terms: Proof of cash disbursements
Diff: Challenging
Objective: LO 23-4
AACSB: Reflective thinking

30) The auditor must extend the audit procedures in the audit of year-end cash when there are
inadequate internal controls.
Answer: TRUE
Terms: Audit procedures; Inadequate internal controls
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

31) Only tests of details of cash balances are useful when auditors are specifically testing for
fraud.
Answer: FALSE
Terms: Fraud; Cash
Diff: Moderate
Objective: LO 23-4
AACSB: Reflective thinking

23.5 Learning Objective 23-5

1) Which of the following is not a correct statement regarding business risk and financial
instruments?
A) Business risks associated with financial instruments will vary depending of the
aggressiveness of a company's investing activity.
B) Business risk will be higher for companies investing in less liquid securities.
C) Financial services firms are exposed to very little risk with their financial instruments.
D) Business risk for a company will be higher when investments represent a greater proportion
of total assets.
Answer: C
Terms: Audit of financial instruments accounts; risk
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

29
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2) Factors that impact inherent risk of financial instruments do not include
A) management's objectives related to investment activity.
B) the complexity of the securities.
C) the cost of the securities.
D) the company's prior experience with certain investments.
Answer: C
Terms: Audit of financial instruments accounts; risk
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

3) The use of unobservable inputs such as a pricing model or discounted cash flow is an example
of a level ________ estimate.
A) 1
B) 2
C) 3
D) 1 and 3
Answer: C
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

4) The majority of financial instruments are valued using

A) cost.
B) fair value estimates.
C) lower of cost or market.
D) realizable value.
Answer: B
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

5) When an audit client uses a service organization to manage their investment activity,
A) the auditor can always rely on the internal controls of the service organization.
B) the auditor must state in their audit opinion that the client uses a service organization.
C) the auditor can rely on the internal controls of the service organization if the service
organization's auditor issues a report on their internal control.
D) the auditor must rely on the service organization to determine the fair level 1, 2, and 3
estimates.
Answer: C
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

30
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6) As part of their internal control procedures, management needs to have procedures in place to
properly classify financial instruments as trading, available-for-sale, or held-to-maturity, based
on
A) cost.
B) intent.
C) maturity.
D) probable future gain or loss.
Answer: B
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

7) Prices in an active market for identical assets is a level ________ fair value estimate.
A) 1
B) 2
C) 3
D) 4
Answer: A
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

8) When auditing financial instruments,

A) the auditor usually performs more extensive substantive testing to reduce reliance on controls.
B) analytical procedures are critical in assessing the year-end balances for financial instruments.
C) the auditor relies on statements and broker's advices from investment managers to test
purchases and sales as long as controls were deemed effective.
D) tests of transactions are generally not performed.
Answer: C
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

9) When auditing financial instruments, analytical procedures can be used to

A) test the reasonableness of interest and dividend income.
B) test the year-end balance.
C) determine if the financial instruments were properly valued.
D) determine if the gain or loss on the sales were properly computed.
Answer: A
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

31
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10) Which is not an important objective for financial instruments?
A) existence
B) cutoff
C) accuracy
D) realizable value
Answer: B
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

11) Level ________ estimates use observable inputs other than quoted prices.
A) 1
B) 2
C) 3
D) 4
Answer: B
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

12) A schedule of investment activity will include all of the following except
A) the purchases and sales.
B) ending balances.
C) the gains and losses.
D) the opinion of management as to the suitability of the investment to the company.
Answer: D
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

13) When auditing financial instruments, a confirmation is sent to the broker-dealer

A) only if the client has poor internal controls.
B) to confirm interest and dividends.
C) to provide assurance on realizable value.
D) to confirm year-end holdings.
Answer: D
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

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14) The auditor is testing for the balance-related audit objective of detail tie-in when they
A) prove the schedule of investment activity as to additions and subtractions.
B) perform a physical inspection of the security.
C) verify the quoted market prices.
D) test management's assumptions related to valuation.
Answer: A
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

15) When the auditor sends a confirmation to the broker-dealer, they are testing the balance-
related audit objective of
A) detail tie-in.
B) existence.
C) cutoff.
D) rights.
Answer: B
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

16) When dealing with financial instruments, the most difficult balance-related audit objective to
test is
A) existence.
B) accuracy.
C) rights.
D) realizable value.
Answer: D
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

17) An auditor is reviewing the minutes of board meetings to determine whether any securities
are pledged as collateral. This test of the detail of balances relates to the audit objective of
A) rights.
B) cutoff.
C) realizable value.
D) classification.
Answer: A
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

33
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18) Determining if the financial instruments included in the schedule of investment activity at
year-end are stated at appropriate amounts in accordance with accounting standards is the
balance-related audit objective of
A) materiality.
B) realizable value.
C) consistency.
D) classification.
Answer: B
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

19) List two common tests of details of balances procedures the auditor would perform when
testing for the balance-related audit objective of realizable value.
Answer:
1. Verify quoted market prices.
2. Test management classifications.
3. Test management's assumptions related to valuation.
4. Consider using a specialist for testing fair value estimates.
5. Consider whether an impairment loss is required.
Terms: Audit of financial instruments accounts
Diff: Challenging
Objective: LO 23-5
AACSB: Reflective thinking

20) The majority of financial instruments are valued at the lower of cost or market.
Answer: FALSE
Terms: Audit of financial instruments accounts
Diff: Easy
Objective: LO 23-5
AACSB: Reflective thinking

21) Business risks associated with financial instruments are the same for all companies.
Answer: FALSE
Terms: Audit of financial instruments accounts; risk
Diff: Easy
Objective: LO 23-5
AACSB: Reflective thinking

22) The starting point for testing the ending balance of financial instruments accounts is to obtain
a gain or loss schedule for the year.
Answer: FALSE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

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23) The auditor needs to have an understanding of the client's internal controls over determining
fair value estimates.
Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

24) A factor that increases inherent risk for financial instruments is the complexity of the
relevant accounting standards.
Answer: TRUE
Terms: Audit of financial instruments accounts; risk
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

25) Level 1 estimates require more management judgment than level 2 or level 3 estimates.
Answer: FALSE
Terms: Audit of financial instruments accounts
Diff: Easy
Objective: LO 23-5
AACSB: Reflective thinking

26) There is significant potential for misstatements and misclassification of financial

instruments.
Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Easy
Objective: LO 23-5
AACSB: Reflective thinking

27) Assessing internal controls related to financial instruments may be necessary in order to
reduce audit risk to an acceptable level.
Answer: TRUE
Terms: Audit of financial instruments accounts; risk
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

28) When auditing financial instruments, interest income and dividends can be recomputed and
compared to a public source.
Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

35
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29) Analytical procedures may be used to assess the year-end balances for financial instruments.
Answer: FALSE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

30) Completeness is an important objective for derivative financial instruments.

Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

31) The most important objectives for financial instruments are existence and consistency.
Answer: FALSE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

32) Presentation and disclosure objectives are important when auditing financial instruments.
Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

33) Tests related to realizable value will vary according to the type of security and the associated
accounting standard.
Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

34) Auditing guidance is provided for auditing accounting estimates specifically for fair values
estimates as considerable auditor judgment is involved.
Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

36
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35) Cutoff is more important in testing transactions as a client may want to record a gain or a
loss on the sale at the end of the year.
Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

36) When an auditor is verifying quoted market prices, they are concerned about the balance-
related audit objective of accuracy.
Answer: FALSE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

37) Securities and contracts will typically be held by the broker-dealer.

Answer: TRUE
Terms: Audit of financial instruments accounts
Diff: Moderate
Objective: LO 23-5
AACSB: Reflective thinking

38) When auditing financial instruments, the most difficult objective to test is existence.
Answer: FALSE
Terms: Financial instruments
Diff: Easy
Objective: LO 23-5
AACSB: Reflective thinking

37
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