Chapter 23 Audit of Cash and Financial Instruments

23.1 Learning Objective 23-1

5) Companies may purchase marketable securities as a way to temporarily invest excess cash.
TRUE
Explain: This approach balances risk, return, and liquidity, ensuring efficient financial
management.

6) Examples of cash equivalents include time deposits, certificates of deposit, and marketable
securities.
FALSE
Explain: Cash equivalents have maturities of ≤3 months; marketable securities usually don't
qualify.

7) Branch bank accounts are useful for building banking relations in local communities.
TRUE
Explain: …. by providing personalized services, fostering trust, and supporting local economic
activities.

8) Cash is the only account included in every cycle except inventory and warehousing.
TRUE
Explain: …. the inventory and warehousing cycle, which primarily tracks inventory levels and
related costs rather than cash transactions.

9) The evidence accumulated for cash balances depends heavily on the results of tests performed
in the other major transaction cycles.
TRUE
Explain: Verifying these cycles helps ensure the accuracy of cash balances

10) Cash is important because of its susceptibility to theft, and cash can be significantly
misstated as illustrated in the China Media Express case.
TRUE
Explain: In this case, the company falsely inflated its cash balances, leading to financial
misstatements.
11) Financial instruments, which include investments in debt and equity securities as well as
derivative instruments, vary in significance across audit clients.
TRUE
Explain: ……. have varying significance depending on the audit client
12) A growing number of organizations, especially larger organizations, use pre-approved V-
cards to make miscellaneous purchases instead of maintaining a petty cash fund.
FALSE
Explain: Because petty cash funds and V-cards serve different purposes and are not always
interchangeable.
13) Consistent with financial accounting standards, equity investments are normally recorded at
cost until they are disposed of in the future.
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FALSE
Explain: It is false because equity investments are not always recorded at cost under financial
accounting standards

14) Debt instruments can be classified as trading securities, available-for-sale securities, or held-
to-maturity securities; auditors should ensure that such debt instruments are classified, properly,
in the financial statements consistent with accounting standards.
TRUE
Explain: Debt instruments are classified as trading securities, available-for-sale securities, or
held-to-maturity securities
15) Describe each of the major types of cash accounts maintained by business entities.
 General cash account. This is the focal point of cash for most organizations because
virtually all cash receipts and disbursements flow through this account.
 Impress payroll account. As a means of improving internal control, many companies
establish a separate impress 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 impress 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.
 Impress 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.

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23.2 Learning Objective 23-2

7) The general cash account will not be audited if the ending balance is immaterial.
FALSE
Explain: Even if the ending balance in the general cash account is immaterial, it will still be
audited.

9) "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?

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.
23.3 Learning Objective 23-3

27) The bank reconciliation control is enhanced when a qualified employee reviews the monthly
reconciliation as soon as possible after its completion.
TRUE
Explain: The bank reconciliation control is indeed enhanced when a qualified employee
reviews the monthly reconciliation promptly after its completion.
28) Many of the auditor's audit procedures in the audit of cash center around the client's bank
confirmations.
FALSE
Explain: Bank confirmations are just one of the many procedures used in auditing cash.

29) Tracing outstanding checks to subsequent period bank statements tests the cutoff audit
objective.
TRUE
Explain: Tracing outstanding checks to subsequent period bank statements tests the cutoff audit
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objective.

30) When auditing the year-end cash balance, one of the areas of focus is on the accuracy
objective.
TRUE
Explain: When auditing the year-end cash balance, one of the key areas of focus is the accuracy
objective.

31) The three most important audit objectives for cash are accuracy, existence, and classification.
FALSE
Explain: The three most important audit objectives for cash are typically accuracy, existence,
and completeness

32) The starting point for the verification of the balance in the general bank account is to obtain a
bank cut-off statement.
FALSE
Explain: The starting point for verifying the balance in the general bank account is typically to
obtain a bank confirmation

33) 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.
FALSE
Explain: The starting point for verifying the general cash account balance is typically to obtain a
bank reconciliation

34) 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.
FALSE
Explain: To test the completeness of the list of outstanding checks, the auditor should trace
checks from the cutoff bank statement back to the client's list of outstanding checks

35) 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.
FALSE
Explain: The auditor, not the client, should mail the bank confirmation requests.

36) Auditors usually design bank confirmations that address the client's specific circumstances.
FALSE
Explain: Bank confirmations generally follow a standardized format rather than being
specifically designed

37) Ordinarily, all deposits-in-transit listed on the year-end bank reconciliation should appear as
deposits on the cutoff bank statement.
TRUE
Explain: Ordinarily, all deposits-in-transit listed on the year-end bank reconciliation should
appear as deposits on the cutoff bank statement.

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38) Auditors are not always required to obtain bank confirmations.
TRUE
Explain: Auditors are not always required to obtain bank confirmations.

39) The auditor is generally concerned about the realizable value and the rights to cash.
FALSE
Explain: The auditor is generally concerned about the existence and completeness of cash

40) 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.
FALSE
Explain: The standard bank confirmation form does not automatically require the bank to inform
auditors of open lines of credit or compensating balance requirements

41) The methodology for auditing year-end cash is generally the same as auditing for all other
balance sheet accounts.
TRUE
Explain: The methodology for auditing year-end cash is generally the same as auditing for all
other balance sheet accounts.

42) A monthly bank reconciliation of the general bank account on a timely basis by someone
involved in either the handling or the recording of cash receipts and disbursements is an essential
control over the ending cash balance.
FALSE
Explain: A monthly bank reconciliation performed on a timely basis, but it should ideally be
done by someone independent

43) Positive pay reduces potential check fraud by matching account number, check number, and
dollar amounts of each check presented for payment against the electronic records of checks
provided by the company.
TRUE
Explain:

44) The presentation of cash in the financial statements is normal straight-forward unless
restrictions on cash or compensating balance agreements with a bank exist.
TRUE
Explain:

45) A common test of details the auditor should perform with regards to determining if cash is
appropriately described and presented in the financial statements is to review the Board of
Director minutes and loan agreements for any restrictions on cash.
TRUE
Explain:

46) Internal controls over year-end cash balances in the general account can be divided into two
categories. List the two below.
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1. controls over the transaction cycles affecting the recording of cash receipts and cash
disbursements

2. independent bank reconciliations

47) Explain what is meant by a cutoff bank statement and discuss the purpose of the cutoff bank
statement in the audit of cash 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.

48) Explain the purpose of testing the client's bank reconciliation and discuss the major audit
procedures involved 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.

49) 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.

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.

50) In testing the year-end balance in the general cash account, the auditor must accumulate
sufficient appropriate evidence to evaluate whether cash, as stated on the balance sheet, is fairly
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stated and properly disclosed in accordance with six of the nine balance-related audit objectives
used for all tests of details of balances. Name those six audit objectives.

Existence; completeness; accuracy; cutoff; detail tie-in; and presentation

23.4 Learning Objective 23-4

18) A proof of cash involves a combination of substantive tests of transactions and tests of
details of balances.
TRUE
Explain: A proof of cash involves a combination of substantive tests of transactions and tests of
details of balances.

19) A proof of cash includes a reconciliation of cash receipts deposited in the bank with the cash
disbursements records for a given period.
FALSE
Explain: Proof of cash does not includes a reconciliation of cash receipts deposited in the bank
with the cash disbursements records for a given period.

20) 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.
TRUE
Explain:

21) Tests for kiting are performed using only a schedule of intrabank transfers.
FALSE
Explain: Tests for kiting are not performed using only a schedule of intrabank transfers.

22) 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.
TRUE
Explain:

23) 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.
TRUE
Explain:

24) 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.
TRUE
Explain:

25) The auditor must extend the audit procedures in the audit of year-end cash when there are
inadequate internal controls.

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TRUE
Explain:

26) Only tests of details of cash balances are useful when auditors are specifically testing for
fraud.
FALSE
Explain: When auditors are specifically testing for fraud, tests of details of cash balances are
not the only procedures that are useful

27) Auditors will often prepare 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 whether 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.

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.

28) A proof of cash includes four reconciliation tasks. List below two of those tasks.

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.

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

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.
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5. Receipts on the interbank transfer schedule should be correctly included in or excluded from
year-end bank reconciliations as deposits in transit.

30) Explain kiting and discuss how it is performed.

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.
23.5 Learning Objective 23-5

19) The majority of financial instruments are valued at the lower of cost or market.
FALSE
Explain: The majority of financial instruments are not valued at the lower of cost or market.

20) Business risks associated with financial instruments are the same for all companies.
FALSE
Explain: The business risks associated with financial instruments are not the same for all
companies.

21) The starting point for testing the ending balance of financial instruments accounts is to obtain
a gain or loss schedule for the year.
FALSE
Explain: The starting point for testing the ending balance of financial instruments accounts is not
typically to obtain a gain or loss schedule for the year

22) The auditor needs to have an understanding of the client's internal controls over determining
fair value estimates.
TRUE
Explain:

23) A factor that increases inherent risk for financial instruments is the complexity of the
relevant accounting standards.
TRUE
Explain:

24) Level 1 estimates require more management judgment than level 2 or level 3 estimates.
FALSE
Explain: Level 1 estimates generally require less management judgment compared to Level 2 or
Level 3 estimates.

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

instruments.
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TRUE
Explain:

26) Assessing internal controls related to financial instruments may be necessary in order to
reduce audit risk to an acceptable level.
TRUE
Explain:

27) When auditing financial instruments, interest income and dividends can be recomputed and
compared to a public source.
TRUE
Explain:

28) Analytical procedures may be used to assess the year-end balances for financial instruments.
FALSE
Explain: Analytical procedures are generally not used for assessing year-end balances for
financial instruments.

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

TRUE
Explain:

30) The most important objectives for financial instruments are existence and consistency.
FALSE
Explain: The most important objectives for financial instruments are generally existence,
valuation, and classification

31) Presentation and disclosure objectives are important when auditing financial instruments.
TRUE
Explain:

32) Tests related to realizable value will vary according to the type of security and the associated
accounting standard.
TRUE
Explain:

33) Auditing guidance is provided for auditing accounting estimates specifically for fair values
estimates as considerable auditor judgment is involved.
TRUE
Explain:

34) 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.
TRUE
Explain:

35) When an auditor is verifying quoted market prices, they are concerned about the balance-
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related audit objective of accuracy.
FALSE
Explain: they are primarily concerned with the existence and valuation

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

TRUE
Explain:

37) When auditing financial instruments, the most difficult objective to test is existence.
FALSE
Explain: When auditing financial instruments, the most difficult objective to test is typically
valuation

38) The auditor should test for the proper classification of debt instruments as either trading
securities, available-for-sale securities, or held-to-maturity securities in the financial statements.
TRUE
Explain:

39) The proper classification of debt instruments in the financial statements is based solely on
the nature of the debt instrument.
FALSE
Explain: The proper classification of debt instruments in the financial statements is not solely
based on the nature of the debt instrument, but also on the company's intent

40) The majority of financial instruments are valued using fair value estimates.
TRUE
Explain:

41) List two common tests of details of balances procedures the auditor would perform when
testing for the balance-related audit objective of realizable value.

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.

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