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Auditing and Assurance Services: An Integrated Approach

Alvin A. Arens, Randal J. Elder, Mark Beasley

Chapter 23

AUDIT OF CASH BALANCES - all with Video Answers

Educators

Chapter Questions

Problem 1

Explain the relationships among the initial assessed control risk, tests of controls and substantive tests of transactions for cash receipts, and the tests of details of cash balances.

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Problem 2

Explain the relationships among the initial assessed control risk, tests of controls and substantive tests of transactions for cash disbursements, and the tests of details of cash balances. Give one example in which the conclusions reached about internal controls in cash disbursements will affect the tests of cash balances.

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02:00

Problem 3

Why is the monthly reconciliation of bank accounts by an independent person an important internal control over cash balances? Which individuals will generally not be considered independent for this responsibility?

Oluwadamilola Ameobi
Oluwadamilola Ameobi
Numerade Educator

Problem 4

Evaluate the effectiveness and state the shortcomings of the preparation of a bank reconciliation by the controller in the manner described in the following statement: "When I reconcile the bank account, the first thing I do is review the sorted list of returned checks and find which numbers are missing. Next I determine the amount of the uncleared checks by referring to the cash disbursements journal. If the bank account reconciles at that point, I am all finished with the reconciliation. If it does not, I search for deposits in transit, checks from the beginning outstanding check list that still have not cleared, other reconciling items, and bank errors until it reconciles. In most instances, I can do the reconciliation in 20 minutes."

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03:05

Problem 5

How do bank confirmations differ from positive confirmations of accounts receivable? Distinguish between them in terms of the nature of the information confirmed, the sample size, and the appropriate action
when the confirmation is not returned after the second request. Explain the rationale for the differences between these two types of confirmations.

Akash M
Akash M
Numerade Educator

Problem 6

Evaluate the necessity of following the practice described by an auditor: "In confirming bank accounts, I insist upon a response from every bank the client has done business with in the past 2 years, even though the account may be closed at the balance sheet date."

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Problem 7

Describe what is meant by a cutoff bank statement and state its purpose.

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Problem 8

Why are auditors usually less concerned about the client's cash receipts cutoff than the cutoff for sales? Explain the procedure involved in testing for the cutoff for cash receipts.

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Problem 9

What is meant by an imprest bank account for a branch operation? Explain the purpose of using this type of bank account.

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Problem 10

Explain the purpose of a four-column proof of cash. List two types of misstatements it is meant to uncover.

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Problem 11

When the auditor fails to obtain a cutoff bank statement, it is common to verify the entire statement for the month subsequent to the balance sheet date. How is this done and what is its purpose?

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Problem 12

Distinguish between lapping and kiting. Describe audit procedures that can be used to uncover each.

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Problem 13

Assume that a client with excellent internal controls uses an imprest payroll bank account. Explain why the verification of the payroll bank reconciliation ordinarily takes less time than the tests of the general bank account, even if the number of disbursements exceeds those for the general account.

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03:05

Problem 14

Distinguish between the verification of petty cash reimbursements and the verification of the balance in the fund. Explain how each is done. Which is more important?

Akash M
Akash M
Numerade Educator

Problem 15

Why is there a greater emphasis on the detection of fraud in tests of details of cash balances than for other balance sheet accounts? Give two specific examples that demonstrate how this emphasis affects the auditor's evidence accumulation in auditing year-end cash.

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00:40

Problem 16

Explain why, in verifying bank reconciliations, most auditors emphasize the possibility of a nonexistent deposit in transit being included in the reconciliation and an outstanding check being omitted rather than the omission of a deposit in transit and the inclusion of a nonexistent outstanding check.

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator
04:47

Problem 17

How will a company's bank reconciliation reflect an electronic deposit of cash received by the bank from credit card agencies making payments on behalf of customers purchasing products from the company's online Web site, but not recorded in the company's records?

Puneet Prajapati
Puneet Prajapati
Numerade Educator

Problem 18

The following questions deal with auditing yearend cash. Choose the best response.
a. A CPA obtains a January 10 cutoff bank statement for a client directly from the bank. Very few of the outstanding checks listed on the client's December 31 bank reconciliation cleared during the cutoff period. A probable cause for this is that the client
(1) is engaged in kiting.
(2) is engaged in lapping.
(3) transmitted the checks to the payees after year-end.
(4) has overstated its year-end bank balance.
b. The auditor should ordinarily send confirmation requests to all banks with which the client has conducted any business during the year, regardless of the year-end balance, because
(1) this procedure will detect kiting activities that would otherwise not be detected.
(2) the confirmation form also seeks information about indebtedness to the bank.
(3) the sending of confirmation requests to all such banks is required by auditing standards.
(4) this procedure relieves the auditor of any responsibility with respect to non-detection of forged checks.
c. The usefulness of the standard bank confirmation request may be limited because the bank employee who completes the confirmation may
(1) be unaware of all the financial relationships that the bank has with the client.
(2) not believe the bank is obligated to verify confidential information to a third party.
(3) sign and return the confirmation without inspecting the accuracy of the client's bank reconciliation.
(4) not have access to the client's bank statement.

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Problem 19

The following questions deal with discovering fraud in auditing year-end cash. Choose the best response.
a. Which of the following is one of the better auditing techniques to detect kiting?
(1) Review composition of authenticated deposit slips.
(2) Review subsequent bank statements and cancelled checks received directly from the banks.
(3) Prepare year-end bank reconciliations.
(4) Prepare a schedule of bank transfers from the client's books.
b. Which of the following cash transfers results in a misstatement of cash at December 31, 2011?
c. A cash shortage may be concealed by transporting funds from one location to another or by converting negotiable assets to cash. Because of this, which of the following is vital?
(1) Simultaneous bank confirmations.
(2) Simultaneous bank reconciliations.
(3) Simultaneous four-column proofs of cash.
(4) Simultaneous surprise cash counts.

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Problem 20

The following are misstatements that might be found in the client's year-end cash balance (assume that the balance sheet date is June 30):
1. The outstanding checks on the June 30 bank reconciliation were underfooted by $$\$ 2,000$$.
2. A loan from the bank on June 26 was credited directly to the client's bank account. The loan was not entered as of June 30 .
3. A check was omitted from the outstanding check list on the June 30 bank reconciliation. It cleared the bank July 7.
4. A check was omitted from the outstanding check list on the bank reconciliation. It cleared the bank September 6.
5. Cash receipts collected on accounts receivable from July 1 to July 5 were included as June 29 and 30 cash receipts.
6. A bank transfer recorded in the accounting records on July 1 was included as a deposit in transit on June 30.
7. A check that was dated June 26 and disbursed in June was not recorded in the cash disbursements journal, but it was included as an outstanding check on June 30.

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Problem 21

The following audit procedures are concerned with tests of details of general cash balances:
1. Obtain a standard bank confirmation from each bank with which the client does business.
2. Compare the balance on the bank reconciliation obtained from the client with the bank confirmation.
3. Compare the checks returned along with the cutoff bank statement with the list of outstanding checks on the bank reconciliation.
4. List the check number, payee, and amount of all material checks not returned with the cutoff bank statement.
5. Review minutes of the board of directors meetings, loan agreements, and bank confirmation for interest-bearing deposits, restrictions on the withdrawal of cash, and compensating balance agreements.
6. Prepare a four-column proof of cash.
7. Compare the bank cancellation date with the date on the cancelled check for checks dated on or shortly before the balance sheet date.
8. Trace deposits in transit on the bank reconciliation to the cutoff bank statement and the current year cash receipts journal.

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Problem 22

You are auditing general cash for the Pittsburgh Supply Company for the fiscal year ended July 31, 2011. The client has not prepared the July 31 bank reconciliation. After a brief discussion with the owner, you agree to prepare the reconciliation, with assistance from one of Pittsburgh Supply's clerks. You obtain the following information:

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Problem 23

In the audit of the Regional Transport Company, a large branch that maintains its own bank account, cash is periodically transferred to the central account in Cedar Rapids. On the branch account's records, bank transfers are recorded as a debit to the home office clearing account and a credit to the branch bank account. Similarly, the home office account is recorded as a debit to the central bank account and a credit to the branch office clearing account. Gordon Light is the head bookkeeper for both the home office and the branch bank accounts. Because he also reconciles the bank account, the senior auditor, Cindy Marintette, is concerned about the internal control deficiency.

As a part of the year-end audit of bank transfers, Marintette asks you to schedule the transfers for the last few days in 2011 and the first few days of 2012. You prepare the following list:

$$
\begin{array}{lcccc}
\begin{array}{l}
\text { Amount of } \\
\text { Transfer }
\end{array} & \begin{array}{c}
\text { Date Recorded in } \\
\text { the Home Office } \\
\text { Cash Receipts } \\
\text { Journal }
\end{array} & \begin{array}{c}
\text { Date Recorded in } \\
\text { the Branch Office } \\
\text { Cash Disbursements } \\
\text { Journal }
\end{array} & \begin{array}{c}
\text { Date Deposited } \\
\text { in the Home } \\
\text { Office Bank } \\
\text { Account }
\end{array} & \begin{array}{c}
\text { Date Cleared } \\
\text { the Branch } \\
\text { Bank Account }
\end{array} \\
\hline \$ 17,000 & 12-27-11 & 12-29-11 & 12-26-11 & 12-27-11 \\
28,000 & 12-28-11 & 01-02-12 & 12-28-11 & 12-29-11 \\
16,000 & 01-02-12 & 12-30-11 & 12-28-11 & 12-29-11 \\
10,000 & 12-26-11 & 12-26-11 & 12-28-11 & 01-03-12 \\
21,000 & 01-02-12 & 01-02-12 & 12-28-11 & 12-31-11 \\
22,000 & 01-07-12 & 01-05-12 & 12-28-11 & 01-03-12 \\
39,000 & 01-04-12 & 01-06-12 & 01-03-12 & 01-05-12 \\
\hline
\end{array}
$$

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Problem 24

The following are various potential misstatements due to errors or fraud (1 through 7), and a list of auditing procedures (a through h) the auditor would consider performing to gather evidence to determine whether the error or fraud is present.
Possible Misstatements Due to Errors or Fraud
1. The auditor suspects that a lapping scheme exists because an accounting department employee who has access to cash receipts also maintains the accounts receivable ledger and refuses to take any vacation or sick days.
2. The auditor suspects that the entity is inappropriately increasing the cash reported on its balance sheet by drawing a check on one account and not recording it as an outstanding check on that account and simultaneously recording it as a deposit in a second account.
3. The entity's cash receipts of the first few days of the subsequent year were properly deposited in its general operating account after the year-end.
However, the auditor suspects that the entity recorded the cash receipts in its books during the last week of the year under audit.
4. The auditor noticed a significant increase in the number of times that petty cash was reimbursed during the year and suspects that the custodian is stealing from the petty cash fund.
5. The auditor suspects that a kiting scheme exists because an accounting department employee who can issue and record checks seems to be leading an unusually luxurious lifestyle.
6. During tests of the reconciliation of the payroll bank account, the auditor notices that a check to an employee is significantly larger than other payroll checks.
7. The auditor suspects that the controller wrote several checks and recorded the cash disbursements just before year-end but did not mail the checks until after the first week of the subsequent year.
List of Auditing Procedures
a. Send a standard bank confirmation confirming the balance in the bank at year-end.
b. Compare the details of the cash receipts journal entries with the details of the corresponding daily deposit slips.
c. Count the balance in petty cash at year-end.
d. Agree gross amount on payroll checks to approved hours and pay rates.
e. Obtain the cutoff bank statement and compare the cleared checks to the year-end reconciliation.
f. Examine invoices, receipts, and other documentation supporting reimbursement of petty cash.
g. Examine payroll checks clearing after year-end with the payroll journal.
h. Prepare a bank transfer schedule.

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01:06

Problem 25

In connection with an audit you are given the following work sheet:
Checks Drawn but Not Paid by Bank
$$
\begin{array}{lr}
\text { No. } & \text { Amount } \\
\hline 573 & \$ 267.27 \\
724 & 39.92 \\
903 & 454.67 \\
907 & 291.80 \\
911 & 648.29 \\
913 & 737.52 \\
914 & 529.10 \\
916 & 36.00 \\
917 & 117.26 \\
& \$ 3,295.15 \\
\hline
\end{array}
$$

Jennifer Stoner
Jennifer Stoner
Numerade Educator

Problem 26

You are doing the first-year audit of Sherman School District and have been assigned responsibility for doing a four-column proof of cash for the month of October 2011. You obtain the following information:

$$
\begin{array}{llr}
\text { 1. Balance per books } & \text { September } 30 & \$ 10,725 \\
& \text { October } 31 & 5,836 \\
\text { 2. Balance per bank } & \text { September } 30 & 6,915 \\
& \text { October } 31 & 8,276 \\
\text { 3. Outstanding checks } & \text { September } 30 & 1,811 \\
& \text { October } 31 & 2,615 \\
\text { 4. Cash receipts for October } & \text { per bank } & 28,792 \\
& \text { per books } & 20,271 \\
\text { 5. Deposits in transit } & \text { September } 30 & 5,621 \\
& \text { October } 31 & 996
\end{array}
$$
6. Interest on a bank loan for the month of October, charged by the bank but not recorded, was $$\$ 596$$.
7. Proceeds on a note of the Jones Company were collected by the bank on October 28 but were not entered on the books:
\begin{tabular}{lr}
Principal & $$\$ 2,900$$ \\
Interest & 396 \\
\hline 33,296
\end{tabular}
8. On October 26 , a $$\$ 1,144$$check of the Billings Company was charged to Sherman School District's account by the bank in error.
9. Dishonored checks are not recorded on the books unless they permanently fail to clear the bank. The bank treats them as disbursements when they are dishonored and deposits when they are redeposited. Checks totaling $$\$ 1,335$$ were dishonored in October; $$\$ 600$$ was redeposited in October and $$\$ 735$$ in November.

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