Chapter 10 [Auditing Cash, Marketable Securities, and Complex Financial Instruments] Flashcards
A standard confirmation sent to all banks with which the client had business during the year to obtain information about the year-end cash balance and additional information about loans outstanding.
Bank confirmation
An asset or a claim on an asset usually held by a borrower or an issuer of a debt instrument to serve as a guarantee for the value of a loan or security. If the borrower fails to pay interest or principal, the ________________ is available to the lender as a basis to recover the principal amount of the loan or debt instrument.
Collateral
Notes issued by major corporations, usually for short periods of time and at rates approximating prime lending rates, usually with high credit rating; their quality may change if the financial strength of the issuer declines.
Commercial paper
A bank statement for a period of time after yearend (usually seven to ten days); sent directly to the auditor, who uses it to verify reconciling items on the client’s year-end bank reconciliation.
Cutoff bank statement
A phenomenon in which an individual (or group) continues on with their previous, inappropriate, course of action even when faced with increasingly negative risks and outcomes should their escalation become known or understood by others.
Escalation of commitment
This issue exists when a company creates fictitious additions to its cash account in order to validate fictitious additions to revenues; thereby violating the existence assertion for both revenue and cash accounts.
Fake cash problem
A broad class of instruments—usually debt securities, but also equity or hedges—that represents financial agreements between a party (usually an issuer) and a counterparty (usually an investor) based on either underlying assets or agreements to incur financial obligations or make payments; instruments range in complexity from a simple bond to complicated agreements
containing puts or options.
Financial instruments
A method by which organizations attempt to ensure accuracy when using processed data. A ____________ includes a summation of numerous data fields from a file, including those not necessarily related to calculations (for example, an account number). Over the course of processing, the ________________ is recalculated and any discrepancies with the original value signal an error to be investigated.
Hash total
An audit document that lists all transfers between client bank accounts starting a short period before year-end and continuing for a short period after year-end; its purpose is to assure that cash in transit is not recorded twice.
Interbank transfer schedule
A fraudulent cash scheme to overstate cash assets at year-end by showing the same cash in two different bank accounts using an interbank transfer.
Kiting
This type of fraud occurs when an employee steals a payment from one customer, and covers it up by using payments from another customer to disguise the theft. For example, the employee steals a payment from Customer X. To cover the theft, the employee applies a payment from Customer Y to Customer X’s account. Before Customer Y has time to notice that its account has not been appropriately credited, the employee applies a payment from Customer Z to Customer Y’s account.
Lapping
A cash management arrangement with a bank whereby an organization’s customers send payments directly to a post office box number accessible to the client’s bank; the bank opens the cash remittances and directly deposits the money in the client’s account.
Lockbox
A security that is readily marketable and held by the company as an investment.
Marketable security
This activity involves creating the appearance that large amounts of cash that an organization obtains from criminal activity such as drug trafficking or terrorist activities originate from a legitimate, non-criminal business source.
Money laundering
Financial crimes committed by women.
Pink collar crimes
The interest rate that commercial banks charge their most credit-worthy customers.
Prime lending rate
This type of fraud occurs when an employee makes a sale but does not record it, and steals the cash.
Skimming
A tactic by which money launderers strategically report transactions just under the $10,000 mandatory reporting requirement to financial institutions.
Smurfing
A tactic by which money launderers strategically divide payments into multiple small transactions to avoid detection by financial institutions.
Split payments
A document sent to the customer to be returned with the customer’s remittance; may be machine-readable and may contain information to improve the efficiency of receipt processing.
Turnaround document
A fake cash problem relates to management’s cash valuation assertion.
T or F?
False
A fake cash problem relates to management’s cash existence assertion.
Short selling enables managers to get away with perpetrating fraud undetected and undeterred.
T or F?
False
Which of the following assertions is relevant to whether the company owns the cash accounts as of the balance sheet date?
a. Existence/occurrence.
b. Completeness.
c. Rights and obligations.
d. Valuation or allocation.
e. All of the above
c
Which of the following assertions is relevant to whether the cash balances reflect the true underlying economic value of those assets?
a. Existence/occurrence.
b. Completeness.
c. Rights and obligations.
d. Valuation or allocation.
e. All of the above.
d
The volume of activity in cash accounts makes cash accounts less susceptible to error than most other accounts.
T or F?
False
The volume of activity in cash accounts makes cash accounts more susceptible to error than most other accounts.
The electronic transfer of cash and the automated controls over cash are such that if errors are built into computer programs, they could be repeated on a large volume of transactions.
T or F?
True
Inherent risk for cash is usually assessed as high for which of the following reasons?
a. The volume of transactions flowing through cash accounts throughout the year makes the account more susceptible to error.
b. The cash account is more susceptible to fraud because cash is liquid and easily transferable.
c. The electronic transfer of cash and the automated controls over cash are such that if errors are built into computer programs, they will be repeated on a large volume of transactions.
d. Cash can be easily manipulated.
e. All of the above.
e
Which of the following questions would be relevant for an inherent risk analysis related to cash?
a. Does the company have significant cash flow problems in meeting its current obligations on a timely basis?
b. Are cash transactions properly authorized?
c. Are bank reconciliations performed on a timely basis by personnel independent of processing?
d. Does the internal audit department conduct timely reviews of the cash management and cash-handling
process?
e. All of the above.
a
Skimming occurs when an employee purchases merchandise and records the sale at an unauthorized discounted price.
T or F?
False
In assessing fraud risk related to cash, auditors engage in brainstorming to consider incentives, opportunities to
commit fraud, and rationalization about risks relating to cash.
T or F?
True
Which of the following terms best defines the following scenario?
The employee steals a payment from Customer X. To cover the theft, the employee applies a payment from Customer Y to Customer X’s account. Before Customer Y has time to notice that its account has not been appropriately credited, the employee applies a payment from Customer Z to Customer Y’s account.
a. Skimming.
b. Kiting.
c. Collateralizing.
d. Lapping.
d
2 Affirmative answers to which of the following questions would lead the auditor to assess fraud risk at a higher level for cash?
a. Is an individual with access to cash or its recording experiencing financial or personal distress?
b. Is an individual with access to cash or its recording being compensated at an amount that he or she might consider low?
c. Is the company in potential violation of its debt covenants?
d. Two of the above (a-c)
e. All of the above (a-c).
e
Controls for completeness of cash are important because they help to provide reasonable assurance that the cash
exists.
T or F?
False
Controls for completeness of cash are important because they help to provide reasonable assurance that the cash is complete.
Because a primary concern is that cash will be stolen and thus understated, the auditor is not usually concerned about overstatements of cash.
T or F?
False
Skimming most likely results in a violation of which of the following management assertions?
a. Existence
b. Completeness
c. Rights and obligations
d. Valuation
e. All of the above
b
A form of white-collar crime, skimming is taking cash “off the top” of the daily receipts of a business (or from any cash transaction involving a third interested party) and officially reporting a lower total. The formal legal term is defalcation.
Which of the following is not a type of common control over cash?
a. Segregation of duties
b. Restrictive endorsements of customer checks
c. Bank reconciliations by employees who handle cash
d. Prenumbered cash receipt documents and turnaround documents
e. Two of the above (a-d)
c
Planning analytical procedures for cash balances are highly effective because of the generally stable relationship with past cash levels and the fact that cash is a managed account.
T or F?
False
If the auditor observes that the company reports consistent profits over several years while cash inflows are decreasing, the auditor should likely assess a heightened
risk of fraud in cash.
T or F?
True
The first step in performing planning analytical procedures is to develop an expectation of the account balance. Which of the following does not typically represent a likely expected relationship for cash accounts?
a. The company reports consistent profits over several years, but operating cash flows are declining.
b. No unusual large cash or other liquid asset transactions are found.
c. Operating cash flow is not significantly different from that of the prior year.
d. Investment income is consistent with the level of and returns expected from the investments.
e. All of the above represent likely expected
relationships.
a
Which of the following is a common example of trend analysis of accounts and ratios that the auditor might consider for cash accounts?
a. Compare monthly cash balances with past years and budgets.
b. Identify unexpected spikes or lows in cash during the year.
c. Compute trends in interest returns on investments.
d. Two of the above (a-c).
e. All of the above (a-c).
e
The relative percentage of substantive analytics that an auditor will use as evidence in the audit of cash will be somewhat limited regardless of the riskiness of the client.
T or F?
True
When auditing cash, the auditor will perform a relatively larger percentage of tests of details for a high-risk client compared to a low-risk client.
T or F?
True
Which mix of evidence would be most appropriate for the following scenario?
This is a client where the auditor has assessed the risk of material misstatement related to the existence and completeness of cash at high. This client has incentives to overstate cash in order to meet debt covenants. Further, the client has relatively weak controls to prevent theft of cash.
a. 100% tests of details.
b. 70% tests of details, 10% analytics, 20% tests of controls.
c. 50% tests of details, 10% analytics, 40% tests of controls.
d. 20% tests of details, 40% analytics, 40% tests of controls.
a
Which mix of evidence would be most appropriate for the following scenario?
This is a client where the auditor has assessed the risk of material misstatement related to the existence and completeness of cash as low, and believes that the client has implemented effective controls in this area.
a. 100% tests of details.
b. 70% tests of details, 10% analytics, 20% tests of controls.
c. 50% tests of details, 10% analytics, 40% tests of controls.
d. 20% tests of details, 40% analytics, 40% tests of controls
c
An example of a monitoring control in cash would include a review of cash budgets and a comparison of them with actual cash balances, with appropriate follow-up.
T or F?
True
Because of the level of inherent risk associated with cash accounts, auditors are required to test the controls over cash accounts.
T or F?
False
Refer to Exhibit 10.6.
Which of the following represents a reasonable test of controls for cash receipts?
a. Document internal controls over cash by completing the internal control questionnaire or by flowcharting the process.
b. Segregation of duties between those handling cash and those recording cash transactions.
c. Obtain a bank confirmation.
d. Obtain a bank cutoff statement.
e. All of the above.
b
Which of the following represents a control related to cash that an auditor might test?
a. Reviews of reconciliations of reported cash receipts with remittances prepared by independent parties.
b. Reviews of cash budgets and comparison of them with actual cash balances.
c. Reviews of discrepancies in cash balances.
d. Two of the above (a-c).
e. All of the above (a-c).
e
Because cash balances are usually relatively low at year-end, auditing standards encourage auditors to send
bank confirmations on a sample basis.
T or F?
False
A typical bank statement prepared at an interim agreed-upon date and sent directly to the auditor is a bank transfer statement.
T or F?
False
Which of the following statements regarding reperformance of bank reconciliations is true?
a. The auditor’s reperformance of a reconciliation of the client’s bank accounts provides evidence as to the accuracy of the year-end cash balance.
b. The process reconciles the balance per the bank statements with the balance per the books.
c. Reperformance of the bank reconciliation is ineffective in detecting major errors, such as those that might be covered up by omitting or underfooting outstanding checks.
d. Two of the above (a-c) are true.
e. All of the above (a-c) are true.
d
A bank confirmation contains which of the following two parts?
- A part that seeks information on the client’s deposit balances, the existence of loans, due dates of the loans, interest rates, dates through which interest has been paid, and collateral for loans outstanding.
- A part that contains a listing of the last checks issued near year-end.
- A part that seeks information about any loan guarantees.
- A part that lists all transfers between the company’s bank accounts for a short period of time before and after year-end.
a. 1 & 2.
b. 1 & 3.
c. 2 & 3.
d. 2 & 4.
e. 3 & 4.
b
The following is an inherent risk that is particularly applicable to owning stock in a company like Genie Energy: Risk of sudden market declines, which would adversely affect the valuation of securities.
T or F?
True
The following is a reasonable test of control over marketable securities: Inquire of management about its process for establishing valuation of marketable securities and review related documentation.
T or F?
True
Refer to Exhibit 10.15.
Which of the following assertions is relevant to whether the marketable securities balances include all securities transactions that have taken place during the period?
a. Existence/occurrence.
b. Completeness.
c. Rights and obligations.
d. Valuation or allocation.
e. All of the above.
b
Refer to Exhibit 10.15.
Which of the following assertions is relevant to the audit procedure for marketable securities that requires the auditor to examine selected documents to identify any restrictions on the securities?
a. Existence/occurrence.
b. Completeness.
c. Rights and obligations.
d. Valuation or allocation.
e. All of the above.
c
When there is a ready market for financial instruments, the audit procedures related to valuation and disclosures are more straightforward than when the instrument is not readily marketable.
T or F?
True
Auditor expertise is critically important in evaluating the validity of the valuation of complex financial instruments.
T or F?
True
An audit client has invested heavily in new equity and debt securities. Which of the following would not constitute an appropriate role for the organization’s board of directors or others charged with governance?
a. Receive and review periodic reports by the internal audit function on compliance with the organization’s investment policies and procedures.
b. Approve all new investments prior to reviewing their risks.
c. Review and approve written policies and guidelines for investments in marketable securities.
d. Periodically review the risks inherent in the portfolio of marketable securities to determine whether the risk is within parameters deemed acceptable by the board.
b
Which of the following is a risk associated with complex financial instruments?
a. Management’s objective for entering into such transactions may relate to misstating the financial statements.
b. Most of these financial instruments have a high volume of activity and relate to deep capital markets.
c. Most management teams today have the necessary sophistication to invest in complex financial instruments with relatively little downside risk.
d. All of the above are risks.
a
____________ is a financial contract between two parties, the buyer and the seller, in which the buyer has the right (but not the obligation) to buy an agreed quantity of a particular commodity or financial instrument (the underlying asset) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price).
CALL OPTION
____________ is a financial contract between the two parties, the buyer and the seller, in which the buyer has the right (but not the obligation) to sell an agreed quantitiy of a particular commodity or financial instrument (the underlying instrument) to the seller of the option at a certain time for a certain price.
PUT OPTION
An ________________ is a financial instrument that is essentially a bet on whether an underlying obligation, most often underlying mortgages on homes, will fail or not fail.
COLLATERALIZED DEBT OBLIGATION
An ________________ is associated with bonds and is intended to protect the bondholder in case of a credit downgrading of the bond, such as might happen in the case of a leveraged buyout.
EVENT-RISK PROTECTED DEBT
____________ are an instrument that allows an organization to hedge against a change in some underlying economic event that may affect the organization.
HEDGES
A ________________ is a debt instrument with a variable interest rate.
FLOATING RATE NOTE
____________ are high-yielding bonds issued by a borrower with lower-than-investment-grade credit rating.
JUNK BOND
An ____________ is an instrument that allows an organization to hedge against future changes in interest rates by either swapping financial instruments, usually a fixed-rate investment, for a variable-rate investment, or vise versa.
INTEREST RATE SWAP
With no periodic interest payments, these bonds are sold at a deep discount from face value.
ZERO-COUPON BOND
Marketable securities can be sold by an investor (not the original issuer) together with a put option that entitles the purchaser to sell the securities back to the investors who sold the securities at a fixed price in the future.
SECURITIES SOLD WITH A PUT OPTION
A ________________ is a debt obligation issued as a special-purpose instrument that is collateralized by a pool of mortgages.
COLLATERALIZED MORTGAGE OBLIGATION
____________ have been converted into a form that can be sold to investors (similar in concept to CMOs).
SECURITIZED RECEIVABLES
