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Chap010 - Chapter 10 Cash and Financial Investments CHAPTER...

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Chapter 10 - Cash and Financial Investments CHAPTER 10 Cash and Financial Investments Review Questions 10-1 The following circumstances might cause a client to understate assets: (1) Management of a privately held company may be motivated to understate assets so as to minimize income taxes. (2) Bank accounts may not be recorded so as to make possible unrecorded, illegal payments. (3) Management may wish to "manage" earnings by “deferring” income until a subsequent year. 10-2 Work on cash is likely to be more extensive than one might expect because (only 2 required): (1) Although the amount of cash shown on the balance sheet may appear relatively small, the amounts flowing into and out of the cash account during the year are often greater than for any other account. Nearly all business transactions eventually require a cash settlement. Thus, the year-end cash balance is not the only measure of materiality. (2) Cash is the most liquid of assets and offers the greatest temptation for theft, embezzlement, and misappropriation. (3) The examination of cash transactions assists the auditors in the substantiation of many other items in the financial statements because these other items either arise from or result in cash transactions. 10-3 The quoted statement is not correct. The purpose of an audit is to gather evidence which will enable the auditors to express an opinion on the financial statements, and not to pursue an extended investigation of minor fraud. If the auditors determine that the fraud could not have a material effect upon the financial statements, they should review the situation with the client before investigating further. This discussion will alert the client to the situation, protect the auditors from charges of incompetence, and avoid wasting audit time on matters that are not material with respect to the financial statements and that may better be pursued by client personnel. 10-1
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Chapter 10 - Cash and Financial Investments 10-4 The two independent records of the client's cash transactions are: (1) the client's own cash records, and (2) the bank's records of the client's account, as evidenced by the monthly bank statements and the year-end bank confirmation available to the auditor. 10-5 A lockbox system is one in which a post office box is controlled by a company's bank at which cash remittances from customers are received. The bank receives the remittances, immediately credits the cash to the company's bank account, and forwards the remittance advices to the company. 10-6 The description of internal control should be prepared first. The areas selected for testing and the size of audit samples will be determined according to the relative quality of internal control over cash receipts, cash disbursements, and cash forecasting. The purpose of tests of controls is to determine the extent to which controls allegedly in use are actually operating effectively.
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