Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
16-1
CHAPTER 16
AUDITING THE FINANCING/INVESTING PROCESS:
CASH AND INVESTMENTS
Answers to Review Questions
16-1 The reliability of an entity’s control activities over cash receipts and cash disbursements
affects the nature and extent of the auditor’s substantive tests of cash balances. The
effective operation of these control activities provides strong evidence that the
completeness assertion is being met. A major internal control activity that directly affects
16-2 A general cash account is the principal cash account for most entities. The major source
of cash receipts for this account is the revenue process, and the major sources of cash
disbursements are the purchasing and human resource management processes.
Companies that have multiple locations are likely to have branch accounts. Such
maintaining adequate control over cash. Use of imprest accounts also minimizes the time
necessary to reconcile the general cash account.
16-3 Because of the residual nature of cash, it does not have a predictable relationship to other
financial statement accounts. As a result, the auditor’s use of analytical procedures for
auditing cash is limited to comparisons with prior years’ cash balances and to budgeted
16-4 The standard bank confirmation form does not identify all information about an entity’s
bank deposits or loans because it does not require bank personnel to conduct a
16-5 A cutoff bank statement is obtained to test the reconciling items included in the bank
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
16-2
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
reconciliation. The outstanding checks or substitute checks returned with the cutoff bank
statement are examined for proper payee, amount, and endorsement.
16-6 Three fraud-related audit procedures for cash are:
• Extended bank reconciliation procedures. These procedures include examining the
disposition of the reconciling items included in the prior months’ reconciliations and
bank transactions have been omitted from the entity’s accounting records.
• Tests for kiting. An interbank transfer schedule is used to test for kiting (see Exhibit
16-5).
16-7 An approach used by auditors to test for kiting is the preparation of an interbank transfer
schedule. With an interbank transfer schedule, the auditor tests the dates of cash
16-8 The main transaction-related assertions for investments are occurrence, authorization,
completeness, accuracy, and classification.
The key segregation of duties for investments and the errors or fraud that they can
prevent are:
Segregation of Duties
Possible Errors or Fraud as a
Result of Conflicts in Duties
The initiation function should be
segregated from the final approval
function.
Fictitious transactions can be made or
securities can be stolen.
The value-monitoring function should
be segregated from the acquisition
function.
Securities values can be improperly
recorded or not reported to management.
Responsibility for maintaining the
securities ledger should be separate
from that of making entries in the
general ledger.
Concealment of a defalcation that would
normally be detected by reconciliation of
subsidiary records with general ledger
control accounts.
Responsibility for custody of securities
should be separate from that of
accounting for the securities.
Theft of securities can be concealed.
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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16-9 FASB ASC Topic 320, “Investments – Debt and Equity Securities,” requires that
investments be classified in three categories and accounted for as follows:
• Debt securities that the entity has the positive intent and ability to hold to maturity are
classified as held-to-maturity securities and reported at amortized cost.
• Debt and equity securities that are bought and held principally for the purpose of
an investment security. Auditing standards provide guidance for determining whether a
decline in value below amortized cost is other than temporary.
16-10 The two presentation classification issues that are important for the audit of investments
are:
• Marketable securities need to be properly classified between held-to-maturity,
16-11 Fair value audit evidence for Level 1 is objective and market-based so the auditor will
obtain fair values from publicly available sources (e.g., finance website). Level 3 fair
value evidence will involve examining management’s assumptions and subjective inputs
to valuation models. Complicated financial instruments, such as credit default swaps,
Answers to Multiple-Choice Questions
16-12
b
16-18
d
16-13
a
16-19
b
16-14
d
16-20
b
16-15
a
16-21
b
16-16
b
16-22
c
16-17
b
16-23
b
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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Solutions to Problems
16-24 The auditor’s internal control questionnaire should include the following additional
questions:
• Does access to the bank safe-deposit vault require the signature or presence of two
designated persons?
• Are all individuals who have access to marketable securities bonded?
• Are those who have access to the securities denied access to the accounting records?
• Does the accounting department keep detailed records of
• Purchases and sales?
• Securities (including number of shares) owned?
• Stock certificate numbers?
• Is the amount of dividends received on individual investments periodically reconciled
to published public records?
• Does the investment committee periodically review compliance with its established
policy?
16-25 Typical audit program steps for auditing Sevcik’s bank balance include the following
steps:
• Review answers to questions on confirmation requests to determine proper
recognition in accounting records and the necessity for financial statement disclosure.
• Make inquiries as to compensating balances and restrictions.
• Obtain copies of the bank reconciliations as of the balance sheet date and
• Examine a sample of checks for payee, amount, date, authorized signatures, and
endorsements to determine any deviations from company policy or fraud in the
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
accounting records.
• Prepare a bank transfer schedule from a review of the cash receipts and disbursements
journals, bank statements, and related paid checks for the last few days before and the
first few days after year-end. Review the schedule to determine that the deposit and
disbursement of each transfer is recorded in the proper period.
• Trace incomplete transfers to the schedule of outstanding checks and deposits in
transit.
16-26 a. 4, 7
16-27 a. The following information is missing:
• The date of purchase of security “S”.
• The date of purchase and sale of security “R”.
• Data concerning the December 31, 2013, revenue accruals.
• Data required to evaluate the classification of securities.
b. The following procedures were not noted as having been performed:
• The securities were not physically inspected or confirmed.
• The broker’s advice (or other independent corroborating evidence) verifying the
sale of “R” was not examined.
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
16-28 a.
Objective
To determine that the custodian holds the securities
as identified in the confirmation.
To determine that all income and related collections
from the investments are properly recorded.
To determine that the market or other value of the
investments is fairly stated.
To determine that transfers are properly authorized
and that the financial statement presentation and
disclosure of investments is in conformity with
generally accepted accounting principles
consistently applied.
To determine that the market or other value of the
investments is fairly stated and the loss is properly
recognized and recorded.
b. Phung should consider applying the following additional substantive auditing
procedures in auditing Vernon’s investments:
• Inspect securities on hand in the presence of the custodian.
• Examine supporting evidence (broker’s advices, etc.) for transactions between the
balance sheet date and the inspection date.
• Obtain confirmation from the issuers or trustees of investments in nonpublic
entities.
• Determine if the amortization of premium or discount on bonds has been properly
computed.
• Determine if trading securities and available-for-sale securities are properly
valued and any unrealized gains and losses are properly accounted for.
• Ascertain whether any investments are pledged as collateral or encumbered by
liens and, if so, are properly disclosed.
16-29 a. 5
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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c. 4
16-8
16-30 a. Available-for-sale portfolio inputs: Current Stock Prices
Option Expense inputs: Current stock price; risk-free rate; dividend-yield; exercise price;
time; standard deviation.
b. Available-for-sale portfolio, FASB ASC Topic 820 Levels
• Stock Price: Level 1
• Overall Portfolio: Level 1
Stock Compensation Expense, FASB ASC Topic 820 Levels
• Current Stock Price: Level 2
c. Audit Plan: Available-for-sale portfolio
• Verify that stock prices listed by company are accurate according to
NYSE ticker quotes as of period-end.
Audit Plan: Stock Compensation Expense
• Verify that risk-free rate as used by the entity is consistent with quoted
Treasury bill prices as of 12/31.
• Verify that standard deviation as used by the entity is consistent with
market information about previous fluctuations in the stock price.
• Review subsequent events.
• Determine appropriateness of valuation techniques considering the current
market environment.
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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Solution to Internet Assignment
16-31 Intel’s home page contains the financial statements for the year ended December 31,
2014. The footnotes state:
Trading Assets
Marketable debt instruments are generally designated as trading assets when a market risk is
economically hedged at inception with a related derivative instrument, or when the marketable debt
instrument itself is used to economically hedge foreign exchange rate risk from remeasurement.
Investments designated as trading assets are reported at fair value. The gains or losses of these
Investments that we designate as available-for-sale are reported at fair value, with unrealized gains and
losses, net of tax, recorded in accumulated other comprehensive income (loss), except as noted in the
“Other-Than-Temporary Impairment” section that follows. We determine the cost of the investment sold
based on an average cost basis at the individual security level. Our available–for–sale investments
include: • Marketable debt instruments when the interest rate and foreign currency risks are not hedged
at the inception of the investment or when our criteria for designation as trading assets are not
met. We generally hold these debt instruments to generate a return commensurate with the U.S.–
continue to have strategic value, we typically do not attempt to reduce or eliminate the equity
market risks through hedging activities. We record the realized gains or losses on the sale or
exchange of marketable equity securities in gains (losses) on equity investments, net.
(losses) on equity investments, net.
• Non-marketable cost method investments when the equity method does not apply.
We record the realized gains or losses on the sale of non-marketable cost method investments in gains
(losses) on equity investments, net.
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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Other-Than-Temporary Impairment
Our available-for–sale investments and non-marketable and other equity investments are subject to a
periodic impairment review. Investments are considered impaired when the fair value is below the
investment’s adjusted cost basis. Impairments affect earnings as follows:
• Marketable debt instruments when the fair value is below amortized cost and we intend to sell
the instrument, or when it is more likely than not that we will be required to sell the instrument
before recovery of its amortized cost basis, or when we do not expect to recover the entire
amortized cost basis of the instrument (that is, a credit loss exists). When we do not expect to
investee, which may include industry and sector performance, changes in technology, operational
and financing cash flow factors, and changes in the investee’s credit rating. We record other–
than-temporary impairment charges on marketable equity securities and marketable equity
method investments in gains (losses) on equity
investments, net.
• Non-marketable equity investments based on our assessment of the severity and duration of the
impairment, and qualitative and quantitative analysis, including:
• the investee’s revenue and earnings trends relative to pre-defined milestones and
overall business prospects;
• the investee’s receipt of additional funding at a lower valuation.
We record other-than-temporary impairment charges for non-marketable cost method investments and
equity method investments in gains (losses) on equity investments, net.
Derivative Financial Instruments
Our primary objective for holding derivative financial instruments is to manage currency exchange rate
risk and interest rate risk, and, to a lesser extent, equity market risk, commodity price risk, and credit risk.
When possible, we enter into master netting arrangements with counterparties to mitigate credit risk in
derivative transactions. A master netting arrangement may allow counterparties to net settle amounts
owed to each other as a result of multiple, separate derivative transactions. Generally, our master netting
agreements allow for net settlement in case of certain triggering events such as bankruptcy or default of
a cash flow hedge. The criteria for designating a derivative as a cash flow hedge include the assessment
of the instrument’s effectiveness in risk reduction, matching of the derivative instrument to its underlying
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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transaction, and the assessment of the probability that the underlying transaction will occur. For
derivatives with cash flow hedge accounting designation, we report the after-tax gain or loss from the
We recognize gains and losses from changes in fair value of derivatives that are not designated as
hedges for accounting purposes in the line item on the consolidated statements of income most closely
associated with the related exposures, primarily in interest and other, net and gains (losses) on equity
cash flows from operating activities or investing activities, depending on the activity the exposure is most
closely associated with.
Measurement of Effectiveness
• Effectiveness for forwards is generally measured by comparing the cumulative change in the fair
value of the hedge contract with the cumulative change in the fair value of the forecasted cash
flows of the hedged item. For currency forward contracts used in cash flow hedging strategies
related to capital purchases, forward points are excluded, and effectiveness is measured using
effectiveness is measured using spot rates to value both the hedge contract and the hedged item.
• Effectiveness for interest rate swaps and commodity swaps is generally measured by
comparing the cumulative change in fair value of the swap with the cumulative change in the fair
value of the hedged item.
If a cash flow hedge is discontinued because it is no longer probable that the original hedged transaction
will occur as previously anticipated, the cumulative unrealized gain or loss on the related derivative is
reclassified from accumulated other comprehensive income (loss) into earnings. Subsequent gains or
losses on the related derivative instrument are recognized in interest and other, net in each period until
Securities Lending
We may enter into securities lending agreements with financial institutions, generally to facilitate hedging
and certain investment transactions. Selected securities may be loaned, secured by collateral in the form
of cash or securities. The loaned securities continue to be carried as investment assets on our
consolidated balance sheets. For lending agreements collateralized by cash and cash equivalents,
collateral is recorded as an asset with a corresponding liability. For lending agreements collateralized by
other securities, we do not record the collateral as an asset or a liability, unless the collateral is
repledged.
Chapter 16 – Auditing the Financing/Investing Process: Cash and Investments
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Intel’s Annual Report also provides the value of investments and similar information can
be found at Microsoft’s home page.