Chapter 23

 Auditing and Assurance Services, 15e (Arens) Chapter 23 Audit of Cash Cash and Financial Instruments

Learning Objective 23-1 1) Which of the following is not a "cash equivalent"? A) i!e e#osits $) %ertificates of e#osit %) &one' !ar(et funs ) &ar(etable securities Answer*  2) An i!#rest #ett' cash fun woul least li(el' be use to #a' for which of the following ite!s? A) &inor office su##lies $) &onthl' interest e+#ense %) ,ta!#s for s!all !ailings ) ,!all contributions to a local charit' Answer* $ 3) An i!#rest #ett' cash fun* A) is a ban( account $) is use for large. unusual #urchases %) is usuall' rei!burse at least once a wee( for goo internal control ) is being re#lace b' #re-a##rove #urchase cars in !an' co!#anies Answer*  /) escribe each of the !ajor t'#es of o f cash accounts !aintaine b' business entities Answer* 0 General cash account. his is the focal #oint of cash for !ost organiations because virtuall' all cash recei#ts an isburse!ents flow through this account 0  Imprest payroll payroll account. As a !eans of i!#roving internal control. !an' co!#anies establish a se#arate i!#rest ban( account for !a(ing #a'roll #a'!ents to e!#lo'ees n such an account. a fi+e balance. such as 1.444. is !aintaine !!eiatel' before each #a' #erio. one chec( is rawn on the general cash account to e#osit the total a!ount of the net #a'roll in the i!#rest #a'roll account 0  Branch bank account. 5or a co!#an' o#erating in !ulti#le locations. it is often esirable to have a se#arate ban( balance at each location $ranch ban( accounts are useful for builing  #ublic relations in local co!!unities an #er!itting #er!itting the centraliation of o#erations at the  branch level 0  Imprest petty petty cash fund. his fun is use for s!all cash acquisitions that can be #ai !ore convenientl' an quic(l' b' cash than b' chec(. or for the convenience of e!#lo'ees in cashing  #ersonal or #a'roll chec(s 0 Cash equivalents. 6+cess cash accu!ulate uring certain #arts of the o#erating c'cle that will be neee in the reasonabl' near future is often investe in short-ter!. highl' liqui cash equivalents such as ti!e e#osits. certificates of e#osit. an !one' !ar(et funs

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Learning Objective 23-2 1) Which of the following !isstate!ents is !ost li(el' to be uncovere uring an auit of a client7s ban( reconciliation? A) u#licate #a'!ent of a venor7s veno r7s invoice $) $illing a custo!er at a lower #rice than inicate b' co!#an' #olic' # olic' %) 5ailure to recor a collection of a note receivable b' the ban( on the client7s behalf  ) 8a'!ent to an e!#lo'ee for !ore than the hours actuall' wor(e Answer* % 2) Which of the following is li(el' to be etecte as #art of the auit of the ban( reconciliation? A) 5ailure to bill a custo!er  $) u#licate #a'!ent of a venor invoice %) %ash receive b' the client c lient after 'ear en. but inclue in cash recei#ts in the current 'ear  ) An e!bele!ent of cash b' interce#ting cash recei#ts fro! custo!ers before the' are recore Answer* % 3) Which of the following woul nor!all' be iscovere as #art of the auit of the ban( ba n( reconciliation? A) 5ailure to bill a custo!er  $) 5ailure to inclue a e#osit in transit on the ban( reconciliation %) u#licate #a'!ent of a venor7s invoice ) 8a'!ent to an e!#lo'ee for !ore hours than she wor(e Answer* $ /) he general cash account is consiere con siere a significant account in al!ost all auits* A) where the ening balance is !aterial $) even when the ening en ing balance is i!!aterial %) e+ce#t those of not-for-#rofit organiations ) where either the beginning or ening balance is !aterial Answer* $ 9) All of the following woul not be uncovere b' a ban( reconciliation except for* A) u#licate #a'!ent of a venor7s invoice $) i!#ro#er #a'!ents of officers7 #ersonal e+#enitures %) #a'!ents on notes #a'able ebite irectl' to the the ban( account b' the ban( but not recore on the boo(s ) #a'!ent to an e!#lo'ee for !ore hours than he wor(e Answer* % :) Which of the following c'cles oes not affect cash in ban(? A) %a#ital acquisitions c'cle $) nventor' an warehousing %) 8a'roll an #ersonnel c'cle ) Acquisitions an isburse!ents Answer* $ 2

;) $an( reconciliation auit tests are esigne to etect !isstate!ents other than through the i!#ro#er #a'!ent of cash or failure to receive cash nor!all' woul not be etecte as #art of the tests of the ban( reconciliation List below at least ) "5ailure to bill a custo!er" is an e+a!#le of an error that results in the failure to receive cash.  but woul not be iscovere as #art of the auit of the ban( reconciliation ,tate three other e+a!#les of errors or irregularities that result in the i!#ro#er #a'!ent of. or failure to receive. cash. but that woul not be iscovere uring the auit of the ban( reconciliation ) he ban( reconciliation* A) !ust be one on a ail' basis if the client uses electronic ban(ing $) shoul be #erfor!e b' so!eone ine#enent of the hanling or recoring of cash recei#ts %) shoul be #erfor!e b' so!eone who hanles cash isburse!ents ) ensures that no cash has been e!bele Answer* $

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1) BBBBBBBB is an auto!ate frau etection tool offere b' !ost ban(s A) 8ositive #a' $) A ban( confir!ation %) 5rau buster  ) %hec( !atching Answer* A 24) Which of the following balance-relate objectives a##lies to auiting the general cash account? A) =ights %lassification =ealiable value es @o es $) =ights  @o

%lassification es

=ealiable value @o

=ights es

%lassification es

=ealiable value es

=ights  @o

%lassification @o

=ealiable value @o

%)

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Answer*  21) he stanar ban( confir!ation for! has been agree u#on b' the* A) ,6% an 5A,$ $) A%8A an the ,6% %) ,6% an the A!erican $an(ers7 Association ) A%8A an the A!erican $an(ers7 Association Answer*  22) he auitors test the client7s !onthl' ban( reconciliation to verif' whether the client7s recore ban( balance is the sa!e a!ount as the actual cash in the ban( Which of the following woul not e+#lain a ifference between the co!#an'7s cash balance an the ban(7s balance for the client? A) e#osits in transit $) %hec(s are written b' the client in the sa!e !onth the chec(s clear the ban( %) Other reconciling ite!s ) Outstaning chec(s Answer* $

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23) f an auitor waits until the subsequent #erio ban( state!ent is available to verif' reconciling ite!s. it is #ri!aril' a test for* A) errors $) o!issions %) (iting ) intentional !isstate!ents Answer*  2/) Which of the following verifications woul generall' not be # erfor!e b' the auitor in the !onth subsequent to the balance sheet ate? A) 5oot the lists of all cancele chec(s. ebit !e!os. e#osits. an creit !e!os $) Cerif' the ban( state!ent balances when the foote totals are use %) Cerif' the boo( state!ent balances tie to the cash recei#ts an isburse!ents journals for the 'ear uner auit ) =eview the ite!s inclue in the footings to !a(e sure that the' were cancelle b' the ban(  Answer* % 29) nternal controls over 'ear-en cash balances in the general account can be ivie into two categories List the two below Answer* 1 %ontrols over transactions c'cle affecting the recoring of cash recei#ts an cash isburse!ents 2 ne#enent ban( reconciliations 2:) 6+#lain what is !eant b' a cutoff bank statement, an iscuss the #ur#ose of the cutoff ban( state!ent in the auit of cash Answer* A cutoff ban( state!ent is a #artial-#erio ban( state!ent an the relate co#ies of cancele chec(s. u#licate e#osit sli#s. an other ocu!ents inclue in ban( state!ents. !aile b' the ban( irectl' to the %8A fir!7s office he #ur#ose of the cutoff ban( state!ents is to verif' the reconciling ite!s on the client7s 'ear-en ban( reconciliation with evience that is not accessible to the client

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2;) 6+#lain the #ur#ose of testing the client7s ban( reconciliation. an iscuss the !ajor auit  #roceures involve Answer* he #ur#ose of testing the client7s reconciliation is to verif' whether the client7s recore ban( balance is the sa!e a!ount as the actual cash in the ban( 8roceures inclue* 0 Cerif' that the client7s ban( reconciliation is !athe!aticall' accurate 0 race the balance on the ban( confir!ation anDor the beginning balance on the cutoff state!ent to the balance #er ban( on the ban( reconciliation to ensure the' are the sa!e 0 race chec(s written an recore before 'ear-en an inclue with the cutoff ban( state!ent to the list of outstaning chec(s on the ban( reconciliation an to the cash isburse!ents journal in the #erio or #erios #rior to the balance sheet ate 0 nvestigate all significant chec(s inclue on the outstaning chec( list that have not cleare the ban( on the cutoff state!ent 0 race e#osits in transit to the cutoff ban( state!ent 0 Account for other reconciling ite!s on the ban( state!ent an ban( reconciliation 2>) nstea of receiving a cutoff ban( state!ent. auitors can wait until the subsequent #erio  ban( state!ent is available to verif' reconciling ite!s iscuss the #ur#ose of reviewing the subsequent #erio ban( state!ent an list the verifications the auitor #erfor!s on this ban( state!ent Answer* he #ur#ose of such a #roof is to test whether the client7s e!#lo'ees have o!itte. ae. or altere an' of the ocu!ents acco!#an'ing the state!ent he auit #roceures inclue footing all the cancelle chec(s. ebit !e!os. e#osits. an creit !e!osE verif'ing that the ban( state!ent balances when the foote totals are useE an reviewing the ite!s inclue in the footings to !a(e sure that the' were cancelle b' the ban( in the #ro#er #erio an o not inclue an' erasures or alterations Learning Objective 23-/ 1) Auitors are li(el' to #re#are a #roof of cash when the client has* A) !aterial control wea(nesses in cash recei#ts an cash isburse!ents $) !aterial control wea(nesses in accounts receivable an revenue %) !aterial control wea(nesses in accounts #a'able an inventor' ) !aterial control wea(nesses in #a'roll Answer* A

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2) he auitor uses a #roof of cash to eter!ine whether* A) All recore cash isburse!ents All a!ounts that were #ai b' the were #ai b' the ban(  ban( were recore es es $) All recore cash isburse!ents were #ai b' the ban(  @o

All a!ounts that were #ai b' the  ban( were recore @o

%) All recore cash isburse!ents were #ai b' the ban( es

All a!ounts that were #ai b' the  ban( were recore @o

) All recore cash isburse!ents were #ai b' the ban(  @o

All a!ounts that were #ai b' the  ban( were recore es

Answer* A 3) A #roof of cash re#resents* A) a test of controls an substantive test of transactions $) a substantive test of transactions %) a substantive test of transactions an test of etails of balances ) a test of etails of balances Answer* % /) A !ajor consieration in the auit of the general cash balance is the #ossibilit' of frau he auitor !ust e+ten his or her #roceures in the auit of 'ear-en cash to eter!ine the  #ossibilit' of a !aterial frau when there are* A) large cash balances at the en of the 'ear $) large cash recei#ts an isburse!ents uring the 'ear %) no i!#rest accounts use for #a'roll ) inaequate internal controls Answer*  9) he auit an accounting concern aresse in a !onthl' #roof of cash is with* A) ajusting account balances $) reconciling the a!ounts recore in the boo(s with the a!ounts inclue in the ban( state!ent %) eter!ining the !onth-en balance ) ientif'ing cash transfers Answer* $ 11

:) A #roof of cash is effective at ientif'ing which of the following !isstate!ents? A) %hec(s written for incorrect a!ounts $) %hec(s issue to invali venors %) 5rauulent chec(s ) %hec(s recore in the boo(s for an a!ount ifferent fro! that on the chec(  Answer*  ;) he #rocess of transferring !one' fro! one ban( account to another an i!#ro#erl' recoring the transaction is referre to as* A) (iting $) la##ing %) sca!!ing ) e!beling Answer* A >) Which of the following is a correct state!ent? A) A #roof of cash recei#ts is a test of the balance in the cash account at a #oint in ti!e $) he #roof of cash isburse!ents is effective for iscovering a chec( written for the incorrect a!ount for which the ollar a!ount in cash isburse!ents is also incorrect %) t is e+tre!el' ifficult for an auitor to etect thefts of cash. es#eciall' o!itte transactions an account balances ) ,egregation of uties is not an i!#ortant control #roceure for cash in a s!all business Answer* % he following infor!ation a##lies to the questions below* Liste below are four interban( cash transfers. inicate b' the nu!bers 1. 2. 3. an /. of a client for late ece!ber 2413 an earl' Fanuar' 241/*

1 2 3 /

$an( Account One isbursing ate G&onthDa') 8er $an( 8er $oo(s 12D31 12D34 1D2 12D34 1D3 12D31 1D3 12D31

$an( Account wo =eceiving ate G&onthDa') 8er $an( 8er $oo(s 12D31 12D34 12D31 12D31 1D2 1D2 1D2 12D31

) $ase on the scheule of interban( transfers above. which of the cash transfers inicates an error in cash cutoff at ece!ber 31. 2413? A) 1 $) 2 %) 3 ) / Answer* %

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14) $ase on the scheule of interban( transfers above. which of the cash transfers woul a##ear  as a e#osit in transit on the ece!ber 31. 2413 ban( reconciliation? A) 1 $) 2 %) 3 ) / Answer*  11) $ase on the scheule of interban( transfers above. which of the cash transfers woul not a##ear as an outstaning chec( on the ece!ber 31. 2413 ban( reconciliation? A) 1 $) 2 %) 3 ) / Answer* A 12) A #roof of cash is not an effective #roceure for ientif'ing which of the following t'#es of !isstate!ents? A) All recore isburse!ents were #ai b' the ban( $) All recore cash recei#ts were e#osite %) All a!ounts that were #ai b' the ban( were recore ) ,o!e chec(s were written for incorrect a!ounts Answer*  13) Listing all ban( transfers !ae a few a's before an after the balance sheet ate an tracing each to the accounting recors for #ro#er recoring is a useful a##roach to test for* A) (iting $) la##ing %) inco!e s!oothing ) channel stuffing Answer* A 1/) On the last a' of the fiscal 'ear. the cash isburse!ents cler( rew a co!#an' chec( on  ban( A an e#osite the chec( in the co!#an' account in ban( $ to cover a #revious theft of cash he isburse!ent has not been recore he auitor will best etect this for! of (iting b'* A) e+a!ining the co!#osition of e#osits in both ban( A an ban( $ subsequent to 'ear-en $) e+a!ining #ai chec(s returne with the ban( state!ent of the ne+t account #erio after 'earen %) #re#aring. fro! the cash isburse!ents recors. a su!!ar' of ban( transfers for one wee(  #rior to an subsequent to 'ear-en ) co!#aring the etail of cash recei#ts as shown b' the client7s cash recei#ts recors with the etail on the confir!e u#licate e#osit tic(ets for three a's #rior to an subsequent to 'earen Answer* $

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19) When the auitor believes the 'ear-en ban( reconciliation !a' be intentionall' !isstate. it is a##ro#riate to #erfor! e+tene tests of the 'ear-en ban( reconciliation Assu!ing the client has a October 31 'ear-en. these e+tene tests woul not inclue* A) co!#aring all ,e#te!ber 34 reconciling ite!s with cancele chec(s an other ocu!ents in the October ban( state!ent $) co!#aring all cancele chec(s an e#osit sli#s in the October ban( state!ent with the October cash isburse!ents an recei#ts recors %) carr'ing out all #ro#er #roceures subsequent to the en of the 'ear with the use of the ban( cutoff state!ent ) eter!ining that all outstaning chec(s ha cleare b' the ate of the ban( cutoff state!ent Answer*  1:) Auitors will often #re#are a #roof of cash when the client has !aterial internal control wea(nesses in cash recei#ts an cash isburse!ents he #ur#ose of the #roof of cash is to eter!ine the client7s accounting recors for cash are reliable List below the four require!ents the #roof of cash is esigne to #rovie for the auitor Answer* All recore cash recei#ts were e#osite All e#osits in the ban( were recore in the accounting recors All recore cash isburse!ents were #ai b' the ban(  All a!ounts that were #ai b' the ban( were recore 1;) A #roof of cash inclues four reconciliation tas(s List below two of those tas(s Answer* 1 =econcile the balance on the ban( state!ent with the general leger balance at the beginning of the #roof-of-cash #erio 2 =econcile cash recei#ts e#osite #er the ban( with the recei#ts recore in the cash recei#ts  journal for a given #erio 3 =econcile electronic #a'!ents an cancelle chec(s clearing the ban( with those recore in the cash isburse!ents journal for a given #erio / =econcile the balance on the ban( state!ent with the general leger balance at the en of the  #roof-of-cash #erio 1>) What shoul be auite on an interban( transfer scheule? Answer* 1 he accurac' of the infor!ation on the interban( transfer scheule shoul be verifie 2 he interban( transfers !ust be recore in both the receiving an isbursing ban(s 3 he ate of the recoring of the isburse!ents an recei#ts for each transfer !ust be in the sa!e fiscal 'ear / isburse!ent on the interban( transfer scheule shoul be correctl' inclue in or e+clue fro! 'ear-en ban( reconciliations as outstaning chec(s 9 =ecei#ts on the interban( transfer scheule shoul be correctl' inclue in or e+clue fro! 'ear-en ban( reconciliations as e#osits in transit

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1) 6+#lain (iting. an iscuss how it is #erfor!e Answer* Hiting is the transfer of !one' fro! one ban( to another an i!#ro#erl' recoring the transaction to cover a theft of cash @ear the balance sheet ate. a chec( is rawn on one ban( account an i!!eiatel' e#osite in a secon account for creit before the en of the accounting #erio n !a(ing this transfer. the e!beler is careful to !a(e sure that the chec( is e#osite at a late enough ate so that it oes not clear the first ban( until after the en of the  #erio f the interban( transfer is not recore until after the balance sheet ate. the a!ount of the transfer is recore as an asset in both ban(s 24) Auitors so!eti!es #re#are a #roof of cash when the client has !aterial internal control wea(nesses in cash List two #roceures that the #roof of cash eter!ines were or were not one Answer* 0 All recore cash recei#ts were e#osite 0 All e#osits in the ban( were recore in the accounting recors 0 All recore cash isburse!ents were #ai b' the ban(  0 All a!ounts that were #ai b' the ban( were recore

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21) &atch si+ of the ter!s Ga-() with the escri#tionsDefinitions #rovie below G1-:)* a  b c  e f g h i  j (

$an( reconciliation $ranch cash account %ash equivalents %utoff ban( state!ent Ieneral cash account !#rest #a'roll account !#rest #ett' cash fun Hiting 8roof of cash ,tanar ban( confir!ation for! La##ing

 BBBBBBBB 1 A fun of cash !aintaine within the co!#an' for s!all cash acquisitions. e+#enses. or to cash e!#lo'ees7 chec(s  BBBBBBBB 2 A for! a##rove b' the A%8A an A!erican $an(ers7 Association through which the ban( res#ons to the auitor about ban( balance an loan infor!ation  BBBBBBBB 3 6+cess cash investe in short-ter!. highl' liqui invest!ents such as ti!e e#osits. certificates of e#osit. an !one' !ar(et funs  BBBBBBBB / he #ri!ar' ban( account for !ost organiations  BBBBBBBB 9 he transfer of !one' fro! one ban( account to another an i!#ro#erl' recoring the transfer so that the a!ount is recore as an asset in both accounts  BBBBBBBB : he ocu!ent usuall' #re#are b' client #ersonnel of the ifferences between the cash balance recore in the general leger an the a!ount in the ban( account Answer* 1 g 2 j 3 c / e 9 h : a

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Learning Objective 23-9 1) All of the following are correct state!ents regaring business ris( an financial instru!ents except for* A) $usiness ris(s associate with financial instru!ents will var' e#ening of the aggressiveness of a co!#an'7s investing activit' $) $usiness ris( will be higher for co!#anies investing in less liqui securities %) 5inancial services fir!s are e+#ose to ver' little ris( with their financial instru!ents ) $usiness ris( for a co!#an' will be higher when invest!ents re#resent a greater #ro#ortion of total assets Answer* % 2) 5actors that i!#act inherent ris( of financial instru!ents o  not inclue* A) !anage!ent7s objectives relate to invest!ent activit' $) the co!#le+it' of the securities %) the cost of the securities ) the co!#an'7s #rior e+#erience with certain invest!ents Answer* % 3) he use of unobservable in#uts such as a #ricing !oel or iscounte cash flow is an e+a!#le of a level BBBBBBBB esti!ate A) 1 $) 2 %) 3 ) 1 an 3 Answer* % /) he !ajorit' of financial instru!ents are value using* A) cost $) fair value esti!ates %) lower of cost or !ar(et ) realiable value Answer* $ 9) When an auit client uses a service organiation to !anage their invest!ent activit'* A) the auitor can alwa's rel' on the internal controls of the service organiation $) the auitor !ust state in their auit o#inion that the client uses a service organiation %) the auitor can rel' on the internal controls of the service organiation if the service organiation7s auitor issues a re#ort on their internal control ) the auitor !ust rel' on the service organiation to eter!ine the fair level 1. 2. an 3 esti!ates Answer* %

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:) As #art of their internal control #roceures. !anage!ent nees to have #roceu res in #lace to  #ro#erl' classif' financial instru!ents as traing. available-for-sale. or hel-to-!aturit'. base on* A) cost $) intent %) !aturit' ) #robable future gain or loss Answer* $ ;) 8rices in an active !ar(et for ientical assets is a level BBBBBBBBfair value esti!ate A) 1 $) 2 %) 3 ) / Answer* A >) When auiting financial instru!ents* A) the auitor usuall' #erfor!s !ore e+tensive substantive testing to reuce reliance on controls $) anal'tical #roceures are critical in assessing the 'ear-en balances for financial instru!ents %) the auitor relies on state!ents an bro(er7s avices fro! invest!ent !anagers to test  #urchases an sales as long as controls were ee!e effective ) tests of transactions are generall' not #erfor!e Answer* % ) When auiting financial instru!ents. anal'tical #roceures can be use to* A) test the reasonableness of interest an ivien inco!e $) test the 'ear-en balance %) eter!ine if the financial instru!ents were #ro#erl' value ) eter!ine if the gain or loss on the sales were #ro#erl' co!#ute Answer* A 14) Which is not an i!#ortant objective for financial instru!ents? A) e+istence $) cutoff  %) accurac' ) realiable value Answer* $ 11) Level BBBBBBBB esti!ates use observable in#uts other than quote #rices A) 1 $) 2 %) 3 ) / Answer* $

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12) A scheule of invest!ent activit' will inclue all but* A) the #urchases an sales $) ening balances %) the gains an losses ) the o#inion of !anage!ent as to the suitabilit' of the invest!ent to the co!#an' Answer*  13) When auiting financial instru!ents. a confir!ation is sent to the bro(er-ealer* A) onl' if the client has #oor internal controls $) to confir! interest an iviens %) to #rovie assurance on realiable value ) to confir! 'ear-en holings Answer*  1/) he auitor is testing for the balance-relate auit objective of etail tie-in when the'* A) #rove the scheule of invest!ent activit' as to aitions an subtractions $) #erfor! a #h'sical ins#ection of the securit' %) verif' the quote !ar(et #rices ) test !anage!ent7s assu!#tions relate to valuation Answer* A 19) When the auitor sens a confir!ation to the bro(er-ealer. the' are testing the balancerelate auit objective of* A) etail tie-in $) e+istence %) cutoff ) rights Answer* $ 1:) When ealing with financial instru!ents. the !ost ifficult balance-relate auit objective to test is* A) e+istence $) accurac' %) rights ) realiable value Answer*  1;) An auitor is reviewing the !inutes of boar !eetings to eter!ine whether an' securities are #lege as collateral his test of the etail of balances relates to the auit objective of* A) rights $) cutoff %) realiable value ) classification Answer* A

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1>) eter!ining if the financial instru!ents inclue in the scheule of invest!ent activit' at 'ear en are state at a##ro#riate a!ounts in accorance with accounting stanars is the  balance-relate auit objective of* A) !aterialit' $) realiable value %) consistenc' ) classification Answer* $ 1) List two co!!on tests of etails of balances #roceures the auitor woul #erfor! when testing for the balance-relate auit objective of realiable value Answer* Cerif' quote !ar(et #rices est !anage!ent classifications est !anage!ent7s assu!#tions relate to valuation %onsier using a s#ecialist for testing fair value esti!ates %onsier whether an i!#air!ent loss is require

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