Audit and Assurance Practice Exam

What question is crucial for assessing inherent risk related to cash flows?

1. Is there a history of cash flow problems?

2. Are cash transactions adequately authorized?

3. Are employees trained to handle cash correctly?

4. Is there a separate department for cash management?

The correct answer is: Is there a history of cash flow problems?

Assessing inherent risk related to cash flows hinges significantly on understanding the entity's historical context regarding cash flow stability. A history of cash flow problems is vital because it provides insight into patterns that may indicate ongoing vulnerabilities. Such an understanding can help auditors identify areas where misstatements or irregularities may occur due to poor cash management practices or external economic factors. Recognizing cash flow issues allows auditors to tailor their audit procedures to address these risks effectively. For instance, if an entity has previously faced cash flow challenges, this may necessitate a deeper examination of cash flow projections, operating cycles, and related internal controls. While the other options address important aspects of cash management – such as authorization, employee training, and departmental structure – they do not directly evaluate the inherent risk posed by the historical performance of cash flows. These factors, while relevant for assessing control risk and establishing a framework for effective cash handling, do not alone provide the comprehensive understanding needed for inherent risk assessment as effectively as knowing whether there has been a history of cash flow problems.