Auditing Chapter 10 Questions

In performing a count of negotiable securities, an auditor records the details of the count on a security count worksheet. What other information is usually included on this worksheet?

An acknowledgment by a client representative that the securities were returned intact.

An auditor's analytical procedures indicate a lower than expected return on an equity method investment. This situation most likely could have been caused by

An error in recording amortization of the excess of the investor's cost over the investment's underlying book value.

In auditing for unrecorded long-term bonds payable, an audit team most likely will...

Compare interest expense with the bond payable amount for reasonableness. The recorded interest expense should reconcile with the outstanding bonds payable. If interest expense appears excessive relative to the recorded bonds payable, unrecorded long-term liabilities may exist.

Which of the following audit procedures would not likely be performed for audits of shareholder's equity?

Compare valuation of stock to published market prices Market price is not important in valuing shareholder's equity.

Which audit procedure would not likely be performed for audits of investments?

Confirm investments with registrar. The registrar would not have information related to the investor or market information.

An auditor usually determines whether dividend income from publicly-held investments is reasonable by computing the amounts that should have been received by referring to

Records produced by investment services.

Which of the following sets of information does an auditor usually confirm on one form? a. Accounts receivable and accrued interest receivable. b. Cash in bank and collateral for loans. c. Inventory on consignment and contingent liabilities. d. Accounts payable and purchase commitments.

b. Cash in bank and collateral for loans.

The auditors should insist that a representative of the client be present during the inspection and count of securities to...

Acknowledge the receipt of securities returned. A client representative should be present to acknowledge return so the auditor will not be accused of theft.

In connection with the audit of an issue of long-term bonds payable, the audit team should...

Ascertain that the client has obtained the opinion of counsel on the legality of the issue. Among the choices available, obtaining an opinion from legal counsel is the best response. The legality of a bond issue is important although not the only important thing.

An audit plan for the examination of the retained earnings account should include a step that requires verification of the...

Authorization for both cash and stock dividends declared and paid. and Gain or loss resulting from disposition of treasury shares Stock splits have no effect on retained earnings and a write-down of accounts receivable would not go to beginning balance of retained earnings. As such, these would not be in the audit plan. On the other hand, the audit plan should include steps to verify that cash and stock dividends are authorized by the board of directors and treasury stock transactions have been audited.

A related party is a person or entity that...

Can exert significant influence over or be influenced by the company.

During an audit of an entity's stockholders' equity accounts, the auditor determines whether there are restrictions on retained earnings resulting from loans, agreements, or state law. This audit procedure most likely is intended to verify management's assertions related to

Classification and understandability

In auditing long-term bonds payable, an auditor most likely would:

Compare interest expense with the bond payable amount for reasonableness.

Jones was engaged to examine the financial statements of Gamma Corporation for the year ended June 30. Having completed an examination of the investment securities, what is the best method of verifying the accuracy of recorded dividend income?

Comparing recorded dividends with a standard financial reporting service's record of dividends. Independent evidence from an outside dividend reporting service is the best evidence for existence, completeness, and valuation.

An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the...

Completeness of recorded investment income. The auditor may develop expectations regarding the completeness assertion for unrecorded investment income from stocks by using dividend records published by standard investment advisory services to recompute dividends received. Interest income from bond investments can be calculated from interest rates and payment dates noted on the certificates. Income from equity-based investments can be estimated from audited financial statements of the investees. Thus, applying an expected rate of return to the net investment amount may be an effective means of estimating total investment income.

In establishing the existence and ownership of a long-term investment in the form of publicly-traded stock, an auditor should inspect the securities or:

Confirm the number of shares owned that are held by an independent custodian.

An audit plan to examine long-term debt most likely would include steps that require

Correlating interest expense recorded for the period with outstanding debt. By reconciling interest expense with interest-bearing obligations, the auditor verifies the amount of outstanding liabilities. If interest expense is excessive in relation to the long-term debt, unrecorded interest-bearing obligations may be outstanding.

The primary reason for preparing a reconciliation between interest-bearing obligations outstanding during the year and interest expense in the financial statements is to...

Detect unrecorded liabilities. "Detect unrecorded liabilities" is the best response, but remember that the procedure might be ineffective if the interest expense on an unrecorded liability is also unrecorded.

When a client engages in transactions involving derivatives, the auditor should:

Develop an understanding of the economic substance of each derivative.

An auditor is testing the reasonableness of dividend income from investments in publicly-held companies. The auditor most likely would compute the amount that should have been received and recorded by the client by:

Electronically accessing the details of dividend records on the Internet.

An auditor's inquiries of management disclosed that the entity recently invested in a series of energy derivatives to hedge against the risks associated with fluctuating oil prices. Under these circumstances, the auditor should

Examine the contracts for possible risk exposure and the need to recognize losses.

All corporate capital stock transactions should ultimately be traced to the...

Minutes of the meetings of the board of directors. Capital stock transactions are important by definition, and the directors should have approved all of them.

When a company's stock record books are maintained by an outside registrar or transfer agent, the auditor should obtain confirmation from the registrar or transfer agent concerning the:

Number of shares issued and outstanding.

An audit team would most likely verify the interest earned on bond investments by...

Recomputing the interest earned on the basis of face amount, interest rate, and period held. The audit program for long-term investments includes making an independent computation of revenue (such as dividends and interest). For example, bond certificates contain information about interest rates, payment dates, issue date, and face amount that the auditor can use to recalculate bond interest earned, including amounts accrued but not collected, during the period the auditee has held the investment.

A client has a large and active investment portfolio that is kept in a bank safe deposit box. If the auditors are unable to count securities at the balance sheet date, they most likely will...

Request the client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date. Securities should be inspected simultaneously with the verification of cash and the count of other liquid assets to prevent transfers among asset categories for the purpose of concealing a shortage. If this procedure is not possible but the securities are kept by a custodian in a bank safe deposit box, the client may instruct the custodian that no one is to have access to the securities unless in the presence of the auditor. Thus, when finally inspecting the securities, the auditor may conclude that they represent what was on hand at the balance-sheet date.

When the client holds a large amount of negotiable securities, auditors need to plan to guard against...

Substitution of securities already counted for other securities that should be on hand but are not. The danger is that someone might move securities so the auditor counts them twice.

If the auditors discover that the carrying amount of a client's investments is overstated because of a loss in value that is other than a temporary decline in market value, they should insist that...

The loss in value be recognized in the financial statements. Losses on investment should be recorded in the accounts and shown in the financial statements. (Losses on trading securities in the income statement; loss on available-for-sale securities in the equity section.)

When a client company does not maintain its own capital stock records, the auditors should obtain written confirmation from the transfer agent and registrar concerning...

The number of shares issued and outstanding. The number of shares issued and outstanding is the record kept by the registrar/transfer agent.

ABC stock has 100 shares of IBM stock that it holds as an investment. The stock was purchased three years ago and has been in the client's safe deposit box along with other investment securities. During an inspection of securities held by the client, the auditor noted the 100 shares of IBM stock had a different CUSIP number than the number listed when purchased and the number verified during the previous audit. What would be the auditor's main concern about this discover?

There had been unauthorized buying and selling of investment securities. There is no evidence that the securities are not properly presented on the balance sheet.

Loan covenants are used for what reason?

To protect the lender from the borrower's substantially weakening of the latter's financial position. This is the purpose of covenants.

In performing tests concerning the granting of stock options, an auditor should:

Trace the authorization for the transaction to a vote of the board of directors.

When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud most likely would be reduced if the:

Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.

When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud most likely would be reduced if the...

Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records. To conceal fraud related to marketable securities, collusion between those responsible for record keeping and custody would be required. The possibility of collusion is reduced if no direct contact between responsible parties exists.

An auditor scans a client's investment records for the period just before and just after the year-end to determine that any transfers between categories of investments have been properly recorded. The primary purpose of this procedure is to obtain evidence about management's financial statement assertions of:

Understandability and classification, and valuation and accuracy.

When independent stock transfer agents are not employed and the corporation issues its own stock and maintains stock records, canceled stock certificates should

be defaced to prevent reissuance and attached to their corresponding stubs. Stock certificates should be defaced but retained so the auditors can actually see the canceled certificate.

Which of the following approaches is most suitable for auditing the finance and investment cycle?

c. Gain an understanding of internal controls and perform extensive substantive procedures Controls must be reviewed (and tested for public companies); however, a substantive approach is preferred.

Which of the following controls would a company most likely use to safeguard marketable securities when an independent trust agent is not employed? a. The internal auditor and the controller independently trace all purchases and sales of marketable securities from the subsidiary ledgers to the general ledger. b. The chairman of the board verifies the marketable securities, which are kept in a bank safe-deposit box, each year on the balance sheet date. c. Two company officials have joint control of marketable securities, which are kept in a bank safe-deposit box. d. The investment committee of the board of directors periodically reviews the investment decisions delegated to the treasurer.

c. Two company officials have joint control of marketable securities, which are kept in a bank safe-deposit box

An audit team's purpose in reviewing the documentation concerning the renewal of a note payable shortly after the balance sheet date most likely is to obtain evidence concerning management's assertion about...

classification Events such as the renewal of the note payable do not require adjustment of the financial statements but may require disclosure. Accordingly, the auditor should determine that the renewal had essentially the same terms and conditions as the recorded debt at year-end. A significant change may affect the presentation of notes payable such as a reclassification from short term to long term.

Which of the following questions would auditors most likely include on an internal control questionnaire for notes payable?

d. Are direct borrowings on notes payable authorized by the board of directors? Control is enhanced when different persons or departments authorize, record, and maintain custody of assets for a class of transactions. Authorization of notes payable transactions is best done by the board of directors.

Which of the following is the most important audit consideration when examining the stockholders' equity section of a client's balance sheet?

d. Entries in the capital stock account can be traced to resolutions in the minutes of meetings of the board of directors. Capital stock transactions are important by definition, and the directors should have approved all of them.