Chapter 14 and 15- Auditing

in the verification of cash dividends, the auditors will perform the following steps:

1. determine the dates and amounts of dividends authorized 2. verify the amounts paid 3. determine the amount of any preferred dividends in arrears 4. review the treatment of unclaimed dividend checks

bond transactions can usually be confirmed directly with the ____

trustee

obtaining an analyses of debt and related accounts satisfies which audit assertion?

valuation

obtaining a trial balance of payables and reconciling it with the ledger satisfies which primary audit objective?

valuation and accuracy

obtaining and preparing an analyses of the capital stock accounts satisfies which audit assertions?

valuation and accuracy

retained earnings increases by ___ and decreases by ___ payments

earnings; dividend

a confirmation of AP mainly satisfies which audit assertions?

existence and valuation

confirming shares outstanding with the independent registrar or stock transfer agent satisfies which audit assertions?

existence, occurrence, and cutoff

failure to pay notes promptly at maturity suggests

financial weakness

use of an ___ ___ largely solves the problem of internal control over bonds payable

independent trustee

in an effective purchasing system, who will prepare and approve the issuance of a purchase requisition that is sent to the purchasing department?

inventory control department

an auditor may send a separate confirmation letter to a financial institution to verify additional details about loan agreements like

lines of credit, contingent liabilities, compensating balance arrangements, letters of credit, or futures contracts

evaluating whether debt provisions have been met satisfies which audit assertion?

presentation

reviewing notes payable paid or renewed after the balance sheet date satisfies which audit assertion?

presentation

when payments are made early to vendors in order to receive percentage deductions from invoices, the auditors should assert that

procedures are followed to assure that deductions from invoices are made in accordance with the agreement

authority to issue debt generally lies with

the board of directors

what are the principle working papers for auditing AP?

a lead sheet for AP, trial balances for the various types of AP balances at the balance sheet date, and confirmation requests for AP

how do auditors verify appropriations of retained earnings?

ascertain that the dates and amounts correspond with the actions of the board

when confirming AP, auditors will send a __ ___ to make the audit procedure more effective at addressing completeness

blank form

the auditors may test purchase discounts by

computing the ratio of cash discounts earned to total purchases during the period and comparing this from period to period. a decrease might indicate change in terms, failure to take discounts, or fraudulent manipulation.

a trustee confirmation should verify

exact description of the bonds, including maturity dates and interest rates; bonds retired, purchased for the treasury, or converted to stock during the year, bonds outstanding as of the balance sheet date, and sinking fund balances and transactions

one of the most effective ways to determine the overall reasonableness of interest-bearing debt is to

examine the relationship between recorded interest expense and the average principal amount of debt outstanding during the year

if the client has not complied with indenture maintenance agreements (sinking fund) the auditors should

inform both the client and the client's legal counsel

balances in the capital stock accounts change when a corporation

issues or repurchases

to determine if bonds were properly authorized, the auditors should

listen to the minutes of the board meeting concerning the issuance of debt

to verify customer deposits, auditors should

obtain a listing of the individual deposits and a comparison of the total with the GL control account

why are the audit procedures for detecting understated liabilities differ from those used to detect overstated assets?

overstating assets usually involves creating fictitious entries, while understating liabilities involves failing to make an entry which is harder to detect

the verification of trade accounts payable is most effective when

performed immediately after the balance sheet date

sending confirmations letters to financial institutions to obtain additional information about financing arrangements (details) satisfies which audit assertion

presentation

what is a business risk that auditors and management should be concerned with related to debt?

risk of noncompliance with debt covenants

notes payables to banks, trade creditors, and officers, directors, stockholders, and affiliates should be listed _____

separately

why should an auditor evaluate the budgets for cash disbursements and review follow up variances from budgeted amounts?

serve a test of controls that provide auditors with sufficient evidence to assess control risk for certain financial statement assertions about AP as being less than the maximum

effective internal control over debt begins with

the authorization to incur the debt

a notes payable analysis shows

the beginning balance of each individual note, additional notes issued and payments on notes during the year, and ending balance of each note

invoice verification and approval should be separate from?

the function of cash disbursement

which two documents should be filed with the purchase requisition?

the purchase order and copy of receiving report

the presentation of capital stock in the balance sheet should include

the title of each issue, par or stated value, dividend rate, dividend preference, conversion and call provisions, number of shares authorized and in treasury, dividends in arrears, and shares reserved for stock options or for conversions

when no change in the liability account has occurred in the period under audit, the only major procedure is to

confirmation with the creditor

what are the basic auditing steps for accrued liabilities?

1. examine any contracts or other documents on hand that provide the basis for the accrual 2. appraise the accuracy of the detailed accounting records maintained for this category of liability 3. identify and evaluate the reasonableness of assumptions made that underlie the computation of liability 4. test the computations made by the client 5. determine that accrued liabilities have been treated consistently from beginning of period to end 6. consider the need for accrual of other accrued liabilities not presently considered 7. for significant estimates, perform a retrospective analysis of the prior years estimates for evidence of management bias

the three principal elements of strong internal control over capital stock and dividends is

1. proper authorization of transactions by the board and corporate officers 2. the segregation of duties handling the transactions (independent agents) 3. maintenance of adequate records

intent and ability to refinance are demonstrated by the client by either

1. refinancing the obligation on a long term basis before the issuance of the financial statements 2. entering into a financing agreement by that date, which clearly permits such refinancing

stockholders ledger

A record showing the number of shares owned by each stockholder. This is the basic record used for preparing dividend payments and other communications with shareholders.

direct registration system

A system that allows electronic direct registration of securities in an investor's name on the books of the transfer agent or the company itself ("the issuer"), and allows shares to be transferred between a transfer agent and a stockbroker electronically.

stock registar

An institution charged with responsibility for avoiding overissuance of a corporation's stock. Every new certificate must be presented to the registrar for examination and registration before it is issued to a stockholder.

stock transfer agents

An institution responsible for maintaining detailed records of shareholders and handling transfers of stock owners

remittance advice

An optional attachment to a check that tells the business the reason for the payment.

debenture bonds

An unsecured bond, dependent upon the general credit of the issuer.

subsequent period

The time extending from the balance sheet date to the date of the auditors' report.

sinking fund

Cash or other assets set aside for the retirement of a debt.

Which of the following is the best audit procedure for determining the existence of unrecorded liabilities? Multiple Choice Examine confirmation requests returned by creditors whose accounts appear on a subsidiary trial balance of accounts payable. Examine unusual relationships between monthly accounts payable balances and recorded purchases. Examine a sample of invoices a few days prior to and subsequent to year-end to ascertain whether they have been properly recorded. Examine selected cash disbursements in the period subsequent to year-end.

Examine selected cash disbursements in the period subsequent to year-end.

n performing a test of controls, the auditors vouch a sample of entries in the purchases journal to the supporting documents. Which assertion would this test of controls most likely test? Multiple Choice Completeness. Existence. Valuation. Rights.

Existence.

the stock certificate book is ____ in itself an adequate record of capital stock outstanding

NOT

treasury stock

Shares of its own stock acquired by a corporation for the purpose of being reissued at a later date.

trust indenture

The formal agreement between bondholders and the issuer as to the terms of the debt.

what is the most effective means of disclosing unrecorded AP?

a comparison of cash payments occurring after the BS date with the AP trial balance

unamortized bond premium is ____ to the face value of bonds or debentures in the liability section of the balance sheet and unamortized bond discount should ____

added; subtracted

in examining a canceled note, the auditors should

also trace the disposition of any collateral used to secure the notes

the declaration of a dividend must specify

amount per share, date of record, and date of payment

owner's equity for corporate clients consists of

capital stock accounts (preferred and common) and retained earnings

the proceeds received from stock issues should be traced to

cash records and bank statements

trustee

charged with the protection of creditors' interests and with monitoring the issuing company's compliance with the provisions of the indenture

audit procedures should have as a primary objective the determination of completeness for which reason?

companies often delay the recording of December's operating expenses until January to overstate net income

the search for unrecorded liabilities satisfies which audit objective?

completeness and cutoff

a comparison of cancelled notes payable with debit entries in the Notes Payable account provides further assurance that notes indicated as paid during the year have in fact been _____

retired

to verify accrued vacation pay, auditors should

review a permanent file copy of the employment contract or agreement stipulating vacation terms. the computation of the accrual should then be verified both as arithmetical accuracy and for agreement with the terms of the company's vacation policy

if a paid note is unavailable for inspection, the auditor should

review the request for a check or other vouchers supporting the disbursement and should discuss the transaction with an appropriate official

when a corporation acts as its own transfer agent and issues paper stock certificates, the auditors should adopt procedures to obtain evidence that is not available by direct confirmation with outside parties like

1. accounting for stock certificate numbers 2. examining cancelled certificates 3. reconciling the stockholder's ledger and stock certificate book with the general ledger

stock certificate books

A book of serially numbered certificates with attached stubs. Each stub shows the corresponding certificate number and provides space for entering the number of shares represented by the certificate, the name of the shareholder, and the serial number of the certificate surrendered in exchange for the new one. Surrendered certificates are canceled and replaced in the certificate book.

voucher register

A journal used in a voucher system to record liabilities requiring cash payment in the near future. Every liability recorded in a voucher register corresponds to a voucher authorizing future payment.

financing cycle

the acquisition and repayment of capital

why should the auditor review unmatched invoices or unmatched receiving reports when searching for unrecorded liabilities

they should review them at the balance sheet date to ascertain that the client has recorded an AP where appropriate

what purpose does a note payable analysis serve?

1. the payment or other disposition of notes listed as outstanding in the previous years audit can be verified 2. the propriety of individual debits and credits can be established 3. the amount of year-end balance of the account is proved through step by step examination of all changes in the account during the year

A client erroneously recorded a large purchase twice. Which of the following internal control measures would be most likely to detect this error in a timely and efficient manner? Multiple Choice Footing the purchases journal. Reconciling vendors' monthly statements with subsidiary payable ledger accounts. Tracing totals from the purchases journal to the ledger accounts. Sending written quarterly confirmation to all vendors.

Reconciling vendors' monthly statements with subsidiary payable ledger accounts.

verification of sales tax payable includes

a review of client's tax returns, reasonableness is tested by a computation applying the tax rate to total taxable sales, examine sales invoices to ensure that customers are being charged the correct amount of tax.

when looking at a bond indenture, the auditor should pay attention to

amount of bonds authorized, interest rates and dates, maturity dates, descriptions of collateral pledged, provisions for retirement or conversion, duties and responsibilities of the trustee, and any restrictions imposed on the borrowing company.

only relatively large companies issue ____, smaller companies obtain funding through ____ or ____

bonds; mortgages; loans

what should the purchasing department do upon receiving the purchase requisition?

determine that the items should be ordered, and select the appropriate vendor, quality, and price. then issue a PO

why should the auditor review vouchers payable entered in the voucher register subsequent to the BS date when searching for unrecorded liabilities

may uncover an item that should have been recorded as of the BS date

why should the auditor review invoices received by the client after the BS date when searching for unrecorded liabilities?

not all vendors send invoices promptly when goods are shipped or services are rendered, the auditors review of this in the subsequent period may disclose unrecorded AP as of the BS date

unless management selects the fair value option, debt is valued at

outstanding face value plus or minus any unamortized premium or discount

what is the purpose of obtaining a trial balance of AP as of the balance sheet date and reconciling with the general ledger?

to determine that the liability figure appearing on the balance sheet is in agreement with individual items comprising the detailed records and provide a starting point for substantive procedures

verification of amounts held from employee pay includes

tracing amounts withheld to the payroll summary sheets, testing computations of taxes withheld and accrued, determining that taxes have been deposited or paid in accordance with federal and state laws and regulations, reviewing quarterly tax returns

In a small corporation that does not use a dividend-paying agent, which person or persons is responsible for the payment of dividends?

treasurer or secretary

the validity of the amount in the general ledger control account for AP may be established by tracing postings to the

voucher register and cash disbursements journal

other items that classify as current liabilities include

amounts withheld from employee pay, sales tax payable, unclaimed wages, customer's deposits, accrued liabilities

analysis of capital stock accounts includes

an appraisal of the nature of all changes and the vouching of these changes to the supporting documents and records

in what ways should auditors obtain evidence that transactions in debt were valid?

auditors vouch the cash recorded as received from the issuance of notes, bonds, or mortgages to the validated copy of the bank deposit slip and to the bank statement

why does a long term debt audit plan not include a distinction between tests of controls and substantive procedures?

because individual transactions will generally be examined for all large debt agreements

in the review of treasury stock transactions, the auditors should refer to permanent file copies of the minutes to determine that

1. the acquisition or re issuance of treasury stock was authorized by directors 2. the price paid or received was in accordance with prices specified by the board

what are the two major steps for audit work on retained earnings and dividends?

1. the analysis of retained earnings and any appropriations of retained earnings 2. the review of dividend procedures for both cash and stock dividends

a copy of a loan agreement or a bond issue should be maintained in the auditor's ___ ___

permanent file

why should the accounts payable department reconcile the vendor's invoice to the receiving report and PO?

prevents the payments of charges for goods in excess of those received

what ratios might auditors use to gain overall reasonableness of AP?

purchases/AP or AP/total current liabilities

the receiving department should be independent of the ___ department

purchasing

The auditors will analyze the unclaimed wages account for the purpose of determining

1. the credits represent all unclaimed wages after each payroll distribution 2. the debits only represent authorized payments to employees, remittances to the state under unclaimed property laws, or transfers back to general cash fund through approved procedures

vendor's statement

A monthly statement prepared by a vendor (supplier) showing the beginning balance, charges during the month for goods or services, amounts collected, and ending balance. This externally created document should correspond (except for timing differences) with an account in the client's accounts payable subsidiary ledger.

Which of the following procedures is least likely to be completed before the balance sheet date? Multiple Choice Confirmation of receivables. Search for unrecorded liabilities. Observation of inventory. Review of internal accounting control over cash disbursements.

Search for unrecorded liabilities.

Accrued liabilities

Short-term obligations for services of a continuing nature that accumulate over time. Examples include interest, taxes, rent, salaries, and pensions. They generally are not evidenced by invoices or statements.

how can the auditors find support for the net proceeds of a public issue?

by referring to the underwriting contract and to the prospectus filed with the SEC

on confirmation requests for long term debts, the payees should be asked to verify

dates of origin, due dates, unpaid balances of notes, interest rates, dates to which interest has been paid, and collateral for the notes

the auditors may also substantiate the existence and amount of a mortgage through

direct confirmation with the mortgagee

examining bylaws, articles of incorporation, and minutes relating to capital stock satisfies which audit assertions?

existence, occurrence, and completeness

when searching for unrecorded liabilities, the auditors will examine transactions that were recorded

following year end

why is a confirmation for AP less necessary than a confirmation for AR?

for AP, auditors will find in the client's possession, externally created documents to substantiate AP, there is less external documentation with AR.

the information required by auditors for each issue of capital stock includes

number of shares authorized and issued, the par or stated value, dividend rates, call and conversion provisions, stock splits and stock options