Chapter 16
January 16, 20X4: As a result of reduced sales, production was curtailed in mid-January and some workers were laid off.
No Disclosure
On January 28, 20X4, a famous analyst who followed the industry provided a negative report on his expectations concerning the short and intermediate term for the industry.
No Disclosure
Which of the following events occurring on January 5, 20X2, is most likely to result in an adjusting entry to the 20X1 financial statements?
Settlement of litigation.
Which of the following is most likely to be considered a Type 1 subsequent event?
Customer checks deposited prior to year-end, but determined to be uncollectible after year-end.
A possible loss, stemming from past events, that will be resolved as to existence and amount by some future event.
Loss contingency
An approach to making materiality judgments that quantifies the total likely misstatement as of the current year-end based on the effects of reflecting misstatements(including projecting misstatements where appropriate) only during the current year.
Rollover approach
On January 3, 20X4, Flowmeter, Inc., received a shipment of raw materials from Canada.The materials had been ordered in October 20X3 and shipped FOB shipping point in December 20X3.
Adjustment
As a result of analytical procedures, the independent auditors determine that the gross profit percentage has declined from 30 percent in the preceding year to 20 percent in the current year. The auditors should:
Consider the possibility of a misstatement in the financial statements.
A possible liability, stemming from past events, that will be resolved as to existence and amount by some future event.
Contingent liability
On January 25, 20X4, the company agreed to purchase for cash the outstanding stock of Porter Electrical Co. The business combination is likely to double the sales volume of Flowmeter, Inc.
Disclosure
A possible loss, stemming from past events that will be resolved as to existence and amount by some future event, is referred to as a(n):
Loss contingency.
Which of the following is the best way for the auditors to determine that every name on a company's payroll is that of a bona fide employee presently on the job?
Make a surprise observation of the company's regular distribution of paychecks on a test basis.
On February 5, 20X4, Flowmeter, Inc., issued to an underwriting syndicate $2 million in convertible bonds.
Disclosure
In evaluating whether there is a sufficiently low probability of material misstatement in the financial statements, the auditors accumulate:
Known, projected, and other estimated misstatements in the financial statements.
Which of the following statements ordinarily is not included among the written client representations made by the chief executive officer and the chief financial officer?
"Sufficient audit evidence has been made available to the auditor to permit the issuance of an unqualified opinion."
Management estimates the company's allowance for doubtful accounts as $200,000, and the auditors develop an estimate that suggests that the amount should be between $230,000 and $250,000. The known misstatement in this situation is:
$0
January 7, 20X4: The mineral content of a shipment of ore en route to Hollis Mfg. Corporation on December 31, 20X3, was determined to be 72 percent. The shipment was recorded at year-end at an estimated content of 50 percent by a debit to Raw Materials Inventory and a credit to Accounts Payable in the amount of $82,400. The final liability to the vendor is based on the actual mineral content of the shipment.
Adjustment
On January 15, 20X4, the company settled and paid a personal injury claim of a former employee as the result of an accident that had occurred in March 20X3. The company had not previously recorded a liability for the claim.
Adjustment
On January 18, 20X4, a major customer filed for bankruptcy. The customer's financial condition had been degenerating over recent years.
Adjustment
When auditing the statement of cash flows, which of the following would an auditor not expect to be a source of receipts and payments?
Capitalization.
A contractual obligation to carry out a transaction at specified terms in the future. Material commitments should be disclosed in the financial statements.
Commitment
Which of the following is not a procedure that is designed to provide evidence about the existence of loss contingencies?
Confirming accounts payable.
The search for unrecorded liabilities for a public company includes procedures usually performed through the:
Date of the auditors' report.
Subsequent to the issuance of the auditor's report, the auditor became aware of facts existing at the report date that would have affected the report had the auditor then been aware of such facts. After determining that the information is reliable, the auditor should next:
Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information.
Which of the following procedures would an auditor most likely perform while evaluating audit findings at the conclusion of an audit?
Develop an estimate of the total likely misstatement in the financial statements.
January 15, 20X4: Following a series of personal disagreements between Ray Hollis, the president, and his brother-in-law, the treasurer, the latter resigned, effective immediately, under an agreement whereby the corporation would purchase his 10 percent stock ownership at book value as of December 31, 20X3. Payment is to be made in two equal amounts in cash on April 1 and October 1, 20X4. In December, the treasurer had obtained a divorce from his wife, who is Ray Hollis's sister.
Disclosure
On February 1, 20X4, a plant owned by Flowmeter, Inc., was damaged by a flood, resulting in an uninsured loss of inventory.
Disclosure
An example of an internal control weakness is to assign the personnel department responsibility for:
Distribution of paychecks.
An auditor accepted an engagement to audit the 20X8 financial statements of EFG Corporation and began the fieldwork on September 30, 20X8. EFG gave the auditor the 20X8 financial statements on January 17, 20X9. The auditor completed the audit on February 10, 20X9, and delivered the report on February 16, 20X9. The client's representation letter normally would be dated:
February 10, 20X9.
An element of the business environment that involves some risk of a future loss. Examples include the risk of accident, strike, price fluctuations, or natural catastrophe. General risk contingencies should not be disclosed in financial statements.
General risk contingency
An approach to making materiality judgments that quantifies the total likely misstatement as of the current year-end based on the effects of reflecting all misstatements (including projecting misstatements where appropriate) existing in the balance sheet at the end of the current year, irrespective of whether the misstatements occurred in the current year or previous years.
Iron curtain approach
The aggregated misstatement in the financial statements is made up of:
Known Misstatements - Yes Projected Misstatements - Yes Other Misstatements - Yes
Specific misstatements identified by the auditors during the course of the audit.
Known misstatements
Misstatements identified by the auditors during the course of the audit that are due to either extrapolation from audit evidence or differences in accounting estimates.
Likely misstatements
Which of the following procedures is most likely to be included in the final review stage of an audit?
Perform analytical procedures.
A refusal by a lawyer to furnish information related to litigation included in the letter of inquiry is likely to result in:
Qualification of the audit report.
Which of the following is least likely to be considered a substantive procedure relating to payroll?
Test whether employee time reports are approved by supervisors.
Shortly after year-end Zero Corporation was informed of the bankruptcy of Bingo. Zero Corporation showed a receivable of $10,000 due from Bingo as of year-end—none of which seems recoverable. The receivable had been questionable for some time as Bingo had been experiencing financial difficulties for the past several years. Yet, Bingo's bankruptcy did not occur until after Zero Corporation's year-end. Under these circumstances:
The Financial statements should be adjusted - Yes The event requires financial statement disclosure, but no adjustment - NO The auditor's report should be modified for lack of consistency - NO
Which of the following is not correct relating to representation letters?
They often serve as a substitute for the application of other procedures.
Auditors should perform audit procedures relating to subsequent events?
Through the date of the audit report.
