Chapter 4 Study Guide
Suspendus Company has the following financial data for the year ended December 31, 2021: net sales $1,680,000, operating expenses $880,000, net income $104,000, stockholders' equity $800,000, and assets $1,901,000. The information for the year ended December 31, 2020 was: net sales $1,450,000, operating expenses $760,000, net income $87,000, stockholders' equity $700,000, and assets $1,601,000. Calculate the return on assets for the year ended December 31, 2021.
$104,000 / ((1,901,000 + 1,601,000)/2) = 5.9%
As of December 31, 2020, CleteCorp has the following selected financial data: net sales $1,450,000, net income $200,000, current assets $600,000, total assets $3,000,000, non-current liabilities $1,500,000, total liabilities $2,000,000. Calculate the current ratio.
1.2
Which of the following is the best synthesis of the term direct and material effect?
A situation in which noncompliance with laws and regulations impacts amounts and disclosures already included in the financial statements
Which standards provide audit guidance associated with related party transactions and disclosures?
AU-C 550 and AS 2410
As an auditor for a company, you discover that the brother of the CFO has received an interest-free loan from the company. What are the potential risks to the company involved with granting this loan to a related party?
All of the answer choices
During your audit of Furniture Factory, Inc. for the year ended December 31, 2020, you discover that Furniture Factory incorrectly booked a January 1, 2021 credit sale in December 2020. Which financial statements may be misstated as a result of this error? Select all that apply.
Balance sheet as of December 31, 2020 Income statement for the 12 months ended December 31, 2021 Income statement for the 12 months ended December 31, 2020
CleteCorp has an inventory turnover in days of 62 in 2018 as compared to 60 in 2017 and an industry average of 55. What does this indicate about CleteCorp?
CleteCorp is doing a worse job of selling their inventory than both the prior year and the industry average.
CleteCorp has a gross profit margin of 50% in 2018 as compared to 52% in 2017 and an industry average of 48%. What does this indicate about CleteCorp?
CleteCorp's gross profitability has declined, however, CleteCorp's gross profitability is still better than the industry average.
A client of yours is testing a new software program, designed by its own staff. Which of the following is NOT a risk involved with testing this new software program?
Client staff are adequately trained to use the new system effectively.
You are hired to audit a private company that does not have an audit committee and does not even have a board of directors. In this situation, what is your best course of action?
Communicate with those charged with governance, including those individuals with the responsibility for overseeing the strategic direction of the entity and the obligations related to the accountability of the entity, including the financial reporting process.
Which of the following statements is correct regarding related party transaction
Companies can have transactions with related parties frequently in the normal course of business, but because they are related parties, there is a risk that some of the transactions may not be accounted for according to their true substance.
Auditors can assess the adequacy of their client's closing procedures in a number of ways. Which is one of the best ways that an auditor can assess that a company's closing procedures were done correctly?
Conduct a comparison to make sure the company's annual revenue and earnings were in line with prior-year or quarterly or monthly periods.
In comparing a company's account balances, which of the following is the auditor generally NOT concerned with?
Current year versus the next year
In which industry is a company more likely to place a high value to inventory turnover as one of its key performance indicators?
Dairy product makers
During the audit of JPG Enterprises, you discover that the industry has low risk of technological obsolescence. Which factor that influences inherent risk does this primarily relate to?
Demand
As an auditor, you review the contract terms of your client and you notice several of your client's clients have been rewarded with a markdown to their pricing. This could affect your client's bargaining power with its customers, which may put profit margins at risk. Which one of the major entity factors that influence inherent risks would this fall under?
Discounts
When are procedures used by auditors to identify related parties?
During the risk assessment phase and throughout the audit
What is the difference between earnings per share (EPS) and cash earnings per share (CEPS)?
Earnings per share reflects the earnings return on each common share issued, whereas cash earnings per share shows the cash flow capacity of a company for each common share issued.
Which of the following is the least likely to result in a higher inherent risk assessment?
Entity sells high-quality products and has a low rate of return.
Deb Fielder is the CEO for Datamart, Inc., a public company. What is her position with regard to the board of directors?
Executive director
Immediate family members of the principal owner of an entity are excluded from the list of related parties of the company.
FALSE
Auditors may or may not determine the risk associated with the client's closing procedures.
False
During a routine audit of the fast-food chain Waffles-N-Syrup, an auditor notices that some of the expenses were incorrectly filed as payroll accounts instead of expense accounts, and as a result payroll taxes were taken out of them and checks were generated. Which type of act has the company committed?
Illegal act, material direct effect
Which of the following describes why an auditor should consider a client's discounting policies as an inherent risk factor?
Inappropriate discounting policies may put profit margin at risk.
If auditors believe their client is under pressure to smooth its income and not report any unexpected increases, which of the following risks are likely with regard to current income? Select all that apply.
Inclusion of expenses incurred after year-end Exclusion of revenues earned just before year-end
If auditors believe the client is under pressure to report strong results, which of the following risks exist with regard to the current year's income? Select all that apply.
Inclusion of revenues earned after year-end Exclusion of expenses incurred before year-end
During your audit of The Chocolate Factory, Inc. for the year ended December 31, 2020, you discover that The Chocolate Factory, Inc. incorrectly booked a January 1, 2021 credit sale in December 2020. Which financial statements may be misstated as a result of this error? Select all that apply
Income statement for the 12 months ended December 31, 2020 Income statement for the 12 months ended December 31, 2021 Balance sheet as of December 31, 2020
Mountain Matcha, a maker of beverages, has taken on more debt this year for capital investments as the company expands and opens new stores. As an auditor, you are concerned with the amount of pressure this has placed on senior management. Which of the following is a valid reason for why you might be concerned?
Inherent risk and potential fraud
An auditor has compiled the following Trend Analysis chart for a company, based on income statement data through 2018. Which aspect of this chart would you highlight for the company's management for further investigation? Income Statement Items`
Interest expense increase from 2015 to 2018
Which of the following statements regarding performance measurement is correct?
It is inappropriate to assume a client will use the same KPIs every year
Which of the following statements is correct regarding related party transactions?
Life insurance policies purchased by the client company are related party transactions that should be monitored.
During the audit of CleteCorp, auditors determine that the P/E (price-to-earnings) and EPS (earnings-per-share) ratios are in decline. What is the auditor's most likely concern in relation to the decline of those ratios?
Management is under pressure to manipulate earnings.
During the audit of CleteCorp, auditors determine that the PE and EPS ratios are in decline. What is the auditor's most likely concern in relation to the decline of those ratios?
Management is under pressure to manipulate earnings.
Which of the following equals price-to-earnings (P/E) ratio?
Market price per share divided by earnings per share
Which of the following descriptions best captures the term "profit margin"?
Measures the profitability of a company after accounting for all operating expenses
Which of the following risk factors would NOT lead the client to get a high (negative) inherent risk assessment as a result of its selection and application of accounting principles?
No change in the application of an accounting standard
Marcus Struthers is on the board of directors for Camp, Inc., however, Marcus is not part of the management team for Camp, Inc. Marcus would be considered which of the following?
Non-executive director
Marcus Struthers is on the board of directors for Camp, Inc.; however, Marcus is not part of the management team for Camp, Inc. Marcus would be considered which of the following?
Non-executive director
A major stockholder paying back a loan at period end, and the company lending the same amount of money back to the stockholder shortly after the quarter ends, is an example of which of the following?
Period-end window dressing
You are auditing the financial statements of POKOGO Enterprises. In addition to the annual financial statements, POKOGO prepares monthly financial statements for internal purposes. You have decided to check these statements to assess the accuracy of their closing procedures. What should you do if there are significant issues, where closing procedures are inadequate, and transactions are not always recorded in the appropriate reporting period?
Plan to spend more time conducting detailed testing of transactions and balances around year-end
You are auditing the financial statements of Pokogo Enterprises. In addition to the annual financial statements, Pokogo prepares monthly financial statements for internal purposes. You have decided to check these statements to assess the accuracy of their closing procedures. What should you do if there are significant issues, where closing procedures are inadequate and transactions are not always recorded in the appropriate reporting period?
Plan to spend more time conducting detailed testing of transactions and balances around year-end.
What is the formula for earnings per share?
Profits divided by weighted average common stock shares issued
Which of the following are procedures used by auditors to identify related parties? Select all that apply.
Read contracts or other agreements related to significant unusual transactions. Obtain a listing of related parties from management. Review the listing of trustees of pension plans and other trusts for the benefit of employees.
Which of the following statements is false regarding related parties?
Related party transactions do not have to be disclosed if they are conducted at "arm's length."
A client of yours has a poor reputation relative to the rest of the industry, as you have observed by studying news articles and industry analyst reports. This may lead to customers and suppliers shifting their business to a competing firm, threatening the client's profits. In such circumstances, a client's management may resort to aggressive accounting choices to improve profits (or reduce losses). Which of the major industry and business environment factors that influence inherent risks would this fall under?
Reputation
You are an auditor and you discover during a conversation with a key employee that a significant volume of transactions is with a vendor owned by the spouse of a member of the management team. Which of the following specific audit procedures would least likely be helpful?
Review life insurance policies purchased by the entity.
During which of the following phases should auditors use specific procedures to confirm related parties identified by management and identify additional related parties not identified by management?
Risk assessment and remaining phases
Analytical procedures are utilized during which phases of an audit? Select all that apply.
Risk response phase At the conclusion of the audit Risk assessment phase
A large, profitable social media client has hired you to perform an audit of the company's financials. The client has briefed you on some of the firm's key performance indicators. Which of the following is likely NOT one of the social media client's KPIs?
Sales per passenger mile
Which of the following statements regarding corporate governance is correct?
Some private companies may not have an audit committee or even a board of directors.
According to FASB ASC Topic 850, Related Party Disclosures, related parties would NOT include which of the following?
Stockholders of the entity and their immediate family members
During the audit of Marcella Stores, the auditors determine that internal controls over inventory security are weak. What should the auditors do?
The auditors should rely less on internal controls and adopt a substantive approach.
During the audit of Marci Stores, the auditors determine that internal controls over inventory security are weak. What should the auditors do?
The auditors should rely less on internal controls and adopt a substantive approach.
Which of the following statements is correct regarding the board of directors?
The board of directors represents the shareholders and is responsible for ensuring the company is being run to benefit the shareholders.
Why is it important that the board of directors have a mixture of executive and non-executive members?
The executive members have a deeper understanding of the company and its workings, whereas the non-executive members may be better representatives of shareholders and can be more impartial in their strategic decision-making.
Which of the following are risks when a client installs a new IT system? Select all that apply
The system may not be appropriate for the client and its reporting requirements. The client staff may not be adequately trained to use the new system effectively.
Suspendus Company has the following financial data for the year ended December 31, 2021: net sales $1,680,000, operating expenses $880,000, net income $104,000, stockholders' equity $800,000, and assets $1,901,000. The information for the year ended December 31, 2020 was: net sales $1,450,000, operating expenses $760,000, net income $87,000, stockholders' equity $700,000, and assets $1,601,000. Calculate the gross profit margin for the year ended December 31, 2021.
There is not enough information to answer the question.
You are auditing the financial statements of ChemCom Enterprises. You are concerned that management may override controls when preparing adjusting and allocating entries, due to the immense pressure to meet earnings targets. Who has responsibility for oversight of this process?
Those charged with governance
It is important that a client has appropriate procedures for which of the following regarding installation of a new IT system? Select all that apply.
Training staff in using the new system Changing from an existing system to a new system Selecting new IT systems
During a recent economic downturn, when the economy as a whole is poor and the entire industry is down, you as an auditor are concerned that the management may face pressures, prompting them to "take a bath" to make the company appear less profitable than it actually is. What measures should you look at first
Understating revenue and overstating expenses
Which of the following statements is NOT correct regarding installation of a new IT system?
When a client installs a new IT system there are very few risks.
Which of the following statements is INCORRECT regarding information technology?
When a client's staff develops a program, the program is less likely to have the features required, but there is no risk of errors if the program is written by experienced staff.
William Boatright, CPA, is performing an audit of Sweet Treats Company. Which of the following statements is correct regarding IT?
William is required to gain an understanding of Sweet Treats' IT system, the associated risks, and related controls, regardless of whether Sweet Treats is a public or private company.
If transactions between the client and a known business partner of a key manager are arranged, could it act as a fraud risk factor?
Yes, it could for the purpose of misappropriating assets.
According to FASB ASC Topic 850, related parties of a company include which of the following?
all answer choices are correct
During which of the phases of the auditing process would auditors be interested in identifying related parties?
all of the answer choices
Information technology is typically included in which of the following processes?
all of the answer choices
Which of the following is a risk associated with the installation of a new IT system?
all of the answer choices
Unauthorized access to data can occur when
all of the answer choices are correct
Which of the following are ways to limit access to technology?
all the answer choices
Client closing procedures:
are the responsibility of those charged with governance who must ensure that transactions are recorded in the correct accounting period.
Companies use profitability measures to assess performance and to:
assess their ability to compete.
When gaining an understanding of the client at the industry level, the auditor will:
consider the level of demand for the goods provided by companies in the industry.
When gaining an understanding of the client's sources of financing, the auditor:
determines if the client is meeting principal and interest payments when they are due.
Risks associated with Information Technology include all of the following EXCEPT
disclosure risk
Deb Fielder is the CFO for Datamart, Inc., a public company. What would Deb's position be in regard to the board of directors?
executive director
Risks of material misstatement that are associated with a client's IT system include all of the following except:
failure to accrue for a contingent liability.
Programs may need to be changed due to all of the following EXCEPT
higher audit fees
Which of the following refers to the use of computers to process, record, and store financial reporting data and other information?
information technologly
One of the major suppliers of your client is having trouble with faulty products, which have to be routinely returned because they are defective. As an auditor, this is a concern. Which one of the thirteen major entity factors that influence inherent risks would this fall under?
major suppliers
In a conversation with a client, Marcie, a member of the audit team, discovers that the marketing agency used by the client is owned by the spouse of the VP of Operations. Recognizing this as a related party relationship, Marcie and the audit team must exercise professional skepticism and identify all of the following risks, EXCEPT
material risk
Marcie, a member of the audit team, discovers during a conversation with a client that the marketing agency used by the client is owned by the spouse of the VP of Operations. Recognizing this as a related party relationship, Marcie and the audit team must exercise professional skepticism and identify all of the following risks EXCEPT
material risk
An audit committee of a publicly traded company should be composed of:
members of the board of directors who are independent directors.
Analytical procedures:
must take into account seasonal variation in the client's business.
Assume you are on the audit team for a medical care product manufacturer whose product is suspected of creating additional health problems for its users and the company is experiencing public relations issues, product returns, and lawsuits as a result. All of the following are accounts and notes disclosures that your team should review carefully, EXCEPT
purchase discounts.
Auditors perform all of the following actions to identify related parties EXCEPT
read industry publications.
Reviewing conflict-of-interest statements from management is one of the ways in which auditors identify
related parties.
When gaining an understanding of the client, the auditor will consider:
related party identification. the appropriateness of the client's system of internal controls to mitigate identified business risks. controls over the technology used to process and store data electronically.
All of the following are examples of common procedures used by auditors to identify related parties EXCEPT
review life insurance policies purchased by the company's employees.
When transferring information from an existing system to a new system, there are
risks of data being corrupted or lost.
Common uses of analytical procedures include all of the following except:
test of internal controls.
You are auditing the financial statements of ChemCom Enterprises, a privately held distributor of silicones. You are concerned that management may override controls when preparing adjusting and allocating entries, due to the immense pressure to meet earnings targets. Who has responsibility to assess the internal controls over this process
the auditor
When gaining an understanding of the client, the auditor will identify the geographic location of the client because:
the auditor may plan to use staff from affiliated offices to visit overseas locations.
Risks associated with IT in regard to errors in applications and programming include all of the following EXCEPT when
the auditor unintentionally makes an accounting mistake when entering the data on a spreadsheet.
A client sells laptops that have experienced returns for faulty screen controls. When evaluating inherent risk, all of the following are inherent risks to consider, EXCEPT
the client's decision to repair the laptops vs. replacing them.
An "arm's length transaction" is a transaction that has
the same terms as a transaction between independent and unrelated parties.
All of the following are risks inherent in new software applications EXCEPT
timely processing of application changes.
Obtaining a listing of the trustees of pension plans and other trusts for the benefit of employees is one of the ways in which auditors identify related parties.
true
During the audit of JPG Enterprises, you discover that there is a history of poor product quality and goods being returned for the same problem. Which factor that influences inherent risk does this primarily relate to?
warranties