CH 10 - Auditing Final
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. Ascertain the reasonableness of imputed interest. Determine the validity of prepaid interest expense. Evaluate internal control over securities.
"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.
Which of the following internal control activities would most likely justify reducing the assessment of the risks of material misstatement for long-term notes payable? The use of prenumbered purchase orders to prevent unrecorded notes. All direct borrowings on notes payable are authorized by the board of directors. Any use of assets for collateral on long-term notes payable are analyzed for criticality to operations. Proceeds from long-term notes payable are included in regular review of budgets to ensure adequacy of cash flow availability.
All direct borrowings on notes payable are authorized by the board of directors. Authorization by the board of directors is the most important control procedure for long-term notes payable.
Estimates in the finance and investment cycle include A reporting unit's fair value. Valuation of equity investments. Actuarial assumptions for pension costs. All of the choices are correct.
All of the choices are correct.
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 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. Decide whether the bond issue was made without violating state or local laws or regulations. Determine whether bondholders are persons other than owners, directors, or officers of the company issuing the bond. Calculate the effective interest rate to see whether it is substantially the same as the rates charged for similar issues.
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.
When independent stock transfer agents are not employed and the corporation issues its own stock and maintains stock records, canceled stock certificates should Be destroyed to prevent fraudulent reissuance. Not be defaced but be segregated from other stock certificates and retained in a canceled certificates file. Be defaced to prevent reissuance and attached to their corresponding stubs. Be defaced and sent to the secretary of state.
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.
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? Existence Valuation Completeness Classification
Classification
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
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, which of the following is the best method of verifying the accuracy of recorded dividend income? Comparing recorded dividends with amounts appearing on federal information Form 1099. Tracing recorded dividend income to cash receipts records and validated deposit slips. Comparing recorded dividends with a standard financial reporting service's record of dividends. Performing analytical procedures and statistical sampling.
Comparing recorded dividends with a standard financial reporting service's record of dividends. Explanation: Independent evidence from an outside dividend reporting service is the best evidence for existence, completeness, and valuation.
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.
A related party is a person or entity that: a. has a family tie to a management member b. does business with the company c. can exert significant influence over or be influenced by the company d. is a member of the company's management team or board of directors
Definition of related party: A related party is one that can exert significant influence over another party. A relationship between two businesses that have a personal or other association that might destroy the self-interest of one of the parties to an extent that one of them might be prevented from fully pursuing its own separate interests.
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.
Electronically accessing the details of dividend records on the Internet.
Controls over making estimates include all of the following except Management communication of the need for proper accounting estimates. Comparison of prior estimates with subsequent results. Consideration of whether estimates are consistent with the company's operational plans. Ensuring the effects of the estimate are in line with analysts forecasts.
Ensuring the effects of the estimate are in line with analysts forecasts. Although clients may manage estimates to obtain results in line with analyst forecasts, controls should be in place to minimize this risk.
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.
Examine the contracts for possible risk exposure and the need to recognize losses.
Inspecting marketable securities provides primary evidence about the ASB balance assertion of Existence. Rights and obligations. Valuation. All of the choices are correct.
Existence Inspecting a security provides the best evidence that the security is real and on hand in cases where the client holds the security.
Goodwill impairment refers to Loss of trust from customers. The amount of amortization. A decline in value of recorded goodwill. A need for increased professional skepticism.
Goodwill impairment :A decline in value of recorded goodwill.
Hedging refers to Calculating goodwill impairment. Using derivatives for market speculation. Using derivatives to protect companies from market uncertainties. Management not giving direct answers in their representations.
Hedging : Using derivatives to protect companies from market uncertainties.
A clause in a loan agreement that is intended to keep the borrower's financial position at the same level it was when the loan was made is called a Guarantee. Indenture. Collateral. Loan covenant.
Loan covenant Loan covenants can relate to required ratios, dividend restrictions, or a prohibition on liquidating certain assets.
An audit plan for the examination of the retained earnings account should include a step that requires verification of the (Click the check box next the two answers that apply.) Check All That Apply Market value used to charge retained earnings to account for a 2-for-1 stock split. Approval of the adjustment to the beginning balance as a result of a write-down of account receivables. Authorization for both cash and stock dividends declared and paid. Gain or loss resulting from disposition of treasury shares.
Market value used to charge retained earnings to account for a 2-for-1 stock split. Authorization for both cash and stock dividends declared and paid. Stock splits have no effect on retained earnings.This would not go to beginning balance of retained earnings.These should be authorized by the board of directors.Gain or loss on treasury stock transactions should be audited.
Which of the following is not a substantive audit procedure for estimates of management? Recalculating the mathematical estimate Observing whether estimates are prepared by qualified personnel Developing an independent estimate based on alternative assumptions Comparing the estimates of management to subsequently discovered facts before the end of fieldwork
Observing whether estimates are prepared by qualified personnel This statement is not a substantive audit procedure for estimates of management.
An audit team would most likely verify the interest earned on bond investments by Multiple Choice Testing internal controls relevant to cash receipts. Vouching the receipt and deposit of interest checks. Confirming the bond interest rate with the issuer of the bonds. Recomputing the interest earned on the basis of face amount, interest rate, and period held.
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.
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.
When the client holds a large amount of negotiable securities, auditors need to plan to guard against Substitution of authentic securities with counterfeit securities. Unauthorized negotiation of the securities before they are counted. Substitution of securities already counted for other securities that should be on hand but are not. Unrecorded sales of securities after they are counted.
Substitution of securities already counted for other securities that should be on hand but are not. Explanation: The danger is that someone might move securities so the auditor counts them twice.
An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the Completeness of recorded investment income. Classification as available-for-sale or trading securities. Valuation of trading securities. Existence of unrealized gains or losses.
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.
Sales of capital stock and large debt financing transactions are usually authorized by The transfer agent. The shareholders. The board of directors. Management.
The board of directors. A primary control in the financing cycle of board of directors' approval of all major transactions
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. The approximate market value of the investments be shown in parentheses on the face of the balance sheet. The equity section of the balance sheet separately show a charge equal to the amount of the loss. The investments be classified as long term for balance-sheet purposes with full disclosure in the footnotes.
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 Guarantees of preferred stock liquidation value. Restrictions on the payment of dividends. The number of shares subject to agreements to repurchase. The number of shares issued and outstanding.
The number of shares issued and outstanding is the record kept by the registrar/transfer agent.
If market prices are not readily available for fair value measurements, management should use Auditors' best estimates. Historical cost. Their own assumptions as long as there are no contrary data. The previous year's value
Their own assumptions as long as there are no contrary data. Management must use their own assumptions for level three fair values where there exists an unobservable price
Loan covenants are used for which of the following reasons? To protect the lender from the borrower's financial position substantially weakening. To protect the borrower from the lender's calling the loan early. To protect shareholders from management taking on too much debt. To protect the auditors from false information by the borrower.
To protect the lender from the borrower's financial position substantially weakening. This is the purpose of loan covenants. Loan Covenants - requirements of borrower such as maintaining certain financial ratios or characteristics
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.
Company bonds and stocks are normally handled by an intermediary called a Registrar Transfer agent Broker Trustee
Transfer agent A transfer agent is a third party who handles the transfer of ownership of bonds and stock.
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 Multiple Choice The trust company places the securities in a bank safe deposit vault under the custodian's exclusive control. Interest and dividend checks are mailed directly to an entity employee who is authorized to sell securities. Securities are registered in the name of the trust company rather than the entity itself. Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.
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.
Which of the following assertions is most likely to have the highest risk of material misstatement for the goodwill account? Existence Completeness Valuation Rights & Obligations
Valuation Because goodwill is not a separately identifiable asset, valuation is a level 3 fair value estimate and is generally considered a substantial risk in an audit.
All corporate capital stock transactions should ultimately be traced to the a. Minutes of the meetings of the board of directors. b. Cash receipts journal. c. Cash disbursements journal. d. Numbered stock certificates.
a.minutesofthemeetingsoftheboardofdirectors.
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.
Which of the following audit procedures would not likely be performed for audits of investments? a. Read board of directors' minutes for authorization of investment strategies. b. Confirm investments with registrar. c. Confirm investments with broker or trustee. d. Compare valuation to published market prices.
b. Confirm investments with registrar.
An audit plan to examine long-term debt most likely would include steps that require a. Comparing the carrying amount of held-to-maturity securities with their year-end market values. b. Correlating interest expense recorded for the period with outstanding debt. c. Verifying the existence of the holders of the debt by direct confirmation. d. Inspecting the accounts payable subsidiary ledger for unrecorded long-term debt.
b. Correlating interest expense recorded for the period with outstanding debt.
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? a. The certificates in the safe deposit box were forgeries. b. There had been unauthorized buying and selling of investment securities. c. The securities may be misclassified on the balance sheet. d. ABC Company no longer owns the securities.
b. There had been unauthorized buying and selling of investment securities.
In auditing for unrecorded long-term bonds payable, an audit team most likely will a. Perform analytical procedures on the bond premium and discount accounts. b. Examine documentation of assets purchased with bond proceeds for liens. c. Compare interest expense with the bond payable amount for reasonableness. d. Confirm the existence of individual bondholders at year-end.
c. Compare interest expense with the bond payable amount for reasonableness.
Which of the following audit procedures would not likely be performed for audits of shareholders' equity? a. Read board of directors' minutes for authorization of equity transactions. b. Confirm outstanding common and preferred stock with stock registrar. c. Compare valuation of stock to published market prices. d. Obtain management representation about number of shares issued and outstanding.
c. Compare valuation of stock to published market prices. While auditing for the SH equity, in order to gain understanding on the valuation, auditor is not required to compare the valuation of investments with peer company valuation (publicly traded entities)
Which of the following approaches is most suitable for auditing the finance and investment cycle? a. Perform extensive tests of controls and limit substantive procedures to analytical procedures b. Ignore internal controls and perform extensive substantive procedures c. Gain an understanding of internal controls and perform extensive substantive procedures d. Ignore internal controls and limit substantive procedures to analytical procedures
c. Gain an understanding of internal controls and perform extensive substantive procedures
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
The auditors should insist that a representative of the client be present during the inspection and count of securities to a. Lend authority to the auditors' directives. b. Detect forged securities. c. Coordinate the return of all securities to proper locations. d. Acknowledge the receipt of securities returned.
d. Acknowledge the receipt of securities returned.
Which of the following questions would auditors most likely include on an internal control questionnaire for notes payable? a. Are assets that collateralize notes payable critically needed for the entity's continuing existence? b. Are two or more authorized signatures required on checks that repay notes payable? c. Are the proceeds from notes payable used to purchase noncurrent assets? d. Are direct borrowings on notes payable authorized by the board of directors?
d. Are direct borrowings on notes payable authorized 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? a. Changes in the capital stock account are verified by an independent stock transfer agent b. Stock dividends and stock splits during the year under audit were approved by the stockholders c. Stock dividends are capitalized at par or stated value on the dividend declaration date. d. Entries in the capital stock account can be traced to resolutions in the minutes of meetings of the board of directors.
d. Entries in the capital stock account can be traced to resolutions in the minutes of meetings of the board of directors.
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 a. Request the bank to confirm to the auditors the contents of the safe deposit box at the balance-sheet date. b. Examine supporting evidence for transactions occurring during the year. c. Count the securities at a subsequent date and confirm with the bank whether securities were added or removed since the balance-sheet date. d. Request the client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date.
d. Request the client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date.
