Chapter 16 Review Questions
What are subsequent events?
"Subsequent events" are events occurring after the date of the balance sheet under audit but prior to completion of the audit and issuance of the report.
Identify three revenue accounts that are verified during the audit of balance sheet accounts; also, identify the related balance sheet accounts.
*Sales - Accounts Receivable *Interest - Notes Receivable *Rent - Property, Plant, & Equipment *Royalties - Intangible Assets
Identify three expense accounts that are verified during the audit of balance sheet accounts; also, identify the related balance sheet accounts.
*Uncollectible accounts and notes expense - Accounts & Notes receivable *Purchases, COGS and payroll - Inventories *Depreciation, Repairs and maintenance, and Depreciation & AMT - Property, plant & equipment *Commssions. fees. bonuses. product warranty expenses & others - Accrued liabilities *Amortization - Intangible Assets
Identify three items often misclassified as miscellaneous revenue.
1. Collections on previously written-off accounts or notes receivable.(These should reduce Allowance for uncollectable accounts) 2. Write-offs of old outstanding checks or unclaimed wages. (Should be credited to a liability account and funds should be submitted to the state). 3. Proceeds from sales of scrap. (Should be applied to COGS under by products). 4. Rebates or refunds of insurance premiums. 5. Proceeds from sales of plant assets.
Should the auditors make a complete review of all correspondence in the client's files? Explain.
A complete review by the auditor of all correspondence in the client's files is usually out of the question. This would consume an enormous count of time and would yield only incidental benefits. The auditor's use of the correspondence files will usually be limited to a request for letters bearing on issues arising during the examination of other records. These are generally letters to banks and other financial institutions, attorneys, and governmental agencies.
Describe a disclosure checklist. What is its purpose?
A disclosure checklist is a list of specific disclosures required by the FASB, the GASB, and the SEC. The purpose of the checklist is to assist the auditors in evaluating the adequacy of the disclosures contained in a set of financial statements.
Explain how a loss contingency exists with respect to an unasserted claim. Should unasserted claims be disclosed in the financial statements?
An unasserted claim is a potential legal claim for which no claimant has demonstrated an intent to pursue legal remedies. Often, however, it is merely a matter of time before an unasserted claim becomes pending litigation. It is not the act of litigation being filed which creates a loss contingency for the defendant. Rather, it is having performed the acts which provide the basis for that litigation. To illustrate an unasserted claim involving the likelihood of loss, assume an airliner crashes in a populated area. For a short period of time, no claimant may exhibit intent to sue. In the long run, however, litigation is inevitable. FASB ASC 450 requires disclosure of unasserted claims when it is (1) probable that a claim will be asserted and (2) reasonably possible that the outcome will be adverse. Unasserted claims not meeting these criteria need not be disclosed.
Describe how the auditors use analytical procedures in the examination of selling, general, and administrative expenses.
Analytical procedures include... Develop an expectation of the account balance Determine the amount of difference from the expectation that can be accepted without investigation compare the company's account balance with the expected account balance. Investigate significant deviations from the expected account balance.
What is the purpose of analytical procedures performed as apart of the overall review?
Analytical procedures performed as a part of the overall review assist the auditors in assessing the validity of the conclusions reached, including the opinion to be issued. The final review may identify areas that need to be examined further as well as provide a consideration of the adequacy of the data gathered in response to unusual or unexpected relationships during the audit.
When the auditors have audited the financial statements, what is their responsibility with respect to other information (not including required supplemental information) included in an annual report to shareholders?
Auditors read the other information and consider whether it is materially inconsistent with information appearing in the audited financial statements. If the other information is inconsistent, and the auditors conclude that neither the audited financial statements nor the audit report requires revision, they should request the client to revise the other information. If the client will not revise the information, the auditors should include an additional paragraph in their report indicating the inconsistency, or withdraw from the engagement. The auditors should also be alert for, and discuss with the client, other types of material misstatements included in the other information.
For which expense accounts should the auditors obtain or prepare analyses to be used in preparation of the client's income tax return?
Because they will be closely scrutinized by state or federal revenue agents Officers salaries Directors fees Taxes Travel & entertainment Contributions Casualty Losses..
What division of duties among independent departments is desirable to achieve maximum internal control over payroll?
Division of payroll duties... (1) employment or human resources (2) timekeeping (3) payroll preparation and record keeping (4) distribution of pay to employees
What are general risk contingencies? Do such items require disclosure in the financial statements?
General risk contingencies are the many factors in the business environment of a particular entity that involve some risk of causing future loss. Examples include the risk of natural catastrophes, competition, strikes, and future raw material shortages. General risk contingencies should not be disclosed in financial statements. In the event that a loss actually occurs, that loss, of course, will be recognized in the financial statements.
When you are first retained to audit the financial statements of Wabash Company, you inquire whether a budget is used to control costs and expenses. The controller, James Lowe, replies that he personally prepares such a budget each year, but that he regards it as a highly confidential document. He states that you may refer to it if necessary, but he wants you to make sure that no employee of the firm sees any of the budget data. Comment on this use of a budget.
I would provide him information on the benefits of sharing this information with other employees, specifically management. Budgets provide management with information as to expected amounts.
Describe the manner in which the auditors evaluate their audit findings.
In evaluating their audit findings, the auditors consider (1) known misstatements, (2) projected misstatements, and (3) other estimated misstatements. By accumulating these types of misstatements, the auditors obtain an estimate of the total likely misstatement in the client's financial statements. If, based on this estimate of the total likely misstatement, the auditors conclude that there is an unacceptable high risk of material misstatement in the financial statements. They should then attempt to get the client to adjust their financial statements for the known misstatements, or perform additional tests to determine if the likely misstatements actually exist.
What are loss contingencies? How are such items presented in the financial statements?
Loss contingencies are possible losses, stemming from past events, which will be resolved as to existence and amount by some future event. Prior to the occurrence of the future event, uncertainty exists not only as to the amount of the loss, but also as to whether any loss has actually been sustained. Loss contingencies should be disclosed in notes to the financial statements whenever it is reasonably possible that a loss has been sustained (or when disclosure is warranted by tradition). If both (1) it is probable that a loss has been incurred and (2) the amount of the loss may be reasonably estimated, loss contingencies should be recognized as actual losses in the financial statements.
Does incorrect required supplemental information included with audited financial statements result in a qualified or adverse audit opinion? Explain.
No. Because the supplemental information is considered unaudited, misstatement of it does not result in a qualified or adverse opinion. An emphasis-of-matter paragraph is added to the audit report.
If the federal income tax returns for prior years have not as yet been reviewed by federal tax authorities, would you consider it necessary for the client to disclose this situation in a note to the financial statement? Explain
No. The status of the IRS's review is not generally disclosed in the notes to the financial statements. However, the auditors should review the prior year returns to make certain that any contingent liabilities for prior taxes are appropriately reflected in the financial statements.
What safeguards should be employed when the inaccessibility of banking facilities makes it desirable to pay employees in cash?
Paymaster will use information submitted by payroll department to fill the payroll enveloped with cash... Paymaster will require proof if identify when distributing cash to employees and require them to sign a receipt Uncollected payroll enveloped should be returned to payroll Unclaimed wages should be deposited in the bank and credited to a special liability account.
What auditing procedure can you suggest for determining the reasonableness of selling, general, and administrative expenses?
Perform analytical procedures related to the accounts. Obtain or prepare analysis of selected expense accounts Obtain or prepare analysis of critical expenses in income tax returns.
What specific procedures are suggested by the phrase "test of controls over payroll transactions"?
The "tests of controls over payroll transactions" includes tracing names and wage rates to human resources department records, tracing hours to time reports, tracing deductions to employee authorization forms, testing extensions and footings, comparing amounts to labor cost records, testing reconciliations of the payroll bank account, investigating the handling of unclaimed wages, and comparing of payroll data with payroll tax returns.
List the audit procedures that should be completed near the date of the audit report.
The audit procedures that are completed near the end of fieldwork include: (1) Search for unrecorded liabilities. (2) Review the minutes of meetings. (3) Perform final analytical procedures. (4) Perform procedures to identify loss contingencies. (5) Perform the review for subsequent events. (6) Obtain the representation letter.
What is the meaning of the term commitment? Give examples. Do commitments appear in financial statements? Explain.
The term commitment means a contractual obligation to carry out a transaction at a specified time in the future. Examples include commitments to sell merchandise at fixed prices, to buy goods at fixed prices, and to employ an executive at a stipulated salary for several years in the future. If commitments were a material factor in a company's operation, they should be disclosed in a note to the financial statements.
What is the usual procedure followed by the CPA in obtaining evidence regarding pending and threatened litigation against the client?
The usual procedure followed by the independent auditors in obtaining evidence regarding pending and threatened litigation against the client is a letter of inquiry (or lawyer's letter) sent to the client's legal counsel. The auditors obtain from management a list of such litigation and ask the client's attorney to comment on this list, add any items to make it complete, and indicate any differences of opinion with management regarding the probable outcome.
How are analytical procedures used in the verification of revenue?
To investigate unusual fluctuations. Material amounts of unrecorded revenue, as well as significant misclassifications affecting revenue accounts, may be discovered by these procedures.
You are asked by a client to outline the procedures you would recommend for handling of unclaimed wages. What procedures do you recommend?
Unclaimed wages should be deposited in the bank and credited to a special liability account. When the employee calls for unclaimed pay, a new check is drawn and a receipt obtained from the employee. If the paymaster or cashier is permitted to retain unclaimed wages, an incentive to payroll padding is created along with an opportunity for intermingling these with other funds and thus concealing shortages.
