Audit Chapter 10

A related party is a person or entity that A) Can exert significant influence over or be influenced by the company. B) Has a family tie to a management member. C) Is a member of the company's management team or board of directors. D) Does business with the company.

A) Can exert significant influence over or be influenced by the company.

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 assertions about A) Completeness. B) Classification. C) Existence. D) Valuation.

B) Classification

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) Compare valuation of stock to published market prices. C) Obtain management representation about number of shares issued and outstanding. D) Confirm outstanding common and preferred stock with stock registrar.

B) Compare valuation of stock to published market prices.

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? A) Tracing recorded dividend income to cash receipts records and validated deposit slips. B) Comparing recorded dividends with amounts appearing on federal information Form 1099. C) Performing analytical procedures and statistical sampling. D) Comparing recorded dividends with a standard financial reporting service's record of dividends.

D) Comparing recorded dividends with a standard financial reporting service's record of dividends.

The primary reason for preparing a reconciliation between interest-bearing obligations outstanding during the year and interest expense in the financial statements is to A) Determine the validity of prepaid interest expense. B) Evaluate internal control over securities. C) Ascertain the reasonableness of imputed interest. D) Detect unrecorded liabilities.

D) Detect unrecorded liabilities.

The auditors should insist that a representative of the client be present during the inspection and count of securities to A) Acknowledge the receipt of securities returned. B) Detect forged securities. C) Coordinate the return of all securities to proper locations. D) Lend authority to the auditors' directives.

A) Acknowledge the receipt of securities returned.

In auditing for unrecorded long-term bonds payable, an audit team most likely will A) Compare interest expense with the bond payable amount for reasonableness. B) Confirm the existence of individual bondholders at year-end. C) Examine documentation of assets purchased with bond proceeds for liens. D) Perform analytical procedures on the bond premium and discount accounts.

A) Compare interest expense with the bond payable amount for reasonableness.

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.) A) Market value used to charge retained earnings to account for a 2-for-1 stock split. B) Approval of the adjustment to the beginning balance as a result of a write-down of account receivables. C) Authorization for both cash and stock dividends declared and paid. D) Gain or loss resulting from disposition of treasury shares.

A) Market value used to charge retained earnings to account for a 2-for-1 stock split. B) Approval of the adjustment to the beginning balance as a result of a write-down of account receivables.

An audit team would most likely verify the interest earned on bond investments by A) Recomputing the interest earned on the basis of face amount, interest rate, and period held. B) Confirming the bond interest rate with the issuer of the bonds. C) Testing internal controls relevant to cash receipts. D) Vouching the receipt and deposit of interest checks.

A) Recomputing the interest earned on the basis of face amount, interest rate, and period held.

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 client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date. B) Count the securities at a subsequent date and confirm with the bank whether securities were added or removed since the balance-sheet date. C) Request the bank to confirm to the auditors the contents of the safe deposit box at the balance-sheet date. D) Examine supporting evidence for transactions occurring during the year.

A) Request the client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date.

Which of the following is the most important audit consideration when examining the stockholders' equity section of a client's balance sheet? A) Stock dividends are capitalized at par or stated value on the dividend declaration date. B) Entries in the capital stock account can be traced to resolutions in the minutes of meetings of the board of directors. C) Changes in the capital stock account are verified by an independent stock transfer agent. D) Stock dividends and stock splits during the year under audit were approved by the stockholders.

B) Entries in the capital stock account can be traced to resolutions in the minutes of meetings of the board of directors.

All corporate capital stock transactions should ultimately be traced to the A) Cash receipts journal. B) Minutes of the meetings of the board of directors. C) Cash disbursements journal. D) Numbered stock certificates.

B) Minutes of the meetings of the board of directors.

When the client holds a large amount of negotiable securities, auditors need to plan to guard against A) Substitution of authentic securities with counterfeit securities. B) Substitution of securities already counted for other securities that should be on hand but are not. C) Unrecorded sales of securities after they are counted. D) Unauthorized negotiation of the securities before they are counted.

B) Substitution of securities already counted for other securities that should be on hand but are not.

Loan covenants are used for which of the following reasons? A) To protect the auditors from false information by the borrower. B) To protect the lender from the borrower's financial position substantially weakening. C) To protect the borrower from the lender's calling the loan early. D) To protect shareholders from management taking on too much debt.

B) To protect the lender from the borrower's financial position substantially weakening.

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 A) Interest and dividend checks are mailed directly to an entity employee who is authorized to sell securities. B) Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records. C) The trust company places the securities in a bank safe deposit vault under the custodian's exclusive control. D) Securities are registered in the name of the trust company rather than the entity itself.

B) Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.

Which of the following audit procedures would not likely be performed for audits of investments? A) Confirm investments with broker or trustee. B) Read board of directors' minutes for authorization of investment strategies. C) Confirm investments with registrar. D) Compare valuation to published market prices.

C) Confirm investments with registrar.

An audit plan to examine long-term debt most likely would include steps that require A) Inspecting the accounts payable subsidiary ledger for unrecorded long-term debt. B) Comparing the carrying amount of held-to-maturity securities with their year-end market values. C) Correlating interest expense recorded for the period with outstanding debt. D) Verifying the existence of the holders of the debt by direct confirmation.

C) Correlating interest expense recorded for the period with outstanding debt.

Which of the following approaches is most suitable for auditing the finance and investment cycle? A) Ignore internal controls and perform extensive substantive procedures. B) Ignore internal controls and limit substantive procedures to analytical procedures. C) Gain an understanding of internal controls and perform extensive substantive procedures. D) Perform extensive tests of controls and limit substantive procedures to analytical procedures.

C) Gain an understanding of internal controls and perform extensive substantive procedures.

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 A) The number of shares subject to agreements to repurchase. B) Guarantees of preferred stock liquidation value. C) The number of shares issued and outstanding. D) Restrictions on the payment of dividends.

C) The number of shares issued and outstanding.

ABC Company 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. Which of the following would be the auditor's main concern about this discovery? A) The certificates in the safe deposit box were forgeries. B) The securities may be misclassified on the balance sheet. C) There had been unauthorized buying and selling of investment securities. D) ABC Company no longer owns the securities.

C) There had been unauthorized buying and selling of investment securities.

Which of the following assertions is most likely to have the highest risk of material misstatement for the goodwill account? A) Existence B) Completeness C) Valuation D) Rights & Obligations

C) Valuation

An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the A) Valuation of trading securities. B) Classification as available-for-sale or trading securities. C) Existence of unrealized gains or losses. D) Completeness of recorded investment income.

D) Completeness of recorded investment income.

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 A) The investments be classified as long term for balance-sheet purposes with full disclosure in the footnotes. B) The equity section of the balance sheet separately show a charge equal to the amount of the loss. C) The approximate market value of the investments be shown in parentheses on the face of the balance sheet. D) The loss in value be recognized in the financial statements.

D) The loss in value be recognized in the financial statements.

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? A) The use of prenumbered purchase orders to prevent unrecorded notes. B) All direct borrowings on notes payable are authorized by the board of directors. C) Any use of assets for collateral on long-term notes payable are analyzed for criticality to operations. D) Proceeds from long-term notes payable are included in regular review of budgets to ensure adequacy of cash flow availability.

B) All direct borrowings on notes payable are authorized by the board of directors.

Which of the following questions would auditors most likely include on an internal control questionnaire for notes payable? A) Are the proceeds from notes payable used to purchase noncurrent assets? B) Are assets that collateralize notes payable critically needed for the entity's continued existence? C) Are direct borrowings on notes payable authorized by the board of directors? D) Are two or more authorized signatures required on checks that repay notes payable?

C) Are direct borrowings on notes payable authorized by the board of directors?

In connection with the audit of an issue of long-term bonds payable, the audit team should A) Decide whether the bond issue was made without violating state or local laws or regulations. B) Determine whether bondholders are persons other than owners, directors, or officers of the company issuing the bond. C) Ascertain that the client has obtained the opinion of counsel on the legality of the issue. D) Calculate the effective interest rate to see whether it is substantially the same as the rates charged for similar issues.

C) Ascertain that the client has obtained the opinion of counsel on the legality of the issue.

When independent stock transfer agents are not employed and the corporation issues its own stock and maintains stock records, canceled stock certificates should A) Be defaced and sent to the secretary of state. B) Be destroyed to prevent fraudulent reissuance. C) Not be defaced but be segregated from other stock certificates and retained in a canceled certificates file. D) Be defaced to prevent reissuance and attached to their corresponding stubs.

D) Be defaced to prevent reissuance and attached to their corresponding stubs.