Auditing Chapter 10 Questions

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: a. Existence. b. Completeness. c. Classification and understandability. d. Valuation and allocation.

Classification and understandability

In auditing for unrecorded long-term bonds payable, an audit team most likely will... a. Perform analytical procedures on the bond premium and discount 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

Compare interest expense with the bond payable amount for reasonableness. (The recorded interest expense should reconcile with the outstanding bonds payable. If interest expense appears excessive relative to the recorded bonds payable, unrecorded long-term liabilities may exist.)

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: a. Inspect the audited financial statements of the investee company. b. Correspond with the investee company to verify the number of shares owned. c. Confirm the number of shares owned that are held by an independent custodian. d. Determine that the investment is carried at the lower of cost or market.

c. Confirm the number of shares owned that are held by an independent custodian. Dual-control

An audit plan for the examination of the retained earnings account should include a step that requires verification of the... 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

*Authorization for both cash and stock dividends declared and paid.* and Gain or loss resulting from disposition of treasury shares

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 loacations. d. Acknowledge the receipt of securities returned.

Acknowledge the receipt of securities returned.

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: a. A substantial fluctuation in the price of the investee's common stock on a national stock exchange. b. The investee's decision to reduce cash dividends declared per share of its common stock. c. An error in recording amortization of the excess of the investor's cost over the investment's underlying book value. d. An error in recording the unrealized gain from an increase in the fair value of available-for sale securities in the income account for trading securities.

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... a. Determine whether bondholders are persons other than owners, directors, or officers of the company issuing the bond b. Calculate the effective interest rate to see whether it is substantially the same as the rates charged for similar issues. c. Decide whether the bond issue was made without violating state or local laws or regulations d. Ascertain that the client has obtained the opinion of counsel on the legality of the issue.

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

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

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

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, what 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. Preforming analytical procedures and statistical sampling. c. comparing recorded dividends with amounts appearing on federal information form 1099 d. Comparing recorded dividends with a standard financial reporting service's record of dividends.

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

An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the... a. Existence of unrealized gains or losses b. Completeness of recorded investment income. c. Classified as available -for-sale or trading securities d. Valuation of trading securities

Completeness of recorded investment income.

Which audit procedure would not likely be performed for audits of investments? a.

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

Correlating interest expense recorded for the period with outstanding debt.

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. Evaluate internal control over securities b. Determine the validity of prepared interest expense c. Ascertain the reasonableness of imputed interest. d. Detect unrecorded liabilities

Detect unrecorded liabilities.

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: a. Confirming the details with the investee companies' registrars. b. Examining the details of the client's most recent cutoff bank statement. c. Electronically accessing the details of dividend records on the Internet. d. Reading the details of the board of directors' meetings.

Electronically accessing the details of dividend records on the Internet.

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 a. Perform analytical procedures to determine if the derivatives are properly valued. b. Examine the contracts for possible risk exposure and the need to recognize losses. c. Document the derivatives in the auditor's communication with those charged with governance. d. Confirm the marketability of the derivatives with a commodity specialist.

Examine the contracts for possible risk exposure and the need to recognize losses.

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. Number stock certificates

Minutes of the meetings of the board of directors.

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

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

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: a. Annual audited financial statements of investee companies. b. Dividend records on file with the SEC. c. Stock ledgers maintained by independent registrars. d. Records produced by investment services.

Records produced by investment services.

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.

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

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

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

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 approximate market value of the investments be shown in parentheses on the face of the BS b. The investments be classified as long term for balance sheet purposes with full disclosure in the footnotes c. The loss in value be recognized in the financial statements. d. The Equity section of the BS separately show a charge equal to the amount of the loss

The loss in value be recognized in the financial statements.

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. Restrictions on the payment of dividends b. The number of shares issued and outstanding. c. Guarantees of preferred stock liquidation value d. The number of shares subject to agreements to repurchase

The number of shares issued and outstanding.

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 miss-classified on the BS ABC Company no longer owns the securities

There had been unauthorized buying and selling of investment securities.

Loan covenants are used for what reason? a. To protect the lender from the borrower's substantially weakening of the latter's financial position. b. To protect the borrower from the lender's calling the loan early c. To protect the auditors from false info by the borrower d. to protect shareholders from management taking on too much debt.

To protect the lender from the borrower's substantially weakening of the latter's financial position.

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

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

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? a. An acknowledgment by a client representative that the securities were returned intact. b. A description of the client's procedures that prevent the negotiation of securities by just one person. c. An evaluation of the client's internal control concerning physical access to the securities. d. An analysis of realized gains and losses from the sale of securities during the year.

a. An acknowledgment by a client representative that the securities were returned intact.

When a client engages in transactions involving derivatives, the auditor should: a. Develop an understanding of the economic substance of each derivative. b. Add an explanatory paragraph to the auditor's report describing the risks associated with each derivative. c. Notify those charged with governance about the risks involved in derivative transactions. d. Confirm with the client's broker whether the derivatives are for trading purposes.

a. Develop an understanding of the economic substance of each derivative.

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

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

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.

In auditing long-term bonds payable, an auditor most likely would: a. Perform analytical procedures on the bond premium and discount accounts. b. Compare interest expense with the bond payable amount for reasonableness. c. Examine documentation of assets purchased with bond proceeds for liens. d. Confirm the existence of individual bondholders at year-end.

b. Compare interest expense with the bond payable amount for reasonableness.

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 to prevent re-issuance and attached to their corresponding stubs. b. Not be defaced but be segregated from other stock certificates and retained in a canceled certificates file. c. Be destroyed to prevent fraudulent reissuance d. Be defaced and sent to the secretary of state

be defaced to prevent reissuance and attached to their corresponding stubs.

Which of the following audit procedures would not likely be performed for audits of shareholder's 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

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

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... a. Existence. b. Valuation c. Completeness d. Classification

classification

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.

When a company's stock record books are maintained by an outside registrar or transfer agent, the auditor should obtain confirmation from the registrar or transfer agent concerning the: a. Amount of dividends paid to related parties. b. Proper authorization of stock rights and warrants. c. Expected proceeds from stock subscriptions receivable. d. Number of shares issued and outstanding.

d. Number of shares issued and outstanding.

In performing tests concerning the granting of stock options, an auditor should: a. Verify the existence of option holders in the entity's payroll records or stock ledgers. b. Confirm the transaction with the Secretary of State in the state of incorporation. c. Determine that sufficient treasury stock is available to cover any new stock issued. d. Trace the authorization for the transaction to a vote of the board of directors.

d. Trace the authorization for the transaction to a vote of the board of directors.

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: a. Rights and obligations, and existence. b. Valuation and accuracy, and rights and obligations. c. Existence, and understand-ability and classification. d. Understand-ability and classification, and valuation and accuracy.

d. Understandability and classification, and valuation and accuracy.