Q&A Hero

Q: Discuss the internal controls related to owners' equity that are of concern to the auditor.

Q: First Global is a public company. You are currently performing the audit of the owner's equity section and you have been asked to write a short memo about the control weaknesses you have identified and the potential risk attached to each weakness. First Global is a public company since March of the current year as it underwent an IPO during the year. The corporation has been implementing various controls with regards to keeping records of the company, but it is still a growing company, and Sasha, the equity accountant, has been having a tough time learning all the new regulations, keeping the records up to date and ensuring that the dividend payments are made on time. First Global issued 2 classes of shares in the IPO. Class A shares with 10 votes were issued to the Truman family so they could retain control and Class B shares with 1 vote each were issued to the general public. When you reviewed the accounting records, you noticed that they contained only one account for capital stocks.

Q: Describe the three objectives of the auditor's examination of owners' equity.

Q: Explain why the auditor's verification of owners' equity is more complex for publicly-held corporations than closely-held corporations.

Q: A primary concern in determining whether retained earnings is correctly disclosed on the balance sheet is A) correct calculation of the net income or loss for the year. B) correct calculation of dividend payments for the year. C) whether adjustments to retained earnings have been made correctly. D) whether there are any restrictions on the payment of dividends.

Q: As part of the audit of dividends, the auditor would verify whether the payment was made to the shareholders who owned the stock at the dividend record date. Which of the following audit tests assists with this objective? A) examine the minutes of board of directors' meetings for the amount of the dividend per share and the dividend date B) review the permanent audit working paper file to determine if there are restrictions on the payment of dividends C) recomputed the amount of dividends declared by multiplying the dividend amount per share by the number of shares outstanding D) select a sample of recorded dividend payments and trace the payee's name on the cancelled cheque to the dividend records

Q: When a dividend is declared by the Board, the source for determining who should receive dividend cheques is the A) shareholders' capital stock register or master file. B) stock certificate books. C) common stock account in the general ledger. D) corporate directory.

Q: The auditor has reconciled the dividend payment amounts disbursed according to the cash disbursements journal to the dividend declared. Which audit assertions is this test associated with? A) valuation and existence B) accuracy and valuation C) accuracy and completeness D) valuation and understandability

Q: The auditor recomputed the dividend declaration amount by multiplying the declared dividend per share by the number of shares outstanding. Which audit assertion is this associated with? A) completeness B) accuracy C) valuation D) existence

Q: The transfer agent confirmed to the auditor that the company had 2,500,000 shares outstanding at December 31, 2010. To have assurance over the accuracy of the dividend payable, the auditor would multiply 2,500,000 by the A) dividend per share declared. B) dividend per share paid during the year. C) dividend per share as per the articles of incorporation, even if it was not declared during the year. D) average dividend for the industry.

Q: An audit procedure that is part of the audit of notes payable is the review of the permanent audit working paper files to determine if there are restrictions on the payment of dividends in bond indenture agreements or preferred share provisions. Which presentation and disclosure audit assertion is this associated with? A) valuation B) completeness C) existence D) classification

Q: When the auditor examines the board of directors' minutes for dividends declared, the auditor should be alert to the possibility of unrecorded dividends declared, particularly shortly before the balance sheet date. Which audit assertion does this address? A) valuation B) existence C) completeness D) understandability

Q: When the auditor examines the minutes of board of directors' meetings for the amount of the dividend per share and the dividend date, the auditor is checking for A) completeness. B) valuation. C) understandability. D) existence.

Q: Usually dividends are audited A) using block sampling. B) on a 100% basis. C) using variables sampling. D) using attributes sampling.

Q: The emphasis in the audit of dividends is on A) ending equity balance. B) transactions. C) opening dividends payable balance. D) confirming the number of shares outstanding.

Q: If a company employs a capital stock registrar and/or transfer agent, the registrar or agent, or both, should be requested to confirm directly to the auditor the number of shares of each class of stock A) surrendered and cancelled during the year. B) authorized at the balance sheet date. C) issued and outstanding at the balance sheet date. D) authorized, issued, and outstanding during the year.

Q: It is normal practice to verify all capital stock transactions A) that are in excess of a material amount. B) if there aren't very many during the year. C) regardless of the controls in existence, because of their materiality and permanence in the records. D) only when the client is small.

Q: Most large corporations employ the services of a stock transfer agent for the purpose of A) maintaining the shareholder records. B) recording share capital in the accounts. C) issuing the shares for the company. D) ensuring that stock issuances are complying with federal and provincial laws.

Q: Kumar is the internal auditor of Tarragon Inc. Kumar wants to put procedures in place in order to prevent misstatements in owners' equity and ensure proper record keeping. Kumar suggested that management implements well-defined policies for preparing stock certificates and recording capital stock transaction. What else should Kumar recommend? A) Independent internal verification of information in the records B) Having all journal entries in the equity account reviewed by the controller C) Perform a monthly reconciliation of shareholder's equity D) Reconcile the dividend payments with the bank statement

Q: As part of the audit, the auditor may examine authorization procedures with respect to the repurchase or redemption of capital stock. In particular, for a public company the auditor would verify that which of the following details have been authorized? A) general ledger accounts affected, dividends included, amount to be paid B) type of stock, timing, amount to be paid C) individuals from whom repurchase will be permitted, maximum amount D) type of stock, amount to be paid, effect upon bond sinking funds

Q: For publicly held corporations, the verification of owners' equity is more complex due to the A) fact that there are many more equity accounts to audit. B) larger numbers of shareholders and frequent changes in the individuals holding the shares. C) problem of having to confirm shares held with many more different individuals. D) need to consider that audit risk will be lower, and different shareholders have different points of view with respect to materiality.

Q: The amount of time spent verifying owners' equity is frequently minimal for closely-held corporations because A) these companies are so small that it is not necessary to audit the capital section. B) the few owners all have access to the books so the auditor spends more time on accounts like liabilities, which affect outsiders. C) there are few if any transactions during the year for the capital stock accounts, except for earnings and dividends. D) there is no public interest in these companies.

Q: Describe the risks of error and fraud in the debt or equity accounts.

Q: State the specific balance-related audit objectives applicable to notes payable and interest and, for each objective, identify one common test of details of balances.

Q: Identify three analytical procedures commonly performed for notes payable.

Q: Discuss the three key controls over notes payable.

Q: Discuss the overall objectives of the audit of notes payable.

Q: Discuss the four characteristics of the capital acquisition and repayment cycle that make it unique from other cycles.

Q: The audit procedure that requires the auditor to examine notes, minutes, and bank confirmations for restrictions is performed to satisfy the audit objective of A) existence. B) completeness. C) accuracy. D) presentation and disclosure.

Q: The audit objective which requires the auditor to determine that notes payable on the notes payable schedule are properly classified can be tested with the following procedure. A) Review the notes to determine whether any are with related parties. B) Confirm notes payable. C) Examine corporate minutes for loan approval. D) Examine notes, minutes, and bank confirmations for restrictions.

Q: A common test of details of balances procedure for notes payable is "examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet date." Which audit assertion is this test of detail associated with? A) allocation (accuracy) B) allocation (cut-off) C) existence D) completeness

Q: The test of details of balances procedure which requires the auditor to recalculate accrued interest will satisfy the audit objective of A) existence. B) completeness. C) classification. D) accuracy

Q: The audit objective to determine that notes payable and accrued interest on the notes payable schedule are accurate is accomplished by which of the following test of balances procedure? A) Examine duplicate copies of notes for principal and interest rates. B) Review the minutes of the board of directors for authorized but unrecorded notes. C) Trace the total of the notes payable schedule to the general ledger. D) Review the notes to determine whether any are with related parties or should be accounts payable.

Q: Caroline is performing the audit of the capital acquisition and repayment cycle. She is currently auditing the payments of interest made during the year. The proper documentation that Caroline should use as supporting evidence of the payment is A) a copy of the note. B) a bank reconciliation. C) documentation of her inquiries with management. D) the notes payable sub-ledger.

Q: The tests of details of balances procedure which requires the auditor to trace the totals of the notes payable list to the general ledger satisfies the objective of A) existence. B) completeness. C) accuracy. D) rights and obligations.

Q: Which of the following audit procedures assists the auditor with testing for completeness? A) Analyze interest expense to uncover a payment to a creditor who is not included in the notes payable schedule B) examine note to determine whether the company has obligations for payment C) examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet date D) examine the dates on duplicate copies of notes to determine whether all or part of the notes are a non-current liability

Q: The audit objective requiring that existing notes payable are included in the notes payable schedule (completeness) is satisfied by performing the following audit procedure. A) Recalculate accrued interest. B) Examine duplicate copies of notes for details. C) Review the notes payable schedule to determine whether any are related parties. D) Obtain confirmations from creditors who have held notes from the client in the past and are not currently included in the notes payable schedule.

Q: The audit objective to determine that existing notes payable are included in the notes payable schedule (completeness) is accomplished by the following test of balances procedure. A) Examine balance sheet for disclosure details. B) Recalculate accrued interest. C) Review the bank reconciliation for new notes credited directly to the bank account by the bank. D) Examine duplicate copies of notes for principal and interest rates.

Q: The tests of details of balances procedure which requires the auditor to examine notes paid after year-end to determine whether they were liabilities at the balance sheet date is an attempt to satisfy the audit objective of A) existence. B) completeness. C) accuracy. D) classification.

Q: The tests of details of balances procedure which requires the auditor to examine corporate minutes for loan approval would satisfy the audit objective of A) classification. B) existence. C) completeness. D) accuracy.

Q: The audit objective to determine that notes payable in the schedule exist is verified by the tests of balances procedure to A) foot the notes payable list. B) confirm notes payable. C) recalculate interest expense. D) examine the balance sheet for proper disclosure of noncurrent portions.

Q: One of the reasons that the auditor reads debt agreements is to discover whether there are any restrictions on the company, such as restrictions on the payment of dividends. It is important for the auditor to identify such restrictions as A) corroborative evidence can then be obtained from management. B) the auditor can make sure that management is adhering to the restrictions. C) the auditor can include the restrictions in the management representation letter. D) they must be disclosed in the footnotes of the financial statements.

Q: Presentation and disclosure are important because acceptable financial reporting frameworks require that footnotes adequately describe the terms of notes payable outstanding and the assets pledged as collateral for the loans. Which assertion does this relate to? A) valuation B) existence C) completeness D) understandability

Q: Two of the audit objectives for notes payable are important because a misstatement could be material even if one note is omitted or incorrect. Which assertions are they? A) completeness and valuation B) existence and completeness C) accuracy and existence D) completeness and accuracy

Q: The most important balance-related and presentation and disclosure-related audit objectives for notes payable are A) accuracy, existence, completeness. B) existence, completeness, valuation. C) accuracy, completeness, understandability. D) accuracy, completeness, valuation.

Q: The normal starting point for the audit of notes payable is A) a discussion with management of any new notes payable for the year. B) a schedule of notes payable and accrued interest obtained from the client. C) the assessment of materiality. D) the minutes of the board of directors.

Q: Comparison of individual notes payable outstanding with the prior year could detect what type of possible misstatement? A) Misstatement of interest expense or accrued interest, or omission of a note payable B) Omission or misstatement of a note payable C) Misclassification of a note payable as long term rather than current D) Misstatement of notes payable, interest expense or accrued interest

Q: Recalculation of an approximate interest expense using the basis of average interests rates and overall monthly notes payable could detect what type of possible misstatement? A) Misstatement of interest expense or accrued interest, or omission of a note payable B) Omission or misstatement of a note payable C) Misclassification of a note payable as long term rather than current D) Misclassification of notes payable, interest expense or accrued interest

Q: During the course of an audit, a public accountant observes that the recorded interest expense seems to be excessive in relation to the balance in the long-term debt account. This observation could lead the auditor to suspect that A) long-term debt is understated. B) discount on bonds payable is overstated. C) long-term debt is overstated. D) premium on bonds payable is understated.

Q: Comparison of the total balance in notes payable, interest expense and accrued interest with these accounts in the prior year could detect what type of possible misstatement? A) Misstatement of interest expense or accrued interest, or omission of a note payable B) Omission or misstatement of a note payable C) Misclassification of a note payable as long term rather than current D) Misstatement of notes payable, interest expense or accrued interest

Q: If actual interest expense is materially larger than the auditor's independent estimate, one possible cause could be A) interest payments on unrecorded notes payable. B) omitted payments of interest (i.e. underpayments). C) interest payments recorded at the wrong lower interest rate. D) notes payable that were set up incorrectly as short term notes.

Q: Tests of details for notes payable interest expense and accrued interest can frequently be eliminated when A) tests of controls are conducted over authorization and recording procedures. B) notes are issued by a person independent of the accounting department. C) the notes payable schedule indicates that all notes have been repaid. D) results of analytical review are favourable.

Q: Which of the following internal controls over notes payable address risks associated with the accuracy, allocation and completeness audit assertions? A) renewals or new notes should be approved by the Board of Directors (as evidenced in the minutes) or by senior management B) authorized employees should perform independent recalculations of interest and reconciliation of the notes payable balance to the general ledger C) subsidiary records should be maintained for each note, and there should be control over blank and paid notes D) paid notes should be cancelled and retained under the custody of an authorized official

Q: Notes payable which have been repaid in full should be A) destroyed so that they will not be paid again inadvertently. B) cancelled and destroyed. C) cancelled and returned to the creditor. D) cancelled and retained by an authorized company official.

Q: Proper authorization for the issuance of notes payable requires that A) whenever notes are renewed (refinanced), they should be subject to the same authorization procedures as those used when they were first issued. B) responsibility for authorizing notes should lie with the manager who will receive the benefits of the loan. C) responsibility for authorization should lie with the treasurer's function, since the treasurer's department will receive the cash generated. D) responsibility for authorization should lie with the manager who must generate the revenue to repay the loan.

Q: Responsibility for the issuance of new notes should be vested in the A) board of directors. B) accounting department. C) accounts payable department. D) purchasing department.

Q: When setting the objectives for auditing notes, the auditor should consider inherent risks associated with A) recording errors. B) uncollectible notes. D) management bias. Answer: D

Q: Control risk for notes payable is usually assessed as low. This occurs because internal controls are normally good for notes payable and A) creditors would complain if the notes are not paid. B) interest expense can easily be distinguished from bank service charges. C) there are a small number of large transactions or this type of transaction. D) inclusion in the accounts payable listing helps track the notes.

Q: Notes payable are easy for companies to correctly value and include in the financial statements. This means that with respect to notes payable, inherent risk is A) low. B) medium. C) high. D) not assessed.

Q: A note payable is A) a long-term account payable. B) a legal obligation to a creditor secured by assets. C) an unsecured legal obligation to a creditor. D) a legal obligation to a creditor which may be unsecured or secured by assets.

Q: There is a direct relationship between the interest and dividend accounts and debt and equity. This means that in the audit of interest-bearing debt, it is desirable to simultaneously verify A) the related dividends declared and dividends payable. B) the related interest expense and interest payable. C) contracts and commitments that are long-term. D) details provided in the Board of Directors' minutes.

Q: In the audit of the transactions and amounts in the capital acquisitions and repayments cycle, the auditor must ensure that significant legal requirements affecting the financial statements have been properly fulfilled and A) any violations are reported to the relevant provincial securities commissions. B) any departures from the agreements are made with management's knowledge and consent. C) are adequately disclosed in the financial statements. D) must issue a disclaimer if they haven't been fulfilled.

Q: The exclusion of a single transaction of the capital acquisition and repayment cycle could be material in itself. This means that the following audit assertion is a major audit concern A) completeness. B) existence. C) accuracy. D) rights and obligations.

Q: The normal audit approach for the audit of bonds issued is to A) examine transactions that occurred near the year end date only. B) verify each transaction taking place in the cycle for the entire year. C) select a statistical sample of transactions throughout the year. D) rely upon controls rather than conducting substantive tests.

Q: Auditing, 12e (Arens) 18.1 Describe the four key characteristics of the capital acquisition and repayment cycle and the risks of fraud or error in the cycle

Q: You are conducting the audit of Files R Us Inc. (FRI), a family-owned business that manufactures a variety of different types of wooden and metal file cabinets. In business for over twenty years, FRI has a reputation for providing high quality products on time or even ahead of schedule. FRI does not sell to the public, but only to fine furniture stores and to a variety of office supply chains. As of the current year end, the company has a total of $6.3 million in assets. Inventory information is as follows: Raw materials (metals and supplies) $ 400,000 Raw materials (wood products) 450,000 Work in progress 1,350,000 Finished goods 250,000 $2,450,000 Finished goods consists of: Material 48% Direct labour 22 Overhead 30 100% File cabinet production is intensely competitive, primarily due to imports from Asia and Mexico. To help manage costs, FRI uses a job-order, standard cost system. Standard costs are assessed quarterly. Each job is costed and compared to standard. Inventory is counted only at the end of the year. There is no perpetual inventory system. Due to problems with raw material quality and new staff, losses have been incurred in the last six months of the year. Your review of last year's audit file indicated that there were numerous inventory adjustments required last year. Required: Using the audit risk model, assess the risks associated with the audit of inventory.

Q: A) State five specific balance-related audit objectives for inventory pricing and compilation and, for each objective, describe one common test of details of balances related to that objective. B) Explain why the audit of work-in-process and finished goods inventory is generally more complex than the audit of purchased inventory.

Q: State five specific balance-related audit objectives for physical inventory observation and, for each objective, describe one common test of details of balances related to that objective.

Q: A) Discuss the key control procedures relating to the client's physical count of inventory. B) State the primary determinants of the amount of time needed to perform the physical observation of inventory.

Q: Identify three analytical procedures commonly used when auditing accounts in the inventory and distribution cycle.

Q: The test of details of balance procedure which requires the auditor to perform tests of lower-of-cost-or-market, selling price, and obsolescence is an attempt to satisfy the objective of A) existence. B) completeness. C) accuracy. D) valuation.

Q: As part of the audit of valuation, the auditor is conducting pricing tests by comparison to supplier invoices. The auditor is making sure that, for each item tested, sufficient supplier invoices are examined to cover the quantity of inventory that was on hand during the physical inventory count. What type of pricing error could this detect? A) clients value their inventory on the basis of the most recent invoice only B) the client has used the incorrect accounting method to value its inventory C) extension errors could occur with numerous different inventory items D) the wrong inventory count quantity could have been recorded on the count sheets

Q: The auditor is determining which specific inventory items should be selected for pricing tests. The auditor has selected a representative sample, and those items that have a large dollar amount. In addition, the auditor should select those items that A) are prone to breakage or theft. B) have wide fluctuations in price. C) are stored in multiple locations. D) are likely to have been miscounted during the inventory count.

Q: What is the first step that the auditor takes when auditing the valuation of inventory? A) conduct analytical review, comparing gross margin for the current year to the prior year B) do an industry analysis to determine whether there is a potential for technology-induced obsolescence C) ask the client about the level of obsolete inventory that was on hand and counted during the inventory count D) establish clearly the valuation method used and how the calculations are being performed

Q: When considering pricing of inventory, three things are important. The first two are that the method must be in accordance with an acceptable financial accounting framework, and the application of the method must be consistent from year to year. What is the third? The A) input edits over the data entry of prices must be robust. B) cut-off testing for the use of supplier invoices should be carefully done. C) cost versus market value must be considered. D) freight should always be included in the cost of the inventory.

Q: Controls which provide a means of ensuring that the physical counts are properly summarized, priced at the same amount as the unit records, correctly extended and totalled, and included in the general ledger at the proper amount are known as A) standard cost records. B) pricing internal controls. C) compilation internal controls. D) count quantity internal controls.

Q: When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that A) all goods purchased before year-end are received before the physical inventory count. B) no goods held on consignment for customers are included in the inventory balance. C) no goods observed during the physical count are pledged or sold. D) all goods owned at year-end are included in the current period inventory balance.

Q: A common inventory observation procedure is to record in the working papers for subsequent follow-up the last shipping document number used at year-end. The audit objective being achieved by this procedure is A) inventory as recorded exists. B) existing inventory is counted and tagged. C) information is obtained to make sure sales and inventory purchases are recorded in the proper period. D) tags are accounted for to make sure none is missing.

Q: An inventory observation procedure which compares physical counts with the perpetual inventory master file is an attempt to satisfy the audit objective of A) existence. B) completeness. C) accuracy. D) classification.

Q: A common inventory observation procedure is to be alert for items that are damaged, rust- or dust-covered, or located in inappropriate places. The balance-related audit objective being achieved by this procedure is A) classification. B) cutoff. C) valuation. D) rights.