Auditing Balance Sheet Accounts Test Bank Ch.13

Chapter 13

Auditing Various Balance Sheet Accounts (and Related Income Statement Accounts)

Question Type: True or False

Operating decisions are the only type of management operating decisions that significantly affect cash balances.

A. True

B. False

The nature of cash balances makes them susceptible to theft.

A. True

B. False

Comparing financial statement presentation with Generally Accepted Accounting Principles (GAAP) requirements is part of presentation and disclosure verification.

A. True

B. False

Inventory in the manufacture of oil and gas field machinery and equipment is less subject to significant obsolescence risk.

A. True

B. False

Prior experience in inventory turnover days, combined with knowledge of cost of sales, can be useful in estimating current inventory levels.

A. True

B. False

A shortening of inventory turnover days may indicate existence or valuation problems.

A. True

B. False

An inventory risk occurs when inventory may not exist for which we can use SKU (Stock Keeping Unit) and UPC (Universal Product Numbers) bar codes for identification of each number.

A. True

B. False

Financing activities include the purchase and sale of land, buildings, equipment, and other long-term assets not generally held for resale.

A. True

B. False

Inherent risk for property, plant and equipment is relatively straightforward.

A. True

B. False

The purpose of the auditor’s test of repair and maintenance expenses is to determine the propriety and consistency of these charges.

A. True

B. False

Investing activities include transactions and events whereby cash is obtained from or repaid to creditors (debt financing) or owners (equity financing).

A. True

B. False

When an auditor finds that a client has engaged in significant new debt or equity transactions, the auditor should be prepared to study a significant volume of legal documents related to the financing transaction and determine the impact of any legal requirements (such as debt covenants) on the entity.

A. True

B. False

While authorizing bonds and capital stock issuance, the board of directors usually authorizes financing transactions based on the entity's strategic plans and investing activities.

A. True

B. False

Question Type: Multiple choice

Cash and cash equivalents typically include _______.

A. cash in the bank

B. imprest accounts, such as a payroll account

C. cash equivalents, such as money market funds

D. All of these answer choices are correct.

An important aspect of developing a preliminary audit strategy involves _______.

A. understanding the entity and its environment

B. understanding the industry that the auditor operates in

C. determining what audit opinion management would like the auditor to issue

D. confirming certain account balances with the internal audit function

Cash equivalents include _______.

A. short-term time deposits

B. certificates of deposits

C. short-term government bonds

D. All of the answer choices are correct

Top performing companies within an industry generate significant free cash flow and_______.

A. are more likely to have significant balances of cash and cash equivalents

B. are more likely to have lower balances of cash and cash equivalents

C. typically incur higher rates of interest on greater debt balances

D. should consider returning the cash to the firm’s stockholders and creditors in the form of stock dividends

Some companies, such as Apple, Inc, _______.

A. have significant negative cash flow from operations, and positive free cash flow

B. have struggled to obtain financing, due to liquidity issues

C. have significant positive cash flow from operations, and positive free cash flow

D. have seen corporate credit ratings downgraded, due to defaults on debt payments

Management’s operating, investing, and financing decisions and strategies _______.

A. have relatively little effect on cash balances

B. significantly affect cash balances

C. have no bearing on cash balances

D. should be approved by the client’s vendors before implementation

Cash receipts and disbursement transactions _______.

A. are subject to minimal inherent risk

B. are subject to increased inherent risk

C. should be recorded weekly by the client

D. should be approved by the bank before recording in the ledger

The most important control over the existence, completeness, and valuation of cash balances _______.

A. is immediate collection of cash by companies

B. is to defer cash collection for as long as possible

C. is an independent bank reconciliation

D. is written representation by senior management with respect to the accuracy of the cash balance

Controls over cash receipts and cash disbursements _______.

A. are usually tested as part of testing controls in the revenue process and the purchasing process

B. are usually tested as part of testing controls in the financing process and the purchasing process

C. receive relatively little auditor attention due to their low inherent risk

D. should not be tested as part of the external audit

Many smaller businesses, not-for-profit organizations, and smaller governments _______.

A. may have inadequate segregation of duties, which results in strong internal controls over cash

B. may have adequate segregation of duties, which results in weak internal controls over cash

C. may have inadequate segregation of duties, which results in weak internal controls over cash

D. utilize their own internal audit function to attest to the accuracy and fairness of their financial statements

If control risk is high or maximum, and there are no compensating controls, the auditor should _______.

A. assume that fraud risk is high, and design appropriate substantive tests, particularly substantive tests of transactions

B. assume that fraud risk is low, and design appropriate substantive tests, particularly substantive tests of transactions

C. consider withdrawing from the engagement

D. request additional written representation from management

In larger public companies where the internal auditor tests controls over cash and cash budgeting, the external auditor_______.

A. should ignore the results of the internal audit

B. will automatically rely on the work performed and results obtained

C. will determine if it is appropriate to use the work of a specialist to support the audit conclusion.

D. will determine if it is appropriate to use the work of the internal auditor to support the audit conclusion.

Tests of cash balances focus on the account balance assertions of _______.

A. completeness, right and obligations, and valuation

B. completeness, right and obligations, and disclosure

C. existence, cutoff, and valuation

D. cutoff, existence, going concern

An example of a substantive test for cash balances would be to _______.

A. obtain written representations from management pertaining to cash balances

B. trace the beginning balance for cash on-hand and in bank to prior year’s working papers

C. rely on the internal audit function for this part of the audit

D. send a confirmation to the client's legal counsel

An analytical procedure related to the substantive testing of cash balances would be to _______.

A. calculate cash as a percent of total assets and compare with auditor expectations

B. calculate cash as a percent of total assets and compare with internal auditor expectations

C. send notes payable confirmations to creditors

D. send confirmations to the client firm's stockholders

Before proceeding with tests of details of cash balances, the auditor should _______.

A. attempt to confirm cash balances with the firms' creditors

B. ensure that an understanding has been obtained regarding the auditor and its environment and the importance of cash balances to the entity

C. ensure that an understanding has been obtained regarding the entity and its environment and the importance of cash balances to the entity

D. issue a tentative audit opinion related to cash

Which of the following include cash in the bank, such as the primary bank account of the company?

A. Cash and cash equivalents

B. Transaction classes

C. Disclosures

D. Debt assets

Which of the following is/are essential to the proper statement of cash at the balance sheet date?

A. Proper cutoff of cash receipts and cash disbursements at the end of the year

B. Proper cutoff of cash receipts, but not disbursements, at the end of the year

C. Cash disbursements at the end of the year

D. Cash assets at the end of the year

In which of the following assertions is inherent risk moderate and cash does not usually have significant disclosures?

A. Presentation and disclosure

B. Valuation and allocation

C. Rights and obligations

D. Completeness

When an auditor is auditing a client's inventory accounts, the primary focus is on the assertions of _______.

A. cutoff, accuracy, and completeness

B. completeness, existence, valuation and allocation, and rights and obligations

C. completeness, verifiability, valuation and allocation, and rights and obligations

D. rights and obligations, existence and occurrence, disclosure

An audit of inventory _______.

A. will vary from client to client

B. is a systematic approach, and rarely varies between clients

C. is typically left to the internal auditors

D. is prescribed by GAAP standards, which must be adhered to closely

Inventory held by the client should be classified as _______.

A. revenue, on the income statement

B. cost of goods sold, on the income statement

C. an asset, on the balance sheet

D. a liability, on the balance sheet

Analytical procedures performed as part of risk assessment activities _______.

A. are typically cost effective and may alert the auditor to potential misstatements

B. are typically expensive to perform, but may alert the auditor to potential misstatements

C. should only be performed with the express approval of senior management

D. should be coordinated with the client's legal counsel beforehand

If the financial statements show a trend of increased profit margin combined with an increase in the number of inventory turnover in days, _______.

A. inventory may be overstated

B. inventory may be understated

C. inventory may be becoming obsolete

D. inventory turnover to payables should increase also

An important rights and obligations issue _______.

A. deals with senior managements potential ownership of inventory

B. involves consignment inventory

C. deals with inventory that has been sold in the normal course of business

D. deals with the valuation of inventory on the income statement

Tests of inventory controls often involve _______.

A. observing the client's controls and reperforming the client's controls

B. observing the auditor's controls and reperforming the client's controls

C. observing the client's controls and reperforming the auditor's controls

D. determining that the inventory is correctly valued on the statement of cost of goods sold

In the case of a merchandiser, the company_______.

A. purchases inventory with the intention of reselling

B. manufactures its own inventory

C. is service-based, and retains no inventory

D. is not part of the value chain

The assertions pertaining to inventory typically tested by the auditor are _______.

A. cutoff, existence, disclosure

B. rights and obligations, disclosure, going concern

C. completeness, valuation, cutoff

D. completeness, existence, valuation, and rights & obligations

The auditor needs to be attuned to _______.

A. changes in an audit client, and tailor the audit to the circumstances that the auditor finds

B. changes in an auditor, and tailor the audit to the circumstances that the auditor finds

C. the results of firms in other industries, and how they compare to the client

D. certain profitability ratios only

The computer manufacturing industry _______.

A. is subject to high inherent risk, and should be avoided by the auditor

B. is subject to technological obsolescence

C. is not subject to technological obsolescence

D. is very profitable for the auditor due to high inherent risk and the greater extent of needed audit procedures

The auditor should be alert to cutoff problems _______.

A. that might have resulted in overstating inventory

B. that might have resulted in correct inventory balances

C. which relate to revenues being valued improperly

D. which relate to expenses being misclassified

The inherent risk of material misstatement arising from inventory transactions for a hotel chain or a university is relatively_______.

A. high, because inventory is not a material part of the entity’s core process

B. low, because inventory is not a material part of the entity’s core process

C. low, because inventory is a material part of the entity’s core process

D. high, because inventory is a material part of the entity’s core process

With a manufacturer, wholesaler, or retailer, _______.

A. inventory is not typically a major part of a client's assets, and thus is not audited

B. inherent risk for inventory may be assessed at or near the minimum

C. inherent risk for inventory may be assessed at or near the maximum

D. inventory is typically a major part of a client's assets, and thus is not audited

With a manufacturer, wholesaler, or retailer, inherent risk for inventory may be assessed at or near the maximum due to _______.

A. a large volume of inventory purchases

B. a wide diversity of inventory items

C. inventories being stored at multiple sites

D. All of these answer choices are correct.

Many elements of valuing inventory _______.

A. should be handled by the internal auditors

B. involve professional judgment and accounting estimates

C. involve professional judgment and strict accounting rules

D. should be ignored by the auditor due to complicated valuation issues

Many of the controls over inventory _______.

A. overlap with other cycles

B. work in isolation

C. are typically redundant, and should not be tested by the auditor

D. are tested by the internal audit function, and can be ignored by the external auditor

A perpetual inventory system _______.

A. involves counting inventory at period end because inventory is not tracked during the year

B. keeps track of the quantity of each item in inventory and where it is located.

C. is not allowed as part of US GAAP

D. should be used for overseas inventories only

The value of goods available for sale consists of _______.

A. beginning inventory plus purchases

B. ending inventory minus purchases

C. calculating the inventory turnover ratio for the period

D. calculating days sales in inventory for the period

Cost of goods sold is determined by calculating _______.

A. beginning inventory plus purchases

B. beginning inventory minus ending inventory

C. value of goods available for sale minus ending inventory

D. value of goods available for sale plus ending inventory

If ending inventory is overstated, _______.

A. cost of goods sold will be understated

B. cost of goods sold will be overstated

C. beginning inventory will be correctly valued

D. the value of purchases will be understated

If ending inventory is understated, _______.

A. cost of goods sold will also be understated

B. cost of goods sold will be overstated

C. accounts receivable balances will be overstated

D. accounts payable balance will be understated

Consigned inventory held by the client, _______.

A. should be listed as an asset by the client

B. should appear on the client's balance sheet

C. should not be listed by the client because the client does not legally own the consigned goods

D. should be listed as part of cost of goods sold by the client

The auditor should be alert to _______.

A. incentives and pressures that may motivate management to misstate inventory

B. incentives and pressures that may motivate management to correctly state the value of inventory

C. sound policies relating to inventory management

D. a relatively stable inventory turnover ratio

Weak internal control over inventory _______.

A. may lead to decreased theft of inventory by employees

B. may lead to increased theft of inventory by employees

C. will automatically mean the inventory balance is misstated

D. will serve to decrease inherent risk related to inventory

An inventory markdown by a client _______.

A. could indicate obsolescence

B. is required every three years as part of GAAP

C. means the client has violated the accounting principle of conservatism

D. is not the responsibility of the auditor to check

The audit strategy pertaining to inventory is highly dependent _______.

A. upon senior management

B. upon the internal audit function

C. on the client's system of internal controls

D. upon the client's legal counsel

In tracing beginning inventory balances to prior year working papers, _______.

A. the auditor should make certain that any audit adjustments agreed upon in the prior year did in fact get recorded

B. the auditor should make certain that any audit adjustments agreed upon in the subsequent years did in fact get recorded

C. the auditor should be mindful of the relationship between inventory sales and accounts payable

D. the auditor should be mindful of the relationship between inventory sales and notes payable

The application of substantive analytical procedures to inventories _______.

A. should be conducted by the internal audit function, as this is an area of lower inherent risk

B. should be conducted by the internal audit function, as this is an area of higher inherent risk

C. uses management's knowledge of the entity and its environment to develop expectations about the financial statements

D. uses the auditor’s knowledge of the entity and its environment to develop expectations about the financial statements

Controls over fixed asset balances often include _______.

A. physical controls over fixed liabilities as well as the maintenance of a fixed asset inventory that is periodically checked against existing assets

B. physical controls over current assets as well as the maintenance of a fixed asset inventory that is periodically checked against existing assets

C. physical controls over fixed assets as well as the maintenance of a fixed asset inventory that is periodically checked against existing assets

D. ensuring all assets are recorded at fair value, and not historical cost

While conducting which type of inventory count will the client frequently identify a small portion of items in the perpetual inventory, count actual inventory, and investigate discrepancies?

A. Cycle

B. Perpetual

C. Virtual

D. Accuracy

Which of the following is usually determined by taking the book value of beginning inventory, adding purchases or production costs, and subtracting the book value of ending inventory?

A. Cost of goods sold

B. Cost of goods purchased

C. Cost of total assets

D. Cost of total deliverables

Which of the following is sent by its owner to an agent who undertakes to sell the goods?

A. Consignment inventory

B. Testing Inventory

C. Disclosure inventory

D. Auditing inventory

Investing activities include _______.

A. the sale of land, buildings, equipment, and other long-term assets not generally held for resale

B. the purchase and sale of land, buildings, equipment, and other long-term assets generally held for resale

C. the purchase and sale of land, buildings, equipment, and other long-term assets not generally held for resale

D. any issuance of bonds and proceeds from sales of stock

Plant assets should be _______.

A. classified as current assets if the intention is to sell them

B. listed as a liability if the assets are financed

C. relatively stable and grow at approximately the rate of sales growth

D. relatively stable and grow at a higher rate than the rate of sales growth

An entity acquires property, plant and equipment assets _______.

A. because they support its operations and core processes

B. to hold for resale at a higher price

C. because they support its ancillary operations and processes

D. as tax write-offs only

Most businesses will acquire new assets if _______.

A. the rate of return generated by those assets is lower than the after-tax marginal cost of debt financing associated with acquiring additional assets

B. the rate of return generated by those assets exceeds the after-tax marginal cost of debt financing associated with acquiring additional assets

C. they have surplus amounts of cash which they need to spend

D. their stockholders vote to do so

The first step in auditing investing activities _______.

A. involves understanding the assets that are needed to support the entity’s operations

B. involves understanding the assets that are needed to support the entity’s sales

C. involves understanding the assets that are needed to support the entity’s compliance with debt covenants

D. is to issue a preliminary audit opinion

The second step in auditing investing activities _______.

A. is to confirm the auditors issued opinion

B. involves determining what assets were disposed of during the period

C. involves determining what assets were acquired during the period

D. involves contacting the client's prior auditor to assist with geographically dispersed locations

Usually the growth in fixed assets should _______.

A. demonstrate a consistent relationship with the growth in revenues, accounting for some startup period

B. demonstrate an inconsistent relationship with the growth in revenues, accounting for some startup period

C. be unrelated to revenue

D. be unrelated to expenses such as cost of goods sold

Substantive tests of property, plant and equipment often focus on _______.

A. Agreeing the beginning balance in property, plant and equipment to the prior year’s audit

B. Auditing the acquisition of new property, plant and equipment

C. Auditing the disposal of property, plant and equipment

D. All of these answer choices are correct.

When an auditor develops a business-based approach to auditing property, plant and equipment, _______.

A. it is not necessary to understand how the long-term assets support the operations of the entity

B. it is essential to understand how the long-term assets support the operations of the entity

C. the auditor recommends which assets to sell and keep

D. the auditor attempts to find competitors who are willing to buy certain of the client's assets

The auditor will often look at how the entity is growing in order to determine_______.

A. the likelihood of being paid for the audit

B. the assets needed to support that growth

C. which assets the client should keep

D. which assets the client should sell

It is important to develop a good understanding of the audit client in order to _______.

A. develop expectations regarding the client's financial statements

B. develop expectations regarding payment for fees earned by the auditor

C. ensure the auditor will be employed in subsequent years by the client

D. help ensure inherent risk is high

Analytical procedures are required _______.

A. by management

B. by the internal auditors

C. as part of risk assessment

D. in order to eliminate risk

Which of the following include(s) the purchase and sale of land, buildings, equipment, and other long-term assets not generally held for resale?

A. Investing activities

B. Property ownership

C. Real estate ownership

D. Ownership activities

Which of the following is the purpose of the auditor’s test of repair and maintenance expense to determine the propriety and consistency of these charges?

A. Review Entries to Repairs and Maintenance Expense.

B. Vouch Plant Asset Disposals.

C. Year-end statement

D. Auditing year transactions.

Fixed assets and key locations are important for which of the following categories?

A. Supermarkets and other grocery stores

B. Hotels and motels

C. College, Universities and other professional school.

D. Real estates

As part of the auditor’s responsibilities with respect to evaluating whether an entity is a going concern,

A. the auditor will attempt to obtain written assurances from management to this effect

B. substantive testing and procedures will likely be extended over common stock and additional paid-in capital accounts

C. the auditor will evaluate the entity’s ability to generate sufficient debt to meet commitments regarding interest expenses, debt maturities, and debt covenants

D. the auditor will evaluate the entity’s ability to generate sufficient cash flow to meet commitments regarding interest expenses, debt maturities, and debt covenants

Financing activities typically include _______.

A. selling to customers

B. acquisition and retirement of debt

C. acquiring shares of stock in another company

D. related party transactions between senior management and the company

Financing activities typically include which of the following?

A. Retirement of debt

B. Selling to customers

C. Acquisition of a building for resale

D. Acquisition of a building to be used for core business operations

The population of debt and equity instruments _______.

A. is typically large in terms of the number of instruments

B. is typically small in terms of the number of instruments

C. is usually of no concern to the auditor

D. should all carry the same interest rates

When an auditor performs risk assessment activities and develops a business-based approach to auditing financing activities, _______.

A. the auditor should be prepared to make recommendations pertaining to which arrangements should be refinanced

B. it is essential to understand how the entity chooses an investing strategy, and the types of financial instruments used by the entity

C. it is essential to understand how the entity chooses a financing strategy, and the types of financial instruments used by the entity

D. it is essential to understand how the entity chooses to finance an operating strategy, and the types of financial instruments used by the entity

With respect to financing activities, _______.

A. there continues to be significant variation from industry to industry

B. there continues to be little variation from industry to industry

C. there should be no deviation between industries

D. the auditor should attempt to confirm all financing activity transactions with the firm's stockholders

With respect to financing activities, an auditor should understand _______.

A. how a company plans to sell its long-term assets

B. how a company plans to fund the acquisition of long-term assets

C. that this area lacks inherent risk, thus can be ignored

D. that this area is handled by the internal audit function, and thus should defer the audit procedures to them

When an auditor finds that a client has engaged in significant new debt or equity transactions, the auditor should_______.

A. be prepared to study a significant volume of legal documents related to the financing transaction in order to determine the impact of any legal requirements

B. be prepared to study a small volume of legal documents related to the financing transaction in order to determine the impact of any legal requirements

C. be prepared to study a significant volume of legal documents related to the operating transaction in order to determine the impact of any legal requirements

D. attempt to obtain additional written representations from management to increase the assurance level

Which of the following functions and related control activities are associated with the financing process?

A. Authorizing bonds and capital stock

B. Paying bond interest and cash dividends

C. Redeeming and reacquiring bonds and capital stock

D. All of these answer choices are correct.

A bond trustee _______.

A. is appointed by the auditor to sell the client's bonds

B. is usually a commercial bank or a trust company that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture

C. is usually a regular bank or a trust company that is given fiduciary powers by a bond issuer to enforce the terms of a bond indenture

D. does not assist the client in selling its bonds under any circumstances

A transfer agent is _______.

A. a trust company, bank, or similar financial institution assigned by a corporation to maintain records of investors and account balances

B. responsible for handling the client's foreign currency exchanges

C. responsible for handling the client's banks foreign currency exchanges

D. seldom used by a publicly traded client due to prohibitive costs

If an entity is a public company, the auditor will most likely _______.

A. not feel the need to test the client’s controls

B. will test controls and follow a higher assessed level of control risk approach

C. will test controls and follow a lower assessed level of control risk approach

D. outsource the testing of controls to the internal audit function

Which of the following activities include transactions and events whereby cash is obtained from or repaid to creditors or owners?

A. Financing activities

B. Investment activities

C. Auditing activities

D. Risk assessment activities

Which of the following formulas is used to calculate the ratio of interest-bearing debt to total assets?

A. Interest bearing rate/total assets

B. Interest bearing rate * total assets

C. Interest bearing rate * debt

D. Interest bearing rate/100 * total assets

Which of the following formulas is used to calculate the dividend payout rate?

A. Cash dividends/net income

B. Cash dividends * net income

C. Cash dividends − net income

D. Average total assets − total dividends

Question Type: Text Entry

A _______ refers to a bank statement for the period subsequent to the date of the balance sheet that the client requests the bank to send directly to the auditor.

bank cutoff statement

A _______ company purchases inventory for resale, as opposed to manufacturing it themselves

Merchandising | merchandising

A regular independent comparison of perpetual records with actual inventory can be done if _______ are inflated.

inventory counts

Controls over the disposition of assets should include specific _______ controls for the sale, or trade-in, of fixed assets

Authorization | Authorization

_______ is the formula applied to find out the ratio of total asset turnover.

Net sales/average total assets

If the auditor knows changes that have occurred in _______ activities, changes in financing activities often are predictable

Investing | investing

A _______ is a trust company, bank, or similar financial institution assigned by a corporation to maintain records of investors and account balances.

transfer agent

Question Type: Drop down

In the given table, match the concepts related to cash balance on the left with their details on the right.

A. Bank cutoff statement

||It is a bank statement for the period subsequent to the date of the balance sheet that the client requests the bank to send directly to the auditor.

B. Proof of cash

||It is usually performed when fraud risk is high.

C. Testing bank reconciliation

||It establishes the correct cash in bank balance at the balance sheet date.

D. Testing cutoff

||It is essential to the proper statement of cash at the balance sheet date.

A bank cutoff statement is a bank statement for the period subsequent to the date of the balance sheet that the client requests the bank to send directly to the auditor.

A proof of cash is usually performed when fraud risk is high.

Testing bank reconciliation establishes the correct cash in bank balance at the balance sheet date.

Testing cutoff is essential to the proper statement of cash at the balance sheet date.

In the given table, match the analytical procedure ratios on the left with their audit significance on the right.

A. Finished goods produced to raw material used

||This ratio is useful in estimating the efficiency of the manufacturing process.

B. Finished goods produced to direct labor

||This ratio is useful in estimating the efficiency of the manufacturing process.

C. Product defects per million

||This ratio is useful in estimating the effectiveness of the manufacturing process.

D. Inventory turnover days

||This ratio combined with knowledge of cost of sales can be useful in estimating current inventory levels.

The ratio of finished goods produced to raw material used is useful in estimating the efficiency of the manufacturing process.

The ratio of finished goods produced to direct labor is useful in estimating the efficiency of the manufacturing process.

Product defects per million is useful in estimating the effectiveness of the manufacturing process.

Inventory turnover days combined with knowledge of cost of sales can be useful in estimating current inventory levels.

In the given table, match the left of the table with the statements on the right-hand side of table.

A. Review Provisions for Depreciation

||In this test, the auditor seeks evidence on the reasonableness, consistency, and accuracy of depreciation charges for the period.

B. Inspect Plant Assets

||Enables the auditor to obtain direct personal knowledge of the existence of plant assets.

C. Confirm if assets have been pledged as collateral for loans

||It is possible that assets may be pledged even though invoices for the purchase of property, plant and equipment might be marked "paid.

D. Impairment of Property, Plant and Equipment

||Exists when the cost of a long-lived asset, or group of assets, exceeds its fair value and is not recoverable.

In the given table, match the concepts on the left of the table with their details on the right.

A. Financing activities

||They include acquiring debt, capital leases, issuing bonds, and issuing preferred or common stock.

B. Analytical procedures

||They assist the auditor in evaluating the reasonableness of the financial statements.

C. Significant inherent risks

||They involve proper accounting for interest rate swaps and classification of equity instruments that behave like debt.

D. Initial procedures

||They are applicable to long-term debt balances.

Financing activities include acquiring debt, capital leases, issuing bonds, and issuing preferred or common stock.

Analytical procedures assist the auditor in evaluating the reasonableness of the financial statements.

Significant inherent risks involve proper accounting for interest rate swaps and classification of equity instruments that behave like debt.

Initial procedures are applicable to long-term debt balances.

Question Type: Multiple choice multi select

Which of the following should be done by the auditor on receipt of the cutoff statement?

A. Tracing a sample of all checks dated in the prior year to the outstanding checks listed on the bank reconciliation

B. Vouch a sample of deposits in transit on the bank reconciliation to deposits on the cutoff statement

C. Scan the cutoff statement and enclosed data for unusual items

D. Consider performing a proof of cash

• 1. Trace a sample of all checks dated in the prior year to the outstanding checks listed on the bank reconciliation.
  2. Vouch a sample of deposits in transit on the bank reconciliation to deposits on the cutoff statement.
  3. Scan the cutoff statement and enclosed data for unusual items.

Which of the following are inventory controls used when inventory counts are inflated?

A. A regular independent comparison of perpetual records with actual inventory

B. Accurate recording of all scrap transactions or spoilage

C. Auditing of bank transfers

D. Processing of accounts receivables

Which three of the following are account balance assertions?

A. The completeness of inventory

B. The existence of inventory

C. The valuation of inventory and the allocation of costs to cost of goods sold

D. Purchases related to inventory

Which of the following procedures may be useful to the auditor in determining whether all retirements have been recorded?

A. Analyzing the miscellaneous revenue accounts for proceeds from sales of plant assets.

B. Investigating the disposition of facilities associated with discontinued product lines and operations.

C. Reviewing insurance policies for termination or reductions of coverage.

D. Making inquiry of investors about retirements.

• 1. Analyzing the miscellaneous revenue accounts for proceeds from sales of plant assets.
  2. Investigating the disposition of facilities associated with discontinued product lines and operations.
  3. Reviewing insurance policies for termination or reductions of coverage.

Which three of the following analytical procedures are commonly used to audit long term debt?

A. Shareholders’ equity to total assets

B. Interest bearing debt to total assets

C. Return on common equity

D. Comparing return on assets with shareholders’ equity

• 1. Shareholders’ equity to total assets
  2. Interest bearing debt to total assets
  3. Return on common equity

Question Type: Short Answer

Identify whether the following tests are tests of controls, substantive analytical procedures, tests of details of transactions, or tests of details of account balances:

1) Select a sample of customer receivables and send positive confirmations to each one of those customers

2) Select a sample of entries in sales journal and trace each to the shipping documents

3) Compute receivable turnover and compare with previous years

4) Compare the dates on a sample of sales invoices with the dates of shipment and the dates they were recorded in the sales journal 

Answe:

1) Tests of details of account balances

2) Tests of details of transactions

3) Substantive analytical procedures

4) Tests of details of transactions

Explain the importance of observing physical inventory during an audit. 

Inventory is typically a large account on the financial statements, especially for manufacturing and retail companies. Examining physical inventory primarily provides evidence that the inventory does exist, but it can also provide evidence for the rights and obligations and valuation assertions. It is also a generally accepted auditing procedure.

You are auditing ZZ Top Inc., which has a December 31^st year-end.

On December 24^th, the person responsible for processing receiving reports and recording the receipt of inventory became ill and was out of the office for a week.

Due to the company's small staff and the holiday season, a number of the receiving reports were not processed on a timely basis.

As an auditor, on which assertion would you place a high importance for this client and how would you test for it? 

A. The cutoff assertion would be very important in this situation. The risk of inventory transactions being recorded in the wrong period is very high. To test for misstatements, the auditor should trace a sample of receiving reports before and after year-end to ensure that the inventory was recorded in the proper period.

For each of the following tests of details, state whether it is a test of details of account balances or whether it is a test of details of disclosures. 

1. Inspect loan agreements under which an entity's inventories are pledged.

2. Review inventory compilation for proper classification among raw materials, work in process and finished goods.

3. Observe the count of physical inventory.

4. Trace test counts and tag control information to the inventory compilation.

5. Inquire of management about issues related to LIFO liquidations.

6. Review book-to-physical adjustments for possible misstatements. 

• 1. Disclosures  (Occurrence, Rights and obligations)
  2. Disclosures  (Classification and understandability)
  3. Account balances (Existence)
  4. Account balances  (Completeness, Valuation and allocation)
  5. Disclosures (Accuracy, Valuation)
  6. Account balances (Valuation and allocation)

List three substantive tests of details of transactions that can be performed over Plant, Property, and Equipment (PP&E), and identify the relevant assertion for each test.

Artwork Gallery has current year total assets of $1,000,000 and prior year total assets of $800,000.  Artwork Gallery has current year debt of $600,000, compared to $400,000 prior year.  The industry debt to assets ratio is approximately 35%.  Calculate the debt to assets ratio for the current year and prior year and explain the significance for the Artwork Gallery audit.

Solution:

Current year debt to assets = $600,000 / $1,000,000 = 60%

Prior year debt to assets = $400,000 / $800,000 = 50%

Debt to assets provides a reasonableness of the entity’s proportion of debt that may be compared with prior years’ experience or industry data.  In this case, the debt to assets ratio is higher than the industry average of 35% and increased over the prior year.  The auditors would need to investigate the reason for the increase to determine if there is a potential misstatement.

Explain how the audit strategy for financing activities would differ for a public company vs. a small private company with a limited number of debt and equity transactions.

Solution: Audit strategy is often determined by the nature of the entity and the complexity of the entity’s transactions.  If the entity is a public company, the auditor will test controls and follow a lower assessed level of control risk approach.   If the entity is not a public company, and debt and equity transactions are limited in number and straight forward, the auditor will often follow a primarily substantive approach after understanding the controls that the entity has placed in operation.  

Question Type: Drag and Drop

_______ formula can be used to find out the ratio of Return on common Shareholder’s equity.

[[Net income - preferred dividends/average common shareholders’ equity]] | Net income- preferred dividends/total fixed asset | Net income/total sale | Total income*total assets

A _______ reconciles not only the ending balance but also cash receipts transactions between the accounting records and the bank?

[[ Proof of cash]] | Asset transaction | year-end statement | Auditing year transaction

_______ can be done if inventory is not recorded.

[[ Investigation of negative balances in inventory records]] | Investigation of bank solution | Writing-off bad debts | Offering sales discounts

In the _______ assertion, inherent risk is often high because assets are usually pledged as collateral for underlying debt.

[[ rights and obligations]] | valuation and allocation | completeness | existence

While _______, transactions are executed in accordance with board of director’s authorizations and treasury stock certificates are physically safeguarded.

[redeeming and reacquiring bonds and capital stock] | authorizing bonds and capital stock | issuing bonds and capital stock | paying bond interest and cash dividends