Auditing & Assurance Services 6th Edition Test Bank - Timothy Louwers

Auditing & Assurance Services 6th Edition Test Bank – Timothy Louwers

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Title : Auditing & Assurance Services

Author : Timothy Louwers

Edition : 6th Edition

Type : TestBank

Product Description

Auditing & Assurance Services 6th Edition Test Bank – Timothy Louwers

Auditing & Assurance Services 6th Edition Test Bank – Timothy Louwers

Sample

Chapter 10
Finance and Investment Cycle

True / False Questions

1. The document that indicates what property plant and equipment the company wants to purchase in a given year is the cash flow forecast.

True False

2. Sales of capital stock and debt financing transactions usually are authorized by Cheif financial officer.

True False

3. All companies use a registrar to keep track of stock certificates issued and outstanding.

True False

4. Documenting ownership of bonds can be handled by a registrar and transfer agent.

True False

5. The board of directors authorizes and executes all investment purchases and sales.

True False

6. Investment transactions list on the monthly statement from the broker should be vouched to the broker’s advice, proper authorization, and the cash accounts.

True False

7. The most significant inherent risk in the fiancé and investment cycle is the proper presentation of items on the balance sheet.

True False

8. The counting of stock certificates held by the company must be done after the balance sheet date to ensure the investments exist at the balance sheet date.

True False

9. Auditors’ test of controls over the production of estimates amounts is limited to a comparison of past estimates compared to actual amounts.

True False

10. In order to check for unrecorded loans in the finance and investment cycle, auditors should search for large cash transactions in the cash receipts journal.

True False

11. When stock is used in exchange for tangible assets, the auditor should inspect the assets to ensure the assets exist.

True False

12. Dividends received from stock investments can be verified by examing the company’s cash receipts journal.

True False

13. An important test for unrecorded debt is to compare the interest expense accounts with long-term debt.

True False

14. When fixed assets are acquired during the year under audit, auditors should inspect the assets.

True False

15. Bank confirmation requests should only include balances for cash accounts.

True False

16. A CUSIP number is used to identify loans taken from a bank.

True False

17. A derivative instrument is designed to remove risk of adverse price movements from a transaction.

True False

18. An indenture is the written agreement between the bond issuer and the bondholder.

True False
Multiple Choice Questions

19. The typical business activity of the finance and investment cycle would not include

A. proposals for cash forecasts, capital budgets, and business expansion.

B. analysis of excess cash funds.

C. reconciliation of cash.

D. sale of stocks, bonds, or notes.
20. Selecting a sample of paid notes and tracing interest to the general ledger account is a test of the PCAOB assertion for

A. accounting.

B. valuation or allocation.

C. completeness.

D. existence or occurrence.
21. The typical assertions related to investments and related accounts would not include the PCAOB assertion that

A. capitalized intangible costs relate to intangibles acquired in exchange transactions.

B. amortization is properly calculated.

C. research and development costs are properly classified.

D. goodwill is valued at market value.
22. The decision of a company to have a transfer agent handle exchanges of shares is related primarily to which of the functional responsibilities?

A. Rights and obligations.

B. Custody.

C. Record keeping.

D. Periodic reconciliation.
23. ABC Company has issued a bond that pays 5% interest semiannually to bond holders on record June 30 and December 30. Payments are made on July 15 and January 15. ABC Company has a December 31 fiscal year-end. The auditor vouches the January 15, 2010 payment to the liabilities recorded on the December 31, 2009 balance sheet. Which of the following ASB balance assertions is the auditor testing?

A. Existence.

B. Rights and obligations.

C. Completeness.

D. Valuation.
24. Auditors count investment securities held by the client primarily to test the ASB balance assertion of

A. existence.

B. rights and obligations.

C. completeness.

D. valuation.
25. Which of the following is not a substantive audit procedure for estimates of management?

A. Recalculating the mathematical estimate.

B. Observing whether estimates are prepared by qualified personnel.

C. Developing an independent estimate based on alternative assumptions.

D. Comparing the estimates of management to subsequently discovered facts before the end of fieldwork.
26. Which of the following would not be a place in which owners’ equity transactions would be documented?

A. Capital budget.

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

C. Proxy statements.

D. Securities offering registration statements.
27. If it would be appropriate to confirm capital stock, the auditor would obtain the confirmation from

A. management.

B. the board of directors.

C. stockholders.

D. an independent registrar.
28. In Case 10.4 (No Treasure in This Treasure Planet), Disney overvalued net assets by capitalizing unrecoverable production costs. The lesson for the auditors in this case was to

A. always recalculate the client’s figures regardless of how simple they appear.

B. maintain professional skepticism when evaluating clients’ estimates.

C. always look into the background of the client before accepting an engagement.

D. none of the above.
29. Which ASB balance assertion is of the most importance to auditors for long-term liabilities?

A. Existence.

B. Completeness.

C. Rights and obligations.

D. Valuation.
30. “Are interest payments and accruals monitored for due dates and financial statement dates?” is an internal control questionnaire item that is related to the ASB transaction assertion of

A. occurrence.

B. completeness.

C. cutoff.

D. accuracy.
31. Which of the following would not be a typical feature of management’s control over the production of estimates?

A. Accumulation of relevant, sufficient, and reliable data.

B. Preparation of estimates by qualified personnel.

C. Review by the independent auditor.

D. Consideration by management of whether particular accounting estimates are consistent with the company’s operational plans.
32. Which of the following management assertions for long-term liabilities is related to the ASB balance assertion of completeness?

A. All material long-term liabilities are recorded.

B. New long-term liabilities and debt extinguishments are properly authorized.

C. Terms, conditions, and restrictions relating to noncurrent debt are adequately disclosed.

D. Disclosures of maturities for the next five years are accurate and adequate.
33. The preferred method of determining fair value of transactions is

A. market-based values.

B. basing them on reasonable management assumptions.

C. external auditor estimates.

D. detailed computations by outside experts.
34. Derivative instruments include

A. stocks.

B. preferred stocks.

C. stock options.

D. all the above.
35. A transfer agent

A. keeps the stockholder list and, from time to time, determines the shareholders eligible to receive dividends.

B. handles the exchange of shares, canceling the shares surrendered by sellers and issuing new certificates.

C. records notes and bonds payable.

D. makes investment decisions for an entity.
36. In the audit of notes payable, an auditor testing the ASB balance assertion of accuracy and valuation most likely would

A. read directors’ and finance committee’s minutes for authorization of financing transactions.

B. select a sample of paid notes and trace interest expense to the general ledger account.

C. select a sample of paid notes and recalculate interest expense for the period under audit.

D. select a sample of notes payable and vouch cash receipt to the bank statement.
37. To determine whether facts support management’s intent to hold securities to maturity, an auditor might

A. study the entity’s cash flow forecasts.

B. obtain published market quotations.

C. compare fair value of the securities to cost.

D. confirm that the securities are held by a broker.
38. Which of the following controls would be most effective in ensuring that the proper custody of assets in the investing cycle is maintained?

A. Direct access to securities in the safety deposit box is limited to only one corporate officer.

B. Personnel who post investment transactions to the general ledger are not permitted to update the investment subsidiary ledger.

C. The purchase and sale of investments are executed on the specific authorization of the board of directors.

D. Independent personnel periodically compare the recorded balances in the investment subsidiary ledger with the contents of the safety deposit box.
39. In auditing long-term bonds payable, an auditor most likely would

A. perform analytical procedures on the bond premium and discount accounts.

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.
40. 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 the ASB presentation and disclosure assertion of

A. occurrence.

B. completeness.

C. rights and obligations.

D. understandability.
41. In auditing intangible assets, an auditor most likely would review or recompute amortization and determine whether the amortization period is reasonable in support of the ASB balance assertion of

A. valuation.

B. existence.

C. completeness.

D. rights and obligations.
42. In confirming with an outside agent, such as a financial institution, that the agent is holding investment securities in the client’s name, an auditor most likely gathers evidence in support of ASB balance assertion of existence and

A. valuation.

B. rights and obligations.

C. completeness.

D. accuracy.
43. The focus of controls in the finance and investment cycle is on

A. proper authorizations and competent personnel.

B. computer controls over transactions.

C. physical security of assets.

D. prenumbered documents.
44. The focus of substantive tests in the finance and investment cycle is on

A. reconciliation of detailed listings with general ledger amounts.

B. proper cut-off.

C. search for unrecorded items.

D. gaining an understanding and verifying amounts and calculations.
45. Compensating controls in the finance and investment cycle

A. feature separation of duties by upper management.

B. feature involvement of two or more persons handling all important responsibilities.

C. include involvement by the external auditor.

D. include all the above.
46. Which of the following is not a relevant aspect of internal controls over estimates?

A. External auditor involvement in developing assumptions.

B. Adequate review by appropriate levels of authority.

C. Comparison of prior estimates with subsequent results.

D. All the above are relevant aspects of internal controls over estimates.
47. Loan covenants

A. describe the collateral of the loan.

B. require the borrower to maintain certain financial characteristics.

C. describe the lender’s responsibilities.

D. include all the above.
48. Related party transactions

A. must be valued as if they were arm’s length.

B. must be assumed to be valued differently than if they were arm’s length.

C. must be disclosed in the financial statements.

D. must be disclosed in the financial statements and the auditor’s report.
49. Taking a “big bath” in the financial statements refers to

A. overstating income.

B. overstating revenues.

C. understating income.

D. an economic downturn.
50. Keeping track of securities owners for payment of interest or dividends is usually done by the company’s

A. treasurer.

B. broker.

C. transfer agent.

D. registrar.
51. Records of stock and bond certificates are usually maintained by the company’s

A. treasurer.

B. chief financial officer.

C. transfer agent.

D. registrar.
52. Tests of controls in the finance and investment cycle

A. normally focus on tests of transactions.

B. primarily involve observing physical security of assets.

C. typically amount to inquiries and observations related to management involvement.

D. can significantly reduce the extent of substantive tests.
53. Documentation of a count of equity securities should include all of the following except

A. interest rate.

B. serial numbers.

C. number of shares.

D. market value.
54. Which of the following is not an estimate required in the finance and investment cycle?

A. Actuarial assumptions for pension accruals.

B. Residual values for leases.

C. Stated market value of publicly traded stocks.

D. All the above are estimates.
55. Appropriate audit inquiries regarding estimates include all of the following except:

A. Who prepares the estimates?.

B. Why are they prepared?.

C. What data are used?.

D. When are they prepared?.
56. Which of the following is not an off-balance-sheet item?

A. Purchase commitment.

B. Capitalized lease.

C. Loan commitment.

D. Synthetic lease.
57. 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.
58. Loan covenants are used for which of the following reasons?

A. To protect the lender from the borrower substantially weakening the borrower’s financial position.

B. To protect the borrower from the lender calling the loan early.

C. To protect the auditors from false information by the borrower.

D. To protect shareholders from management taking on too much debt.
59. 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.
60. 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. Performing 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.
61. 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 securities.
62. 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 if it is substantially the same as the rates for similar issues.

C. decide whether the bond issue was made without violating state or local law.

D. ascertain that the client has obtained the opinion of counsel on the legality of the issue.
63. 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.
64. 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 balance sheet.

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 balance sheet separately show a charge equal to the amount of the loss.
65. 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 prepaid interest expense.

C. ascertain the reasonableness of imputed interest.

D. detect unrecorded liabilities.
66. 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 locations.

D. acknowledge the receipt of securities returned.
67. 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 reissuance 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.
68. 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.
69. 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. numbered stock certificates.
70. 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.

D. dividends received from investments.
71. 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 a bank safe deposit vault under the custodian’s exclusive control.
72. An audit team would most likely verify the interest earned on bond investments by

A. vouching the receipt and deposit of interest 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.
73. 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.
74. 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. classification as available-for-sale or trading securities.

D. valuation of trading securities.
75. In auditing for unrecorded long-term bonds payable, an audit team most likely will

A. perform analytical procedures on the bond premium and discount accounts.

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.
76. 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.
77. 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 continued existence?

B. Are two or more authorized signatures required on checks that repay notes payable?

C. Are the proceeds from notes payable used for the purchase of noncurrent assets?

D. Are direct borrowings on notes payable authorized by the board of directors?
78. 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. existence.

B. valuation.

C. completeness.

D. classification.
79. Which of the following audit procedures would not likely be performed for audits of investments?

A. Read board of directors’ minutes for authorization of investment strategies.

B. Confirm investments with registrar.

C. Confirm investments with broker or trustee.

D. Compare valuation to published market prices.
80. 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. 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.
81. ABC Company has 100 shares of IBM stock that is held 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. There was unauthorized buying and selling of investment securities.

C. The securities may be misclassified on the balance sheet.

D. The securities were no longer owned by ABC Company.
82. The typical business activity in the financing and investment cycle that requires an accounting entry is

A. short- and long-term forecast.

B. meeting with investment bankers.

C. proposal to board of directors for investing excess monies.

D. investment of excess funds in temporary or long-term securities.
83. If a company keeps investments in a bank safe deposit box, which of the following two people ideally should have access to the safe deposit box?

A. A director and the president.

B. The president and vice president for finance.

C. A director and vice president for finance.

D. A director and general ledger accountant.
84. Selecting a sample of notes payable transactions and vouching payments to canceled checks is a test of the ASB balance assertion of

A. accuracy.

B. completeness.

C. existence.

D. presentation.
85. The typical assertion relating to investments and related accounts in a manufacturing company would not include the assertion that

A. all investments are valued at cost.

B. investment securities are on hand or held in safekeeping by a trustee.

C. investment income has been received and recorded.

D. investments are adequately classified and described in the balance sheet, including disclosures.
86. In an audit test of recorded interest expense and accrued interest, the auditor was able to detect that the recorded interest expense was higher than the calculations showed. This may indicate

A. a failure to accrue interest occurred.

B. interest payments are in default.

C. interest payments were charged to another account.

D. interest was paid on an unknown debt or unrecorded liability.
87. When auditing the market value of an investment, an auditor would be least likely to

A. examine quoted market prices.

B. evaluate management’s procedure for determining market prices.

C. make his or her own determination of market prices.

D. confirm market prices with a broker.
88. When a company keeps its own stock records, which of the following procedures is not required?

A. Confirm outstanding common stock with stock registrar agent.

B. Inspect the stock record stubs for certificate numbers and number of shares.

C. Inspect the unissued certificates.

D. Obtain written representation about the number of shares issued and outstanding.
89. Which of the following is not a typical assertion relating to owners’ equity?

A. The number of shares shown as issued is in fact issued.

B. The accounting is proper for options, warrants, and other stock issue plans, and related disclosure is adequate.

C. All owners’ equity transactions have been authorized by the board of directors.

D. The valuation of shares issued for noncash consideration is reflected at book value.
90. When auditing the valuation assertion of an equity method investment, which of the following is the auditor most likely to do?

A. Inspect stock certificates.

B. Obtain audited financial statements of the investee company.

C. Obtain the market price of the stock as of year-end.

D. Review management’s calculations.
91. An agent of a bond issuer who handles the administrative aspects of a loan and ensures that the borrower complies with the terms of the bond indenture is called a

A. registrar.

B. transfer agent.

C. trustee.

D. none of the above.

Fill in the Blank Questions

92. A ___________________________ approved by the board of directors constitutes the authorization for capital asset acquisitions and investments.

________________________________________

93. _________________________________ transactions are obligations and commitments that are not required to be recorded.

________________________________________

94. A _____________________________ is a financial institution appointed to record the issuance and ownership of company securities.

________________________________________

95. A _________________________ handles the exchange of shares, canceling the shares surrendered by sellers and issuing new certificates to buyers.

________________________________________

96. Records of interest rates and bonds payable are maintained by the _____________________________ and the ____________________________.

________________________________________

97. Capital stock may be subject to _____________________________ when independent registrars and transfer agents are employed.

________________________________________

98. The responsibility for financing and investment transactions is basically in the hands of _____________________________________.

________________________________________

99. A ______________________________ is a control feature relied upon when a standard internal control procedure is not in place.

________________________________________

100. An ___________________________________ is an approximation of a financial statement element, item, or account.

________________________________________

101. _______________________________ is responsible for making estimates and should have a _____________________________ and _____________________________ designed to reduce the likelihood of material misstatements in them.

________________________________________

102. When circumstances call for extended procedures, information on outstanding stock may be ________________________________________________.

________________________________________

103. The ASB balance assertion of _____________________________ is paramount in the verification of long-term liabilities and determination that all liabilities are recorded.

________________________________________

104. The confirmation of notes payable to banks may use the _____________________________________ confirmation.

________________________________________

105. Investment accounting may be on the _____________________________ method, _____________________________ method, or _____________________________ method.

________________________________________

106. __________________________________ of securities can prevent the use of company securities as _____________________________ for personal loans.

________________________________________

107. The primary audit concern with the verification of long-term liabilities is that all _________________ are recorded and that the ___________________ is properly paid or ____________.

________________________________________
Matching Questions

108. This question relates to off-balance-sheet commitments. Match the type of commitment with the typical procedures and sources of evidence.

1. Vouching of sales contracts; inquiry of sales personnel; confirmation by customer Commitments to sell at fixed prices ____
2. Vouching of contracts; confirmation by customer; inquiry of client management Loan commitments (as by a financial institution) ____
3. Vouching of open commitment file; inquiry of loan officers Repurchase or remarketing agreements ____
4. Vouching of open purchase orders; inquiry of purchasing personnel; confirmation by supplier Commitments to purchase at fixed prices ____
5. Vouching of lease agreement; confirmation with lessor or lessee Lease commitments ____

Short Answer Questions

109. For each of the internal contro1 questions for notes payable, indicate by letter the related ASB transaction assertion. Answers may be used more than once.

110. XYZ Company has investment securities held by a broker. An auditor is reviewing the last broker’s statement for the year. For each of the tests 1-5, select the ASB balance assertions listed in A-D that the auditor is testing.

 

Essay Questions

111. What are “off-balance-sheet” financing transactions? Explain and provide two or more examples.

112. What is a compensating control? Describe what type of compensating controls might be implemented in the finance and investment cycle.

113. According to auditing standards, specific relevant aspects of an internal control system for making estimates include:

• Management communication of the need for proper accounting estimates.
• Accumulation of relevant, sufficient, and reliable data for estimates.
• Preparation of estimates by qualified personnel.
• Adequate review and approval by appropriate levels of authority.
• Comparison of prior estimates with subsequent results to assess the reliability of the estimation outcomes.
• Consideration by management of whether particular accounting estimates are consistent with the company’s operational plans.

Required:

a. How would the auditor test these control activities over the production of estimates?
b. What substantive audit procedures would the auditor use to test the accounting estimates?

114. Interest expense related to interest-bearing liabilities could be audited using analytical procedures. Describe how this might be done and how the results would be used.

115. Red Corporation had a temporary cash squeeze near its balance-sheet date. It needed cash badly for a seasonal dip in sales. However, a loan covenant requiring a certain debt/equity ratio would be violated if any additional money were borrowed. To remedy this, the top two officers of the Corporation set up another corporation, Pink Inc., Red made a large sale of inventory to Pink at cost. Pink used the inventory as collateral for a three-month loan from a local bank. The money from the loan was used to pay Red for the accounts receivable resulting from the “sale.” The officers intended to have Red buy back the inventory from Pink at the end of the three-month period at a price that would allow Pink to pay off the loan plus interest.

Required:

a. How would this transaction designed by the two officers enable Red to maintain its required debt/equity ratio while obtaining the cash it needed?
b. What tests of controls and substantive tests would enable an auditor to detect this scheme?

116. Mike is the controller at Huskie Supply Company. Huskie Supply has an investment account with DT National Brokerage. Mike is authorized to call the broker and initiate trades on behalf of the company. Mike’s son goes to MEU (Most Expensive University) and Mike has a CD with the money for this year’s tuition. MEU changed the tuition due date such that the tuition came due 30 days before Mike’s CD matured. Mike would lose a large amount of interest if he cashed in the CD early, and a loan from the bank was not possible (Mike is already over extended), and interest on a credit card advance would be 28%.

Mike authorized DT National Brokerage to sell one of the company’s investments and send the check to his attention at the company. Mike paid the tuition and 30 days later, when the CD came due Mike repurchased the investment with the broker. In fact, the stock had dropped $3 and mike made a profit of $900.

A) Define the internal control weakness that allowed the situation to exist – if any;
B) One (and only one) specific internal controls that should be in place to prevent or detect the problem; and.
C) One (and only one) test of control audit procedure.
D) One (and only one) substantive audit procedure that may detect the situation described.

Consider each item separately – no credit will be given for generic controls (e.g. policies and procedures; separation of duties (without specifics); discuss with management.
Chapter 10 Finance and Investment Cycle Answer Key

True / False Questions

1. The document that indicates what property plant and equipment the company wants to purchase in a given year is the cash flow forecast.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Topic: Finance and Investment Cycle: Typical Activities

2. Sales of capital stock and debt financing transactions usually are authorized by Cheif financial officer.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Topic: Finance and Investment Cycle: Typical Activities

3. All companies use a registrar to keep track of stock certificates issued and outstanding.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Topic: Finance and Investment Cycle: Typical Activities

4. Documenting ownership of bonds can be handled by a registrar and transfer agent.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Topic: Finance and Investment Cycle: Typical Activities

5. The board of directors authorizes and executes all investment purchases and sales.

FALSE

AACSB: Reflective Thinking
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Topic: Control Risk Assessment

6. Investment transactions list on the monthly statement from the broker should be vouched to the broker’s advice, proper authorization, and the cash accounts.

TRUE

AACSB: Reflective Thinking
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Topic: Control Risk Assessment

7. The most significant inherent risk in the fiancé and investment cycle is the proper presentation of items on the balance sheet.

FALSE

AACSB: Reflective Thinking
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Topic: Control Risk Assessment

8. The counting of stock certificates held by the company must be done after the balance sheet date to ensure the investments exist at the balance sheet date.

FALSE

AACSB: Reflective Thinking
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Topic: Control Risk Assessment

9. Auditors’ test of controls over the production of estimates amounts is limited to a comparison of past estimates compared to actual amounts.

FALSE

AACSB: Reflective Thinking
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Topic: Control Risk Assessment

10. In order to check for unrecorded loans in the finance and investment cycle, auditors should search for large cash transactions in the cash receipts journal.

TRUE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Topic: Financing Activities: Assertions and Substantive Procedures

11. When stock is used in exchange for tangible assets, the auditor should inspect the assets to ensure the assets exist.

TRUE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Topic: Financing Activities: Assertions and Substantive Procedures

12. Dividends received from stock investments can be verified by examing the company’s cash receipts journal.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Topic: Finance and Investment Cycle: Typical Activities

13. An important test for unrecorded debt is to compare the interest expense accounts with long-term debt.

TRUE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Topic: Finance and Investment Cycle: Typical Activities

14. When fixed assets are acquired during the year under audit, auditors should inspect the assets.

TRUE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Topic: Financing Activities: Assertions and Substantive Procedures

15. Bank confirmation requests should only include balances for cash accounts.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Topic: Financing Activities: Assertions and Substantive Procedures

16. A CUSIP number is used to identify loans taken from a bank.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Topic: Financing Activities: Assertions and Substantive Procedures

17. A derivative instrument is designed to remove risk of adverse price movements from a transaction.

FALSE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Topic: Financing Activities: Assertions and Substantive Procedures

18. An indenture is the written agreement between the bond issuer and the bondholder.

TRUE

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Topic: Finance and Investment Cycle: Typical Activities
Multiple Choice Questions

19. The typical business activity of the finance and investment cycle would not include

A. proposals for cash forecasts, capital budgets, and business expansion.

B. analysis of excess cash funds.

C. reconciliation of cash.

D. sale of stocks, bonds, or notes.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

20. Selecting a sample of paid notes and tracing interest to the general ledger account is a test of the PCAOB assertion for

A. accounting.

B. valuation or allocation.

C. completeness.

D. existence or occurrence.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

21. The typical assertions related to investments and related accounts would not include the PCAOB assertion that

A. capitalized intangible costs relate to intangibles acquired in exchange transactions.

B. amortization is properly calculated.

C. research and development costs are properly classified.

D. goodwill is valued at market value.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

22. The decision of a company to have a transfer agent handle exchanges of shares is related primarily to which of the functional responsibilities?

A. Rights and obligations.

B. Custody.

C. Record keeping.

D. Periodic reconciliation.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

23. ABC Company has issued a bond that pays 5% interest semiannually to bond holders on record June 30 and December 30. Payments are made on July 15 and January 15. ABC Company has a December 31 fiscal year-end. The auditor vouches the January 15, 2010 payment to the liabilities recorded on the December 31, 2009 balance sheet. Which of the following ASB balance assertions is the auditor testing?

A. Existence.

B. Rights and obligations.

C. Completeness.

D. Valuation.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

24. Auditors count investment securities held by the client primarily to test the ASB balance assertion of

A. existence.

B. rights and obligations.

C. completeness.

D. valuation.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

25. Which of the following is not a substantive audit procedure for estimates of management?

A. Recalculating the mathematical estimate.

B. Observing whether estimates are prepared by qualified personnel.

C. Developing an independent estimate based on alternative assumptions.

D. Comparing the estimates of management to subsequently discovered facts before the end of fieldwork.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

26. Which of the following would not be a place in which owners’ equity transactions would be documented?

A. Capital budget.

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

C. Proxy statements.

D. Securities offering registration statements.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

27. If it would be appropriate to confirm capital stock, the auditor would obtain the confirmation from

A. management.

B. the board of directors.

C. stockholders.

D. an independent registrar.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

28. In Case 10.4 (No Treasure in This Treasure Planet), Disney overvalued net assets by capitalizing unrecoverable production costs. The lesson for the auditors in this case was to

A. always recalculate the client’s figures regardless of how simple they appear.

B. maintain professional skepticism when evaluating clients’ estimates.

C. always look into the background of the client before accepting an engagement.

D. none of the above.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-04 Describe common errors and frauds in the accounting for investment and financing transactions and investments; and design audit procedures for detecting them.
Source: Original
Topic: Fraud Cases: Extended Audit Procedures

29. Which ASB balance assertion is of the most importance to auditors for long-term liabilities?

A. Existence.

B. Completeness.

C. Rights and obligations.

D. Valuation.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

30. “Are interest payments and accruals monitored for due dates and financial statement dates?” is an internal control questionnaire item that is related to the ASB transaction assertion of

A. occurrence.

B. completeness.

C. cutoff.

D. accuracy.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

31. Which of the following would not be a typical feature of management’s control over the production of estimates?

A. Accumulation of relevant, sufficient, and reliable data.

B. Preparation of estimates by qualified personnel.

C. Review by the independent auditor.

D. Consideration by management of whether particular accounting estimates are consistent with the company’s operational plans.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

32. Which of the following management assertions for long-term liabilities is related to the ASB balance assertion of completeness?

A. All material long-term liabilities are recorded.

B. New long-term liabilities and debt extinguishments are properly authorized.

C. Terms, conditions, and restrictions relating to noncurrent debt are adequately disclosed.

D. Disclosures of maturities for the next five years are accurate and adequate.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

33. The preferred method of determining fair value of transactions is

A. market-based values.

B. basing them on reasonable management assumptions.

C. external auditor estimates.

D. detailed computations by outside experts.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

34. Derivative instruments include

A. stocks.

B. preferred stocks.

C. stock options.

D. all the above.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

35. A transfer agent

A. keeps the stockholder list and, from time to time, determines the shareholders eligible to receive dividends.

B. handles the exchange of shares, canceling the shares surrendered by sellers and issuing new certificates.

C. records notes and bonds payable.

D. makes investment decisions for an entity.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

36. In the audit of notes payable, an auditor testing the ASB balance assertion of accuracy and valuation most likely would

A. read directors’ and finance committee’s minutes for authorization of financing transactions.

B. select a sample of paid notes and trace interest expense to the general ledger account.

C. select a sample of paid notes and recalculate interest expense for the period under audit.

D. select a sample of notes payable and vouch cash receipt to the bank statement.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

37. To determine whether facts support management’s intent to hold securities to maturity, an auditor might

A. study the entity’s cash flow forecasts.

B. obtain published market quotations.

C. compare fair value of the securities to cost.

D. confirm that the securities are held by a broker.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

38. Which of the following controls would be most effective in ensuring that the proper custody of assets in the investing cycle is maintained?

A. Direct access to securities in the safety deposit box is limited to only one corporate officer.

B. Personnel who post investment transactions to the general ledger are not permitted to update the investment subsidiary ledger.

C. The purchase and sale of investments are executed on the specific authorization of the board of directors.

D. Independent personnel periodically compare the recorded balances in the investment subsidiary ledger with the contents of the safety deposit box.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: AICPA
Topic: Finance and Investment Cycle: Typical Activities

39. In auditing long-term bonds payable, an auditor most likely would

A. perform analytical procedures on the bond premium and discount accounts.

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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

40. 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 the ASB presentation and disclosure assertion of

A. occurrence.

B. completeness.

C. rights and obligations.

D. understandability.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

41. In auditing intangible assets, an auditor most likely would review or recompute amortization and determine whether the amortization period is reasonable in support of the ASB balance assertion of

A. valuation.

B. existence.

C. completeness.

D. rights and obligations.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

42. In confirming with an outside agent, such as a financial institution, that the agent is holding investment securities in the client’s name, an auditor most likely gathers evidence in support of ASB balance assertion of existence and

A. valuation.

B. rights and obligations.

C. completeness.

D. accuracy.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: AICPA
Topic: Control Risk Assessment

43. The focus of controls in the finance and investment cycle is on

A. proper authorizations and competent personnel.

B. computer controls over transactions.

C. physical security of assets.

D. prenumbered documents.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

44. The focus of substantive tests in the finance and investment cycle is on

A. reconciliation of detailed listings with general ledger amounts.

B. proper cut-off.

C. search for unrecorded items.

D. gaining an understanding and verifying amounts and calculations.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

45. Compensating controls in the finance and investment cycle

A. feature separation of duties by upper management.

B. feature involvement of two or more persons handling all important responsibilities.

C. include involvement by the external auditor.

D. include all the above.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

46. Which of the following is not a relevant aspect of internal controls over estimates?

A. External auditor involvement in developing assumptions.

B. Adequate review by appropriate levels of authority.

C. Comparison of prior estimates with subsequent results.

D. All the above are relevant aspects of internal controls over estimates.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: Original
Topic: Control Risk Assessment

47. Loan covenants

A. describe the collateral of the loan.

B. require the borrower to maintain certain financial characteristics.

C. describe the lender’s responsibilities.

D. include all the above.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

48. Related party transactions

A. must be valued as if they were arm’s length.

B. must be assumed to be valued differently than if they were arm’s length.

C. must be disclosed in the financial statements.

D. must be disclosed in the financial statements and the auditor’s report.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

49. Taking a “big bath” in the financial statements refers to

A. overstating income.

B. overstating revenues.

C. understating income.

D. an economic downturn.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-04 Describe common errors and frauds in the accounting for investment and financing transactions and investments; and design audit procedures for detecting them.
Source: Original
Topic: Fraud Cases: Extended Audit Procedures

50. Keeping track of securities owners for payment of interest or dividends is usually done by the company’s

A. treasurer.

B. broker.

C. transfer agent.

D. registrar.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

51. Records of stock and bond certificates are usually maintained by the company’s

A. treasurer.

B. chief financial officer.

C. transfer agent.

D. registrar.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

52. Tests of controls in the finance and investment cycle

A. normally focus on tests of transactions.

B. primarily involve observing physical security of assets.

C. typically amount to inquiries and observations related to management involvement.

D. can significantly reduce the extent of substantive tests.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: Original
Topic: Control Risk Assessment

53. Documentation of a count of equity securities should include all of the following except

A. interest rate.

B. serial numbers.

C. number of shares.

D. market value.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: Original
Topic: Control Risk Assessment

54. Which of the following is not an estimate required in the finance and investment cycle?

A. Actuarial assumptions for pension accruals.

B. Residual values for leases.

C. Stated market value of publicly traded stocks.

D. All the above are estimates.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

55. Appropriate audit inquiries regarding estimates include all of the following except:

A. Who prepares the estimates?.

B. Why are they prepared?.

C. What data are used?.

D. When are they prepared?.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

56. Which of the following is not an off-balance-sheet item?

A. Purchase commitment.

B. Capitalized lease.

C. Loan commitment.

D. Synthetic lease.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

57. 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: Original
Topic: Control Risk Assessment

58. Loan covenants are used for which of the following reasons?

A. To protect the lender from the borrower substantially weakening the borrower’s financial position.

B. To protect the borrower from the lender calling the loan early.

C. To protect the auditors from false information by the borrower.

D. To protect shareholders from management taking on too much debt.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

59. 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.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

60. 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. Performing 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

61. 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 securities.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

62. 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 if it is substantially the same as the rates for similar issues.

C. decide whether the bond issue was made without violating state or local law.

D. ascertain that the client has obtained the opinion of counsel on the legality of the issue.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

63. 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

64. 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 balance sheet.

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 balance sheet separately show a charge equal to the amount of the loss.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

65. 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 prepaid interest expense.

C. ascertain the reasonableness of imputed interest.

D. detect unrecorded liabilities.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

66. 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 locations.

D. acknowledge the receipt of securities returned.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

67. 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 reissuance 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: Original
Topic: Control Risk Assessment

68. 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

69. 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. numbered stock certificates.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

70. 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.

D. dividends received from investments.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

71. 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 a bank safe deposit vault under the custodian’s exclusive control.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-04 Describe common errors and frauds in the accounting for investment and financing transactions and investments; and design audit procedures for detecting them.
Source: AICPA
Topic: Fraud Cases: Extended Audit Procedures

72. An audit team would most likely verify the interest earned on bond investments by

A. vouching the receipt and deposit of interest 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

73. 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

74. 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. classification as available-for-sale or trading securities.

D. valuation of trading securities.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

75. In auditing for unrecorded long-term bonds payable, an audit team most likely will

A. perform analytical procedures on the bond premium and discount accounts.

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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

76. 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

77. 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 continued existence?

B. Are two or more authorized signatures required on checks that repay notes payable?

C. Are the proceeds from notes payable used for the purchase of noncurrent assets?

D. Are direct borrowings on notes payable authorized by the board of directors?
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: AICPA
Topic: Control Risk Assessment

78. 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. existence.

B. valuation.

C. completeness.

D. classification.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: AICPA
Topic: Financing Activities: Assertions and Substantive Procedures

79. Which of the following audit procedures would not likely be performed for audits of investments?

A. Read board of directors’ minutes for authorization of investment strategies.

B. Confirm investments with registrar.

C. Confirm investments with broker or trustee.

D. Compare valuation to published market prices.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

80. 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. 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.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

81. ABC Company has 100 shares of IBM stock that is held 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. There was unauthorized buying and selling of investment securities.

C. The securities may be misclassified on the balance sheet.

D. The securities were no longer owned by ABC Company.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

82. The typical business activity in the financing and investment cycle that requires an accounting entry is

A. short- and long-term forecast.

B. meeting with investment bankers.

C. proposal to board of directors for investing excess monies.

D. investment of excess funds in temporary or long-term securities.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

83. If a company keeps investments in a bank safe deposit box, which of the following two people ideally should have access to the safe deposit box?

A. A director and the president.

B. The president and vice president for finance.

C. A director and vice president for finance.

D. A director and general ledger accountant.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

84. Selecting a sample of notes payable transactions and vouching payments to canceled checks is a test of the ASB balance assertion of

A. accuracy.

B. completeness.

C. existence.

D. presentation.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

85. The typical assertion relating to investments and related accounts in a manufacturing company would not include the assertion that

A. all investments are valued at cost.

B. investment securities are on hand or held in safekeeping by a trustee.

C. investment income has been received and recorded.

D. investments are adequately classified and described in the balance sheet, including disclosures.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

86. In an audit test of recorded interest expense and accrued interest, the auditor was able to detect that the recorded interest expense was higher than the calculations showed. This may indicate

A. a failure to accrue interest occurred.

B. interest payments are in default.

C. interest payments were charged to another account.

D. interest was paid on an unknown debt or unrecorded liability.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

87. When auditing the market value of an investment, an auditor would be least likely to

A. examine quoted market prices.

B. evaluate management’s procedure for determining market prices.

C. make his or her own determination of market prices.

D. confirm market prices with a broker.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

88. When a company keeps its own stock records, which of the following procedures is not required?

A. Confirm outstanding common stock with stock registrar agent.

B. Inspect the stock record stubs for certificate numbers and number of shares.

C. Inspect the unissued certificates.

D. Obtain written representation about the number of shares issued and outstanding.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

89. Which of the following is not a typical assertion relating to owners’ equity?

A. The number of shares shown as issued is in fact issued.

B. The accounting is proper for options, warrants, and other stock issue plans, and related disclosure is adequate.

C. All owners’ equity transactions have been authorized by the board of directors.

D. The valuation of shares issued for noncash consideration is reflected at book value.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

90. When auditing the valuation assertion of an equity method investment, which of the following is the auditor most likely to do?

A. Inspect stock certificates.

B. Obtain audited financial statements of the investee company.

C. Obtain the market price of the stock as of year-end.

D. Review management’s calculations.
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

91. An agent of a bond issuer who handles the administrative aspects of a loan and ensures that the borrower complies with the terms of the bond indenture is called a

A. registrar.

B. transfer agent.

C. trustee.

D. none of the above.
AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities
Fill in the Blank Questions

92. A ___________________________ approved by the board of directors constitutes the authorization for capital asset acquisitions and investments.

capital budget
Question also found in study guide

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

93. _________________________________ transactions are obligations and commitments that are not required to be recorded.

Off-balance-sheet financing
Question also found in study guide

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

94. A _____________________________ is a financial institution appointed to record the issuance and ownership of company securities.

registrar
Question also found in study guide

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

95. A _________________________ handles the exchange of shares, canceling the shares surrendered by sellers and issuing new certificates to buyers.

transfer agent
Question also found in study guide

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

96. Records of interest rates and bonds payable are maintained by the _____________________________ and the ____________________________.

accounting department; CFO (or controller)
Question also found in study guide

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

97. Capital stock may be subject to _____________________________ when independent registrars and transfer agents are employed.

confirmation
Question also found in study guide

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Remember
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

98. The responsibility for financing and investment transactions is basically in the hands of _____________________________________.

senior management officials
Question also found in study guide

AACSB: Analytic
AICPA: BB Industry
AICPA: FN Risk Analysis
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

99. A ______________________________ is a control feature relied upon when a standard internal control procedure is not in place.

compensating control
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: AICPA
Topic: Control Risk Assessment

100. An ___________________________________ is an approximation of a financial statement element, item, or account.

accounting estimate
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

101. _______________________________ is responsible for making estimates and should have a _____________________________ and _____________________________ designed to reduce the likelihood of material misstatements in them.

Client’s management; process; controls
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

102. When circumstances call for extended procedures, information on outstanding stock may be ________________________________________________.

confirmed directly with the stockholders
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

103. The ASB balance assertion of _____________________________ is paramount in the verification of long-term liabilities and determination that all liabilities are recorded.

completeness
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

104. The confirmation of notes payable to banks may use the _____________________________________ confirmation.

standard bank
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

105. Investment accounting may be on the _____________________________ method, _____________________________ method, or _____________________________ method.

cost; equity; consolidation
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

106. __________________________________ of securities can prevent the use of company securities as _____________________________ for personal loans.

Proper custodial control; collateral
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

107. The primary audit concern with the verification of long-term liabilities is that all _________________ are recorded and that the ___________________ is properly paid or ____________.

liabilities; interest expense; accrued
Question also found in study guide

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: AICPA
Topic: Control Risk Assessment
Matching Questions

108. This question relates to off-balance-sheet commitments. Match the type of commitment with the typical procedures and sources of evidence.

1. Vouching of sales contracts; inquiry of sales personnel; confirmation by customer Commitments to sell at fixed prices 1
2. Vouching of contracts; confirmation by customer; inquiry of client management Loan commitments (as by a financial institution) 3
3. Vouching of open commitment file; inquiry of loan officers Repurchase or remarketing agreements 2
4. Vouching of open purchase orders; inquiry of purchasing personnel; confirmation by supplier Commitments to purchase at fixed prices 4
5. Vouching of lease agreement; confirmation with lessor or lessee Lease commitments 5
AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures
Short Answer Questions

109. For each of the internal contro1 questions for notes payable, indicate by letter the related ASB transaction assertion. Answers may be used more than once.

1. B; 2. A; 3. B; 4. C

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Source: Original
Topic: Control Risk Assessment

110. XYZ Company has investment securities held by a broker. An auditor is reviewing the last broker’s statement for the year. For each of the tests 1-5, select the ASB balance assertions listed in A-D that the auditor is testing.

1. A; 2. B; 3. D; 4. D; 5. C

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures
Essay Questions

111. What are “off-balance-sheet” financing transactions? Explain and provide two or more examples.

“Off-balance-sheet” financing transactions exist when companies enter into obligations and commitments that are not required to be recorded in the accounts. Examples are leases, endorsements on discounted notes or on other companies’ obligations, letters of credit, guarantees, repurchase or remarketing agreements, commitments to purchase at fixed prices, commitments to sell at fixed prices, and certain kinds of stock options.

AACSB: Analytic
AICPA: BB Legal
AICPA: FN Research
Blooms: Understand
Difficulty: 3 Hard
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

112. What is a compensating control? Describe what type of compensating controls might be implemented in the finance and investment cycle.

A compensating control is a control activity that is used when a standard control activity is not in place or is not operating effectively at a company. In the finance and investment cycle, upper-level management is normally involved in making decisions. Therefore, the traditional separation of duties is difficult to employ. In this cycle, a common compensating control would be to have two or more persons involved in each kind of important functional responsibility. If involvement of multiple persons is not specified, then oversight or review can be substituted instead.

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Source: Original
Topic: Finance and Investment Cycle: Typical Activities

113. According to auditing standards, specific relevant aspects of an internal control system for making estimates include:

• Management communication of the need for proper accounting estimates.
• Accumulation of relevant, sufficient, and reliable data for estimates.
• Preparation of estimates by qualified personnel.
• Adequate review and approval by appropriate levels of authority.
• Comparison of prior estimates with subsequent results to assess the reliability of the estimation outcomes.
• Consideration by management of whether particular accounting estimates are consistent with the company’s operational plans.

Required:

a. How would the auditor test these control activities over the production of estimates?
b. What substantive audit procedures would the auditor use to test the accounting estimates?

a. An auditor would primarily use inquiries and observations to test controls over the production of estimates. Such inquires would include determining who prepares estimates, when are they prepared, what data are used, who reviews and approves the estimates, have you compared prior estimates with subsequent actual events? Observations include the study of (1) data documentation, (2) comparisons of prior estimates with subsequent actual experience, and (3) intercompany correspondence concerning estimates and operational plans.
b. Beyond tests of controls, substantive audit procedures include recalculating the mathematical estimate, developing an auditor’s own independent estimate based on alternative assumptions, and comparing the estimate to subsequently discovered facts to the extent they are known before the end of the fieldwork.

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Control Risk Assessment
Topic: Financing Activities: Assertions and Substantive Procedures

114. Interest expense related to interest-bearing liabilities could be audited using analytical procedures. Describe how this might be done and how the results would be used.

For interest-bearing liabilities, interest expense can normally be recalculated based on information about the liability. The amount of debt, interest rate, and the time the liability is outstanding during the audit period are used to determine whether the interest expense and accrued interest are properly recorded. By comparing the audit results to the recorded amount, the auditor can determine the reasonableness of the recorded amount. If the amounts are equal, the auditor would normally be satisfied that interest is materially correct. If the calculated amount is more or less than the recorded amount, additional audit work would be required.

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Financing Activities: Assertions and Substantive Procedures

115. Red Corporation had a temporary cash squeeze near its balance-sheet date. It needed cash badly for a seasonal dip in sales. However, a loan covenant requiring a certain debt/equity ratio would be violated if any additional money were borrowed. To remedy this, the top two officers of the Corporation set up another corporation, Pink Inc., Red made a large sale of inventory to Pink at cost. Pink used the inventory as collateral for a three-month loan from a local bank. The money from the loan was used to pay Red for the accounts receivable resulting from the “sale.” The officers intended to have Red buy back the inventory from Pink at the end of the three-month period at a price that would allow Pink to pay off the loan plus interest.

Required:

a. How would this transaction designed by the two officers enable Red to maintain its required debt/equity ratio while obtaining the cash it needed?
b. What tests of controls and substantive tests would enable an auditor to detect this scheme?

a. By devising this transaction as a sale at cost, the result was to obtain the cash without recording the liability. The cash replaced the inventory on the balance sheet, thus maintaining the same debt/equity ratio. If the proper entry were made, both assets and liabilities would increase, which would also increase the debt/equity ratio.
b. For tests of controls, an auditor would inquire about any large or unusual financing transactions. Because this transaction was large, it might also have been detected in test of controls procedures in the revenue and collection cycle.
For substantive tests, analytical procedures would detect the large unexpected amount of sales in this typically low period of sales. Inquiry about related-party transactions might also provoke a response about this transaction. Due to the large amount of the transaction, analysis of accounts receivable and subsequent collections may also have brought this transaction to the auditor’s attention.

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Control Risk Assessment
Topic: Finance and Investment Cycle: Typical Activities
Topic: Financing Activities: Assertions and Substantive Procedures

116. Mike is the controller at Huskie Supply Company. Huskie Supply has an investment account with DT National Brokerage. Mike is authorized to call the broker and initiate trades on behalf of the company. Mike’s son goes to MEU (Most Expensive University) and Mike has a CD with the money for this year’s tuition. MEU changed the tuition due date such that the tuition came due 30 days before Mike’s CD matured. Mike would lose a large amount of interest if he cashed in the CD early, and a loan from the bank was not possible (Mike is already over extended), and interest on a credit card advance would be 28%.

Mike authorized DT National Brokerage to sell one of the company’s investments and send the check to his attention at the company. Mike paid the tuition and 30 days later, when the CD came due Mike repurchased the investment with the broker. In fact, the stock had dropped $3 and mike made a profit of $900.

A) Define the internal control weakness that allowed the situation to exist – if any;
B) One (and only one) specific internal controls that should be in place to prevent or detect the problem; and.
C) One (and only one) test of control audit procedure.
D) One (and only one) substantive audit procedure that may detect the situation described.

Consider each item separately – no credit will be given for generic controls (e.g. policies and procedures; separation of duties (without specifics); discuss with management.

Format your answer in the following manner

Weakness: Separation of duties – Mike executes transactions and receives the custody of the asset i.e. the check.

Control:

• Money should be electronically transferred to the Huskie Supply’s cash account.
• Broker account has instructions only to send checks to the cash receipts department.
• Brokerage advises send to an individual not involved in investment transactions.

Control Audit Procedure:

• Vouch trades to the Board of Directors minutes.
• Reconciliation of monthly brokerage statements by someone independent of investment transactions.

Substantive Audit Procedure:

• Trace stock sale proceeds from brokerage accounts to bank statement.

AACSB: Analytic
AICPA: BB Critical Thinking
AICPA: FN Risk Analysis
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 10-01 Describe the finance and investment cycle; including typical source documents and controls.
Learning Objective: 10-02 Give examples of tests of control activities over debt and stockholders’ equity transactions and investment transactions.
Learning Objective: 10-03 Describe substantive testing procedures for finance and investment accounts.
Source: Original
Topic: Control Risk Assessment
Topic: Finance and Investment Cycle: Typical Activities
Topic: Financing Activities: Assertions and Substantive Procedures

Auditing & Assurance Services 6th Edition Test Bank – Timothy Louwers

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