Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

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Title : Auditing: A Risk-Based Approach to Conducting a Quality Audit

Author : Karla Johnstone – Audrey Gramling – Larry E. Rittenberg

Edition : 9th Edition

Type : TestBank

Product Description

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

 

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

 

SAMPLE

Chapter 13: Auditing Debt Obligations and Stockholders’ Equity Transactions

Student: ___________________________________________________________________________

  1. Valuation is a relevant assertion when auditing premiums or discounts on bonds.
    True    False

 

  1. The potential dilutive effect of convertible debt or preferred stock, stock options, and warrants should be disclosed in accordance with relevant accounting guidance in computing primary and fully diluted earnings per share.
    True    False

 

  1. Relevant accounts when auditing stockholders’ equity include leasehold improvements.
    True    False

 

  1. Bonds are issued to finance major expansions or to refinance existing debt.
    True    False

 

  1. The auditor is primarily concerned with overstatement when auditing bonds.
    True    False

 

  1. An organization typically has many debt transactions during the year, with each individual transaction being material.
    True    False

 

  1. A bond premium/discount amortization spreadsheet can be used to help assure that the bond is appropriately valued and disclosed in the financial statements.
    True    False

 

  1. Typically, the most relevant assertion related to debt obligations is existence.
    True    False

 

  1. Inherent risks related to debt obligations primarily concern the authorization of debt, receipt of funds, recording debt transactions, and compliance with any debt covenants.
    True    False

 

  1. Existence is the most relevant assertion associated with an inherent risk for treasury stock transactions recorded in the wrong period.
    True    False

 

  1. Valuation is the most relevant assertion associated with an inherent risk for the cost of treasury stock  that is subsequently retired and not properly allocated among the appropriate accounts.
    True    False

 

  1. When an auditor is investigating the inherent risk associated with stock issuances/sales that are recorded in the wrong period, the auditor is most likely assessing the risks of material misstatements associated with the existence assertion.
    True    False

 

  1. Presentation and disclosure is the most relevant audit assertion associated with the inherent risk of using inaccurate periods of service for stock options.
    True    False

 

  1. Completeness is the most relevant assertion associated with an inherent risk for dividends that are recorded and paid before being declared.
    True    False

 

  1. Rights/obligations is the most relevant audit assertion associated with an inherent risk for finding stock options or warrants being granted without being properly approved.
    True    False

 

  1. A potential fraud risk associated with debt obligations is the intentional misclassification of short-term debt as long-term debt.
    True    False

 

  1. If an auditor discovers that a company intentionally applied loan payments to interest rather than principal, this would result in fraudulent overstatement of income.
    True    False

 

  1. As part of brainstorming activities, the auditor might identify possible fraudulent transactions related to stockholders’ equity accounts that are the result of charging expenses directly to retained earnings rather than to the appropriate expense accounts.
    True    False

 

  1. Auditing standards require the auditor to identify and assess the risks of material misstatement due to fraud at the financial statement level only.
    True    False

 

  1. Once the auditor has obtained an understanding of the inherent and fraud risks of material misstatement associated with debt obligations and stockholders’ equity transactions, the auditor needs to understand the controls that the client has designed and implemented to address those risks.
    True    False

 

  1. A typical control for stockholders’ equity transactions is for the board of directors to approve all stock transactions (including options and warrants).
    True    False

 

  1. When identifying and assessing control risks of material misstatement associated with debt obligations and stockholders’ equity transactions, documentation is only required for integrated audits, not financial statement only audits.
    True    False

 

  1. Normally, an auditor can gain an understanding of internal controls by means of a walkthrough of the process, inquiry, observation, and review of the client’s documentation.
    True    False

 

  1. When documenting controls, the auditor can provide this documentation in various formats including a control matrix, a control risk assessment questionnaire, and/or a memo.
    True    False

 

  1. When planning the audit related to stockholders’ equity transactions, the auditor is not required to perform preliminary analytical procedures.
    True    False

 

  1. Trend analyses are typically used as preliminary analytical procedures related to debt obligations.
    True    False

 

  1. If preliminary analytical procedures do not identify any unexpected relationships related to debt obligations, the auditor would conclude that there is not a heightened risk of material misstatements in these accounts.
    True    False

 

  1. If there were unusual or unexpected relationships, the planned audit procedures (tests of controls, substantive procedures) would be adjusted to address the potential material misstatements.
    True    False

 

  1. When planning the audit related to debt obligations, the auditor should not have expectations as to the nature and magnitude of any account balance changes because they might bias the outcome of the audit.
    True    False

 

  1. Typically, when determining the appropriate audit procedures to perform for debt accounts, the auditor will usually decide to test debt obligations, including interest, using only substantive procedures.
    True    False

 

  1. Using substantive procedures to test debt obligations is most appropriate because there are a relatively large number of transactions involving immaterial dollar amounts.
    True    False

 

  1. A substantive approach using only tests of controls is most commonly used to audit equity accounts.
    True    False

 

  1. For both debt accounts and stockholders’ equity accounts, the boxes of evidence would typically be filled only with evidence obtained through substantive procedures.
    True    False

 

  1. When obtaining evidence about internal control operating effectiveness, the auditor will select only entity-wide controls for testing.
    True    False

 

  1. For integrated audits, a typical test of controls may include an inquiry of personnel performing the control.
    True    False

 

  1. For financial statement audit purposes, when auditing debt obligations and stockholders’ equity transactions, the auditor will most likely perform a substantive audit, and therefore will not perform tests of controls for the debt and equity accounts.
    True    False

 

  1. If the auditor identifies control deficiencies, the auditor will not need to judge the severity of the deficiencies but instead would consult management about the need for a fraud audit.
    True    False

 

  1. Confirmations are not substantive procedure designed to obtain evidence on the completeness of debt obligations.
    True    False

 

  1. Stockholders’ equity accounts will be tested with only substantive analytical procedures.
    True    False

 

  1. The transactions in the stockholders’ equity accounts are typically tested using a statistical sampling approach.
    True    False

 

  1. If interest expense recorded by the client is significantly lower than the auditor’s expectation, it may mean that interest payments have not been properly recorded, possibly having been charged to principal.
    True    False

 

  1. When performing a substantive analytical procedure related to interest expense, the auditor will likely not test the client’s internal controls.
    True    False

 

  1. A starting point for substantive tests of details on debt obligations is to have the client provide a cash flow statement.
    True    False

 

  1. For additions to debt, the auditor traces the proceeds into the cash receipts records and the bank statement.
    True    False

 

  1. To determine whether notes have been paid in full, the auditor would obtain the most appropriate evidence by examining the board of directors meeting minutes.
    True    False

 

  1. As a starting point for testing capital stock and equity transactions, the auditor should review a copy of the client’s articles of incorporation.
    True    False

 

  1. When auditing debt and equity transactions, the auditor should be skeptical, and therefore alert to the possibility, that management is managing earnings by not appropriately recording expenses, such as charging expenses directly to retained earnings or under-recording interest expense.
    True    False

 

  1. If the auditor identifies a risk of material misstatement due to fraud related to debt obligations or stockholders’ equity accounts, the auditor needs to determine the appropriate responses, potentially including changing the nature, timing, and extent of audit procedures.
    True    False

 

  1. Which of the following is the auditor’s primary objective when auditing debt obligations?
    A. Understatement of the debt obligation focusing on the completeness assertion.
    B. Proper valuation of bond premiums or bond discounts, including amortization valuation.
    C. Valuation of gains or losses on refinancing debt.
    D. Proper presentation and disclosure, including important restrictions contained in the debt obligations.

 

  1. Which of the following is not typically included in the audit of debt obligations?
    A. Interest expense.
    B. Interest income.
    C. Notes payable.
    D. Bonds payable.

 

  1. How are most bonds marketed?
    A. Through the board of directors.
    B. Through an underwriter.
    C. Through auditors.
    D. Through employees.

 

  1. Which of the following statements about bonds is false?
    A. They may be issued to finance major expansions.
    B. They may be issued to refinance existing debt.
    C. They account for many of the organization’s transactions.
    D. They are generally highly material to the financial statements.

 

  1. Which assertion is generally the most relevant when auditing the restrictions contained in debt obligations?
    A. Completeness.
    B. Valuation.
    C. Proper presentation and disclosure.
    D. Existence.

 

  1. Which of the following is not a common debt covenant restriction?
    A. Maintenance of a minimum level of retained earnings before dividends can be paid.
    B. Maintenance of a minimum working-capital ratio.
    C. Specification of a maximum debt-equity ratio.
    D. Specification of a minimum earnings per share.

 

  1. Which of the following is not a relevant account when auditing stockholders’ equity?
    A. Treasury stock.
    B. Dividends.
    C. Sinking fund for plant expansion.
    D. Retained earnings.

 

  1. Which of the following is not a common transaction affecting stockholders’ equity?
    A. The purchase of treasury stock.
    B. The declaration and payment of dividends.
    C. The exercises and expirations of stock options and warrants.
    D. Bond amortization.

 

  1. Which of the following results in a situation where an auditor has the least amount of difficulty in determining stock valuation?
    A. When stock is issued for land.
    B. When stock is exchanged for another business.
    C. When stock options are issued and exercises occur.
    D. When stock is issued for cash.

 

  1. How would an auditor generally measure the value of a stock option expense?
    A. Fair value.
    B. Appraised value
    C. By computing a weighted average value of all classes of stock authorized.
    D. All of these methods can be used.

 

  1. In auditing equity accounts, the auditor primarily focuses on which of the following two assertions?
    A. Valuation and completeness.
    B. Valuation and existence.
    C. Presentation and disclosure and valuation.
    D. Presentation and disclosure and completeness.

 

  1. When auditing the gains or losses on refinancing debt, the auditor primarily focuses on which assertion?
    A. Completeness.
    B. Existence.
    C. Valuation.
    D. Presentation and disclosure.

 

  1. When auditing the premium or discount on bonds (including amortization), the auditor primarily focuses on which assertion?
    A. Existence.
    B. Completeness.
    C. Presentation and disclosure
    D. Valuation.

 

  1. Which of the following would a bond indenture not provide information about?
    A. The time period before repayment.
    B. Whether the bond is convertible.
    C. Whether the bond is callable.
    D. The date the bond will be called.

 

  1. Which of the following would not typically be included as part of the balance sheet disclosures related to stockholders’ equity?
    A. Accumulated other comprehensive income
    B. Details on stock repurchases
    C. Price/earnings ratios for stock
    D. Prior period adjustments to retained earnings

 

  1. Which of the following is not an inherent risk typically associated with the existence of dividends?
    A. Dividends are recorded in the wrong period.
    B. Dividends are recorded before declared.
    C. Dividends are not properly amortized.
    D. Dividends have not been approved before being declared.

 

  1. Which of the following is not an inherent risk typically associated with debt covenant compliance issues?
    A. Whether debt covenants are calculated accurately.
    B. Whether debt payment transactions are properly initiated.
    C. Whether compliance with debt covenants is appropriately disclosed.
    D. Whether compliance with debt covenants is appropriately reviewed.

 

  1. Which of the following is not an inherent risk typically associated with recording debt transactions?
    A. Interest expense not being properly recorded.
    B. Failure to accrue interest expense.
    C. Debt not being properly classified.
    D. Debt not being properly authorized.

 

  1. The inherent risk of proceeds from stock sales not being received is most likely related to which of the following management assertions?
    A. Completeness.
    B. Presentation and disclosure.
    C. Valuation.
    D. Existence.

 

  1. An auditor determines that there is an inherent risk that all stock repurchased is not recorded as treasury stock. This determination is most likely tied to which of the following management assertions?
    A. Completeness.
    B. Presentation and disclosure.
    C. Valuation.
    D. Existence.

 

  1. An auditor determines that there is an inherent risk that dividends may be recorded and paid before being declared. This determination is most likely tied to which of the following management assertions?
    A. Completeness.
    B. Presentation and disclosure.
    C. Valuation.
    D. Existence.

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

  1. An auditor determines that there is an inherent risk that a company has not included both the basic earnings per share and diluted earnings per share amounts in financial statements even though significant dilutive securities are part of the company’s complex capital structure. This determination is most likely tied to which of the following management assertions?
    A. Valuation.
    B. Presentation and disclosure.
    C. Rights and obligations.
    D. Existence.

 

  1. An auditor determines that there is an inherent risk that stock options exercised or expired remain on the organization’s books. This determination is most likely tied to which of the following management assertions?
    A. Valuation.
    B. Presentation and disclosure.
    C. Rights and obligations.
    D. Existence.

 

  1. Which of the following is not a potential fraud related to debt obligations?
    A. Long-term or short-term debt is misclassified.
    B. Entire loan payments are charged to either principal or interest.
    C. Dividends are paid in violation of restrictive covenants.
    D. Debt obligations are not properly authorized.

 

  1. Which of the following is not a potential fraud related to stockholders’ equity accounts?
    A. Stock sales or issuances are not authorized.
    B. Entire loan payments are charged to either principal or interest.
    C. Dividends are paid in violation of restrictive covenants.
    D. Stock options are back-dated.

 

  1. What type of risk is intentional failure by management to accurately disclose violations of debt covenants?
    A. Inherent risk
    B. Fraud risk
    C. Control risk
    D. Detection risk.

 

  1. Which of the following statements is true regarding the identification and assessment of the risks of material misstatements by the auditor?
    A. Auditing standards require the auditor to identify and assess the risks of material misstatement due to fraud at the financial statement level.
    B. Auditing standards require the auditor to identify and assess the risks of material misstatement due to fraud at the assertion level.
    C. As part of brainstorming activities, the auditor should identify possible frauds that could occur.
    D. All of these statements are true.

 

  1. Which of the following would an auditor not typically perform as part of gaining an understanding of the client’s controls related to debt obligations?
    A. Review policies related to approval required for new debt.
    B. Inquire of management about the process for reviewing compliance with debt covenants.
    C. Review the client’s documentation of controls.
    D. Recalculate interest expense.

 

  1. In general, which of the following would an auditor not typically perform as part of gaining an understanding of the client’s controls?
    A. A walkthrough of the process.
    B. Inquiry.
    C. Observation.
    D. All of these are used to gain an understanding of the controls.

 

  1. Which of the following does an auditor consider when gaining an overall understanding of the client’s internal controls?
    A. Entity-wide controls at the account level only.
    B. Transaction controls at the account level only.
    C. Entity-wide controls at the assertion level only.
    D. Both entity-wide controls and transaction controls at the account and assertion levels.

 

  1. Which of the following would the auditor consider as part of the control environment related to debt obligations?
    A. Inquiry of trustee regarding the registration of current bondholders and distribution of interest payments.
    B. Recalculation of the underwriter’s commission.
    C. Independence of the board of directors with respect to long-term financing.
    D. Inspection of documentation to confirm refinancing of debt.

 

  1. Which of the following are entity-wide components of internal control that can mitigate the risk material misstatement related to debt obligations?
    A. Risk assessment.
    B. Information and communication.
    C. Monitoring controls.
    D. All of these are entity-wide components of internal control.

 

  1. Which of the following is a typical control for debt obligations?
    A. The board of directors approves all new debt.
    B. The stockholders approve all new debt.
    C. The CFO approves all new debt.
    D. Upper managers approve all new debt.

 

  1. Which of the following statements is typically not true regarding controls related to proper accounting for stock option grants?
    A. The proper accounting for stock option grants is researched by the organization’s accountant.
    B. The analysis of the accountant regarding stock option grants is reviewed by the CFO.
    C. The analysis of the accountant regarding stock option grants is reviewed by the organization’s legal counsel.
    D. The analysis of the accountant regarding stock option grants is reviewed by the board of directors.

 

  1. Which of the following statements is true regarding preliminary analytical procedures for debt obligations and stockholders’ equity transactions?
    A. Trend analysis would not typically be performed for debt obligations.
    B. The long-term debt to equity ratio could be considered by the auditor as part of the preliminary analytical procedures.
    C. Because there are typically only a few stockholders’ equity transactions, the auditor is not required to perform preliminary analytical procedures for stockholders’ equity accounts.
    D. If unusual or unexpected relationships are identified by preliminary analytical procedures, the auditor should stick with the original expectations of misstatements, because this could be an anomaly and bias the audit overall.

 

  1. Which of the following is not an example of typical analytical procedures related to debt obligations?
    A. Perform a trend analysis of the balances in notes payable, interest expense, and accrued interest with prior periods, considering known client activities related to debt.
    B. Calculate the total debt-to-equity ratio and perform a trend analysis with prior periods.
    C. Calculate the times interest earned ratio and perform a trend analysis with prior periods.
    D. Calculate the current ratio and perform a trend analysis with prior periods.

 

  1. Which of the following is not true regarding preliminary analytical procedures performed by the auditor when planning the audit?
    A. The primary preliminary analytical procedure for stockholders’ equity accounts is a comparison of current year account balances with prior year account balances.
    B. If there are unusual or unexpected relationships, the planned audit procedures would be adjusted to address the potential material misstatements.
    C. The auditor should have an expectation as to the nature and magnitude of any account balance changes.
    D. Auditors show focus on just the numbers when performing analytical procedures.

 

  1. Which of the following statements is true regarding the appropriate audit procedures to perform for debt and stockholder’s equity accounts?
    A. The auditor will usually decide to test debt obligations, including interest, using only substantive procedures.
    B. Testing debt obligations, including interest, is typically accomplished using only control procedures.
    C. When auditing stockholders’ equity transactions, the auditor commonly uses a control procedure approach, but uses only substantive procedures to test debt obligation transactions.
    D. None of these statements is true.

 

  1. Which of the following is not true about auditing stockholders’ equity transactions?
    A. The auditor usually uses a substantive approach.
    B. The number of equity transactions with outside parties is usually small.
    C. The dollar amount is usually immaterial.
    D. An approach using only tests of details is most commonly used to audit equity accounts.

 

  1. For integrated audits, when does the auditor test the operating effectiveness of important controls?
    A. As of the beginning of the client’s fiscal year.
    B. As of the client’s year end.
    C. As of the end of the second quarter of the client’s fiscal year.
    D. None of these answers is correct.

 

  1. Which of the following is not true regarding appropriate tests of controls?
    A. The auditor selects controls that are important to the auditor’s conclusion about whether the organization’s controls adequately address the assessed risk of material misstatement for the relevant debt and equity accounts.
    B. The client’s audit committee selects controls that are important to the auditor’s conclusion about whether the organization’s controls adequately address the assessed risk of material misstatement for the relevant debt and equity accounts.as of the client’s year end.
    C. The auditor will select both entity-wide and transaction controls for testing.
    D. If the auditor wants to rely on controls for the financial statement audit, the auditor would test the operating effectiveness of those controls throughout the year.

 

  1. If tests of controls result in identified control deficiencies, how will the auditor assess those deficiencies?
    A. By estimating interest expense based on average interest rates and average debt outstanding.
    B. By comparing current year account balances with prior year account balances.
    C. By determining their severity and the impact on the opinion of internal control effectiveness.
    D. By calculating the long-term debt-to-equity ratio and performing a trend analysis with prior periods.

 

  1. Which of the following is not a typical test of controls when auditing debt and equity transactions?
    A. Inquiry of personnel performing the control.
    B. Comparing current year account balances with prior year account balances.
    C. Observation of the control being performed.
    D. Reperformance of the control by the auditor testing the control.

 

  1. Which of the following procedures would be included in the auditor’s audit program for long-term debt?
    A. Investigation of credits to the bond interest income account.
    B. Inspection of the accounts payable master file.
    C. Verification of the existence of the bondholders.
    D. Review debt loan agreements.

 

  1. Which of the following is not true regarding the testing of transactions in the stockholders’ equity accounts?
    A. The transactions are typically tested on a 100% basis.
    B. The transactions are typically tested on a sampling basis.
    C. The number of transactions is typically small.
    D. Most of these transactions are highly material.

 

  1. When auditing debt obligations, which of the following is the primary substantive analytical procedure?
    A. Reading loan agreements.
    B. Developing an independent expectation of interest expense.
    C. Tracing bond proceeds to cash receipts.
    D. Confirming transactions with outside parties.

 

  1. Which of the following is the least important in helping the auditor develop an independent expectation of interest expense as a substantive analytical procedure?
    A. Determine average interest rates.
    B. Determine average debt outstanding.
    C. Examine disaggregated data by type of debt.
    D. Examine an interest revenue schedule.

 

  1. Which of the following will an auditor not perform when looking for additions to debt?
    A. Trace the proceeds into the cash receipts records.
    B. Examine canceled notes.
    C. Obtain assurance regarding board approval of the debt through review of board meeting minutes
    D. Trace the proceeds into the bank statement.

 

  1. Which of the following will an auditor not perform when looking for debt reductions?
    A. Examine proceeds into the cash receipts records.
    B. Examine canceled checks.
    C. Examine payments through the cash disbursements records.
    D. Examine canceled notes.

 

  1. Which of the following procedures is a typical substantive procedure related to the relevant assertion of completeness for debt obligations?
    A. Recalculating accrued interest.
    B. Reviewing debt agreements for the restrictive covenants.
    C. Using analytical procedures to analyze interest expense.
    D. Confirming debt obligations with relevant outside parties.

 

  1. Which of the following procedures is a typical substantive procedure related to the relevant assertion of valuation and allocation for debt obligations?
    A. Determine the related parties resulting from debt transactions.
    B. Reviewing debt agreements for the restrictive covenants.
    C. Recalculating accrued interest.
    D. Confirming debt obligations with relevant outside parties.

 

  1. Which of the following is a typical substantive procedure related to the relevant assertion of presentation and disclosure for debt obligations?
    A. Vouching additions and deletions to debt obligations.
    B. Reviewing debt agreements for the restrictive covenants.
    C. Recalculating accrued interest.
    D. Confirming debt obligations with relevant outside parties.

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

  1. If the auditor determines that the client’s current ratio is below a particular covenant level, which of the following would the auditor not do?
    A. Assess the effects of the violation.
    B. Assume that the debt will need to be reclassified, if the violation is not waived.
    C. Consider that the debt will be due and payable, if the violation is not waived.
    D. Issue an adverse audit opinion.

 

  1. As a starting point for testing capital stock and equity transactions, which of the following should the auditor perform?
    A. Trace the proceeds of stock sold to the cash receipts journal.
    B. Review the minutes of the board of directors meetings.
    C. Examine documentation maintained by the transfer agent.
    D. Review a copy of the client’s articles of incorporation.

 

  1. For those clients with treasury stock, which of the following would the auditor be least likely to perform?
    A. Obtaining confirmations from the stock transfer agent.
    B. Tracing transactions through the cash receipts journal.
    C. Tracing transactions through the cash disbursements journal.
    D. Reviewing a copy of the client’s articles of incorporation.

 

  1. In its 2004 through 2006 inspections, which of the following was not a deficiency the PCAOB noted related to inadequate testing of stockholders’ equity transactions?
    A. The auditors failed to properly address and evaluate the substance, business purpose, or significant terms of the equity arrangements.
    B. The auditors failed to consider the accounting principles potentially applicable to the equity transactions.
    C. The auditors failed to evaluate whether the audit clients had appropriately determined the fair values assigned to equity-based transactions and to test the reasonableness of such fair values.
    D. The auditors failed to disclose each class of stock issued by the clients.

 

  1. Which of the following is not a substantive test of details for dividends?
    A. Calculation of the dividend payout ratio.
    B. Examination of the minutes of the board of directors meetings for authorization of the dividend per share amount.
    C. Examination of the minutes of the board of directors meetings for the dividend record date.
    D. Agreement of the dividend amount with the payment in the cash disbursements journal.

 

  1. If the auditor wants to obtain evidence as to whether the dividend payment was made to the stockholders who owned the stock as of the dividend record date, which of the following would the auditor do?
    A. Recalculate the dividends per share.
    B. Examine the minutes of the board of directors meetings for authorization.
    C. Trace the payee’s name on the canceled check to the dividend records.
    D. Determine that dividend restrictions are adequately disclosed in the financial statements.

 

  1. Which of the following is not true regarding restrictions on dividend payments?
    A. These restrictions typically arise when loan agreements prohibit the registrant from paying cash dividends without the consent of the lender.
    B. In certain cases, restrictions at a subsidiary-company level exist such that the registrant’s subsidiary companies may not transfer amounts to the registrant without the consent of a third party.
    C. Amounts subject to restrictions must be disclosed.
    D. The auditor will typically confirm with shareholders whether there are any side agreements regarding dividend restrictions.

 

  1. In those audits where there is a heightened risk of fraud related to debt obligations, which of the following will the auditor not typically perform?
    A. Search public records to identify debt obligations.
    B. Vouch and trace loan proceeds and debt payments.
    C. Send confirmations to lenders and creditors, including confirmation of compliance with any debt covenants.
    D. Obtain photocopies of supporting documents.

 

  1. In those audits where there is a heightened risk of fraud related to stockholders’ equity accounts, which of the following will the auditor typically not perform?
    A. Confirm terms of equity arrangements and shares held directly with shareholders.
    B. Account for and vouch all proceeds from stock issues.
    C. Confirm with shareholders whether there are any side agreements.
    D. Review equity authorizations in the board meeting minutes.

 

  1. Which of the following is not important documentation for substantive procedures for debt obligations?
    A. Copies of the debt agreements.
    B. The client’s articles of incorporation.
    C. A summary of the calculations supporting the compliance debt covenance.
    D. Identification of the specific items tested.

 

  1. Which of the following is not important documentation for substantive procedures for capital stock and equity transactions?
    A. Confirmations with transfer agent or shareholders.
    B. The client’s articles of incorporation.
    C. A summary of the changes in equity accounts.
    D. A memo regarding audit ideas generated during the brainstorming session regarding potential frauds applicable to the capital stock and equity transactions.

 

  1. Why are audits of most stock issuance usually considered to be relatively straightforward?
    A. The number of transactions is small.
    B. The transactions are typically material.
    C. Most stock is issued for cash.
    D. There are no disclosure issues to worry about, since stock amounts are reported in the body of the balance sheet.

 

  1. Listed below are several inherent risks associated with stockholder’s equity.REQUIRED:List the assertion associated with each of these.
Inherent Risk Related Assertion
1. Proceeds are not received.
2. All stock repurchased is not recorded as treasury stock.
3. The cost of treasury stock that is subsequently retired is not properly allocated among the appropriate accounts.
4. Dividends are recorded in the wrong period.
5. Stock options  exercised or expired remain on the organization’s books.
6. Stock issued in exchange for goods/services is not properly valued.
7. Issuances/sales not authorized in accordance with organization’s bylaws.
8. Dividends may be recorded and paid before being declared.

 

 

 

 

 

 

  1. Barley Company is a medium-sized industrial firm that has been audited by your firm for several years.  The only interest-bearing debt owed by Barley is a $300,000 long-term notes payable held by First National Bank. The notes were issued 4 years earlier and will mature in 8 more years. Barley is highly profitable, has no pressing needs for additional financing and has excellent internal controls of the recording of loan and related interest cost transactions.REQUIRED:
    1. Based on this scenario, describe the auditing procedures that you think will be necessary for notes payable and related interest accounts.2. How will you answer differ if instead Barley Company was unprofitable, needed additional financing and had ineffective internal controls?

 

 

 

 

 

  1. A CPA firm is engaged in the examination of the financial statements of Garrison Corporation for the year ended December 31, 2014. Garrison Corporation’s financial statements and records have never been audited by a CPA. The stockholders’ equity section of Garrison Corporation’s balance sheet at December 31, 2014, follows:

    Stockholders’ Equity:
Capital stock—20,000 shares of $10 par value authorized:
5,500 shares issued and outstanding $  55,000
Capital contributed in excess of par value of capital stock 63,800
Retained earnings 110,000
Total stockholders’ equity $228,800

Founded in 2006, Garrison Corporation has ten stockholders and serves as its own registrar and transfer agent. It has no capital stock subscription contracts in effect.

REQUIRED:
Prepare the detailed audit program for the examination of the three accounts composing the stockholders’ equity section of Garrison Corporation’s balance sheet. (Do not include in the audit program the verification of the results of the current-year operations.)

 

 

 

 

 

  1. James Carson and Martin Tighe, CPAs have audited all the figures on the balance sheet. James Carson argues with Martin Tighe that since the retained earnings figure is a balancing figure, it requires no further verification. Martin Tighe, however, disagrees and argues that they should still choose to verify retained earnings. Who do you agree with and why?

 

 

 

 

 

  1. On your first audit for Stark Company, you learn that the company declared a 15% stock dividend during the last quarter of the year. Identify the evidence you would examine to determine whether the stock dividend was accounted for properly.

 

 

 

 

 

  1. The following covenants are extracted from the indenture for McMorris Industries’ 20 year-bond. The indenture provides that failure to comply with its terms in any respect automatically advances the due date of the loan to the date of noncompliance.REQUIRED: Assume that each of these is an independent scenario and identify the audit steps that should be taken or reporting requirements necessary in connection with (a) through (d).a.         The debtor company shall endeavor to maintain a working capital ratio of 2.5 to 1 at all times, and, in any fiscal year following a failure to maintain this ratio, the company shall restrict compensation of the CEO and executive officers to a total of no more than $1,000,000. Executive officers for this purpose shall include the chairman of the board of directors, the president, all vice presidents, the secretary, and the treasurer.b.         The debtor company shall insure all property that is security for this debt against loss by hurricane to the extent of 90% of its actual value. Insurance policies securing this protection shall be filed with the trustee.c.         The debtor company shall pay all taxes legally assessed against the property that serves as security for this debt within the time provided by law for payment without penalty and shall deposit receipted tax bills or equally acceptable evidence of payment of same with the trustee.d.         A sinking fund shall be established and deposited with the trustee by semiannual payments of $450,000, from which the trustee shall, at his/her discretion, purchase bonds of this issue.

 

 

 

 

 

  1. You are engaged in the audit of Bordon Corporation, whose records have not previously been audited by your firm. The company has an independent transfer agent, as well as a registrar for its capital stock.  The transfer agent maintains the record of stockholders, while the registrar checks that there is no overissue of stock. Both the transfer agent and registrar are required to validate stock certificates.One of the seniors on the audit proposes that confirmations be obtained from both the transfer agent and registrar regarding the outstanding stock balance at the balance sheet date. If the confirmations agree with the books, then he proposes that no additional work is to be performed on the capital stock account.REQUIRED:Do you agree or disagree that this will be sufficient? If yes, give the justification for your position. If no, state specifically all additional steps you would take and why you would take them.

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

 

 

  1. The Thomas Corporation took out a 20-year mortgage on a new headquarters building on June 30, 2014 for $3,000,000 and pledged its only manufacturing facility and the land on which it stands as collateral. The monthly payment to the mortgagor is $25,000 and was first paid on July 1, 2014. Your firm has audited this client before, but the client has never had a mortgage in previous years.  You are in charge of the current year audit for Thomas, which has a balance sheet date of December 31, 2014.REQUIRED:
    1. Explain why it is desirable to prepare a schedule for the permanent file regarding the mortgage.  What type of information should this include?2. Explain why the audit of mortgage payable, interest expense, and interest payable should all be performed together.3. List audit procedures that are typically performed to verify the issue of the mortgage, the mortgage and the interest payable account balances at December 31, 2014, and the balance in interest expense for 2014.4. What type of information should be disclosed in the footnotes for this mortgage to help the auditor determine whether the completeness and presentation/disclosure assertions are satisfied?

 

 

 

 

 

 

 

Chapter 13: Auditing Debt Obligations and Stockholders’ Equity Transactions Key

  1. Valuation is a relevant assertion when auditing premiums or discounts on bonds.
    TRUE

 

  1. The potential dilutive effect of convertible debt or preferred stock, stock options, and warrants should be disclosed in accordance with relevant accounting guidance in computing primary and fully diluted earnings per share.
    TRUE

 

  1. Relevant accounts when auditing stockholders’ equity include leasehold improvements.
    FALSE

 

  1. Bonds are issued to finance major expansions or to refinance existing debt.
    TRUE

 

  1. The auditor is primarily concerned with overstatement when auditing bonds.
    FALSE

 

  1. An organization typically has many debt transactions during the year, with each individual transaction being material.
    TRUE

 

  1. A bond premium/discount amortization spreadsheet can be used to help assure that the bond is appropriately valued and disclosed in the financial statements.
    TRUE

 

  1. Typically, the most relevant assertion related to debt obligations is existence.
    FALSE

 

  1. Inherent risks related to debt obligations primarily concern the authorization of debt, receipt of funds, recording debt transactions, and compliance with any debt covenants.
    TRUE

 

  1. Existence is the most relevant assertion associated with an inherent risk for treasury stock transactions recorded in the wrong period.
    FALSE

 

  1. Valuation is the most relevant assertion associated with an inherent risk for the cost of treasury stock  that is subsequently retired and not properly allocated among the appropriate accounts.
    TRUE

 

  1. When an auditor is investigating the inherent risk associated with stock issuances/sales that are recorded in the wrong period, the auditor is most likely assessing the risks of material misstatements associated with the existence assertion.
    TRUE

 

  1. Presentation and disclosure is the most relevant audit assertion associated with the inherent risk of using inaccurate periods of service for stock options.
    FALSE

 

  1. Completeness is the most relevant assertion associated with an inherent risk for dividends that are recorded and paid before being declared.
    FALSE

 

  1. Rights/obligations is the most relevant audit assertion associated with an inherent risk for finding stock options or warrants being granted without being properly approved.
    FALSE

 

  1. A potential fraud risk associated with debt obligations is the intentional misclassification of short-term debt as long-term debt.
    TRUE

 

  1. If an auditor discovers that a company intentionally applied loan payments to interest rather than principal, this would result in fraudulent overstatement of income.
    FALSE

 

  1. As part of brainstorming activities, the auditor might identify possible fraudulent transactions related to stockholders’ equity accounts that are the result of charging expenses directly to retained earnings rather than to the appropriate expense accounts.
    TRUE

 

  1. Auditing standards require the auditor to identify and assess the risks of material misstatement due to fraud at the financial statement level only.
    FALSE

 

  1. Once the auditor has obtained an understanding of the inherent and fraud risks of material misstatement associated with debt obligations and stockholders’ equity transactions, the auditor needs to understand the controls that the client has designed and implemented to address those risks.
    TRUE

 

  1. A typical control for stockholders’ equity transactions is for the board of directors to approve all stock transactions (including options and warrants).
    TRUE

 

  1. When identifying and assessing control risks of material misstatement associated with debt obligations and stockholders’ equity transactions, documentation is only required for integrated audits, not financial statement only audits.
    FALSE

 

  1. Normally, an auditor can gain an understanding of internal controls by means of a walkthrough of the process, inquiry, observation, and review of the client’s documentation.
    TRUE

 

  1. When documenting controls, the auditor can provide this documentation in various formats including a control matrix, a control risk assessment questionnaire, and/or a memo.
    TRUE

 

  1. When planning the audit related to stockholders’ equity transactions, the auditor is not required to perform preliminary analytical procedures.
    FALSE

 

  1. Trend analyses are typically used as preliminary analytical procedures related to debt obligations.
    TRUE

 

  1. If preliminary analytical procedures do not identify any unexpected relationships related to debt obligations, the auditor would conclude that there is not a heightened risk of material misstatements in these accounts.
    TRUE

 

  1. If there were unusual or unexpected relationships, the planned audit procedures (tests of controls, substantive procedures) would be adjusted to address the potential material misstatements.
    TRUE

 

  1. When planning the audit related to debt obligations, the auditor should not have expectations as to the nature and magnitude of any account balance changes because they might bias the outcome of the audit.
    FALSE

 

  1. Typically, when determining the appropriate audit procedures to perform for debt accounts, the auditor will usually decide to test debt obligations, including interest, using only substantive procedures.
    TRUE

 

  1. Using substantive procedures to test debt obligations is most appropriate because there are a relatively large number of transactions involving immaterial dollar amounts.
    FALSE

 

  1. A substantive approach using only tests of controls is most commonly used to audit equity accounts.
    FALSE

 

  1. For both debt accounts and stockholders’ equity accounts, the boxes of evidence would typically be filled only with evidence obtained through substantive procedures.
    TRUE

 

  1. When obtaining evidence about internal control operating effectiveness, the auditor will select only entity-wide controls for testing.
    FALSE

 

  1. For integrated audits, a typical test of controls may include an inquiry of personnel performing the control.
    TRUE

 

  1. For financial statement audit purposes, when auditing debt obligations and stockholders’ equity transactions, the auditor will most likely perform a substantive audit, and therefore will not perform tests of controls for the debt and equity accounts.
    TRUE

 

  1. If the auditor identifies control deficiencies, the auditor will not need to judge the severity of the deficiencies but instead would consult management about the need for a fraud audit.
    FALSE

 

  1. Confirmations are not substantive procedure designed to obtain evidence on the completeness of debt obligations.
    FALSE

 

  1. Stockholders’ equity accounts will be tested with only substantive analytical procedures.
    FALSE

 

  1. The transactions in the stockholders’ equity accounts are typically tested using a statistical sampling approach.
    FALSE

 

  1. If interest expense recorded by the client is significantly lower than the auditor’s expectation, it may mean that interest payments have not been properly recorded, possibly having been charged to principal.
    TRUE

 

  1. When performing a substantive analytical procedure related to interest expense, the auditor will likely not test the client’s internal controls.
    TRUE

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

  1. A starting point for substantive tests of details on debt obligations is to have the client provide a cash flow statement.
    FALSE

 

  1. For additions to debt, the auditor traces the proceeds into the cash receipts records and the bank statement.
    TRUE

 

  1. To determine whether notes have been paid in full, the auditor would obtain the most appropriate evidence by examining the board of directors meeting minutes.
    FALSE

 

  1. As a starting point for testing capital stock and equity transactions, the auditor should review a copy of the client’s articles of incorporation.
    TRUE

 

  1. When auditing debt and equity transactions, the auditor should be skeptical, and therefore alert to the possibility, that management is managing earnings by not appropriately recording expenses, such as charging expenses directly to retained earnings or under-recording interest expense.
    TRUE

 

  1. If the auditor identifies a risk of material misstatement due to fraud related to debt obligations or stockholders’ equity accounts, the auditor needs to determine the appropriate responses, potentially including changing the nature, timing, and extent of audit procedures.
    TRUE

 

  1. Which of the following is the auditor’s primary objective when auditing debt obligations?
    A.Understatement of the debt obligation focusing on the completeness assertion.
    B. Proper valuation of bond premiums or bond discounts, including amortization valuation.
    C. Valuation of gains or losses on refinancing debt.
    D. Proper presentation and disclosure, including important restrictions contained in the debt obligations.

 

  1. Which of the following is not typically included in the audit of debt obligations?
    A.Interest expense.
    B. Interest income.
    C. Notes payable.
    D. Bonds payable.

 

  1. How are most bonds marketed?
    A.Through the board of directors.
    B. Through an underwriter.
    C. Through auditors.
    D. Through employees.

 

  1. Which of the following statements about bonds is false?
    A.They may be issued to finance major expansions.
    B. They may be issued to refinance existing debt.
    C. They account for many of the organization’s transactions.
    D. They are generally highly material to the financial statements.

 

  1. Which assertion is generally the most relevant when auditing the restrictions contained in debt obligations?
    A.Completeness.
    B. Valuation.
    C. Proper presentation and disclosure.
    D. Existence.

 

  1. Which of the following is not a common debt covenant restriction?
    A.Maintenance of a minimum level of retained earnings before dividends can be paid.
    B. Maintenance of a minimum working-capital ratio.
    C. Specification of a maximum debt-equity ratio.
    D. Specification of a minimum earnings per share.

 

  1. Which of the following is not a relevant account when auditing stockholders’ equity?
    A.Treasury stock.
    B. Dividends.
    C. Sinking fund for plant expansion.
    D. Retained earnings.

 

  1. Which of the following is not a common transaction affecting stockholders’ equity?
    A.The purchase of treasury stock.
    B. The declaration and payment of dividends.
    C. The exercises and expirations of stock options and warrants.
    D. Bond amortization.

 

  1. Which of the following results in a situation where an auditor has the least amount of difficulty in determining stock valuation?
    A.When stock is issued for land.
    B. When stock is exchanged for another business.
    C. When stock options are issued and exercises occur.
    D. When stock is issued for cash.

 

  1. How would an auditor generally measure the value of a stock option expense?
    A.Fair value.
    B. Appraised value
    C. By computing a weighted average value of all classes of stock authorized.
    D. All of these methods can be used.

 

  1. In auditing equity accounts, the auditor primarily focuses on which of the following two assertions?
    A.Valuation and completeness.
    B. Valuation and existence.
    C. Presentation and disclosure and valuation.
    D. Presentation and disclosure and completeness.

 

  1. When auditing the gains or losses on refinancing debt, the auditor primarily focuses on which assertion?
    A.Completeness.
    B. Existence.
    C. Valuation.
    D. Presentation and disclosure.

 

  1. When auditing the premium or discount on bonds (including amortization), the auditor primarily focuses on which assertion?
    A.Existence.
    B. Completeness.
    C. Presentation and disclosure
    D. Valuation.

 

  1. Which of the following would a bond indenture not provide information about?
    A.The time period before repayment.
    B. Whether the bond is convertible.
    C. Whether the bond is callable.
    D. The date the bond will be called.

 

  1. Which of the following would not typically be included as part of the balance sheet disclosures related to stockholders’ equity?
    A.Accumulated other comprehensive income
    B. Details on stock repurchases
    C. Price/earnings ratios for stock
    D. Prior period adjustments to retained earnings

 

  1. Which of the following is not an inherent risk typically associated with the existence of dividends?
    A.Dividends are recorded in the wrong period.
    B. Dividends are recorded before declared.
    C. Dividends are not properly amortized.
    D. Dividends have not been approved before being declared.

 

  1. Which of the following is not an inherent risk typically associated with debt covenant compliance issues?
    A.Whether debt covenants are calculated accurately.
    B. Whether debt payment transactions are properly initiated.
    C. Whether compliance with debt covenants is appropriately disclosed.
    D. Whether compliance with debt covenants is appropriately reviewed.

 

  1. Which of the following is not an inherent risk typically associated with recording debt transactions?
    A.Interest expense not being properly recorded.
    B. Failure to accrue interest expense.
    C. Debt not being properly classified.
    D. Debt not being properly authorized.

 

  1. The inherent risk of proceeds from stock sales not being received is most likely related to which of the following management assertions?
    A.Completeness.
    B. Presentation and disclosure.
    C. Valuation.
    D. Existence.

 

  1. An auditor determines that there is an inherent risk that all stock repurchased is not recorded as treasury stock. This determination is most likely tied to which of the following management assertions?
    A.Completeness.
    B. Presentation and disclosure.
    C. Valuation.
    D. Existence.

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

  1. An auditor determines that there is an inherent risk that dividends may be recorded and paid before being declared. This determination is most likely tied to which of the following management assertions?
    A.Completeness.
    B. Presentation and disclosure.
    C. Valuation.
    D. Existence.

 

  1. An auditor determines that there is an inherent risk that a company has not included both the basic earnings per share and diluted earnings per share amounts in financial statements even though significant dilutive securities are part of the company’s complex capital structure. This determination is most likely tied to which of the following management assertions?
    A.Valuation.
    B. Presentation and disclosure.
    C. Rights and obligations.
    D. Existence.

 

  1. An auditor determines that there is an inherent risk that stock options exercised or expired remain on the organization’s books. This determination is most likely tied to which of the following management assertions?
    A.Valuation.
    B. Presentation and disclosure.
    C. Rights and obligations.
    D. Existence.

 

  1. Which of the following is not a potential fraud related to debt obligations?
    A.Long-term or short-term debt is misclassified.
    B. Entire loan payments are charged to either principal or interest.
    C. Dividends are paid in violation of restrictive covenants.
    D. Debt obligations are not properly authorized.

 

  1. Which of the following is not a potential fraud related to stockholders’ equity accounts?
    A.Stock sales or issuances are not authorized.
    B. Entire loan payments are charged to either principal or interest.
    C. Dividends are paid in violation of restrictive covenants.
    D. Stock options are back-dated.

 

  1. What type of risk is intentional failure by management to accurately disclose violations of debt covenants?
    A.Inherent risk
    B. Fraud risk
    C. Control risk
    D. Detection risk.

 

  1. Which of the following statements is true regarding the identification and assessment of the risks of material misstatements by the auditor?
    A.Auditing standards require the auditor to identify and assess the risks of material misstatement due to fraud at the financial statement level.
    B. Auditing standards require the auditor to identify and assess the risks of material misstatement due to fraud at the assertion level.
    C. As part of brainstorming activities, the auditor should identify possible frauds that could occur.
    D. All of these statements are true.

 

  1. Which of the following would an auditor not typically perform as part of gaining an understanding of the client’s controls related to debt obligations?
    A.Review policies related to approval required for new debt.
    B. Inquire of management about the process for reviewing compliance with debt covenants.
    C. Review the client’s documentation of controls.
    D. Recalculate interest expense.

 

  1. In general, which of the following would an auditor not typically perform as part of gaining an understanding of the client’s controls?
    A.A walkthrough of the process.
    B. Inquiry.
    C. Observation.
    D. All of these are used to gain an understanding of the controls.

 

  1. Which of the following does an auditor consider when gaining an overall understanding of the client’s internal controls?
    A.Entity-wide controls at the account level only.
    B. Transaction controls at the account level only.
    C. Entity-wide controls at the assertion level only.
    D. Both entity-wide controls and transaction controls at the account and assertion levels.

 

  1. Which of the following would the auditor consider as part of the control environment related to debt obligations?
    A.Inquiry of trustee regarding the registration of current bondholders and distribution of interest payments.
    B. Recalculation of the underwriter’s commission.
    C. Independence of the board of directors with respect to long-term financing.
    D. Inspection of documentation to confirm refinancing of debt.

 

  1. Which of the following are entity-wide components of internal control that can mitigate the risk material misstatement related to debt obligations?
    A.Risk assessment.
    B. Information and communication.
    C. Monitoring controls.
    D. All of these are entity-wide components of internal control.

 

  1. Which of the following is a typical control for debt obligations?
    A.The board of directors approves all new debt.
    B. The stockholders approve all new debt.
    C. The CFO approves all new debt.
    D. Upper managers approve all new debt.

 

  1. Which of the following statements is typically not true regarding controls related to proper accounting for stock option grants?
    A.The proper accounting for stock option grants is researched by the organization’s accountant.
    B. The analysis of the accountant regarding stock option grants is reviewed by the CFO.
    C. The analysis of the accountant regarding stock option grants is reviewed by the organization’s legal counsel.
    D. The analysis of the accountant regarding stock option grants is reviewed by the board of directors.

 

  1. Which of the following statements is true regarding preliminary analytical procedures for debt obligations and stockholders’ equity transactions?
    A.Trend analysis would not typically be performed for debt obligations.
    B. The long-term debt to equity ratio could be considered by the auditor as part of the preliminary analytical procedures.
    C. Because there are typically only a few stockholders’ equity transactions, the auditor is not required to perform preliminary analytical procedures for stockholders’ equity accounts.
    D. If unusual or unexpected relationships are identified by preliminary analytical procedures, the auditor should stick with the original expectations of misstatements, because this could be an anomaly and bias the audit overall.

 

  1. Which of the following is not an example of typical analytical procedures related to debt obligations?
    A.Perform a trend analysis of the balances in notes payable, interest expense, and accrued interest with prior periods, considering known client activities related to debt.
    B. Calculate the total debt-to-equity ratio and perform a trend analysis with prior periods.
    C. Calculate the times interest earned ratio and perform a trend analysis with prior periods.
    D. Calculate the current ratio and perform a trend analysis with prior periods.

 

  1. Which of the following is not true regarding preliminary analytical procedures performed by the auditor when planning the audit?
    A.The primary preliminary analytical procedure for stockholders’ equity accounts is a comparison of current year account balances with prior year account balances.
    B. If there are unusual or unexpected relationships, the planned audit procedures would be adjusted to address the potential material misstatements.
    C. The auditor should have an expectation as to the nature and magnitude of any account balance changes.
    D. Auditors show focus on just the numbers when performing analytical procedures.

 

  1. Which of the following statements is true regarding the appropriate audit procedures to perform for debt and stockholder’s equity accounts?
    A.The auditor will usually decide to test debt obligations, including interest, using only substantive procedures.
    B. Testing debt obligations, including interest, is typically accomplished using only control procedures.
    C. When auditing stockholders’ equity transactions, the auditor commonly uses a control procedure approach, but uses only substantive procedures to test debt obligation transactions.
    D. None of these statements is true.

 

  1. Which of the following is not true about auditing stockholders’ equity transactions?
    A.The auditor usually uses a substantive approach.
    B. The number of equity transactions with outside parties is usually small.
    C. The dollar amount is usually immaterial.
    D. An approach using only tests of details is most commonly used to audit equity accounts.

 

  1. For integrated audits, when does the auditor test the operating effectiveness of important controls?
    A.As of the beginning of the client’s fiscal year.
    B. As of the client’s year end.
    C. As of the end of the second quarter of the client’s fiscal year.
    D. None of these answers is correct.

 

  1. Which of the following is not true regarding appropriate tests of controls?
    A.The auditor selects controls that are important to the auditor’s conclusion about whether the organization’s controls adequately address the assessed risk of material misstatement for the relevant debt and equity accounts.
    B. The client’s audit committee selects controls that are important to the auditor’s conclusion about whether the organization’s controls adequately address the assessed risk of material misstatement for the relevant debt and equity accounts.as of the client’s year end.
    C. The auditor will select both entity-wide and transaction controls for testing.
    D. If the auditor wants to rely on controls for the financial statement audit, the auditor would test the operating effectiveness of those controls throughout the year.

 

  1. If tests of controls result in identified control deficiencies, how will the auditor assess those deficiencies?
    A.By estimating interest expense based on average interest rates and average debt outstanding.
    B. By comparing current year account balances with prior year account balances.
    C. By determining their severity and the impact on the opinion of internal control effectiveness.
    D. By calculating the long-term debt-to-equity ratio and performing a trend analysis with prior periods.

 

  1. Which of the following is not a typical test of controls when auditing debt and equity transactions?
    A.Inquiry of personnel performing the control.
    B. Comparing current year account balances with prior year account balances.
    C. Observation of the control being performed.
    D. Reperformance of the control by the auditor testing the control.

 

  1. Which of the following procedures would be included in the auditor’s audit program for long-term debt?
    A.Investigation of credits to the bond interest income account.
    B. Inspection of the accounts payable master file.
    C. Verification of the existence of the bondholders.
    D. Review debt loan agreements.

 

  1. Which of the following is not true regarding the testing of transactions in the stockholders’ equity accounts?
    A.The transactions are typically tested on a 100% basis.
    B. The transactions are typically tested on a sampling basis.
    C. The number of transactions is typically small.
    D. Most of these transactions are highly material.

 

  1. When auditing debt obligations, which of the following is the primary substantive analytical procedure?
    A.Reading loan agreements.
    B. Developing an independent expectation of interest expense.
    C. Tracing bond proceeds to cash receipts.
    D. Confirming transactions with outside parties.

 

  1. Which of the following is the least important in helping the auditor develop an independent expectation of interest expense as a substantive analytical procedure?
    A.Determine average interest rates.
    B. Determine average debt outstanding.
    C. Examine disaggregated data by type of debt.
    D. Examine an interest revenue schedule.

 

  1. Which of the following will an auditor not perform when looking for additions to debt?
    A.Trace the proceeds into the cash receipts records.
    B. Examine canceled notes.
    C. Obtain assurance regarding board approval of the debt through review of board meeting minutes
    D. Trace the proceeds into the bank statement.

 

  1. Which of the following will an auditor not perform when looking for debt reductions?
    A.Examine proceeds into the cash receipts records.
    B. Examine canceled checks.
    C. Examine payments through the cash disbursements records.
    D. Examine canceled notes.

 

  1. Which of the following procedures is a typical substantive procedure related to the relevant assertion of completeness for debt obligations?
    A.Recalculating accrued interest.
    B. Reviewing debt agreements for the restrictive covenants.
    C. Using analytical procedures to analyze interest expense.
    D. Confirming debt obligations with relevant outside parties.

 

  1. Which of the following procedures is a typical substantive procedure related to the relevant assertion of valuation and allocation for debt obligations?
    A.Determine the related parties resulting from debt transactions.
    B. Reviewing debt agreements for the restrictive covenants.
    C. Recalculating accrued interest.
    D. Confirming debt obligations with relevant outside parties.

 

  1. Which of the following is a typical substantive procedure related to the relevant assertion of presentation and disclosure for debt obligations?
    A.Vouching additions and deletions to debt obligations.
    B. Reviewing debt agreements for the restrictive covenants.
    C. Recalculating accrued interest.
    D. Confirming debt obligations with relevant outside parties.

 

  1. If the auditor determines that the client’s current ratio is below a particular covenant level, which of the following would the auditor not do?
    A.Assess the effects of the violation.
    B. Assume that the debt will need to be reclassified, if the violation is not waived.
    C. Consider that the debt will be due and payable, if the violation is not waived.
    D. Issue an adverse audit opinion.

 

  1. As a starting point for testing capital stock and equity transactions, which of the following should the auditor perform?
    A.Trace the proceeds of stock sold to the cash receipts journal.
    B. Review the minutes of the board of directors meetings.
    C. Examine documentation maintained by the transfer agent.
    D. Review a copy of the client’s articles of incorporation.

 

  1. For those clients with treasury stock, which of the following would the auditor be least likely to perform?
    A.Obtaining confirmations from the stock transfer agent.
    B. Tracing transactions through the cash receipts journal.
    C. Tracing transactions through the cash disbursements journal.
    D. Reviewing a copy of the client’s articles of incorporation.

 

  1. In its 2004 through 2006 inspections, which of the following was not a deficiency the PCAOB noted related to inadequate testing of stockholders’ equity transactions?
    A.The auditors failed to properly address and evaluate the substance, business purpose, or significant terms of the equity arrangements.
    B. The auditors failed to consider the accounting principles potentially applicable to the equity transactions.
    C. The auditors failed to evaluate whether the audit clients had appropriately determined the fair values assigned to equity-based transactions and to test the reasonableness of such fair values.
    D. The auditors failed to disclose each class of stock issued by the clients.

 

  1. Which of the following is not a substantive test of details for dividends?
    A.Calculation of the dividend payout ratio.
    B. Examination of the minutes of the board of directors meetings for authorization of the dividend per share amount.
    C. Examination of the minutes of the board of directors meetings for the dividend record date.
    D. Agreement of the dividend amount with the payment in the cash disbursements journal.

 

  1. If the auditor wants to obtain evidence as to whether the dividend payment was made to the stockholders who owned the stock as of the dividend record date, which of the following would the auditor do?
    A.Recalculate the dividends per share.
    B. Examine the minutes of the board of directors meetings for authorization.
    C. Trace the payee’s name on the canceled check to the dividend records.
    D. Determine that dividend restrictions are adequately disclosed in the financial statements.

 

  1. Which of the following is not true regarding restrictions on dividend payments?
    A.These restrictions typically arise when loan agreements prohibit the registrant from paying cash dividends without the consent of the lender.
    B. In certain cases, restrictions at a subsidiary-company level exist such that the registrant’s subsidiary companies may not transfer amounts to the registrant without the consent of a third party.
    C. Amounts subject to restrictions must be disclosed.
    D. The auditor will typically confirm with shareholders whether there are any side agreements regarding dividend restrictions.

 

  1. In those audits where there is a heightened risk of fraud related to debt obligations, which of the following will the auditor not typically perform?
    A.Search public records to identify debt obligations.
    B. Vouch and trace loan proceeds and debt payments.
    C. Send confirmations to lenders and creditors, including confirmation of compliance with any debt covenants.
    D. Obtain photocopies of supporting documents.

 

  1. In those audits where there is a heightened risk of fraud related to stockholders’ equity accounts, which of the following will the auditor typically not perform?
    A.Confirm terms of equity arrangements and shares held directly with shareholders.
    B. Account for and vouch all proceeds from stock issues.
    C. Confirm with shareholders whether there are any side agreements.
    D. Review equity authorizations in the board meeting minutes.

 

  1. Which of the following is not important documentation for substantive procedures for debt obligations?
    A.Copies of the debt agreements.
    B. The client’s articles of incorporation.
    C. A summary of the calculations supporting the compliance debt covenance.
    D. Identification of the specific items tested.

 

  1. Which of the following is not important documentation for substantive procedures for capital stock and equity transactions?
    A.Confirmations with transfer agent or shareholders.
    B. The client’s articles of incorporation.
    C. A summary of the changes in equity accounts.
    D. A memo regarding audit ideas generated during the brainstorming session regarding potential frauds applicable to the capital stock and equity transactions.

 

  1. Why are audits of most stock issuance usually considered to be relatively straightforward?
    A.The number of transactions is small.
    B. The transactions are typically material.
    C. Most stock is issued for cash.
    D. There are no disclosure issues to worry about, since stock amounts are reported in the body of the balance sheet.

 

  1. Listed below are several inherent risks associated with stockholder’s equity.REQUIRED:List the assertion associated with each of these.
Inherent Risk Related Assertion
1. Proceeds are not received.
2. All stock repurchased is not recorded as treasury stock.
3. The cost of treasury stock that is subsequently retired is not properly allocated among the appropriate accounts.
4. Dividends are recorded in the wrong period.
5. Stock options  exercised or expired remain on the organization’s books.
6. Stock issued in exchange for goods/services is not properly valued.
7. Issuances/sales not authorized in accordance with organization’s bylaws.
8. Dividends may be recorded and paid before being declared.

 

 

Inherent Risk Related Assertion
1. Proceeds are not received. Existence
2. All stock repurchased is not recorded as treasury stock. Completeness
3. The cost of treasury stock that is subsequently retired is not properly allocated among the appropriate accounts. Valuation
4. Dividends are recorded in the wrong period. Existence
5. Stock options  exercised or expired remain on the organization’s books. Rights/Obligations
6. Stock issued in exchange for goods/services is not properly valued. Valuation
7. Issuances/sales not authorized in accordance with organization’s bylaws. Existence
8. Dividends may be recorded and paid before being declared. Existence

 

  1. Barley Company is a medium-sized industrial firm that has been audited by your firm for several years.  The only interest-bearing debt owed by Barley is a $300,000 long-term notes payable held by First National Bank. The notes were issued 4 years earlier and will mature in 8 more years. Barley is highly profitable, has no pressing needs for additional financing and has excellent internal controls of the recording of loan and related interest cost transactions.REQUIRED:
    1. Based on this scenario, describe the auditing procedures that you think will be necessary for notes payable and related interest accounts.2. How will you answer differ if instead Barley Company was unprofitable, needed additional financing and had ineffective internal controls?
  2. Auditing necessary for Barley’s notes payable and related interest accounts in this scenario would be minimal. Aside from checking interest calculations and postings to the proper accounts as a matter of audit routine, the only major audit procedure would be to confirm the amount and provisions of the note with First National Bank.2.      If Barley was unprofitable, needed additional financing, and had ineffective internal controls, the story would be much different.  It would be necessary to search for unrecorded notes by obtaining standard bank confirmations with specific reference to the existence of notes payable, reviewing the bank statements and reconciliations for new notes credited directly to the bank account by the bank, and analyzing interest expense to uncover a payment to a creditor who is not included on the notes payable schedule.

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

  1. A CPA firm is engaged in the examination of the financial statements of Garrison Corporation for the year ended December 31, 2014. Garrison Corporation’s financial statements and records have never been audited by a CPA. The stockholders’ equity section of Garrison Corporation’s balance sheet at December 31, 2014, follows:

    Stockholders’ Equity:
Capital stock—20,000 shares of $10 par value authorized:
5,500 shares issued and outstanding $  55,000
Capital contributed in excess of par value of capital stock 63,800
Retained earnings 110,000
Total stockholders’ equity $228,800

Founded in 2006, Garrison Corporation has ten stockholders and serves as its own registrar and transfer agent. It has no capital stock subscription contracts in effect.

REQUIRED:
Prepare the detailed audit program for the examination of the three accounts composing the stockholders’ equity section of Garrison Corporation’s balance sheet. (Do not include in the audit program the verification of the results of the current-year operations.)

Audit Program for Stockholders’ Equity

1. Examine articles of incorporation, the bylaws, and minutes of the board of directors from inception to determine the provisions or decisions relating to the capital accounts. (Necessary only for the first year of the audit. Subsequent years will update the information.) Determine that the accounting records are in accordance with the provisions and that appropriate footnote disclosure is made. Extract pertinent date for the permanent file.

2. Examine stock certificate stub book and determine if it agrees with the capital stock account. Alternatively, if the stock is listed with an independent agent, confirm the stock transactions and current outstanding stock with the independent stock agent.

3. Schedule all entries to the accounts since inception. Vouch (examine documentation) supporting all entries into the accounts. Recompute major transactions to determine that the accounts have been properly classified and amounts credited to capital in excess are properly computed.

4. Examine retained earnings from inception:
·     Schedule all entries into the account noting all that come from other than the annual closing of income and expense summaries.
·     Examine support for all entries to retained earnings to determine if classification is correct.
·     All stock dividends, or cash dividends, should be examined to determine appropriate valuation to retained earnings.

 

  1. James Carson and Martin Tighe, CPAs have audited all the figures on the balance sheet. James Carson argues with Martin Tighe that since the retained earnings figure is a balancing figure, it requires no further verification. Martin Tighe, however, disagrees and argues that they should still choose to verify retained earnings. Who do you agree with and why?

Martin Tighe is correct.

The retained earnings account should be audited because these audit procedures help to provide reasonable assurance that:
·     no important items were overlooked in the examination of the account;
·     the account is handled in accordance with GAAP, for example, only prior period correcting entries are taken to retained earnings directly;
·     extraordinary items are recorded through the income statement; and
·     stock dividends are recorded correctly.

 

  1. On your first audit for Stark Company, you learn that the company declared a 15% stock dividend during the last quarter of the year. Identify the evidence you would examine to determine whether the stock dividend was accounted for properly.

Stark Company’s 15% stock dividend should be accounted for as a debit to retained earnings for the fair market value of the dividend and credited to capital stock and capital in excess of par. The auditor should be sure the board of directors authorized the dividend through review of the board minutes and should examine The Wall Street Journal or another financial reporting service to determine the fair market value of the dividend at the time of declaration. The auditor could then trace the amounts to their recording in the general ledger to determine if they were properly accounted for.

 

  1. The following covenants are extracted from the indenture for McMorris Industries’ 20 year-bond. The indenture provides that failure to comply with its terms in any respect automatically advances the due date of the loan to the date of noncompliance.REQUIRED: Assume that each of these is an independent scenario and identify the audit steps that should be taken or reporting requirements necessary in connection with (a) through (d).a.         The debtor company shall endeavor to maintain a working capital ratio of 2.5 to 1 at all times, and, in any fiscal year following a failure to maintain this ratio, the company shall restrict compensation of the CEO and executive officers to a total of no more than $1,000,000. Executive officers for this purpose shall include the chairman of the board of directors, the president, all vice presidents, the secretary, and the treasurer.b.         The debtor company shall insure all property that is security for this debt against loss by hurricane to the extent of 90% of its actual value. Insurance policies securing this protection shall be filed with the trustee.c.         The debtor company shall pay all taxes legally assessed against the property that serves as security for this debt within the time provided by law for payment without penalty and shall deposit receipted tax bills or equally acceptable evidence of payment of same with the trustee.d.         A sinking fund shall be established and deposited with the trustee by semiannual payments of $450,000, from which the trustee shall, at his/her discretion, purchase bonds of this issue.

Any failure, or likely failure, of McMorris Industries to comply with the covenants should be reported in a note to the financial statements.

Audit steps for each independent scenario follow:

a. The balance sheets should be reviewed for each applicable period to determine compliance with the covenant. If the company is below the stated ratio, the auditor should review officer compensation to determine if it is in compliance with the covenant.

b. Examine client copies of insurance policies or certificates of insurance to determine compliance with the covenant. The auditor should prepare a summary of all the scheduled information contained in the policies. In addition, the auditor should confirm the existence of the policies with the trustee.

c. Examine vouchers supporting tax payments on all property covered by the indenture. If vouchers are questionable, confirm tax payments with the trustee who holds the tax receipts.

d. Vouch the payments to the sinking fund. Confirm bond purchases and the sinking fund balance with trustee. Confirm any cancellation of bonds with the trustee or observe the canceled bond.

 

  1. You are engaged in the audit of Bordon Corporation, whose records have not previously been audited by your firm. The company has an independent transfer agent, as well as a registrar for its capital stock.  The transfer agent maintains the record of stockholders, while the registrar checks that there is no overissue of stock. Both the transfer agent and registrar are required to validate stock certificates.One of the seniors on the audit proposes that confirmations be obtained from both the transfer agent and registrar regarding the outstanding stock balance at the balance sheet date. If the confirmations agree with the books, then he proposes that no additional work is to be performed on the capital stock account.REQUIRED:Do you agree or disagree that this will be sufficient? If yes, give the justification for your position. If no, state specifically all additional steps you would take and why you would take them.

The senior’s proposal of limiting work to the confirmations is not justified by the facts in the scenario. Although the transfer agent and the registrar know the number of shares issued, they do not necessarily know the number of shares outstanding. Furthermore, an audit of capital stock includes more than just determining the number of shares outstanding. For example, do authorizations exist for the issuance of shares? What assets were received in payment of shares? How were the transactions recorded? Are there any subscription contracts? Confirmation from the registrar could not help in determining these things.
Additional audit steps that need to be taken for the Bordon Corporation audit are:
1.      Examine the corporation charter to determine the number of shares authorized and the special provisions for each class of stock if more than one class is authorized.
2.      Examine minutes of stockholders’ and directors’ meetings to determine authorization for appointments of the registrar and the transfer agent; to determine authorization for the issuance or reacquisition of shares.
3.      Examine provisions regarding capital stock in the corporation law of the state of incorporation—to determine any special provisions, such as those for the issuance of no par stock.

4.      Analyze the capital stock accounts to obtain an orderly picture of stock transactions for use as a guide to other auditing procedures and as a permanent record.
5.      Trace the consideration received for capital stock into the records—to determine what consideration has been received and how it has been recorded.
6.      Examine and schedule treasury stock and review entries for treasury stock—to determine the existence of treasury stock as authorized and to determine that a proper record has been made.
7.      Review registrar’s invoices and cash disbursements—to determine that original issue taxes have been paid.
8.      Compare dividends with stock outstanding at dividend dates—to determine that dividends have been properly paid and also to substantiate the stock outstanding.
9.      Review subscription and option contracts, etc.—to determine the facts in regard to subscriptions and options and to determine that these facts have been properly recorded and that they are adequately disclosed.

 

  1. The Thomas Corporation took out a 20-year mortgage on a new headquarters building on June 30, 2014 for $3,000,000 and pledged its only manufacturing facility and the land on which it stands as collateral. The monthly payment to the mortgagor is $25,000 and was first paid on July 1, 2014. Your firm has audited this client before, but the client has never had a mortgage in previous years.  You are in charge of the current year audit for Thomas, which has a balance sheet date of December 31, 2014.REQUIRED:
    1. Explain why it is desirable to prepare a schedule for the permanent file regarding the mortgage.  What type of information should this include?2. Explain why the audit of mortgage payable, interest expense, and interest payable should all be performed together.3. List audit procedures that are typically performed to verify the issue of the mortgage, the mortgage and the interest payable account balances at December 31, 2014, and the balance in interest expense for 2014.4. What type of information should be disclosed in the footnotes for this mortgage to help the auditor determine whether the completeness and presentation/disclosure assertions are satisfied?
  2.       It is a good idea to prepare an audit schedule for the permanent file for the mortgage information concerning the mortgage so it will be conveniently available for future years’ audits. This information should include all the provisions of the mortgage as well as the purchase price, date of purchase, and a list of items pledged as collateral. It may also contain an amortization schedule of principal and interest.
    2.            The audit of mortgage payable, interest expense, and interest payable should all be performed together since these accounts are related and the results of testing each account affect the other accounts. The likelihood of misstatement in the client’s records is determined more efficiently and effectively by performing these procedures together.
    3.            The audit procedures that should ordinarily be performed to verify the issue of the mortgage, the balance in the mortgage and interest payable, and the balance in the interest expense accounts are:
    a.      Determine if the mortgage was properly authorized.
    b.      Obtain the mortgage agreement and schedule the pertinent provisions in the permanent file, including the face amount, payments, interest rate, restrictions, and collateral.
    c.      Confirm the mortgage amount, terms, and collateral with the lending institution.
    d.      Recompute interest payable at the balance sheet date and reconcile interest expense to the decrease in principal and the payments made.
    e.      Test interest expense for reasonableness.
    4.            Generally accepted accounting principles require disclosures related to long-term debt. The terms of the mortgage are to be disclosed, including interest rates, maturity dates, five-year payment information, assets pledged as collateral, among other items. Significant restrictions on the activities of the company, such as maintaining cash or other compensating balances or restricting the amount of dividends that can be paid, should be disclosed. Thus, auditors should obtain copies of the mortgage agreement to determine that the client’s disclosures are complete and accurate.

Auditing: A Risk-Based Approach to Conducting a Quality Audit 9th Edition test bank – Johnstone

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