Test bank auditing and assurance principles ch13 substantive audit testing financing and investing cycle

No events have occurred subsequent to the balance sheet date that require adjustment to, or disclosure in, the financial statementsa. Generally accepted auditing standards require the au

Substantive Audit Testing: Financing and

Investing Cycle MULTIPLE CHOICE:

1 Which of the following expressions is least likely to be

included in a client's representation letter?

a No events have occurred subsequent to the balance sheet

date that require adjustment to, or disclosure in, the financial statements

b The company has complied with all aspects of

contractual agreements that would have a material effect on the financial statements in the event of noncompliance

c Management acknowledges responsibility for illegal

actions committed by employees

d Management has made available all financial statements

and related data ANSWER: C

2 When reviewing working papers, an audit supervisor will be

primarily concerned with determining whether the

a Audit programs have been carried out without deviation

b Working papers adequately support the audit findings,

conclusions, and reports

c Working papers reflect adherence to budget constraints

d Auditing department's standard formats and tick marks

have been used consistently ANSWER: B

3 A written representation from a client's management which,

among other matters, acknowledges responsibility for the

fair presentation of financial statements, should normally be signed by the

a Chief executive officer and the chief financial

officer

b Chief financial officer and the chairman of the

board of directors

c Chairman of the audit committee of the board of

directors

d Chief executive officer, and the chairman of the

board of directors, and the client's lawyer ANSWER: A

4 Generally accepted auditing standards require the auditor to

apply analytical procedures in both the planning and review stages of the audit The major reason for applying

analytical procedures as part of audit review is

a To identify abnormalities that warrant audit attention

b To assist the auditor in establishing materiality

thresholds

c To ascertain that the auditor has gathered adequate

evidence to resolve suspicions arising during the planning stages of the audit

d To provide documentary evidence in the event of future

litigation

ANSWER: C

5 The existence of a related party transaction may be

indicated when another entity

a Sells real estate to the corporation at a price that

is comparable to its appraised value

b Absorbs expenses of the corporation

c Borrows from the corporation at a rate of interest

which equals the current market rate

d Lends to the corporation at a rate of interest which

equals the current market rate ANSWER: B

6 The main purpose of the auditor/client conference held at

the close of audit field work is to

a Discuss unresolved matters and audit fee arrangements

b Review proposed audit adjustments, internal control

weaknesses, and needed disclosures, and agree on the type of audit report to be rendered

c Discuss areas of major audit risk and use of client

personnel to assist in high risk areas

d Arrange for a meeting with outside legal counsel for

the purpose of discussing pending litigation

ANSWER: B

7 After discovering that a related party transaction exists,

the auditor should be aware that the

a Substance of the transaction could be significantly

different from its form

b Adequacy of disclosure of the transaction is secondary

to its legal form

c Transaction is assumed to be outside the ordinary

course of business

d Financial statements should recognize the legal form

of the transaction rather than its substance ANSWER: A

8 Which of the following matters describes a "reportable

condition" that should be included in the auditor's

communication of the same?

a A significant audit adjustment was required because a

major year-end adjustment was inadvertently overlooked

by the client

b The client's recently installed on-line real-time

computer system lacks necessary input editing features

c A major customer of the client is verging on

bankruptcy

d The auditors do not agree with the economic feasibility

of the client's proposed acquisition of a new subsidiary

ANSWER: B

9 An attorney is responding to an independent auditor as a

result of the audit client's letter of inquiry The

attorney may appropriately limit the response to

a Asserted claims and litigation

b Matters to which the attorney has given substantive

attention in the form of legal consultation or representation

c Asserted, overtly threatened, or pending claims and

litigation

d Items which have an extremely high probability of

being resolved to the client's detriment ANSWER: B

10 An auditor is verifying a company's ownership of equipment

What is the best evidence of ownership?

a The current year's depreciation expense journal entry

b A canceled check written to acquire the equipment

c An interview with the equipment custodian verifying

company ownership

d The presence of the equipment on the company's balance

sheet ANSWER: B

11 If a lawyer refuses to furnish corroborating information

regarding litigation, claims, and assessments, the auditor should

a Honor the confidentiality of the client-lawyer

relationship

b Consider the refusal to be tantamount to a scope

limitation

c Seek to obtain the corroborating information from

management

d Disclose this fact in a footnote to the financial

statements ANSWER: B

12 In auditing investments for proper valuation, the auditor

should do all but the following:

a Confirm securities held in safekeeping off the client's

premises

b Vouch purchases and sales of securities by tracing to

brokers' advices and canceled checks

c Compare cost and market by reference to year end market

values for selected securities

d Recalculate gain or loss on disposals

ANSWER: A

13 When examining a client's statement of cash flows for audit

evidence, an auditor will rely primarily upon

a Determination of the amount of working capital at

year-end

b Cross-referencing to balances and transactions reviewed

in connection with the examination of the other

financial statements

c Analysis of significant ratios of prior years as

compared to the current year

d The guidance provided by the APB Opinion on the

statement of cash flows ANSWER: B

14 A limitation on the scope of the auditor's examination

sufficient to preclude an unqualified opinion will always result when management

a Prevents the auditor from reviewing the working papers

of the predecessor auditor

b Engages the auditor after the year-end physical

inventory count is completed

c Fails to correct a material internal control weakness

that had been identified during the prior year's audit

d Refuses to furnish a client representation letter to

the auditor ANSWER: D

15 When an audit is made in accordance with generally accepted

auditing standards, the auditor should always

a Test control procedures by reprocessing a representa-

tive sample of completed transactions

b Examine all negotiable and nonnegotiable securities,

regardless of location

c Obtain certain written representations from management

d Observe the taking of the physical inventory on the

balance sheet date ANSWER: C

16 Which of the following audit procedures provides the best

evidence about the collectability of notes receivable?

a Confirmation of note receivable balances with the

debtors

b Examination of notes for appropriate debtors'

signatures

c Examination of cash receipts records to determine

promptness of interest and principal payments

d Reconciliation of the detail of notes receivable and

the provision for uncollectible amounts to the general ledger control ANSWER: C

17 An audit program 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 for a

two-for-one stock split

b Approval of the adjustment to the beginning balance as

a result of a write-down of an account receivable

c Authorization for both cash and stock dividends

d Gain or loss resulting from disposition of treasury

shares ANSWER: C

18 In testing the reasonableness of interest income, an auditor

could most effectively use analytical tests involving

a The beginning balance in the investments account for

fixed income securities

b The average monthly balance in the investments account

for fixed income securities

c The ending balance in the investments accounts for

fixed income securities

d Documentary support of specific entries in the account ANSWER: B

19 Which of the following would provide the best form of

evidential matter pertaining to the annual valuation of a long-term investment in which the independent auditor's

client owns a 30% voting interest?

a Market quotations of the investee company's stock

b Current fair value of the investee company's assets

c Historical cost of the investee company's assets

d Audited financial statements of the investee company ANSWER: D

20 Which of the following is a "Type I" subsequent event?

a The client's Long Island warehouse was destroyed by

fire two weeks following the balance sheet date The warehouse and its contents were uninsured and

represented 15% of the client's total assets

b As the result of an uninsured flood loss, one of the

client's major customers declared bankruptcy The client doesn't expect to recover more than 5% of the outstanding receivable which accounts for 30% of total accounts receivable The flood and bankruptcy

declaration both occurred after the balance date but before the release of the audit report No additional provision for loss had been made as of year end

c Three weeks after the balance sheet date, a major

strike was called by the labor union representing 80%

of the client's work force

d After the balance sheet date, but prior to release of

the audit report, a product liability judgment against the client was rendered by a judge The judgment

assessed damages and fines totaling 30% of audited net income The events giving rise to the judgment

occurred prior to the balance sheet date The client does not plan to appeal the decision

ANSWER: D

21 Which of the following statements regarding the audit of

negotiable notes receivable is not correct?

a The auditor should confirm all notes receivable as of

the balance sheet date

b Materiality of the amount involved is a factor considered when selecting the accounts to be confirmed

c Physical inspection of a note by the auditor does not

provide conclusive evidence

d Notes receivable discounted with recourse need to be

confirmed ANSWER: A

22 Which of the following matters should not be included in the

auditor's letter of communication with the client's audit committee?

a An audit adjustment was required reducing inventory by

40%

b Management was reluctant to answer the auditor's

questions concerning the economic substance of material related party transactions

c Contrary to a previous understanding, the client did

not have an adjusted trial balance completed prior to the commencing of audit field work Moreover, several errors were detected by the audit team as a result of significant weaknesses in internal control

d An internal control weakness discovered during the

previous year's audit was corrected during the current year

ANSWER: D

23 Apex, Incorporated issued common stock to acquire another company, in an acquisition that was accounted for as a

pooling of interests The auditor examining this

transaction would be least interested in

a The net book value of the acquired company

b The par value of the stock that was issued

c Whether or not the acquisition was approved by the

board of directors of Apex, Incorporated

d Whether the fair market value of the acquired assets

were independently appraised ANSWER: D

24 An internal auditor discovered an error in a receivable due

from a major stockholder The receivable's balance accounts for less than one percent of the company's total

receivables Would the auditor be likely to consider the

error material?

a Yes, if relative risk is low

b No, if there will be further transactions with

this stockholder

c Yes, because a related party is involved

d No, because a small dollar amount is in error

ANSWER: C 25 Two months before the year end, the bookkeeper erroneously recorded the receipt of a long-term bank loan by a debit to cash and a credit to sales Which of the following is the most effective procedure for detecting this type of error? a Analyze the notes payable journal

b Analyze bank confirmation information

c Prepare a year-end bank reconciliation

d Prepare a year-end bank transfer schedule

ANSWER: B 26 Of the following statements regarding further analysis of materiality thresholds during audit review, which one is true? a Audit adjustments reducing net income may suggest a need to lower individual item and aggregate materiality thresholds b Audit adjustments reducing net income may suggest a need to lower the individual item threshold, but should not affect aggregate materiality thresholds c Audit adjustments that increase net income may suggest a need to lower aggregate materiality thresholds d An increase in the assessment of control risk suggests a need to lower the individual item materiality threshold ANSWER: A 27 A written understanding between the auditor and the client concerning the auditor's responsibility for the discovery of illegal acts is usually set forth in a(an)

a Client representation letter

b Letter of audit inquiry

c Management letter

d Engagement letter

ANSWER: D 28 A letter from the company's attorney in response to inquiries about possible litigation is best described as: a Confirmation evidence

b Analytical evidence

c Documentary evidence

d Physical evidence

ANSWER: A 29 The auditor can best verify a client's bond sinking fund

transactions and year-end balance by

a Confirmation with individual holders of retired bonds b Confirmation with the bond trustee

c Recomputation of interest expense, interest payable, and amortization of bond discount or premium

d Examination and count of the bonds retired during the year

ANSWER: B 30 Which of the following procedures would an auditor ordinarily perform during the review of subsequent events?

a An analysis of related party transactions for the

discovery of possible fraud

b A review of the cut-off bank statements for the period after the year-end

c An inquiry of the client's legal counsel concerning

litigation

d An investigation of material weaknesses in internal

control previously communicated to the client

ANSWER: C 31 Which of the following is not an audit procedure which the independent auditor would perform with respect to litigation, claims, and assessments

a Inquire of and discuss with management the policies

and procedures adopted for identifying, evaluating, and accounting for litigation, claims, and assessments

b Obtain from management a description and evaluation of litigation, claims, and assessments that

existed at the balance sheet date

c Obtain assurance from management that it has disclosed

all unasserted claims that the lawyer has advised are probable of assertion and must be disclosed

d Confirm directly with the client's lawyer that all

claims have been recorded in the financial statements ANSWER: D

32 The auditee has acquired another company by purchase Which

of the following would be the best audit procedure to test the appropriateness of the allocation of cost to tangible

assets?

a Determine whether assets have been recorded at their

book value at the date of purchase

b Evaluate procedures used to estimate and record fair

market values for purchased assets

c Evaluate the reasonableness of recorded values by use

of replacement cost data

d Evaluate the reasonableness of recorded values by

discussion with operating personnel ANSWER: B

33 A CPA has received an attorney's letter in which no

significant disagreements with the client's assessments

a Undisclosed unasserted claims may have arisen

b The attorney was unable to form a conclusion with

respect to the significance of litigation, claims,

c The auditor must begin a completely new examination of

contingent liabilities

d An adverse opinion will be necessary ANSWER: A

34 An audit procedure that provides evidence about proper

valuation of marketable securities arising from a short-term investment of excess cash is

a Comparison of carrying value with current market

quotations

b Confirmation of securities held by broker

c Recalculation of investment carrying value by applying

the equity method