Deck 16: Audit of the Capital Acquisition and Repayment Cycle

Question 1

The exclusion of a single transaction of the capital acquisition and repayment cycle could be material in itself. This means that the following audit assertion is a major audit concern:

A) completeness.
B) existence.
C) accuracy.
D) rights and obligations.

Answer 1

A

Question 2

The amount of time spent verifying owners' equity is frequently minimal for closely-held corporations because

A) these companies are so small that it is not necessary to audit the capital section.
B) the few owners all have access to the books, so the auditor spends more time on accounts like liabilities, which affect outsiders.
C) there are few, if any, transactions during the year for the capital stock accounts, except for earnings and dividends.
D) there is no public interest in these companies.

Answer 2

C

Question 3

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

Answer 3

The risks of fraud and error for such accounts are as follows:
•errors in calculating interest payments, posting such amounts to the wrong period, or omitting them
•misclassifying debt as equity or vice versa, or misclassifications between current and long-term
•recording debt or equity transactions in the wrong period
•incorrect or inaccurate disclosure of terms or amounts
•deliberate misclassification of debt or equity as revenue or other fraudulent manipulations
•over or underpayment of interest due to the use of different interest rates
•duplication of interest payments in error

Question 4

Comparison of the total balance in notes payable, interest expense, and accrued interest with these accounts in the prior year could detect what type of possible misstatement?

A) misstatement of interest expense or accrued interest, or omission of a note payable
B) omission or misstatement of a note payable
C) misclassification of a note payable as long-term rather than current
D) misstatement of notes payable, interest expense, or accrued interest

Question 5

There is a direct relationship between the interest and dividend accounts and debt and equity. This means that in the audit of interest-bearing debt, it is desirable to simultaneously verify

A) the related dividends declared and dividends payable.
B) the related interest expense and interest payable.
C) contracts and commitments that are long-term.
D) details provided in the board of directors' minutes.

Question 6

Discuss the overall objectives of the audit of notes payable.

Question 7

Tests of details for notes payable interest expense and accrued interest can frequently be eliminated when

A) tests of controls are conducted over authorization and recording procedures.
B) notes are issued by a person independent of the accounting department.
C) the notes payable schedule indicates that all notes have been repaid.
D) results of analytical review are favourable.

Question 8

The normal audit approach for the audit of bonds issued is to

A) examine transactions that occurred near the year-end date only.
B) verify each transaction taking place in the cycle for the entire year.
C) select a statistical sample of transactions throughout the year.
D) rely on controls rather than conducting substantive tests.

Question 9

A note payable is

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

Question 10

Discuss the four key controls over notes payable.

Question 11

Notes payable are easy for companies to correctly value and include in the financial statements. This means that with respect to notes payable, inherent risk is

A) low.
B) medium.
C) high.
D) not assessed.

Question 12

Proper authorization for the issuance of notes payable requires that

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

Question 13

Notes payable that have been repaid in full should be

A) destroyed so that they will not be paid again inadvertently.
B) cancelled and destroyed.
C) cancelled and returned to the creditor.
D) cancelled and retained by an authorized company official.

Question 14

Responsibility for the issuance of new notes should be vested in the

A) board of directors.
B) accounting department.
C) accounts payable department.
D) purchasing department.

Question 15

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

Question 16

When setting the objectives for auditing notes, the auditor should consider inherent risks associated with

A) recording errors.
B) uncollectible notes.
C) duplicated notes.
D) management bias.

Question 17

In the audit of the transactions and amounts in the capital acquisitions and repayments cycle, the auditor must ensure that significant legal requirements affecting the financial statements have been properly fulfilled and

A) any violations are reported to the relevant provincial securities commissions.
B) any departures from the agreements are made with management's knowledge and consent.
C) are adequately disclosed in the financial statements.
D) must issue a disclaimer if they haven't been fulfilled.

Question 18

Control risk for notes payable is usually assessed as low. This occurs because internal controls are normally good for notes payable and

A) creditors would complain if the notes are not paid.
B) interest expense can easily be distinguished from bank service charges.
C) there are a small number of large transactions for this type of transaction.
D) inclusion in the accounts payable listing helps track the notes.

Question 19

Which of the following internal controls over notes payable address risks associated with the accuracy, allocation, and completeness audit assertions?

A) Renewals or new notes should be approved by the board of directors (as evidenced in the minutes) or by senior management.
B) Authorized employees should perform independent recalculations of interest and reconciliation of the notes payable balance to the general ledger.
C) Subsidiary records should be maintained for each note and there should be control over blank and paid notes.
D) Paid notes should be cancelled and retained under the custody of an authorized official.

Question 20

If actual interest expense is materially larger than the auditor's independent estimate, one possible cause could be

A) interest payments on unrecorded notes payable.
B) omitted payments of interest (i.e., underpayments).
C) interest payments recorded at the wrong (lower) interest rate.
D) notes payable that were set up incorrectly as short-term notes.

Question 21

The tests of details of balances procedure that requires the auditor to examine notes paid after year-end to determine whether they were liabilities at the balance sheet date is an attempt to satisfy the audit objective of

A) existence.
B) completeness.
C) accuracy.
D) classification.

Question 22

The tests of details of balances procedure that requires the auditor to examine corporate minutes for loan approval would satisfy the audit objective of

A) classification.
B) existence.
C) completeness.
D) accuracy.

Question 23

Identify three analytical procedures commonly performed for notes payable.

Question 24

The normal starting point for the audit of notes payable is

A) a discussion with management of any new notes payable for the year.
B) a schedule of notes payable and accrued interest obtained from the client.
C) the assessment of materiality.
D) the minutes of the board of directors.

Question 25

Presentation and disclosure are important because acceptable financial reporting frameworks require that footnotes adequately describe the terms of notes payable outstanding and the assets pledged as collateral for the loans. Which assertion does this relate to?

A) valuation
B) existence
C) completeness
D) understandability

Question 26

Which of the following audit procedures assists the auditor with testing for completeness?

A) Analyze interest expense to uncover a payment to a creditor who is not included in the notes payable schedule.
B) Examine notes to determine whether the company has obligations for payment.
C) Examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet date.
D) Examine the dates on duplicate copies of notes to determine whether all or part of the notes are non-current liabilities.

Question 27

The most important balance-related and presentation and disclosure-related audit objectives for notes payable are

A) accuracy, existence, and completeness.
B) existence, completeness, and valuation.
C) accuracy, completeness, and understandability.
D) accuracy, completeness, and valuation.

Question 28

The tests of details of balances procedure that requires the auditor to trace the totals of the notes payable list to the general ledger satisfies the objective of

A) existence.
B) completeness.
C) accuracy.
D) rights and obligations.

Question 29

Two of the audit objectives for notes payable are important because a misstatement could be material even if one note is omitted or incorrect. Which assertions are they?

A) completeness and valuation
B) existence and completeness
C) accuracy and existence
D) completeness and accuracy

Question 30

The audit objective to determine that notes payable and accrued interest on the notes payable schedule are accurate is accomplished by which of the following test of balances procedure?

A) Examine duplicate copies of notes for principal and interest rates.
B) Review the minutes of the board of directors for authorized but unrecorded notes.
C) Trace the total of the notes payable schedule to the general ledger.
D) Review the notes to determine whether any are with related parties or should be accounts payable.

Question 31

The audit objective to determine that existing notes payable are included in the notes payable schedule (completeness) is accomplished by the following test of balances procedure.

A) Examine balance sheet for disclosure details.
B) Recalculate accrued interest.
C) Review the bank reconciliation for new notes credited directly to the bank account by the bank.
D) Examine duplicate copies of notes for principal and interest rates.

Question 32

Caroline is performing the audit of the capital acquisition and repayment cycle. She is currently auditing the payments of interest made during the year. The proper documentation that Caroline should use as supporting evidence of the payment is

A) a copy of the note.
B) a bank reconciliation.
C) documentation of her inquiries with management.
D) the notes payable sub-ledger.

Question 33

Comparison of individual notes payable outstanding with the prior year could detect what type of possible misstatement?

A) misstatement of interest expense or accrued interest, or omission of a note payable
B) omission or misstatement of a note payable
C) misclassification of a note payable as long-term rather than current
D) misstatement of notes payable, interest expense, or accrued interest

Question 34

The audit objective to determine that notes payable in the schedule exist is verified by the tests of balances procedure to

A) foot the notes payable list.
B) confirm notes payable.
C) recalculate interest expense.
D) examine the balance sheet for proper disclosure of noncurrent portions.

Question 35

During the course of an audit, a public accountant observes that the recorded interest expense seems to be excessive in relation to the balance in the long-term debt account. This observation could lead the auditor to suspect that

A) long-term debt is understated.
B) discount on bonds payable is overstated.
C) long-term debt is overstated.
D) premium on bonds payable is understated.

Question 36

Recalculation of an approximate interest expense using the basis of average interests rates and overall monthly notes payable could detect what type of possible misstatement?

A) misstatement of interest expense or accrued interest, or omission of a note payable
B) omission or misstatement of a note payable
C) misclassification of a note payable as long-term rather than current
D) misclassification of notes payable, interest expense, or accrued interest

Question 37

The audit objective requiring that existing notes payable are included in the notes payable schedule (completeness) is satisfied by performing the following audit procedure.

A) Recalculate accrued interest.
B) Examine duplicate copies of notes for details.
C) Review the notes payable schedule to determine whether any are related parties.
D) Obtain confirmations from creditors who have held notes from the client in the past and are not currently included in the notes payable schedule.

Question 38

What procedure can an auditor use to determine whether notes payable on the notes payable schedule are properly classified?

A) Review the notes to determine whether any are with related parties.
B) Confirm notes payable.
C) Examine corporate minutes for loan approval.
D) Examine notes, minutes, and bank confirmations for restrictions.

Question 39

A common test of details of balances procedure for notes payable is to examine duplicate copies of notes to determine whether notes were dated on or before the balance sheet date. Which audit assertion is this test of detail associated with?

A) allocation (accuracy)
B) allocation (cutoff)
C) existence
D) completeness

Question 40

The test of details of balances procedure that requires the auditor to recalculate accrued interest will satisfy the audit objective of

A) existence.
B) completeness.
C) classification.
D) accuracy.

Question 41

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

Question 42

When the auditor examines the board of directors' minutes for dividends declared, the auditor should be alert to the possibility of unrecorded dividends declared, particularly shortly before the balance sheet date. Which audit assertion does this address?

A) valuation
B) existence
C) completeness
D) understandability

Question 43

An audit procedure that is part of the audit of notes payable is the review of the permanent audit working paper files to determine if there are restrictions on the payment of dividends in bond indenture agreements or preferred share provisions. Which presentation and disclosure audit assertion is this associated with?

A) valuation
B) completeness
C) existence
D) classification

Question 44

As part of the audit, the auditor may examine authorization procedures with respect to the repurchase or redemption of capital stock. In particular, for a public company the auditor would verify that which of the following details have been authorized?

A) general ledger accounts affected, dividends included, amount to be paid
B) type of stock, timing, amount to be paid
C) individuals from whom repurchase will be permitted, maximum amount
D) type of stock, amount to be paid, effect upon bond sinking funds

Question 45

It is normal practice to verify all capital stock transactions

A) that are in excess of a material amount.
B) if there aren't very many during the year.
C) regardless of the controls in existence, because of their materiality and permanence in the records.
D) only when the client is small.

Question 46

The emphasis in the audit of dividends is on

A) ending equity balance.
B) transactions.
C) opening dividends payable balance.
D) confirming the number of shares outstanding.

Question 47

The auditor recomputed the dividend declaration amount by multiplying the declared dividend per share by the number of shares outstanding. Which audit assertion is this associated with?

A) completeness
B) accuracy
C) valuation
D) existence

Question 48

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

Question 49

The audit procedure that requires the auditor to examine notes, minutes, and bank confirmations for restrictions is performed to satisfy the audit objective of

A) existence.
B) completeness.
C) accuracy.
D) presentation and disclosure.

Question 50

One of the reasons the auditor reads debt agreements is to discover whether there are any restrictions on the company, such as restrictions on the payment of dividends. It is important for the auditor to identify such restrictions so that

A) corroborative evidence can then be obtained from management.
B) the auditor can make sure that management is adhering to the restrictions.
C) the auditor can include the restrictions in the management representation letter.
D) they can be disclosed in the footnotes of the financial statements.

Question 51

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

Question 52

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

Question 53

For publicly held corporations, the verification of owners' equity is more complex due to the

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

Question 54

If a company employs a capital stock registrar and/or transfer agent, the registrar or agent (or both) should be requested to confirm directly to the auditor the number of shares of each class of stock

A) surrendered and cancelled during the year.
B) authorized at the balance sheet date.
C) issued and outstanding at the balance sheet date.
D) authorized, issued, and outstanding during the year.

Question 55

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

Question 56

Usually dividends are audited

A) using block sampling.
B) on a 100% basis.
C) using variables sampling.
D) using attributes sampling.

Question 57

Most large corporations employ the services of a stock transfer agent for the purpose of

A) maintaining the shareholder records.
B) recording share capital in the accounts.
C) issuing the shares for the company.
D) ensuring that stock issuances are complying with federal and provincial laws.

Question 58

Kumar is the internal auditor of Tarragon Inc. Kumar wants to put procedures in place to prevent misstatements in owners' equity and ensure proper record keeping. Kumar has suggested that management implement well-defined policies for preparing stock certificates and recording capital stock transactions. What else should Kumar recommend?

A) independent internal verification of information in the records
B) having all journal entries in the equity account reviewed by the controller
C) performing a monthly reconciliation of shareholder's equity
D) reconciling the dividend payments with the bank statement

Question 59

When the auditor examines the minutes of board of directors' meetings for the amount of the dividend per share and the dividend date, the auditor is checking for

A) completeness.
B) valuation.
C) understandability.
D) existence.

Question 60

The transfer agent confirmed to the auditor that the company had 2 500 000 shares outstanding at December 31, 2010. To have assurance over the accuracy of the dividend payable, the auditor would multiply 2 500 000 by the

A) dividend per share declared.
B) dividend per share paid during the year.
C) dividend per share as per the articles of incorporation, even if it was not declared during the year.
D) average dividend for the industry.

Question 61

When a dividend is declared by the board, the source for determining who should receive dividend cheques is the

A) shareholders' capital stock register or master file.
B) stock certificate books.
C) common stock account in the general ledger.
D) corporate directory.

Question 62

As part of the audit of dividends, the auditor would verify whether the payment was made to the shareholders who owned the stock at the dividend record date. Which of the following audit tests assists with this objective?

A) examining the minutes of board of directors' meetings for the amount of the dividend per share and the dividend date
B) reviewing the permanent audit working paper file to determine if there are restrictions on the payment of dividends
C) recomputing the amount of dividends declared by multiplying the dividend amount per share by the number of shares outstanding
D) selecting a sample of recorded dividend payments and tracing the payee's name on the cancelled cheque to the dividend records

Question 63

Describe the audit procedures and related audit assertions for the audit of dividends.

Question 64

A primary concern in determining whether retained earnings is correctly disclosed on the balance sheet is

A) correct calculation of the net income or loss for the year.
B) correct calculation of dividend payments for the year.
C) whether adjustments to retained earnings have been made correctly.
D) whether there are any restrictions on the payment of dividends.

Question 65

The auditor has reconciled the dividend payment amounts disbursed according to the cash disbursements journal to the dividend declared. Which audit assertions is this test associated with?

A) valuation and existence
B) accuracy and valuation
C) accuracy and completeness
D) valuation and understandability

Question 66

State the four audit concerns for capital stock and describe how the auditor typically verifies each of these areas.