Deck 10: Finance and Investment Cycle

Question 1

Reliance on controls normally reduces the extent of substantive audit procedures on finance and investment cycle accounts.

Answer 1

False

Question 2

Confirmation requests should be sent only to lenders with a liability balance at the audit date.

Answer 2

False

Question 3

When there are no independent agents,most audit evidence about capital stock is gathered by confirmation directly with the stockholders.

Answer 3

False

Question 4

The preferred source of fair values for investments is management's estimate of what the market value should be.

Question 5

All investment policies should be approved by the board of directors or its investment committee.

Question 6

Sales of capital stock and debt financing transactions usually are authorized by the board of directors.

Question 7

Financial planning starts with the chief financial officer's cash flow forecast.

Question 8

The most significant reconciliation opportunities in the investment and intangible accounts are confirmation with brokers and the inspection and count of negotiable securities certificates.

Question 9

Auditors' test of controls over the production of estimates amounts to inquiries and observations.

Question 10

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

A) Proposals for cash forecasts, capital budgets, and business expansion.
B) Analyses of excess cash funds.
C) Reconciliation of cash.
D) Sale of stocks, bonds, or notes.

Question 11

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

A) Accounting.
B) Valuation or allocation.
C) Completeness.
D) Existence or occurrence.

Question 12

The balance-sheet classification of investments by management should be confirmed with outside parties.

Question 13

In large companies,custody of stock certificate books is a significant management problem.

Question 14

The primary audit concern with the verification of long-term liabilities is that all liabilities are recorded and that the interest expense is properly paid or accrued.

Question 15

It is very common for auditors to perform substantive procedures on 100 percent of the details in the finance and investment accounts.

Question 16

Documenting ownership of bonds can be handled by a trustee having duties and responsibilities similar to those of registrars and transfer agents.

Question 17

Owners' equity transactions usually are not well documented.

Question 18

When fixed assets are acquired during the year under audit,auditors should inquire about the source of funds for financing the new asset.

Question 19

Confirmation and inquiry procedures are not required for a class of items loosely termed off-balance-sheet information.

Question 20

The segregation of functional responsibilities is relatively easy for the finance and investment cycle.

Question 21

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

A) Accumulation of relevant, sufficient, and reliable data.
B) Preparation of estimates by qualified personnel.
C) Review by the independent auditor.
D) Consideration by management of whether particular accounting estimates are consistent with the company's operational plans.

Question 22

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

A) Perform analytical procedures on the bond premium and discount accounts.
B) Examine documentation of assets purchased with bond proceeds for liens.
C) Compare interest expense with the bond payable amount for reasonableness.
D) Confirm the existence of individual bondholders at year-end.

Question 23

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

A) Recalculating the mathematical estimate.
B) Observing whether estimates are prepared by qualified personnel.
C) Developing an independent estimate based on alternative assumptions.
D) Comparing the estimates of management to subsequently discovered facts before the end of fieldwork.

Question 24

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

A) Read directors' and finance committee's minutes for authorization of financing transactions.
B) Select a sample of paid notes and trace interest expense to the general ledger account.
C) Select a sample of paid notes and recalculate interest expense for the period under audit.
D) Select a sample of notes payable and vouch cash receipt to the bank statement.

Question 25

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

A) Always recalculate the client's figures regardless of how simple they appear.
B) Maintain professional skepticism when evaluating clients' estimates.
C) Always look into the background of the client before accepting an engagement.
D) None of the above.

Question 26

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

A) Existence.
B) Rights and obligations.
C) Completeness.
D) Valuation.

Question 27

During an audit of an entity's stockholders' equity accounts,the auditor determines whether there are restrictions on retained earnings resulting from loans,agreements,or state law.This audit procedure most likely is intended to verify the ASB presentation and disclosure assertion of

A) Occurrence.
B) Completeness.
C) Rights and Obligations.
D) Understandability.

Question 28

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

A) Occurrence.
B) Completeness.
C) Cutoff.
D) Accuracy.

Question 29

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

A) All material long-term liabilities are recorded.
B) New long-term liabilities and debt extinguishments are properly authorized.
C) Terms, conditions, and restrictions relating to noncurrent debt are adequately disclosed.
D) Disclosures of maturities for the next five years are accurate and adequate.

Question 30

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

A) Capital budget.
B) Minutes of the meetings of the board of directors.
C) Proxy statements.
D) Securities offering registration statements.

Question 31

A transfer agent

A) Keeps the stockholder list and, from time to time, determines the shareholders eligible to receive dividends.
B) Handles the exchange of shares, canceling the shares surrendered by sellers and issuing new certificates.
C) Records notes and bonds payable.
D) Makes investment decisions for an entity.

Question 32

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

A) Management.
B) The board of directors.
C) Stockholders.
D) An independent registrar.

Question 33

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

A) Capitalized intangible costs relate to intangibles acquired in exchange transactions.
B) Amortization is properly calculated.
C) Research and development costs are properly classified.
D) Goodwill is valued at market value.

Question 34

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

A) Existence.
B) Rights and obligations.
C) Completeness.
D) Valuation.

Question 35

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

A) Existence.
B) Completeness.
C) Rights and obligations.
D) Valuation.

Question 36

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

A) Study the entity's cash flow forecasts.
B) Obtain published market quotations.
C) Compare fair value of the securities to cost.
D) Confirm that the securities are held by a broker.

Question 37

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

A) Rights and obligations.
B) Custody.
C) Record keeping.
D) Periodic reconciliation.

Question 38

Derivative instruments include

A) Stocks.
B) Preferred stocks.
C) Stock options.
D) All the above.

Question 39

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

A) Direct access to securities in the safety deposit box is limited to only one corporate officer.
B) Personnel who post investment transactions to the general ledger are not permitted to update the investment subsidiary ledger.
C) The purchase and sale of investments are executed on the specific authorization of the board of directors.
D) Independent personnel periodically compare the recorded balances in the investment subsidiary ledger with the contents of the safety deposit box.

Question 40

The preferred method of determining fair value of transactions is

A) Market-based values.
B) Basing them on reasonable management assumptions.
C) External auditor estimates.
D) Detailed computations by outside experts.

Question 41

Jones was engaged to examine the financial statements of Gamma Corporation for the year ended June 30.Having completed an examination of the investment securities,which of the following is the best method of verifying the accuracy of recorded dividend income?

A) Tracing recorded dividend income to cash receipts records and validated deposit slips.
B) Performing analytical procedures and statistical sampling.
C) Comparing recorded dividends with amounts appearing on federal information Form 1099.
D) Comparing recorded dividends with a standard financial reporting service's record of dividends.

Question 42

A related party is a person or entity that

A) Has a family tie to a management member.
B) Does business with the company.
C) Can exert significant influence over or be influenced by the company.
D) Is a member of the company's management.

Question 43

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

A) Treasurer
B) Broker
C) Transfer Agent
D) Registrar

Question 44

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

A) External auditor involvement in developing assumptions.
B) Adequate review by appropriate levels of authority.
C) Comparison of prior estimates with subsequent results.
D) All the above are relevant aspects of internal controls over estimates.

Question 45

Records of stock and bond certificates are usually maintained by the company's

A) Treasurer
B) Chief Financial Officer
C) Transfer Agent
D) Registrar

Question 46

Loan covenants

A) Describe the collateral of the loan.
B) Require the borrower to maintain certain financial characteristics.
C) Describe the lender's responsibilities.
D) Include all the above.

Question 47

Taking a "big bath" in the financial statements refers to

A) Overstating income.
B) Overstating revenues.
C) Understating income.
D) An economic downturn.

Question 48

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

A) Reconciliation of detailed listings with general ledger amounts.
B) Proper cut-off.
C) Search for unrecorded items.
D) Gaining an understanding and verifying amounts and calculations.

Question 49

Loan covenants are used for which of the following reasons?

A) To protect the lender from the borrower substantially weakening the borrower's financial position.
B) To protect the borrower from the lender calling the loan early.
C) To protect the auditors from false information by the borrower.
D) To protect shareholders from management taking on too much debt.

Question 50

Compensating controls in the finance and investment cycle

A) Feature separation of duties by upper management.
B) Feature involvement of two or more persons handling all important responsibilities.
C) Include involvement by the external auditor.
D) Include all the above.

Question 51

Related party transactions

A) Must be valued as if they were arm's length.
B) Must be assumed to be valued differently than if they were arm's length.
C) Must be disclosed in the financial statements.
D) Must be disclosed in the financial statements and the auditor's report.

Question 52

Which of the following approaches is most suitable for auditing the finance and investment cycle?

A) Perform extensive tests of controls and limit substantive procedures to analytical procedures.
B) Ignore internal controls and perform extensive substantive procedures.
C) Gain an understanding of internal controls and perform extensive substantive procedures.
D) Ignore internal controls and limit substantive procedures to analytical procedures.

Question 53

Tests of controls in the finance and investment cycle

A) Normally focus on tests of transactions.
B) Primarily involve observing physical security of assets.
C) Typically amount to inquiries and observations related to management involvement.
D) Can significantly reduce the extent of substantive tests.

Question 54

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

A) Purchase commitment.
B) Capitalized lease.
C) Loan commitment.
D) Synthetic lease.

Question 55

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

A) Interest rate.
B) Serial numbers.
C) Number of shares.
D) Market value.

Question 56

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

A) Valuation.
B) Rights and obligations.
C) Completeness.
D) Accuracy.

Question 57

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

A) Valuation.
B) Existence.
C) Completeness.
D) Rights and obligations.

Question 58

Appropriate audit inquiries regarding estimates include all of the following except

A) Who prepares the estimates?
B) Why are they prepared?
C) What data are used?
D) When are they prepared?

Question 59

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

A) Actuarial assumptions for pension accruals.
B) Residual values for leases.
C) Stated market value of publicly traded stocks.
D) All the above are estimates.

Question 60

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

A) Proper authorizations and competent personnel.
B) Computer controls over transactions.
C) Physical security of assets.
D) Prenumbered documents.

Question 61

The auditors should insist that a representative of the client be present during the inspection and count of securities to

A) Lend authority to the auditors' directives.
B) Detect forged securities.
C) Coordinate the return of all securities to proper locations.
D) Acknowledge the receipt of securities returned.

Question 62

An audit team's purpose in reviewing the documentation concerning the renewal of a note payable shortly after the balance-sheet date most likely is to obtain evidence concerning management's assertions about

A) Existence.
B) Valuation.
C) Completeness.
D) Classification.

Question 63

The primary reason for preparing a reconciliation between interest-bearing obligations outstanding during the year and interest expense in the financial statements is to

A) Evaluate internal control over securities.
B) Determine the validity of prepaid interest expense.
C) Ascertain the reasonableness of imputed interest.
D) Detect unrecorded liabilities.

Question 64

Which of the following is the most important audit consideration when examining the stockholders' equity section of a client's balance sheet?

A) Changes in the capital stock account are verified by an independent stock transfer agent.
B) Stock dividends and stock splits during the year under audit were approved by the stockholders.
C) Stock dividends are capitalized at par or stated value on the dividend declaration date.
D) Entries in the capital stock account can be traced to resolutions in the minutes of meetings of the board of directors.

Question 65

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

A) Perform analytical procedures on the bond premium and discount accounts.
B) Examine documentation of assets purchased with bond proceeds for liens.
C) Compare interest expense with the bond payable amount for reasonableness.
D) Confirm the existence of individual bondholders at year-end.

Question 66

An audit plan for the examination of the retained earnings account should include a step that requires verification of the

A) Market value used to charge retained earnings to account for a 2-for-1 stock split.
B) Approval of the adjustment to the beginning balance as a result of a write-down of account receivables.
C) Authorization for both cash and stock dividends.
D) Dividends received from investments.

Question 67

Which of the following audit procedures would not likely be performed for audits of shareholders' equity?

A) Read board of directors' minutes for authorization of equity transactions.
B) Confirm outstanding common and preferred stock with stock registrar.
C) Compare valuation of stock to published market prices.
D) Obtain management representation about number of shares issued and outstanding.

Question 68

When the client holds a large amount of negotiable securities,auditors need to plan to guard against

A) Unauthorized negotiation of the securities before they are counted.
B) Unrecorded sales of securities after they are counted.
C) Substitution of securities already counted for other securities that should be on hand but are not.
D) Substitution of authentic securities with counterfeit securities.

Question 69

In connection with the audit of an issue of long-term bonds payable,the audit team should

A) Determine whether bondholders are persons other than owners, directors, or officers of the company issuing the bond.
B) Calculate the effective interest rate to see if it is substantially the same as the rates for similar issues.
C) Decide whether the bond issue was made without violating state or local law.
D) Ascertain that the client has obtained the opinion of counsel on the legality of the issue.

Question 70

An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the

A) Existence of unrealized gains or losses.
B) Completeness of recorded investment income.
C) Classification as available-for-sale or trading securities.
D) Valuation of trading securities.

Question 71

An audit plan to examine long-term debt most likely would include steps that require

A) Comparing the carrying amount of held-to-maturity securities with their year-end market values.
B) Correlating interest expense recorded for the period with outstanding debt.
C) Verifying the existence of the holders of the debt by direct confirmation.
D) Inspecting the accounts payable subsidiary ledger for unrecorded long-term debt.

Question 72

When a client company does not maintain its own capital stock records,the auditors should obtain written confirmation from the transfer agent and registrar concerning.

A) Restrictions on the payment of dividends.
B) The number of shares issued and outstanding.
C) Guarantees of preferred stock liquidation value.
D) The number of shares subject to agreements to repurchase.

Question 73

All corporate capital stock transactions should ultimately be traced to the

A) Minutes of the meetings of the board of directors.
B) Cash receipts journal.
C) Cash disbursements journal.
D) Numbered stock certificates.

Question 74

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

A) Read board of directors' minutes for authorization of investment strategies.
B) Confirm investments with registrar.
C) Confirm investments with broker or trustee.
D) Compare valuation to published market prices.

Question 75

Which of the following questions would auditors most likely include on an internal control questionnaire for notes payable?

A) Are assets that collateralize notes payable critically needed for the entity's continued existence?
B) Are two or more authorized signatures required on checks that repay notes payable?
C) Are the proceeds from notes payable used for the purchase of noncurrent assets?
D) Are direct borrowings on notes payable authorized by the board of directors?

Question 76

A client has a large and active investment portfolio that is kept in a bank safe deposit box.If the auditors are unable to count securities at the balance-sheet date,they most likely will

A) Request the bank to confirm to the auditors the contents of the safe deposit box at the balance-sheet date.
B) Examine supporting evidence for transactions occurring during the year.
C) Count the securities at a subsequent date and confirm with the bank whether securities were added or removed since the balance-sheet date.
D) Request the client to have the bank seal the safe deposit box until the auditors can count the securities at a subsequent date.

Question 77

When an entity uses a trust company as custodian of its marketable securities,the possibility of concealing fraud most likely would be reduced if the

A) Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.
B) Securities are registered in the name of the trust company rather than the entity itself.
C) Interest and dividend checks are mailed directly to an entity employee who is authorized to sell securities.
D) The trust company places the securities in a bank safe deposit vault under the custodian's exclusive control.

Question 78

If the auditors discover that the carrying amount of a client's investments is overstated because of a loss in value that is other than a temporary decline in market value,they should insist that

A) The approximate market value of the investments be shown in parentheses on the face of the balance sheet.
B) The investments be classified as long term for balance-sheet purposes with full disclosure in the footnotes.
C) The loss in value be recognized in the financial statements.
D) The equity section of the balance sheet separately show a charge equal to the amount of the loss.

Question 79

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

A) Vouching the receipt and deposit of interest checks.
B) Confirming the bond interest rate with the issuer of the bonds.
C) Recomputing the interest earned on the basis of face amount, interest rate, and period held.
D) Testing internal controls relevant to cash receipts.

Question 80

When independent stock transfer agents are not employed and the corporation issues its own stock and maintains stock records,canceled stock certificates should

A) Be defaced to prevent reissuance and attached to their corresponding stubs.
B) Not be defaced but be segregated from other stock certificates and retained in a canceled certificates file.
C) Be destroyed to prevent fraudulent reissuance.
D) Be defaced and sent to the secretary of state.