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Auditing and Assurance Services, 14e (Arens)
Chapter 22 Audit of the Capital Acquisition and Repayment Cycle
Learning Objective 22-1
1) Which of the following statements is correct regarding the capital acquisition and payment cycle?
A) Bonds are frequently issued by companies
in small amounts.
B) There are relatively few transactions and each transaction is typically highly material.
C) A primary emphasis in auditing debt is on existence.
D) Audit procedures for Notes Payable and Interest Income are often performed simultaneously.
Answer: B
Terms: Capital acquisition and payment cycle
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
2) The capital acquisition and repayment cycle does not include:
A) payment of
interest.
B) payment of dividends.
C) payment of vendor invoices.
D) acquisition of capital through interest-bearing debt.
Answer: C
Terms: Capital acquisition and payment cycle
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
3) Which of the following statements regarding the capital acquisition and repayment cycle is most
correct?
A) Relatively few transactions affect the cycle, and most are smaller amounts.
B) Large numbers of
transactions affect the cycle, and most are smaller amounts.
C) Relatively few transactions affect the cycle, and most are highly material.
D) Large number of transaction affect the cycle, and most are highly material.
Answer: C
Terms: Capital acquisition and repayment cycle
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
4) The primary audit objectives to focus on when auditing debt are:
A) accuracy and completeness.
B) accuracy and
existence.
C) completeness and valuation.
D) accuracy and valuation.
Answer: A
Terms: Primary audit objectives focus on when auditing debt
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
1
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5) Tolerable misstatement is often set at a(n) ________ level for notes payable.
A) high
B) moderate
C) low
D) unknown
Answer: C
Terms: Tolerable misstatement level for notes payable
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
6) When auditing interest-bearing debt, the auditor should ________ verify the related interest expense
and interest payable.
A) not
B) attempt to
C) simultaneously
D) never
Answer: C
Terms:
Audit of interest-bearing debt and related interest expense and interest payable
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
7) Assessed control risk and results of substantive tests of transactions are normally unimportant for
designing tests of details of balances for which of the following accounts?
A) Accounts receivable
B) Inventory
C) Accounts payable
D) Notes payable
Answer: D
Terms: Assessed control risk; Results of substantive
tests of transactions; Unimportant for designing tests of details
of balances
Diff: Moderate
Objective: LO 22-1
AACSB: Reflective thinking skills
8) In the audit of the transactions and amounts in the capital acquisitions and repayments cycle, the
auditor must take great care in making sure that the significant legal requirements affecting the financial
statements have been properly fulfilled and:
A) any violations are reported to the SEC.
B) are adequately
disclosed in the financial statements.
C) must issue a disclaimer if they haven't been fulfilled.
D) any departures from the agreements are made with management's knowledge and consent.
Answer: B
Terms: Audit of transactions and amounts in the capital acquisitions and repayments cycle
Diff: Moderate
Objective: LO 22-1
AACSB: Reflective thinking skills
2
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9) Describe the methodology for designing tests of details of balances for notes payable.
Answer: The methodology is:
• Identify client business risks affecting notes payable.
• Set tolerable misstatement and access inherent risk for notes payable.
• Assess control risk for notes payable.
• Design and perform tests of controls and substantive tests of transactions for the acquisition and
payment cycle and notes payable.
• Design and perform analytical procedures for
notes payable balance.
• Design tests of details of notes payable balance to satisfy balance-related audit objectives. Decide
sample size, items to select for testing, audit procedures, and timing of procedures.
Terms: Methodology for designing tests of details of balances for notes payable
Diff: Moderate
Objective: LO 22-1
AACSB: Reflective thinking skills
10) Discuss the four characteristics of the capital acquisition and repayment cycle that make it unique
from
other cycles.
Answer: The four characteristics are:
• Relatively few transactions affect the account balances, but each transaction is often highly material in
amount.
• The exclusion of a single transaction could be material in itself.
• There is a legal relationship between the client entity and the holder of the stock, bond, or similar
ownership document.
• There is a direct relationship between the interest and dividends accounts and debt and equity.
Terms: Unique
characteristics of capital acquisition and repayment cycle
Diff: Challenging
Objective: LO 22-1
AACSB: Reflective thinking skills
3
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11) List six accounts in the capital acquisition and repayment cycle commonly
found on balance sheets.
What characteristics do these accounts have in common that distinguish them from other accounts?
Answer: Balance sheet accounts in the capital acquisition and repayment cycle include:
• Notes payable
• Contracts payable
• Mortgages payable
• Bonds payable
• Accrued interest
• Cash in the bank
• Capital stockcommon
• Capital stockpreferred
• Paid-in capital in excess of par
• Donated capital
• Retained earnings
• Appropriations of
retained earnings
• Treasury stock
• Dividends declared
• Dividends payable
• Relatively few transactions affect the account balances, but each transaction is often highly material
in amount.
• The exclusion of a single transaction could be material in itself.
• There is a legal relationship between the client entity and the holder of the stock, bond, or similar
ownership document.
• There is a direct relationship between the interest and dividends accounts and debt
and equity.
Terms: Accounts commonly found in capital acquisition and repayment cycle and unique characteristics
Diff: Challenging
Objective: LO 22-1
AACSB: Reflective thinking skills
12) One unique characteristic of the capital acquisition and repayment cycle is that relatively few
transactions affect the account balances, but each transaction is often highly material in amount.
A) True
B) False
Answer: A
Terms: Characteristic of capital acquisitions and
repayment cycle
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
13) Auditors seldom learn about the capital acquisition and repayment cycle when gaining an
understanding of the client's business and industry.
A) True
B) False
Answer: B
Terms: Capital acquisition and repayment cycle
Diff: Easy
Objective: LO 22-1
AACSB: Reflective thinking skills
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14) When auditing the capital acquisition and repayment cycle, it is common to verify each transaction
taking place in the cycle for the entire year as a part of verifying the balance sheet accounts.
A) True
B) False
Answer: A
Terms: Auditing capital acquisition and repayment cycle; Verify
transactions
Diff: Moderate
Objective: LO 22-1
AACSB: Reflective thinking skills
Learning Objective 22-2
1) Which of the following is not an objective of the auditor's examination of notes payable?
A) To determine whether internal controls are adequate.
B) To determine whether client's financing arrangements are effective and efficient.
C) To determine whether transactions regarding the principal and interest of notes are properly
authorized.
D) To determine
whether the liability for notes and related interest expense and accrued liabilities are
properly stated.
Answer: B
Terms: Objectives of auditor's examination of notes payable
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
2) Responsibility for the issuance of new notes payable would normally be vested in the:
A) board of directors.
B) purchasing department.
C) accounting department.
D) accounts payable department.
Answer: A
Terms:
Responsibility for issuance of notes payable
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
3) An auditor is determining whether an issuance of notes payable for cash was correctly recorded. Her
best course of action would be to:
A) confirm with the bond trustee as to the amount of bonds issued.
B) confirm with the underwriter as to the appropriate market yield on the bonds.
C) trace the cash received from the proceeds to the accounting records.
D)
verify that the amount was included in a footnote disclosure.
Answer: C
Terms: Audit of bonds payable
Diff: Challenging
Objective: LO 22-2
AACSB: Analytic skills
5
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4) The auditor's independent estimate of
interest expense from notes payable uses average interest rates
and:
A) average notes payable outstanding.
B) year-end notes payable outstanding.
C) only notes payable above the level of materiality.
D) only notes payable to major lenders.
Answer: A
Terms: Auditor's independent estimate of interest expense from notes payable
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
5) The tests of details of balances procedure which requires the auditor
to trace the totals of the notes
payable list to the general ledger satisfies the audit objective of:
A) accuracy.
B) existence.
C) detail tie-in.
D) completeness.
Answer: C
Terms: Tests of details of balances procedures for notes payable
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
6) The audit objective to determine that notes payable in the schedule actually exist is verified by the test
of details 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.
Answer: B
Terms: Audit objective to determine notes payable actually exist
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
7) An auditor's substantive analytical procedure provides the auditor with an interest expense amount
that is significantly higher than the client's recorded
interest expense. This finding would most likely lead
the auditor to conclude that:
A) client has not recorded all long-term interest bearing debt in the accounting records.
B) client has not recorded all interest expense paid or accrued.
C) client has not properly accounting for the discount of bonds payable account.
D) client has not properly recorded interest income.
Answer: B
Terms: Substantive analytical procedures results in interest expense higher than actually
recorded
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
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8) You are auditing the long-term notes payable account for a client. Which of the following audit
procedures would you most likely
employ?
A) compare interest expense recorded by the client with the notes payable account for reasonableness
B) confirm bonds payable with individual bond holders
C) perform analytical procedures on the bond discount or premium account
D) examine bond documents for the presence of hybrid securities
Answer: A
Terms: Audit of long-term bonds payable
Diff: Challenging
Objective: LO 22-2
AACSB: Analytic skills
9) The two most important balance related audit
objectives for notes payable are:
A) completeness and detail tie-in.
B) completeness and valuation.
C) accuracy and valuation.
D) accuracy and completeness.
Answer: D
Terms: Most important balance related audit objectives for notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
10) Which of the following audit tests would provide evidence regarding the balance-related audit
objective of existence for an audit of notes
payable?
A) Examine due dates on duplicate copies of notes.
B) Examine balance sheet for proper presentation and disclosure of notes payable.
C) Examine corporate minutes for loan approval.
D) Foot the notes payable list for notes payable and accrued interest.
Answer: C
Terms: Audit tests to provide evidence regarding the balance-related audit objective of existence for audit of notes
payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
11)
Which of the following balance-related audit objectives is not applicable to the audit of notes payable?
A) Realizable value
B) Detail tie-in
C) Cutoff
D) Classification
Answer: A
Terms: Balance-related audit objectives not related to audit of notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
7
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12) When there are not numerous transactions involving notes payable during the year, the normal
starting point for the audit of notes payable is:
A) a schedule of notes payable and accrued interest prepared by the audit team.
B) a schedule of notes payable and accrued interest obtained from the client.
C) a schedule of only those notes with unpaid balances at the end of the year prepared by the client.
D) the notes payable account in the general ledger.
Answer:
B
Terms: Starting point for audit of notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
13) The tests of details of balances procedure which requires the auditor to examine notes paid after yearend 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.
Answer: B
Terms: Tests of details of balances
procedures to examine notes paid after year-end satisfies audit objective
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
14) The audit objective that requires that existing notes payable be included in the notes payable schedule
is satisfied by performing which of the following audit procedures?
A) confirm notes payable
B) trace the total of the notes payable schedule to the general ledger
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
Answer: D
Terms: Audit objective that requires existing notes payable be included in notes payable schedule
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
15) The audit objective that requires the auditor to determine that notes payable on the notes payable
schedule are
properly classified can be tested by performing the procedure to:
A) confirm notes payable.
B) examine corporate minutes for loan approval.
C) examine notes, minutes, and bank confirmations for restrictions.
D) review the notes to determine whether any are with related parties.
Answer: D
Terms: Audit objective that requires auditor to determine that notes payable are properly classified
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
8
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16) During the course of an audit, a CPA 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.
Answer: A
Terms: CPA observes recorded interest expense excessive in relation to balance in long-term debt account
Diff: Challenging
Objective: LO 22-2
AACSB: Analytic skills
17) A company issued long-term notes payable for cash during the year under audit. To ascertain that
this transaction was properly
recorded, the auditor's best course of action is to:
A) trace the cash received from the issuance to the accounting records.
B) confirm the results of the issuance with the underwriter or investment banker.
C) verify that the new cash received is credited to an account entitled "Bonds Payable."
D) request a statement from the bond trustee as to the amount of bonds issued and outstanding.
Answer: A
Terms: Issuance of bonds properly recorded
Diff: Challenging
Objective: LO
22-2
AACSB: Reflective thinking skills
18) In the audit of notes payable, it is common to include tests of principal and interest payments as a part
of the audit of the acquisitions and payment cycle because the payments are in the cash disbursements
journal that is being sampled. It is also normal to test these transactions as part of the capital acquisitions
and repayment cycle because:
A) it is not unusual for the auditor to duplicate a process, thereby gathering a larger
quantity of evidence.
B) replicating the evidence will provide the auditor with a higher level of assurance.
C) the tests done in the acquisitions and payments cycle will look only at the cash credit side so the tests
done in the capital acquisitions and repayment cycle will look at the debit side of the transaction.
D) due to the infrequency of these transactions, in many cases no transactions involving notes payable are
included in the sample tests of acquisitions and
payments.
Answer: D
Terms: Audit of notes payable tests of principal and interest payments
Diff: Challenging
Objective: LO 22-2
AACSB: Reflective thinking skills
9
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19) Which of the following is not an
important control over notes payable?
A) proper authorization over the issuance of new notes payable
B) notes payable are issued when the business climate is favorable
C) adequate controls exist over repayment of interest and principal
D) there exists proper documents and records
Answer: B
Terms: Issuance of mortgage bonds
Diff: Challenging
Objective: LO 22-2
AACSB: Analytic skills
20) The audit procedure "examine duplicate copies of notes payable to determine
whether the notes
payable were dated on or before the balance sheet date" is done for which of the following balancerelated audit objective?
A) completeness
B) cut-off
C) detail tie-in
D) existence
Answer: B
Terms: Balance-related audit objective to examine duplicate copies of notes payable
Diff: Challenging
Objective: LO 22-2
AACSB: Reflective thinking skills
21) The two most important balance related objectives in notes payable are:
A) completeness and
accuracy
B) existence and completeness
C) accuracy and classification
D) existence and occurrence
Answer: A
Terms: Audit of bond seeking fund transactions
Diff: Challenging
Objective: LO 22-2
AACSB: Analytic skills
22) Why are analytical procedures essential for notes payable?
Answer: They are essential because tests of details for interest expense and accrued interest can often be
eliminated if the results from the analytical procedures are favorable.
Terms:
Analytical procedures for notes payable
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
23) What are the two most important balance-related audit objectives in notes payable?
Answer:
• Existing notes payable are included (completeness).
• Notes payable are accurately recorded (accuracy).
Terms: Balance-related audit objectives in notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
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24) Identify three analytical procedures commonly performed for notes payable.
Answer: Some possible analytical procedures for notes payable include:
• Recalculate approximate interest expense on the basis of average interest rates and
overall monthly
notes payable.
• Compare individual notes outstanding with the prior years.
• Compare total balance in notes payable, interest expense, and accrued interest with prior years.
Terms: Analytical procedures for notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
25) The starting point for the audit of notes payable is a schedule of notes payable and accrued interest.
Discuss the information typically included in the
schedule.
Answer: The usual schedule includes detailed information of all transactions that took place during the
entire year for principal and interest, the beginning and ending balances for notes and interest payable,
and descriptive information about the notes, such as the due date, the interest rate, and the assets pledged
as collateral.
Terms: Information included in notes payable schedule
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
26)
You are employing tests of details of balances for notes payable and interest expense. Describe below
specific audit procedures you would perform for the balance-related audit objectives of detail tie-in and
existence. List at least two for each objective.
Answer: Detail tie-in: Foot the notes payable list for notes payable and accrued interest; trace the totals
on the notes payable list to the general ledger; trace the individual notes payable to the master file.
Existence:
Confirm notes payable, examine duplicate copies for authorization; examine corporate minutes
for loan approval.
Terms: Tests of details of balances for notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
detail tie-in and existence balance-related audit objectives
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27) Discuss the four key controls over notes payable.
Answer: The four key controls over notes payable are:
• Proper authorization for the issue of new notes. Responsibility for the issuance of new notes should be
vested in the board of directors or high-level management personnel, with signatures of two authorized
officials required for all loan agreements.
• Adequate controls over the repayment of principal and interest. At the time notes are issued, the
accounting
department should receive a copy in the same manner in which it receives vendors' invoices and
receiving reports. The accounts payable department should automatically issue checks for the notes when
they become due, in the same manner in which it prepares checks for acquisitions of goods and services.
• Proper documents and records. These include the maintenance of subsidiary records and control over
blank and paid notes by a responsible person. Paid notes should be
canceled and retained under the
custody of an authorized official.
• Periodic independent verification. The detailed note records should be reconciled periodically with the
general ledger and compared with the note holders' records by an employee who is not responsible for
maintaining the detailed records.
Terms: Key controls over notes payable
Diff: Challenging
Objective: LO 22-2
AACSB: Reflective thinking skills
28) Discuss the overall objectives of the audit of
notes payable.
Answer: The overall objectives of the audit of notes payable are to determine whether:
• The internal controls over notes payable are adequate.
• Transactions for principal and interest involving notes payable are properly authorized and recorded
as defined by the six transaction-related audit objectives.
• The liability for notes payable and the related interest expense and accrued liability are properly
stated as defined by eight of the nine balance-related
audit objectives (realizable value is excluded).
Terms: Objectives of audit of notes payable
Diff: Challenging
Objective: LO 22-2
AACSB: Reflective thinking skills
29) Notes payable are generally for short periods of time.
A) True
B) False
Answer: B
Terms: Notes payable time
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
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30) When performing analytical procedures for notes payable, if actual interest expense is materially
larger than the auditor's expectation, one possible cause would be interest payments on unrecorded notes
payable.
A) True
B) False
Answer: A
Terms: Analytical procedures for notes payable
Diff: Easy
Objective: LO 22-2
AACSB: Reflective thinking skills
31) The balance-related audit objective realizable value is not applicable when auditing notes
payable.
A) True
B) False
Answer: A
Terms: Auditing notes payable and balance-related audit objective realizable value
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
32) The three most important balance-related audit objectives for notes payable are existence, realizable
value, and accuracy.
A) True
B) False
Answer: B
Terms: Balance-related audit objectives for notes payable; Existence, realizable value and accuracy
Diff:
Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
33) The audit procedure "Foot the notes payable list and trace the totals to the general ledger" is
performed when verifying the accuracy objective for notes payable.
A) True
B) False
Answer: B
Terms: Verifying accuracy objective for notes payable audit procedure
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
34) The audit procedure "Examine notes payable, minutes, and bank confirmations for restrictions" is
performed when verifying the classification objective for notes payable.
A) True
B) False
Answer: A
Terms: Audit procedure to verify classification objective for notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
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35) The audit procedure "Examine paid notes for cancellation to make sure they are not still outstanding"
is performed when verifying the completeness objective for notes payable.
A) True
B) False
Answer: A
Terms: Audit procedure performed when verifying completeness objective for notes payable
Diff: Moderate
Objective: LO 22-2
AACSB: Reflective thinking skills
Learning Objective 22-3
1) Which of the following would generally not need to be approved by
the board of directors?
A) Issuing capital stock
B) Repurchasing capital stock
C) Declaration of a Dividend
D) Payment of a Dividend
Answer: D
Terms: Not need approval by board of directors
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
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2) Which of the following owners' equity transactions usually require specific authorization from a
company's board of directors?
A)
Repurchase of common
stock
Issuance of common stock
Payment of dividends
Yes
Yes
Yes
B)
Repurchase of common
stock
Yes
Issuance of common stock
Yes
Payment of dividends
No
C)
Repurchase of common
stock
No
Issuance of common stock
Yes
Payment of dividends
No
D)
Repurchase
of common
stock
No
Issuance of common stock
No
Payment of dividends
Yes
Answer: B
Terms: Owners' equity transactions that require specific authorization
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
3) When a company maintains its own records of stock transactions and outstanding stock, internal
controls must be adequate to ensure that:
A) actual owners are recorded in the bylaws.
B) the correct amount of dividends is
paid to stockholders owning the stock on the dividend record date.
C) the correct amount of dividends is paid to stockholders owning the stock on the declaration date.
D) actual owners are recorded in the minutes.
Answer: B
Terms: Internal controls to maintain records of stock transactions and outstanding stock
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
15
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4) 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: C
Terms: Time spent verifying owners' equity for closely held corporations
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
5) Which of the following types of owners' equity transactions would not require authorization by the
board of directors?
A) Issuance of capital stock
B) Repurchase of capital stock
C) Declaration of dividends
D) None of the above
Answer: D
Terms: Owners' equity
transaction not requiring authorization by board of directors
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
6) The record of the issuance and repurchase of capital stock for the life of the corporation is maintained
in the:
A) shareholders' capital stock master file.
B) capital stock certificate record.
C) schedule of stock owners.
D) corporate directory.
Answer: B
Terms: Record of issuance and repurchase of capital stock
Diff:
Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
7) The record of the outstanding shares at any given time is maintained in the:
A) corporate directory.
B) stock certificate books.
C) schedule of stock owners.
D) shareholders' capital stock master file.
Answer: D
Terms: Record of outstanding shares
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
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8) When a dividend is declared by the board of directors, the source for determining who should receive
dividend checks is the:
A) shareholders' capital stock master file.
B) stock certificate books.
C) common stock account in the general ledger.
D) corporate
directory.
Answer: A
Terms: Source for determining who should receive dividend checks
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
9) The authorization of an issuance of capital stock normally includes all but which of the following?
A) type of stock to be issued
B) number of shares to be issued
C) date shares are to be issued
D) amount of dividend to be paid on shares issued
Answer: D
Terms: Authorization of issuance of capital stock
includes
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
10) Any company with stock listed on a securities exchange is required to engage a(n) ________.
A) equity analyst
B) stock transfer agent
C) independent registrar
D) equity placement specialist
Answer: C
Terms: Company with stock listed on securities exchange required to engage
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
11) 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 canceled 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.
Answer: C
Terms: Confirmation to auditor from capital stock registrar and/or transfer agent
Diff:
Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
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12) Which of the following statements is true?
A) There is an inverse relationship between the interest and dividends accounts and debt and
equity.
B) There is no relationship between the interest and dividends accounts and debt and equity.
C) There is a direct relationship between the interest and dividends accounts and debt and equity.
D) None of the above is true.
Answer: C
Terms: Relationship between interest and dividends
Diff: Moderate
Objective: LO 22-2 and LO 22-3
AACSB: Reflective thinking skills
13) When a company maintains its own records of stock transactions and capital stock outstanding
its
internal controls must be adequate to accomplish three objectives. List them below.
Answer: Actual owners of the stock are recognized in the corporate records.
The correct amount of dividends is paid to stockholders owning the stock as of the dividend record date.
The potential for misappropriation of assets is minimized.
Terms: Internal controls and objectives when records maintained of stock transactions and capital stock outstanding
Diff: Easy
Objective: LO
22-3
AACSB: Reflective thinking skills
14) What is the difference between an independent registrar and a stock transfer agent?
Answer: Companies whose shares are listed on a securities exchange are required to enlist the services of
an independent registrar. The registrar is responsible for making sure that all stock is issued by a
corporation in accordance with the corporate charter and is properly authorized by the board of directors.
The registrar is also responsible for
signing all newly issued shares. A stock transfer agent maintains
stockholder records, including transfers of stock ownership. Transfer agents may also disburse cash
dividends to shareholders.
Terms: Independent registrar and stock transfer agent differences
Diff: Easy
Objective: LO 22-3
AACSB: Reflective thinking skills
15) What are two important procedures that companies should implement to prevent misstatements in
owners' equity?
Answer: Companies should
develop:
1. well-defined policies for preparing stock certificates and recording capital stock transactions, and
2. independent internal verification of information in the owners' equity records.
Terms: Procedures to prevent misstatements in owners' equity
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
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16) Discuss the internal controls related to owners' equity that are of concern to the auditor.
Answer:
• Proper authorization of transactions. Material transactions should be approved by the board of directors,
including issuance of capital stock, repurchase of capital stock, and declaration of dividends.
• Proper recordkeeping and segregation of duties. This should include well-defined policies for preparing
stock certificates and recording capital stock transactions,
and independent internal verification of
information in the records. Many companies use a capital stock certificate book and a shareholders'
capital stock master file to improve control over capital stock transactions.
• Independent registrar and stock transfer agent. An independent registrar acts as a control to prevent the
improper issuance of stock certificates. A stock transfer agent acts as a control over the stock records.
Terms: Internal controls related to owners'
equity
Diff: Challenging
Objective: LO 22-3
AACSB: Reflective thinking skills
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17) Match six of the terms (a-i) used in the capital acquisitions and repayment cycle with the descriptions
provided below
(1-6):
a.
b.
c.
d.
e.
f.
g.
h.
i.
Capital acquisition and repayment cycle
Capital stock certificate book
Closely held corporation
Independent registrar
Note payable
Publicly held corporation
Stock transfer agent
Schedule of notes payable and accrued interest
Stock maintenance agent
________ 1. An outside person engaged by a corporation to make sure that its stock is issued in
accordance with capital stock provisions in the
corporate charter and authorizations by the board of
directors.
________ 2. The normal starting point for the audit of notes payable; includes detailed information of all
transactions related to notes payable that took place during the year.
________ 3. A record of the issuance and repurchase of capital stock for the life of the corporation.
________ 4. An outside person engaged by a corporation to maintain the stockholder records, and often to
disburse cash
dividends.
________ 5. An entity that is required to engage an independent registrar.
________ 6. The cycle that concerns the acquisition of capital resources through interest-bearing debt and
owners' equity and repayment of the capital.
Answer:
1. d
2. h
3. b
4. g
5. f
6. a
Terms: Capital acquisition and payment cycle; Capital stock certificate book; Independent registrar; Publicly held
corporation; Stock transfer agent; Schedule of notes payable and
accrued interest
Diff: Moderate
Objective: LO 22-1, LO 22-2, and LO 22-3
AACSB: Reflective thinking skills
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18) The Securities and Exchange Commission requires companies listed on exchanges to employ stock
transfer agents.
A) True
B) False
Answer: B
Terms: Securities and Exchange Commission; Stock transfer agents
Diff: Easy
Objective: LO 22-3
AACSB: Reflective thinking skills
19) Public companies whose stock is listed on a stock exchange must employ an independent registrar.
A) True
B) False
Answer: A
Terms: Public companies with stock listed on stock exchange; Independent registrar
Diff: Easy
Objective: LO 22-3
AACSB: Reflective thinking skills
20) The shareholders' capital stock master file is used as the basis for the payment of dividends and also
acts as a check on the accuracy of the common stock balance in the general ledger.
A) True
B) False
Answer: A
Terms: Shareholders' capital master file use
Diff: Easy
Objective: LO 22-3
AACSB: Reflective thinking skills
21) Independent registrars commonly disburse cash dividends to shareholders.
A) True
B) False
Answer: B
Terms: Independent
registrars
Diff: Easy
Objective: LO 22-3
AACSB: Reflective thinking skills
22) Few large companies employ stock transfer agents, but small companies commonly do so.
A) True
B) False
Answer: B
Terms: Stock transfer agents
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
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23) Any company that has more than 10 percent of its stock owned by one person is considered to be
closely held.
A) True
B) False
Answer: B
Terms: Closely held company
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
24) A shareholders' capital stock master file is a record of the issuance and repurchase of capital stock
over the life of the corporation.
A) True
B) False
Answer: B
Terms:
Shareholders' capital stock master file
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
25) Capital stock represents a legal obligation to a shareholder and ensures a certain return to the
shareholder.
A) True
B) False
Answer: B
Terms: Capital stock represents
Diff: Moderate
Objective: LO 22-3
AACSB: Reflective thinking skills
Learning Objective 22-4
1) In auditing debits and credits to retained earnings, OTHER than net
income and dividends, the
auditors first concern is:
A) whether the transactions should have been included in retained earnings.
B) whether the transactions have been accurately recorded.
C) whether the transactions are classified correctly in the footnotes.
D) whether the transactions existed as of the balance sheet date.
Answer: A
Terms: Audit of retained earnings
Diff: Moderate
Objective: LO 22-4
AACSB: Reflective thinking skills
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2) The audit of owners' equity of public and private companies is very different. Which of the following is
not one of these differences?
A) The number of transactions (private companies have fewer transactions).
B) Payment of dividends
(public companies rarely pay dividends).
C) Complexity of transactions (public companies generally have more complex transactions).
D) Type of noncurrent debt (public companies issue more bonds).
Answer: B
Terms: Audit of owners' equity of public and private companies
Diff: Moderate
Objective: LO 22-4
AACSB: Reflective thinking skills
3) Which of the following audit objectives is least important in the audit of capital stock and paid-incapital in excess of par?
A)
Completeness
B) Accuracy
C) Rights and obligations
D) Presentation and disclosure
Answer: C
Terms: Audit objective least important in audit of capital stock and paid-in capital
Diff: Moderate
Objective: LO 22-4
AACSB: Reflective thinking skills
4) The 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 prior-period adjustments have been made correctly.
D) whether there are any restrictions on the payment of dividends.
Answer: D
Terms: Primary concern in determining correct disclosure of retained earnings
Diff: Moderate
Objective: LO 22-4
AACSB: Reflective thinking skills
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5) What type of audit test will auditors use when testing to see if existing capital stock transactions are
recorded?
A)
Tests of details of balances
Tests of transactions
Tests of controls
No
Yes
Yes
B)
Tests of details of balances
Yes
Tests of transactions
No
Tests of controls
Yes
C)
Tests of details of balances
Yes
Tests of transactions
No
Tests of controls
No
D)
Tests of details of
balances
No
Tests of transactions
Yes
Tests of controls
No
Answer: A
Terms: Audit test to see if existing capital stock transactions are recorded
Diff: Moderate
Objective: LO 22-4
AACSB: Reflective thinking skills
6) What type of audit test will auditors use when testing to see if the amounts of capital stock transactions
are accurately recorded?
A)
Tests of details of balances
Tests of transactions
Tests of
controls
No
Yes
Yes
B)
Tests of details of balances
Yes
Tests of transactions
No
Tests of controls
Yes
C)
Tests of details of balances
No
Tests of transactions
Yes
Tests of controls
No
D)
Tests of details of balances
Yes
Tests of transactions
No
Tests of controls
No
Answer: D
Terms: Capital stock transactions accurately recorded
Diff: Moderate
Objective: LO 22-4
AACSB: Reflective
thinking skills
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7) When a company has treasury stock certificates on hand, a year-end count of the certificates by the
auditor is:
A) always required.
B) not required if treasury stock is a deduction from
stockholders' equity.
C) required when the company classifies treasury stock with other assets.
D) required when the company had treasury stock transactions during the year.
Answer: A
Terms: Treasury stock certificates
Diff: Challenging
Objective: LO 22-4
AACSB: Reflective thinking skills
8) When conducting the audit of stockholders' equity it is normal practice to verify all capital stock
transactions:
A) only when the client is small.
B) that are in excess
of a material amount.
C) if there aren't very many during the year.
D) regardless of the controls in existence, because of their materiality and permanence in the records.
Answer: D
Terms: Audit of stockholders' equity and verification of capital stock transactions
Diff: Challenging
Objective: LO 22-4
AACSB: Reflective thinking skills
9) State the four most important audit objectives for capital stock and describe how the auditor typically
verifies each of the
four objectives.
Answer: The four most important audit objectives for capital stock are:
• Existing capital stock transactions are recorded (completeness). Confirm with the registrar or transfer agent
whether any capital stock transactions occurred.
• Recorded capital stock transactions occurred and are accurately recorded (occurrence and accuracy). Existence
can be tested by examining the minutes of the board of directors' meetings for proper authorization.
Accuracy can be
tested by confirming the amount with the transfer agent and tracing the amount of the
recorded capital stock transactions to the cash receipts journal.
• Capital stock is accurately recorded (accuracy). The ending balance in the capital stock account is verified
by first determining, via confirmation from the transfer agent, the number of shares outstanding at the
balance sheet date. The recorded par value in the capital account can be verified by multiplying the
number of shares
outstanding by the par value of the stock.
• Capital stock is properly presented and disclosed (presentation and disclosure). Using the corporate charter,
the minutes of board of directors' meeting and the auditor's analysis of capital stock transactions, the
auditor should determine that there is a proper description of each class of stock. The proper presentation
and disclosure of stock options, stock warrants, and convertible securities should also be verified by
examining
legal documents or other evidence of the provisions of these agreements.
Terms: Important audit objectives for capital stock and how they are verified
Diff: Challenging
Objective: LO 22-4
AACSB: Reflective thinking skills
25
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