Chapter 13


Identify the letter of the choice that best completes the statement or answers the question.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 15. When an audit is made in accordance with generally accepted auditing standards, the auditor should always
a. Test control procedures by reprocessing a representative 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 24. An internal auditor discovered an error in a receivable due from a major stockholder. The receivables 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 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.

____ 33. A CPA has received an attorney's letter in which no significant disagreements with the client's assessments of contingent liabilities were noted. The resignation of the client's lawyer shortly after receipt of the letter should alert the auditor that
a. Undisclosed unasserted claims may have arisen.
b. The attorney was unable to form a conclusion with respect to the significance of litigation, claims, and assessments.
c. The auditor must begin a completely new examination of contingent liabilities.
d. An adverse opinion will be necessary

____ 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.
d. Calculation of premium or discount amortization.

____ 35. Hall accepted an engagement to audit the 2002 financial statements of XYZ Company. XYZ completed the preparation of the 2002 financial statements on February 13, 2003, and Hall began the field work on February 17, 2003. Hall completed the field work on March 24, 2003, and completed the report on March 28, 2003. The client's representation letter normally would be dated
a. February 13, 2003
b. February 17, 2003
c. March 24, 2003
d. March 28, 2003

____ 36. The auditee has just acquired another company by purchasing all its assets. As a result of the purchase, "goodwill" has been recorded on the auditee's books. Which of the following comparisons would be the most appropriate audit test for the amount of recorded goodwill?
a. The purchase price and the book value of assets purchased.
b. The figure for goodwill specified in the contract for purchase.
c. Earnings in excess of 15% of net assets for the past five years.
d. The purchase price and the fair market value of assets purchased.

____ 37. All corporate capital stock transactions should ultimately be traced to the
a. Minutes of the Board of Directors.
b. Cash receipts journal.
c. Cash disbursements journal.
d. Numbered stock certificates.

____ 38. A logical substantive test for accrued interest receivable would be to
a. Compare the interest income with published interest- investment records.
b. Verify the interest income by a calculation based on the face amount of notes and the nominal interest rate.
c. Verify the cost, carrying value, and market value of notes receivable.
d. Recalculate interest earned and compare it to the amounts received.

____ 39. In verifying the amount of goodwill recorded by a client, the most convincing evidence which an auditor can obtain is by comparing the recorded value of assets acquired with the
a. Assessed value as evidenced by tax bills.
b. Seller's book value as evidenced by financial statements.
c. Insured value as evidenced by insurance policies.
d. Appraised value as evidenced by independent appraisals.

____ 40. An auditor who wishes to substantiate the gross balance of the account "Trade Notes Receivable" is considering the advisability of performing the four procedures listed below. Which pair of procedures is best suited to this objective?

I. Age the receivables.
II. Confirm the notes with the makers.
III. Inspect the notes.
IV. Trace a sample of postings from the sales journal to the notes receivable ledger.

a. I and III.
b. I and IV.
c. II and III.
d. II and IV.

____ 41. Jones was engaged to examine the financial statements of Gamma Corporation for the year ended June 30, 2002. 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. Utilizing analytical review techniques and statistical sampling.
c. Comparing recorded dividends with amounts appearing on federal information forms 1099.
d. Comparing recorded dividends with a standard financial reporting service's record of dividends.

____ 42. An auditor's program to examine long-term debt most likely would include steps that require
a. Comparing the carrying amount of the debt to its year- end market value.
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.