Chapter 4 Set 3

Question 1

When control risk is assessed as low for assertions related to payroll, substantive tests of payroll balances most likely would be limited to applying analytical procedures and:

Answer 1

If the control risk is assessed as low, less substantive testing is necessary. In such an instance, substantive testing would normally be limited to analytical procedures and recalculating year-end accruals.

Question 2

In establishing the existence and ownership of a long-term investment in the form of publicly-traded stock, an auditor should inspect the securities or:

Answer 2

The auditor would confirm the number of shares held by an independent custodian to establish the existence and ownership of a long-term investment in publicly traded securities

Question 3

Determining that proper amounts of depreciation are expensed provides assurance about management’s assertion of:

Answer 3

Determining that proper amounts of depreciation are expensed provides assurance with regard to valuation and allocation related to the asset, and accuracy in terms of financial statement presentation.

Question 4

In auditing accounts receivable the negative form of confirmation request most likely would be used when:

Answer 4

Negative confirmations are used when the combined assessed level of inherent and control risk is low, a large number of small balances is involved, and the auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration.

Question 5

Which of the following internal controls most likely would prevent direct labor hours from being charged to manufacturing overhead?

Answer 5

The use of time tickets to record actual labor worked on production orders is the best way to prevent direct labor from being charged to manufacturing overhead.

Question 6

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:

Answer 6

When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud would be reduced if the trust company deals only with the person reconciling the accounts, and not with the employees responsible for maintaining investment records.

Question 7

An auditor scans a client’s investment records for the period just before and just after the year-end to determine that any transfers between categories of investments have been properly recorded. The primary purpose of this procedure is to obtain evidence about management’s financial statement assertions of:

Answer 7

Investments may be classified as trading, available-for-sale, or held-to-maturity. The classification of each investment into one of these three categories determines how it will be shown on the balance sheet (understandability and classification) and whether it will be valued at market or at amortized cost (valuation and accuracy).

Question 8

Which of the following procedures represents a weakness in internal controls for payroll?

Answer 8

Unclaimed payroll checks should be returned to an independent party for follow up. Returning such checks (assets) to the payroll department (recordkeeping) represents an inadequate segregation of duties.

Question 9

When a client engages in transactions involving derivatives, the auditor should:

Answer 9

In auditing investments in securities and derivatives, the auditor must assess the reasonableness and appropriateness of assumptions, market variables, and valuation models. In order to do this, the auditor must consider whether the substance of transactions or events differs materially from their form. Remember that generally accepted accounting principles require transactions and events to be reported in accordance with their economic substance, even if this differs from their form.

Question 10

An auditor usually determines whether dividend income from publicly-held investments is reasonable by computing the amounts that should have been received by referring to:

Answer 10

Investment income from dividends is generally recalculated by comparing recorded income with dividend record books produced by investment advisory services such as “Moody’s Dividend Record.” These books state the dividend that was declared and paid by the investee.

Question 11

An auditor’s inquiries of management disclosed that the entity recently invested in a series of energy derivatives to hedge against the risks associated with fluctuating oil prices. Under these circumstances, the auditor should:

Answer 11

Generally accepted accounting principles specify that, in order to qualify for hedge treatment, the entity must demonstrate and disclose a number of transaction features including risk exposure. The auditor would therefore need to examine the contracts to evaluate the character of the hedge and the degree to which losses should be recognized in the determination of income, as well as the character of any disclosures.

Question 12

An auditor is testing the reasonableness of dividend income from investments in publicly-held companies. The auditor most likely would compute the amount that should have been received and recorded by the client by:

Answer 12

Electronically accessing the details of dividend records on the Internet is an efficient means of verifying dividend rates for multiple investments in a short amount of time.

Question 13

Which of the following procedures would an auditor least likely perform before the balance sheet date?

Answer 13

The auditor should consider whether the year-end balances of the particular asset or liability accounts that might be selected for interim examination are reasonably predictable with respect to amount, relative significance, and composition. Accounts payable is relatively difficult to predict because it may fluctuate at management’s discretion.

Question 14

The auditor’s inventory observation test counts are traced to the client’s inventory listing to test for which of the following financial statement assertions?

Answer 14

Completeness.

Question 15

To gain assurance that all inventory items in a client’s inventory listing schedule are valid, an auditor most likely would trace:

Answer 15

Tracing from the inventory schedule to the inventory tags and the auditor’s recorded count sheets verifies the validity (existence) of the items. Note that the correct term for the directional test for existence is “vouch.” However, in practice (and on the CPA Exam), the term trace is sometime used interchangeably with the term vouch.

Question 16

Upon receipt of customers’ checks in the mailroom, a responsible employee should prepare a remittance listing that is forwarded to the cashier. A copy of the listing should be sent to the:

Answer 16

A copy of the remittance listing is sent to the accounts receivable clerk and used to update the subsidiary accounts receivable records.

Question 17

An auditor suspects that a client’s cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditor most likely would compare the:

Answer 17

When lapping occurs, an employee uses current remittances to conceal remittances that have been stolen previously. Thus, a lag will exist from the time that this current payment is deposited until the current customer’s account is actually credited. (The current payment is applied to the previous customer’s account).

Question 18

Which of the following payroll control activities would most effectively ensure that payment is made only for work performed?

Answer 18

A direct supervisor’s approval of the time cards most effectively ensures that payment is paid for work performed as the supervisor observes the employees and determines whether employees are present and working.

Question 19

An auditor’s analytical procedures indicate a lower than expected return on an equity method investment. This situation most likely could have been caused by:

Answer 19

Under equity method accounting, the amortization of the excess of the investor’s cost over the investment’s underlying book value reduces the investor’s income from the equity method investment. If amortization is calculated incorrectly (i.e., the amortization is too high), this could lower the return on the investment.

Question 20

Which of the following procedures would be most appropriate for testing the completeness assertion as it applies to inventory?

Answer 20

Performing cutoff procedures provides assurance that goods in transit (shipped or received) are appropriately included or excluded from inventory and this procedure is most appropriate for testing the completeness assertion.