CPA Core 1 - Week 3

Question 1

Audit evidence is primarily gathered during which stage of the audit process?

a)

Stage 1 — Acceptance/continuance

b)

Stage 1 — Planning

c)

Stage 2 — Execution

d)

Stage 3 — Reporting

Answer 1

c) is correct because audit evidence is primarily gathered during the execution stage (Stage 2) of the audit process.

Question 2

Audit evidence can consist of information that:

a)

Contradicts management’s assertions

b)

Supports management’s assertions

c)

Is primarily gathered during the planning of an audit

d)

Both a) and b) above

Answer 2

d) is correct because both a) and b) are correct. Audit evidence can consist of information that both supports and contradicts management’s assertions.

Question 3

If the practitioner is unable to obtain sufficient appropriate audit evidence related to all accounts, classes of transactions, and disclosures in the financial statements, then the practitioner is unable to:

a)

Continue with the engagement

b)

Issue an unqualified opinion

c)

Use a combined audit approach

d)

Rely on management’s statements as fact

Answer 3

b) is correct because if sufficient and appropriate audit evidence is not obtained, then the practitioner is unable to issue an unmodified audit opinion.

Question 4

Which of the following statements regarding audit evidence is true?

a)

Sufficiency is the measure of the quality of audit evidence.

b)

The higher the relevance and reliability of evidence, the lower the quality of results

c)

The higher the quality of evidence, the less evidence may be required.

d)

Reliability refers to the connection between audit procedures and assertions.

Answer 4

c) is correct because the higher the quality of evidence, the less evidence may be required.

Question 5

Which of the following is the most reliable type of audit evidence?

a)

Calculating the current ratio

b)

Inspecting bank statements from the client

c)

Footing (recalculating) the accounts receivable subledger

d)

Performing test counts of inventory

Answer 5

d) is correct because the auditor’s execution of procedures or controls is an externally generated type of audit evidence, which is the most reliable of the three types of audit evidence (internally generated, externally generated but held by the client, and externally generated).

Question 6

You have assessed the risk for property, plant, and equipment, and now must begin additional substantive testing. Which of the following tests provides the least
compelling audit evidence?

a)

Adding and cross-adding the client’s property, plant, and equipment balances, and recalculating the amortization provisions

b)

Comparing current-year property, plant, and equipment balances to the prior year

c)

Examining the repairs and maintenance account for material items that may be property, plant, and equipment

d)

Physically inspecting the new capital additions

Answer 6

b) is correct because additions, dispositions, and/or depreciation have likely occurred during the year, meaning that comparisons to prior years are not as meaningful.

Question 7

Which one of the following statements describes analytical procedures?

a)

Analytical procedures are only used in the planning stage of an engagement.

b)

Analytical procedures help to identify unusual or unexpected balances that require further assurance work.

c)

Analytical procedures are not used in the planning stage of an engagement.

d)

Analytical procedures are used exclusively on the income statement to analyze the reasonability of accounts as compared to plan and prior year.

Answer 7

b) is correct because analytical procedures are generally used to identify items that indicate risk of misstatement, exceptions to predicted patterns, and items that should be addressed or followed up on.

Question 8

Substantive procedures are designed to:

a)

Detect material misstatements at the account level

b)

Detect material misstatements at the overall financial statement level

c)

Detect all misstatements.

d)

Detect changes from the prior year’s financial statements.

Answer 8

a) is correct. Substantive procedures are designed to detect material misstatements at the account level.

Question 9

Obtaining written communication from a third party and footing a subledger are examples of which two types of substantive procedures, respectively?

a)

Inspection and observation

b)

Confirmation and recalculation

c)

Analytical reviews and reperformance

d)

Inquiry and reperformance

Answer 9

b) is correct because a written communication from a third party is a confirmation type of substantive procedure and footing a subledger is a recalculation type of substantive procedure.

Question 10

Discussion with management and examining tangible assets are examples of which two types of substantive procedures, respectively?

a)

Confirmation and observation

b)

Confirmation and reperformance

c)

Inquiry and inspection

d)

Inquiry and analytical reviews

Answer 10

c) is correct because discussion with management is an inquiry substantive procedure and examination of tangible assets is an inspection substantive procedure.

Question 11

KR Ltd. has agreed to lease a piece of equipment with the following terms:

Payments are $15,000 per year over seven years, with the first payment due January 1, 20X6.
The economic life of the equipment is eight years.
The interest rate implicit in the lease contract is 4% and is known to KR.
The fair value of the equipment on January 1, 20X6, is $99,000.
What asset amount should KR Ltd. record on the statement of financial position following IFRS for this lease at January 1, 20X6?

a)

$99,000

b)

$90,000

c)

$93,600

d)

$0, because this is an operating lease

Answer 11

c) is correct. This is the amount of the ROU asset to be recognized. The present value of the lease payments = $15,000 + $15,000(PVIFA, 6 years, 4%) = $15,000 + $15,000(5.24) = $93,600.

Question 12

On January 1, 20X6, Beatty Inc. entered into a five-year lease to acquire some machinery. Beatty reports under ASPE and is the lessee. The terms of the lease are as follows:

Lease payments of $25,000 are made annually on the first day of the year.
Included in the annual lease payments are maintenance fees of $2,000 per year.
The machinery reverts to the lessor at the end of the lease and the lease contains no renewal options.
Beatty uses straight-line depreciation for the machinery that it owns.
The machinery has a fair value of $100,000 on January 1, 20X6, and has an estimated economic life of five years with no residual value.
Beatty’s incremental borrowing rate is 11% per year.
The lease’s implicit interest rate is 10%.
What is the present value of the minimum lease payments at the inception date?

a)

$95,907

b)

$94,356

c)

$104,247

d)

$102,561

Answer 12

a) is correct. The present value of the minimum lease payments = $23,000 ($25,000 – $2,000 in maintenance fees) × present value of an annuity due at the beginning of the period for five periods at 10% = $23,000 × 4.16986 = $95,907. The lessor’s implicit rate of 10% was correctly used instead of the lessee’s incremental borrowing rate of 11%, as this is the lower of the two rates. ASPE states that the lower of the two rates must be used when calculating the present value of the minimum lease payments.

Question 13

Sunnyside Manufacturing (Sunnyside), a publicly traded company, has entered into an agreement with FP Inc. to lease a specialized piece of production equipment. Significant modifications would be required to make this equipment available to others after the lease has expired. The terms of the lease are as follows:

The lease term is five years.
The expected life of the equipment is eight years.
The implicit interest rate is 8%.
Sunnyside’s borrowing rate is 6%.
The annual lease payment is $57,000 plus $3,000 for maintenance (made at the beginning of the year).
At the end of the lease, there is a guaranteed residual amount of $80,000, which Sunnyside expects to pay.
Assuming Sunnyside elects to include non-lease component costs as part of the lease payment, at what amount would Sunnyside initially recognize the ROU asset at the inception of the lease?

a)

$258,700

b)

$300,200

c)

$313,100

d)

$327,700

Answer 13

c) is correct because Sunnyside is a public company and is therefore reporting under IFRS. The value of the ROU asset is the present value of the lease payments discounted at the implicit rate in the lease. The present value of the lease payments = $60,000 + $60,000(PVIFA, 4 years, 8%) + $80,000 (PVIF, 5 years, 8%) = $258,700 + $54,400 = $313,100.

Question 14

On January 1, 20X6, Lessor Corp. entered into a contract to lease equipment to Lessee Co. with the following terms:

The lease term is five years, with payments due on the first day of the year.
The first payment is due on January 1, 20X6.
The equipment has a fair market value of $300,000 on January 1, 20X6.
Lessee Co. has an incremental borrowing rate of 9% and Lessee Co. is aware of Lessor Corp.’s rate of 10%.
The equipment has an estimated useful life of six years.
Both the lessor and the lessee use straight-line amortization.
The annual lease payment equals $70,733, which includes a $4,000 reimbursement to Lessor Corp. for insurance costs paid by the lessor to the insurance company.
Both Lessor Corp. and Lessee Co. report under ASPE.
What is the present value of the minimum lease payments for this lease?

a)

$299,900

b)

$282,900

c)

$294,900

d)

$278,300

Answer 14

b) is correct. Lease payments = $66,733 ($70,733 less $4,000 in insurance costs). PV = $66,733 + $66,733(PVIFA, 4 years, 9%) = $282,900

Question 15

Easten Co. leased a new forklift on January 1. This lease has the following details:

The lease agreement is for 10 years.
The annual payment of $5,000 is due at the beginning of each year.
Easten has the option to buy the forklift at the end of the lease for $1.
At the end of the lease, Easten may choose to return the forklift with no penalty.
This forklift sells for $35,000.
The interest rate implicit in the lease is 7%.
Easten follows ASPE and uses the effective interest rate method. What is the interest expense to be recorded for Year 1?

a)

2,280

b)

2,700

c)

3,150

d)

3,382

Answer 15

b) is correct. The present value of the lease payments discounted at 7% is $37,576. (PMT = $5,000; N = 10; I/Y = 7%; CPT PV = $37,576). However, this amount is higher than the asset’s fair value. Since the leased asset cannot be recorded for more than fair market value ($35,000), a revised rate implicit in the lease must be recalculated using a present value of $35,000. (PV = –$35,000; PMT = $5,000; N = 10; CPT I/Y = 9%). Since the lease payment is paid at the beginning of the year, this first payment must be deducted, and interest expense is calculated on the net amount. Using this revised implicit rate of 9%, the first year’s interest is ($35,000 – $5,000) × 9% = $2,700.

Question 16

On January 1, 20X6, Beatty Inc. entered into a lease to acquire some machinery. Beatty reports under IFRS and is the lessee. The terms of the lease are as follows:

Lease payments of $25,000 are made annually on the first day of the year for five years.
Included in the annual lease payments are maintenance fees of $2,000 per year.
The machinery reverts to the lessor at the end of the lease and the lease contains no renewal option.
Beatty’s incremental borrowing rate is 11% per year.
The lease’s implicit interest rate is 10%.
Beatty has made no election with respect to the non-lease component costs.
What is the balance of the lease obligation at January 1, 20X7?

a)

$56,210

b)

$57,201

c)

$62,175

d)

$72,910

Answer 16

b) is correct because the balance of the lease obligation at January 1, 20X7, is $57,201, calculated as follows:
PV of lease payment at Jan. 1, 20X6: PMT (beginning of period) = $23,000; N = 5; I/Y = 10%; CPT PV = 95,910

                                     Interest
                  Annual       (10%) on    Reduction
                     lease       unpaid          of lease    Balance of Date            payment    obligation   obligation      obligation Jan. 1, 20X6	 	 	 	                                   $95,910 Jan. 1, 20X6	$23,000	     $0	     $23,000	   $72,910 Jan. 1, 20X7	$23,000	  $7,291	     $15,709	   $57,201

Question 17

You, CPA, are preparing a comparison of ASPE versus IFRS for a professional development session. You are looking at how ASPE and IFRS account for non-monetary transactions (NMTs). Which of the statements below is true?

a)

IFRS and ASPE standards are completely converged in terms of NMTs; there are no differences.

b)

IFRS requires non-monetary, revenue-generating transactions to be recorded at the fair value of the asset received when known.

c)

IFRS does not provide guidance on measurement of NMTs and ASPE does.

d)

ASPE does not provide guidance on measurement of NMTs and IFRS does.

Answer 17

b) is correct because the main difference is that under IFRS (IFRS 15 Revenue from Contracts with Customers), non-monetary, revenue-generating transactions are recorded at the fair value of the asset received, unless it is unknown, in which case the fair value of the asset given up is used. Under ASPE (Section 3831 Non-monetary Transactions), the transaction is measured at the more reliably measurable of the fair value of the asset given up and the fair value of the asset received. When both are reliably measurable, the fair value of the asset given up is used.

Question 18

Which of the following is an example of a non-reciprocal non-monetary transaction?

a)

Stuart Co. gives up equipment with a fair market value of $10,000 in exchange for $8,000 cash.

b)

Stuart Co. gives up a car with a fair market value of $15,000 in exchange for a similar car of a different colour that has a fair market value of $15,000.

c)

Stuart Co. gives up a piece of art with a fair market value of $20,000 in exchange for a donation receipt from a local charity.

d)

Stuart Co. gives up equipment with a fair value of $25,000 in exchange for shares in Roger Co. worth $20,000 and a note receivable for $3,000.

Answer 18

c) is correct. This is an example of a non-reciprocal exchange, since this is a one-sided exchange where only a non-monetary asset is given up.

Question 19

Which of the following is an example of a non-monetary transaction that will be recognized at carrying value of the asset given up? Lori Co. (Lori) follows ASPE.

a)

Lori gives up 100 shares in Steve Co. with a fair market value of $20,000 in exchange for a long-term note receivable of $18,000.

b)

Lori gives up vacant land with a fair market value of $15,000 in exchange for 150 shares in Mickey Inc. The shares are not publicly traded and therefore, the more reliable measure of fair value is the land.

c)

Lori Co. is in the business of selling kitchen appliances. Lori exchanged a refrigerator with a customer for future accounting services.

d)

Lori gave up a vehicle with a fair value of $18,000 to a shareholder as payment for a dividend.

Answer 19

d) is correct. This is a non-monetary non-reciprocal exchange, since there is a non-monetary asset given up as payment for an in-kind dividend. Lori will recognize this in-kind dividend at the carrying value of the vehicle.

Question 20

Colin Inc. (Colin) entered into a transaction to exchange equipment (with a carrying value of $30,000 and an approximate fair value of $35,000) and cash of $3,000, for 100% of the shares in Water Corp. Water Corp. is a private company with a fair value of $40,000. The fair value of the equipment is not reliably measurable.

At what amount will Colin recognize the new shares in Water Corp.?

a)

$37,000

b)

$38,000

c)

$40,000

d)

$43,000

Answer 20

c) is correct. This transaction has commercial substance and is therefore measured at fair value. However, the fair value of the equipment given up is not reliably measurable, so the fair value of the shares is used to recognize the assets received.

Question 21

Amtrek Inc. is planning to dispose of a collection of assets. Amtrek has designated these assets as a disposal group. The carrying amount of these assets immediately before classification as held for sale was $20 million. Upon being classified as held for sale, the assets were evaluated to establish their fair value of $18 million. Amtrek has estimated that it will cost $1 million to sell the group of assets.

What is the carrying amount of the disposal group after it is classified as held for sale?

a)

$20 million

b)

$18 million

c)

$17 million

d)

$19 million

Answer 21

c) is correct because when the disposal group is classified as held for sale, the disposal group is remeasured to the lower of its carrying value ($20 million) and its fair value ($18 million) less the costs to sell ($1 million).

Question 22

In order to qualify for separate presentation on the income statement, a discontinued operation must be considered a component of an entity.

Which of the following would be considered a component of an entity?

a)

A hotel in a hotel chain

b)

The administration building of a large manufacturing company

c)

A truck stop for a national trucking company

d)

The warehouse of a communications company

Answer 22

a) is correct. A hotel in a hotel chain is considered a component of an entity because it is a group of assets directly generating cash flows that are clearly distinguishable from the rest of the entity.

Question 23

Under IFRS, assets are considered held for sale when several criteria have been met. Which of the following criteria must be met in order to define an asset as held for sale?

a)

The asset is available for immediate sale in its present condition.

b)

There is an authorized plan to sell the asset.

c)

The asset is actively marketed and expected to be sold within two years.

d)

Both a) and b) above.

Answer 23

d) is correct because both a) and b) are correct.

Question 24

Which of the following best represents a valid difference between IFRS and ASPE in regards to the reporting of non-current assets held for sale (HFS)?

a)

Under IFRS, non-current assets held for sale can be written back up if their value recovers. Under ASPE, no subsequent increase in value can be recognized.

b)

Under ASPE, long-lived assets held for sale that have been written down for an impairment loss can have the loss reversed, but only to the extent that the write-down occurred after the HFS classification. Under IFRS, impairment losses prior to the HFS classification may also be reversed.

c)

There is no difference; the reporting of non-current assets held for sale is the same under IFRS and ASPE.

d)

Under IFRS, non-current assets held for sale are no longer depreciated. Under ASPE, non-current assets held for sale are depreciated over their remaining useful life.

Answer 24

b) is correct because under IFRS, if the fair value less costs to sell of the non-current asset held for sale subsequently increases, the asset can be written up to the extent of any previous impairment losses taken (as a result of either the HFS classification or prior impairment losses). A gain is recognized for this reversal. Under ASPE, the loss can only be reversed to the extent that the write-down occurred once the asset was classified as held for sale.

Question 25

Cinnamon Inc. (CI) is selling the net assets of its packaging division. The packaging division qualifies as a discontinued operation in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. Pertinent information for the most recent fiscal year end is as follows:

Income up to the date that CI’s Board of Directors voted on disposal of the division: $3,000,000
Income between the date of the board’s decision and the fiscal year end: $500,000
Carrying value of net assets of the division: $600,000
Fair value of net assets of the division: $500,000
Sales commission to be incurred related to the disposal: 5% of proceeds
Estimated income from the division during the three months between the fiscal year end and when the disposition is expected to take place: $200,000
Assuming CI’s effective tax rate is 40%, what amount will be reported for discontinued operations in the statement of comprehensive income for the recent fiscal year end?

a)

$2,025,000

b)

$225,000

c)

$2,100,000

d)

$2,145,000

Answer 25

a) is correct. Proof of correct answer:
= $3,000,000 (income up to the date of the decision to discontinue) + $500,000 (income between the date of the decision to discontinue and the fiscal year end) – $125,000 (write-down to fair value of net assets less selling costs)
= $3,375,000 × (1 – 40%)
= $2,025,000