Final Exam

Question 1

Financial Audit

Answer 1

Carrying out a thorough examination of an entity’s books and records, financial accounts, and policies and procedures

Question 2

Who performs Audits?

Answer 2

External, independent auditors who are certified public accountants (CPAs)

Question 3

Internal controls

Answer 3

Procedures or systems which are designed promote efficiency, safeguard assets, avoid fraud and errors, and keep accounting data accurate

Question 4

Five Elements of Internal Controls

Answer 4

1. Control environment - management must set an ethical tone
2. Risk assessment - put policies in place to mitigate risks
3. Control activities - procedures/policies to protect its assets
4. Information/communication - those policies/procedures must be communicated to employees
5. Monitoring - follow-up on rules

Question 5

Sampling

Answer 5

Using a random subset of the population in order to form an opinion on the population as a whole

Question 6

Audit evidence

Answer 6

Information gathered by the auditors for their analysis

Question 7

Materiality

Answer 7

Refers to the size of an error in the financial statements. Big enough to affect the decision of a reasonable person looking at the mistake but not knowing its there

Question 8

Public Company Accounting Oversight Board (PCAOB)

Answer 8

Under SEC… oversees the auditing of publicly help companies

Question 9

Sarbanes-Oxley (Sarbox) implications for auditors

Answer 9

• Second partner review
• “Quality Review” by PCAOB every year
• Can’t provide consulting services to audit clients
• Lead auditor must rotate every five years

Question 10

Sarbox implications for companies

Answer 10

• Audit committee: oversights of internal audit, independent & one must have financial expertise, hires and receives report from independent auditors
• Limits loans made to executives
• Section 404 internal control audit required

Question 11

What do public accounting firms provide? Explain each.

Answer 11

Assurance services: independent, professional services that improve information quality (audits of financial statements/internal controls)
Non-assurance services: tax preparation/planning, fraud investigations, information technology consulting

Question 12

Opinions on audits

Answer 12

Unmodified, qualified, adverse, or disclaimer opinion

Question 13

Generally accepted auditing standards (GAAS)

Answer 13

Standards that all auditors must follow to make their job uniform for everyone

Question 14

Unmodified opinion

Answer 14

AKA clean, which means that the auditors have found the financial statements to be in accordance with GAAP or IFRS (best opinion a company can get)

Question 15

Qualified opinion

Answer 15

Means the auditors found something they wanted to bring to light but other than that they statements are correct

Question 16

Fraud Triangle

Answer 16

Qualities of someone who may commit fraud: financial need, see an opportunity that is unlikely to be detected, or they have convinced themselves of entitlement (employee feels he should’ve gotten a raise)

Question 17

Details of Sarbanes - Oxley Act (Know the two sections as well)

Answer 17

Corporate governance - Making firms improve their overall ethical operations. Requires publicly held companies to create an “audit committee” aka the “supervisory committee”. They are in charge of hiring the external auditing firm, maintaining proper statements, and can’t be employees of the company. It also requires management to sign an agreement known as Section 302 that promises they properly audited their statements.
Requirements for Auditors - Auditors can have no other job for the company but to audit. Created the Public Company Accounting Oversight Board (PCAOB). Requires auditing companies to provide opinions on financial statements, and Sec. 404 where the auditing firm gives an opinion on the company’s internal controls.

Question 18

How is managerial different from financial?

Answer 18

Managerial is:

• Primarily internal
• Governed by management not GAAP
• Future-oriented not historical
• Quantified and non-financial info versus quantified financial statements

Question 19

Formula for cost of inventory for a manufacturing firm

Answer 19

Direct materials + direct labor + manufacturing overhead = product costs

Question 20

Manufacturing overhead costs

Answer 20

Indirect materials, indirect labor, and all other manufacturing costs

Question 21

Two types of product costing

Answer 21

Job order costing: costs are accumulated by jobs. Used when the product produced is specific.
Process costing: costs are averaged over all units. Used in the manufacture of uniform or homogeneous products.

Question 22

Relevant range

Answer 22

The range or production in which the company expects to operate.

Question 23

Mixed costs

Answer 23

Costs that have some fixed and some variable components.

Question 24

Step costs

Answer 24

Costs that increase in a step manner rather than gradually.

Question 25

Finding the breakeven point in dollars

Answer 25

Total fixed costs / contribution margin ratio

Question 26

Finding sales in units to achieve a certain net income.

Answer 26

(Total fixed costs + target income) / contribution margin per unit

Question 27

Sales in dollars to achieve a target net income

Answer 27

(total fixed costs + target income) / contribution margin ratio

Question 28

Breakeven point in units

Answer 28

Total fixed costs / contribution margin per unit

Question 29

Proprietorship and taxes

Answer 29

Owned by one individual, so all net income flows through the owner to pay taxes. Pays tax on the taxable income, not amount of cash withdrawn.

Question 30

Partnerships and taxes

Answer 30

Owned by two or more parties, not incorporated. The partnership files a tax return but does not pay tax. Income flows through the owners to pay taxes on their individual returns.

Question 31

Regular corporations and taxes

Answer 31

A business that is incorporated and has to file a tax return and pay corporate tax. Tax is paid on taxable income at corporate level AND dividends are not deductible to the corporation but are taxable income to stockholders.

Question 32

What happens if a corporation is a stockholder?

Answer 32

Dividends Received Deduction is:

• 70% of dividend, if own less than 20% of corporation
• 80% of dividend, if own between 20% and 80% of corporation
• 100% of dividend, if own greater than 80% of corporation

Question 33

S Corporations

Answer 33

Business who is incorporated, but chose to be taxed as a partnership. Same exact taxing process as a partnership. Hard to meet qualifications to be “S” status

Question 34

Limited-liability Companies (LLCs)

Answer 34

Elected to be treated as an association having some characteristics of a corporation and some of either a prop. or partnership. They have limited liability (like corps.) and flow-through taxation (like props and partners).

Question 35

Taxable income equation

Answer 35

Gross income realized 
- exclusions 
= gross income recognized for tax purposes 
- deductions 
= taxable income (then to tax bracket) 
- tax credits 
= total tax owed

Question 36

Marginal tax rate

Answer 36

The tax rate at which your next dollar would be taxed. Helps decide whether to invest in a project or not.