Certified Public Accountant CPA Questions + Answers Part 39

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QUESTION 152
To establish the existence and ownership of a long-term investment in the common stock of a publiclytraded company, an auditor ordinarily performs a security count or:
A. Reliesontheclient'sinternalaccountingcontrolsiftheauditorhasreasonableassurancethatthecontrolactivitiesarebeingappliedasprescribed. B. Confirmsthenumberofsharesownedthatareheldbyanindependentcustodian.
C. Determines the market price per share at the balance sheet date from published quotations.
D. Confirms the number of shares owned with the issuing company.

Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Auditors obtain a confirmation (safekeeping list) indicating the number of shares of stocks held by an outside independent custodian. Choice "a" is incorrect. Even a good system of internal control does not necessarily provide sufficient evidence of existence and ownership.
Choice "c" is incorrect. Verifying the market price doesn't provide evidence regarding ownership or existence.
Choice "d" is incorrect. Confirmations are generally sent to the independent custodian, not to the issuing company.
QUESTION 153
An auditor testing long-term investments would ordinarily use analytical review as the primary audit procedure to ascertain the reasonableness of the:
A. Valuationofmarketableequitysecurities.
B. Classificationofgainsandlossesonthedisposalofsecurities. C. Completeness of recorded investment income.
D. Existence and ownership of investments.
Correct Answer: C
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Analytical review is generally used to ascertain the reasonableness of investment income in relationship to the amount invested.
Choice "a" is incorrect. Valuation would be verified using listed prices (NYSE, etc.). Choice "b" is incorrect. Classification of gains or losses would be evaluated based upon appropriate accounting principles.
Choice "d" is incorrect. Existence and ownership is generally evaluated by inspection of securities, review of brokerage statements, or confirmation with an outside independent custodian.
QUESTION 154
An auditor would most likely verify the interest earned on bond investments by:
A. Vouchingthereceiptanddepositofinterestchecks.
B. Confirmingthebondinterestratewiththeissuerofthebonds.
C. Recomputing the interest earned on the basis of face amount, interest rate, and period held.

D. Testing the internal controls over cash receipts.
Correct Answer: C
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Recomputing the interest earned is the most likely method of auditing interest earned on bond investments.
Choice "a" is incorrect. Vouching cash receipts would only verify the recording of checks received. This may not be the same as interest earned, since interest is accrued between cash payment dates. Choice "b" is incorrect. Confirmation of the bond interest rate with the issuer is not sufficient, as the rate still needs to be applied based on face amount and period held. Choice "d" is incorrect. Internal control testing of cash receipts would not provide evidence that earned interest was properly recorded, since interest is accrued between cash payment dates.
QUESTION 155
Which of the following controls would be most effective in assuring that the proper custody of assets in the investing cycle is maintained?
A. Directaccesstosecuritiesinthesafetydepositboxislimitedtoonlyonecorporateofficer.
B. Personnelwhopostinvestmenttransactionstothegeneralledgerarenotpermittedtoupdatetheinvestmentsubsidiaryledger.
C. The purchase and sale of investments are executed on the specific authorization of the board of directors.
D. The recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safety deposit box by independent personnel.
Correct Answer: D
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. An independent person comparing the contents of the safety deposit box with the recorded balances in the investment subsidiary ledger is an effective control for assuring that the proper custody of assets in the investing cycle is maintained. Choice "a" is incorrect. Direct access to securities in the safety deposit box being limited to only one corporate officer is a weakness in internal control since there is no independent verification of the box's contents. Good internal control generally requires that two or more individuals be present when the safety deposit box is opened.
Choice "b" is incorrect. While it is a good idea to have separate employees post investment transactions to the general and subsidiary ledgers (so they can later be reconciled), this control relates to recordkeeping, not to custody.
Choice "c" is incorrect. Authorization of the purchase and sale of investments by the board of directors is a good control over the approval of investment transactions but does little to assure that proper custody of assets is maintained.
QUESTION 156
To satisfy the valuation assertion when auditing an investment accounted for by the equity method, an auditor most likely would:

A. Inspectthestockcertificatesevidencingtheinvestment.
B. Examinetheauditedfinancialstatementsoftheinvesteecompany.
C. Review the broker's advice or canceled check for the investment's acquisition. D. Obtain market quotations from financial newspapers or periodicals.
Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. To satisfy the valuation assertion when auditing an investment accounted for by the equity method, an auditor most likely would examine the audited financial statements of the investee company, performing recalculations of prorata share of income/loss and analytical procedures to determine if the investment is carried at the lower of cost or market. Choices "a" and "c" are incorrect. Inspecting the stock certificates evidencing the investment or reviewing the broker's advice or canceled check for the investment's acquisition are procedures that satisfy the existence assertion, not the valuation assertion. Choice "d" is incorrect. Obtaining market quotations from financial newspapers or periodicals would satisfy the valuation assertion for an investment accounted for by the cost method.
QUESTION 157
Which of the following controls would an entity most likely use in safeguarding against the loss of marketable securities?
A. Anindependenttrustcompanythathasnodirectcontactwiththeemployeeswhohaverecordkeepingresponsibilitieshaspossessionofthesecurities. B. Theinternalauditorverifiesthemarketablesecuritiesintheentity'ssafeeachyearonthebalancesheetdate.
C. The independent auditor traces all purchases and sales of marketable securities through the subsidiary ledgers to the general ledger.
D. A designated member of the board of directors controls the securities in a bank safe-deposit box.
Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The control most likely to be used by an entity in safeguarding against the loss of marketable securities is that an independent trust company that has no direct contact with the employees who have recordkeeping responsibilities, has possession of the securities. For good internal control over the safeguarding of any asset, the individual who has the recordkeeping responsibilities over that asset should never have access to it.
Choice "b" is incorrect. Verifying the securities held in the entity's safe would detect that the loss occurred, but it would not prevent the loss.
Choice "c" is incorrect. Tracing purchases and sales of marketable securities would verify that the transactions were properly recorded, but would not safeguard

against loss. Choice "d" is incorrect. Having one person control the securities in a bank safe-deposit box is a weakness in internal control because that one person can steal the securities. A better system requires that at least two employees have joint control over the securities in a bank safe-deposit box.
QUESTION 158
Which of the following controls most likely would give the greatest assurance that securities held as investments are safeguarded?
A. Thereisnoaccesstosecuritiesbetweentheyear-endandthedateoftheauditor'ssecuritycount.
B. Proceedsfromthesaleofinvestmentsarereceivedbyanemployeewhodoesnothaveaccesstosecurities. C. Investment acquisitions are authorized by a member of the Board of Directors before execution.
D. Access to securities requires the signatures and presence of two designated officials.
Correct Answer: D
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. Requiring the signatures and presence of two designated officials in order to gain access to securities is an internal control that provides assurance regarding the safeguarding of securities.
Choice "a" is incorrect. Having no access to securities between the year-end and the date of the auditor's security count would assure that no securities are added or taken away before the auditor counts them, but it would not ensure that securities are safeguarded for the entire year. Choice "b" is incorrect. Proceeds from the sale of investments should be received by an employee who does not have access to securities, but this control does not prevent the theft of investments that are not sold.
Choice "c" is incorrect. Requiring authorization from a member of the board of directors before execution assures that investment purchases are approved and consistent with the financial philosophy of the organization (level of financial risk that the company is willing to accept), but this approval does not provide assurance that the assets will be safeguarded.
QUESTION 159
In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the:
A. Completenessofrecordedinvestmentincome.
B. Classificationbetweenbalancesheetportfolios.
C. Valuation of marketable equity securities.
D. Existence of unrealized gains or losses in the portfolio.
Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation

Explanation/Reference:
Explanation:
Choice "a" is correct. In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the completeness of recorded investment income. These procedures would probably include a comparison of the recorded investment income with the expected amount (based upon the related interest rate, dividends declared, etc.) and the income balance audited in the prior year.
Choice "b" is incorrect. Classification between balance sheet portfolios would most likely be tested by confirming the terms of the investment and making inquiries of management regarding how long they intend to hold the securities.
Choice "c" is incorrect. To test the valuation of marketable equity securities an auditor would most likely compare to market quotations (cost method) or examine the audited financial statements of the investee company (equity method).
Choice "d" is incorrect. To identify and quantify the existence of unrealized gains and losses in the portfolio, an auditor would examine the trading prices in the Wall Street Journal (or other source) for those long-term investments carried under the cost method. For those carried under the equity method, an auditor would review the audited financial statements of the investee company.
QUESTION 160
Which of the following internal controls would an entity most likely use to assist in satisfying the completeness assertion related to long-term investments?
A. Seniormanagementverifiesthatsecuritiesinthebanksafedepositboxareregisteredintheentity'sname. B. Theinternalauditorcomparesthesecuritiesinthebanksafedepositboxwithrecordedinvestments.
C. The treasurer vouches the acquisition of securities by comparing brokers' advices with canceled checks.
D. The controller compares the current market prices of recorded investments with the brokers' advices on file.
Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Requiring the internal auditor to compare the securities in the bank safe deposit box with recorded investments is the procedure an entity most likely would use in satisfying the completeness assertion related to long-term investments. Choice "a" is incorrect. Verifying that securities in the bank safe deposit box are registered in the entity's name provides evidence regarding rights and obligations, not completeness. Choice "c" is incorrect. Vouching the acquisition of securities by comparing brokers' advices with canceled checks provides evidence regarding rights and obligations, not completeness. Choice "d" is incorrect. The controller comparing the current market prices of recorded investments with the broker advices on file provides assurance that the long-term investments are properly valued, and that unrealized gains and losses are properly recognized.
QUESTION 161
A client has a large and active investment portfolio that is kept in a bank safe deposit box. If the auditor is unable to count the securities at the balance sheet date, the auditor most likely will:
A. Requestthebanktoconfirmtotheauditorthecontentsofthesafedepositboxatthebalancesheetdate.

B. Examinesupportingevidencefortransactionsoccurringduringtheyear.
C. Count the securities at a subsequent date and confirm with the bank whether securities were added or removed since the balance sheet date. D. Request the client to have the bank seal the safe deposit box until the auditor can count the securities at a subsequent date.
Correct Answer: D
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. If the auditor is unable to count the securities at the balance sheet date the auditor should request the client to have the bank seal the safe deposit box until the auditor can count the securities.
Choice "a" is incorrect. Bank employees are not present when items are put into or taken from the safety deposit box and do not keep records of safety deposit box contents. They would therefore be unable to provide any information to the auditors.
Choice "b" is incorrect. Examining supporting evidence for the transactions occurring during the year is inefficient, as many of the securities purchased during the year may have been sold before the balance sheet date. Counting securities is preferable as it provides direct external evidence of the securities on hand at year- end.
Choice "c" is incorrect. Bank employees are not present when items are put into or taken from the safety deposit box and do not keep records of safety deposit box contents. They would therefore be unable to provide any information to the auditors.
QUESTION 162
Property acquisitions that are misclassified as maintenance expense would most likely be detected by an internal accounting control system that provides for:
A. Investigationofvarianceswithinaformalbudgetingsystem.
B. Reviewandapprovalofthemonthlydepreciationentrybytheplantsupervisor.
C. Segregation of duties of employees in the accounts payable department.
D. Examination by the internal auditor of vendor invoices and canceled checks for property acquisitions.
Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Investigation of variances in a formal budget might show maintenance costs over budget or acquisition costs under budget, either of which would trigger an investigation. Choice "b" is incorrect. Review of journal entries relating to depreciation would not disclose acquisitions misclassified as maintenance expense, since no depreciation would be recorded for the misclassified items.
Choice "c" is incorrect. Segregation of duties in the accounts payable department would have no effect on the account classification of an approved invoice.

Choice "d" is incorrect. Since the internal auditor would be looking at invoices and checks related to recorded property acquisitions, he or she would not be likely to identify payments that were erroneously excluded from the property account.
QUESTION 163
Which of the following controls is most likely to prevent the improper disposition of equipment?
A. Aseparationofdutiesbetweenthoseauthorizedtodisposeofequipmentandthoseauthorizedtoapproveremovalworkorders. B. Theuseofserialnumberstoidentifyequipmentthatcouldbesold.
C. Periodic comparison of removal work orders to authorizing documentation.
D. A periodic analysis of the scrap sales and the repairs and maintenance accounts.
Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Separation of duties between those authorized to dispose of equipment and those authorized to approve removal work orders is most likely to prevent the improper disposition of equipment.
Choice "b" is incorrect. Serial number tracking is a good audit and control activity but it will not prevent improper dispositions of equipment.
Choices "c" and "d" are incorrect. Periodic comparison of removal work orders to authorizing documentation and periodic analysis of scrap sales and the repairs and maintenance accounts may identify improper dispositions that have already occurred, but such procedures will not prevent improper dispositions.
QUESTION 164
When auditing prepaid insurance, an auditor discovers that the original insurance policy on plant equipment is not available for inspection. The policy's absence most likely indicates the possibility of a (an):
A. Insurancepremiumduebutnotrecorded. B. Deficiencyinthecoinsuranceprovision. C. Lien on the plant equipment.
D. Understatement of insurance expense.
Correct Answer: C
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:

Choice "c" is correct. If an auditor discovers that the original insurance policy on plant equipment is not available for inspection, this most likely indicates that there is a lien on the plant equipment, since the original policy would likely be in the possession of the lien holder. Choices "a", "b", and "d" are incorrect. The absence of the original policy does not necessarily indicate that there is an insurance premium due but not recorded, that there is a deficiency in the coinsurance provision, or that insurance expense is understated, since the policy must be reviewed before any of these conclusions can be drawn.
QUESTION 165
Which of the following combinations of procedures would an auditor most likely perform to obtain evidence about fixed asset additions?
A. Inspectingdocumentsandphysicallyexaminingassets.
B. Recomputingcalculationsandobtainingwrittenmanagementrepresentations.
C. Observing operating activities and comparing balances to prior period balances.
D. Confirming ownership and corroborating transactions through inquiries of client personnel.
Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. In order to obtain evidence about fixed asset additions, an auditor would most likely inspect documents (e.g., purchase invoices) and physically examine the new assets. Choice "b" is incorrect. Recomputing calculations might provide evidence about depreciation, and obtaining management representations might provide evidence about commitments with respect to fixed assets, but neither procedure provides specific evidence about fixed asset additions. Choice "c" is incorrect. Observing operating activities and comparing balances to prior years might provide evidence that depreciation expense was properly recorded, but does not provide evidence supporting additions.
Choice "d" is incorrect. Inquiry alone is not as persuasive as direct personal observation.
QUESTION 166
Which of the following internal controls most likely would justify a reduced assessed level of control risk concerning plant and equipment acquisitions?
A. Periodicphysicalinspectionofplantandequipmentbytheinternalauditstaff.
B. Comparisonofcurrent-yearplantandequipmentaccountbalanceswithprior-yearactualbalances. C. The review of prenumbered purchase orders to detect unrecorded trade-ins.
D. Approval of periodic depreciation entries by a supervisor independent of the accounting department.
Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:

Explanation:
Choice "a" is correct. Periodic physical inspection of plant and equipment by the internal audit staff is an internal control that would most likely justify a reduced assessed level of control risk concerning plant and equipment acquisitions. Such inspections would provide assurance that recorded acquisitions are real (existence assertion).
Choice "b" is incorrect. The comparison of current-year plant and equipment account balances with prioryear actual balances might indicate that acquisitions occurred, but it would not justify a reduced assessed level of control risk, since the controls over the acquisition process are not tested. Choice "c" is incorrect. A review of prenumbered purchase orders is unlikely to provide evidence regarding plant and equipment acquisitions. (Generally a special requisition form is used for such acquisitions.)
Choice "d" is incorrect. Approval of depreciation entries has little bearing on the control risk relating to plant and equipment acquisitions.
QUESTION 167
Equipment acquisitions that are misclassified as maintenance expense most likely would be detected by an internal control activity that provides for:
A. Segregationofdutiesofemployeesintheaccountspayabledepartment.
B. Independentverificationofinvoicesfordisbursementsrecordedasequipmentacquisitions. C. Investigation of variances within a formal budgeting system.
D. Authorization by the board of directors of significant equipment acquisitions.
Correct Answer: C
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Equipment acquisitions that are misclassified as maintenance expense most likely would be detected by internal control procedures that provide for investigation of variances within a formal budgeting system.
Choice "a" is incorrect. Segregation of duties of employees in the accounts payable department would not prevent the misclassification of equipment acquisitions as maintenance expense. Choice "b" is incorrect. Verifying invoices for disbursements already recorded as equipment acquisitions would not include examining invoices for disbursements recorded as maintenance expense. Choice "d" is incorrect. Since the authorization by the board of directors occurs before the disbursement is recorded, this control would not prevent any misclassification.
QUESTION 168
In testing for unrecorded retirements of equipment, an auditor most likely would:
A. Selectitemsofequipmentfromtheaccountingrecordsandthenlocatethemduringtheplanttour.
B. Comparedepreciationjournalentrieswithsimilarprior-yearentriesinsearchoffullydepreciatedequipment.
C. Inspect items of equipment observed during the plant tour and then trace them to the equipment subsidiary ledger. D. Scan the general journal for unusual equipment additions and excessive debits to repairs and maintenance expense.

Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Tracing (old) equipment recorded in the books to the actual equipment during a plant tour is a control which tests for unrecorded retirements. Choice "b" is incorrect. Determining which assets are fully depreciated does not tell you which ones are retired, as fully depreciated assets may continue to be used. Choice "c" is incorrect. Selecting items from the plant tour and then tracing them to the equipment subsidiary ledger will provide evidence that all equipment is recorded. It will not detect whether recorded equipment has been retired. (This step is backwards.) Choice "d" is incorrect. Scanning the general journal for unusual equipment additions and excessive debits to repairs and maintenance expense provides evidence regarding fixed asset additions, not retirements.
QUESTION 169
An auditor ordinarily sends a standard confirmation request to all banks with which the client has done business during the year under audit, regardless of the year- end balance. A purpose of this procedure is
to:
A. Providethedatanecessarytoprepareaproofofcash.
B. Requestacutoffbankstatementandrelatedchecksbesenttotheauditor. C. Detect kiting activities that may otherwise not be discovered.
D. Seek information about contingent liabilities and security agreements.
Correct Answer: D
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. The standard confirmation request seeks information on contingent liabilities and security agreements in addition to information related to deposit account balances. Choice "a" is incorrect. The standard confirmation request does not provide all of the data necessary to prepare a "proof of cash" (i.e., bank reconciliation), since it only confirms the balances at the end of a period, and does not provided information about the activity during the period under audit. Such information is necessary to perform a bank reconciliation and would be provided in a bank statement. Choice "b" is incorrect. A request for a cut-off statement, and not the standard bank confirmation form, is used to obtain a cut-off bank statement and related checks. Choice "c" is incorrect. The bank cut-off statement, not the standard confirmation request, is used to detect kiting activities that may not otherwise be discovered.
QUESTION 170
In an audit of contingent liabilities, which of the following procedures would be least effective?

A. Reviewingabankconfirmationletter.
B. Examiningcustomerconfirmationreplies.
C. Examining invoices for professional services. D. Reading the minutes of the board of directors.
Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Customer confirmations relate to receivables, and would not be likely to disclose a contingent liability.
Choice "a" is incorrect. A standard bank confirmation will most likely identify contingent liabilities because it contains confirmation of discounted drafts and/or guarantees of notes and/or other open letters of credit.
Choice "c" is incorrect. Examining professional invoices may disclose a contingent liability. For example, invoices from attorneys may provide information regarding litigation, claims, and assessments.
Choice "d" is incorrect. Reviewing the board minutes may identify a contingent liability. For example, the board may discuss contingencies during one of its meetings. Other procedures that may be effective in an audit of contingent liabilities include:
Discussing long-term purchase commitments with the purchasing agent.
Reviewing long-term leases.
Obtaining a client representation letter.
QUESTION 171
The primary evidence regarding year-end cash balances in the financial statements is documented in the:
A. Standardbankconfirmations. B. Bank reconciliations.
C. Interbank transfer schedule. D. Bank deposit lead schedule.
Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. The primary evidence regarding year-end cash balances in the financial statements is documented in the bank reconciliation, which reconciles the balance per the bank to that per the financial statements.
Choice "a" is incorrect. The standard bank confirmation does not provide evidence about certain transactions that are necessary to compute the cash balance,

such as deposits in transit and outstanding checks.
Choice "c" is incorrect. The interbank transfer schedule provides evidence about bank transfers over a period of time. It is used to detect kiting, not to support the year-end cash balance. Choice "d" is incorrect. A "cash lead schedule" is a schedule that summarizes all the various balances that comprise cash. It is created by the auditor and is not, in and of itself, evidence supporting cash.
QUESTION 172
An auditor's program to examine long-term debt should include steps that require:
A. Examiningbondtrustindentures.
B. Inspectingtheaccountspayablesubsidiaryledger.
C. Investigating credits to the bond interest income account. D. Verifying the existence of the bondholders.
Correct Answer: A
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Examination of bond trust indentures should be included in audit program of longterm debt to assure that the client was not in violation of any covenants in the indentures. Choice "b" is incorrect. Inspecting the accounts payable subsidiary ledger relates to accounts payable, a current liability.
Choice "c" is incorrect. Long-term debt generates interest expense, not interest income. Choice "d" is incorrect. Generally, the existence of the bondholders of debt is not verified.
QUESTION 173
An auditor's plan to examine long-term debt most likely would include steps that require:
A. Comparingthecarryingamountofthedebttoitsyear-endmarketvalue.
B. Correlatinginterestexpenserecordedfortheperiodwithoutstandingdebt.
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.
Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:

Choice "b" is correct. An auditor's plan to examine long-term debt most likely would include steps that require correlating interest expense recorded for the period with outstanding debt. This is an analytical procedure that would provide evidence regarding the reasonableness of the interest expense balance. Choice "a" is incorrect. This question was released prior to the issuance of FAS 107, which requires disclosure of the fair values of financial instruments. Accordingly, the auditor now needs to audit the year-end market values of long-term debt. Choice "a" is still not the best answer, however, since the auditor would not need to compare the carrying amount to the year-end market value. (Both values are shown, as FAS 107 does not require that debt securities be written down to (a lower) market value.) Choice "c" is incorrect. Generally the existence of the holders of the debt is not verified. Choice "d" is incorrect. Inspecting the accounts payable subsidiary ledger would be included in the audit of accounts payable, not long-term debt.
QUESTION 174
Which of the following is not an audit procedure that the independent auditor would perform concerning litigation, claims, and assessments?
A. Obtainassurancefrommanagementthatithasdisclosedallunassertedclaimsthatthelawyerhasadvisedareprobableofassertionandmustbedisclosed. B. Confirmdirectlywiththeclient'slawyerthatallclaimshavebeenrecordedinthefinancialstatements.
C. Inquire of and discuss with management the controls adopted for identifying, evaluating, and accounting for litigation, claims, and assessments.
D. Obtain from management a description and evaluation of litigation, claims, and assessments existing at the balance sheet date.
Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. The independent auditor would not confirm directly with the client's lawyer that all claims have been recorded in the financial statements. Management has the responsibility to include all claims in the financial statements, not the lawyers. The purpose of a legal letter is to obtain outside corroboration of the information furnished by management concerning litigation, claims, and assessments.
Choice "a" is incorrect. The auditor should obtain assurance from management that it has disclosed all unasserted claims that the lawyer has advised are probable of assertion and must be disclosed. Choice "c" is incorrect. The auditor should inquire of and discuss with management the controls adopted for identifying, evaluating, and accounting for litigation, claims, and assessments. Choice "d" is incorrect. The auditor should obtain from management a description and evaluation of litigation, claims, and assessments existing at the balance sheet date.
QUESTION 175
An auditor should request that an audit client send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide:
A. Theopinionofaspecialistastowhetherlosscontingenciesarepossible,probable,orremote.
B. Adescriptionoflitigation,claims,andassessmentsthathaveareasonablepossibilityofunfavorableoutcomes. C. An objective appraisal of management's controls adopted for identifying and evaluating legal matters.
D. The corroboration of the information furnished by management concerning litigation, claims, and assessments.

Correct Answer: D
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. The primary reason for an auditor to request that the audit client send a letter of inquiry to its attorneys is to provide corroboration of the information furnished by management concerning litigation, claims and assessments.
Choice "a" is incorrect. The letter of inquiry is used to corroborate information furnished by management.
The likelihood of loss contingencies occurring is only one item addressed in this correspondence, but it is not the primary purpose of the request.
Choice "b" is incorrect. The description of litigation, claims and assessments that have a reasonable possibility of unfavorable outcomes should be provided by management, not the attorneys. Choice "c" is incorrect. The attorneys do not give an appraisal of management's controls adopted for identifying and evaluating legal matters.
QUESTION 176
The most likely result of ineffective internal control policies and procedures in the revenue cycle is that:
A. Irregularitiesinrecordingtransactionsinthesubsidiaryaccountscouldresultinadelayingoodsshipped.
B. Omissionofshippingdocumentscouldgoundetected,causinganunderstatementofinventory.
C. Final authorization of credit memos by personnel in the sales department could permit an employee defalcation scheme. D. Fictitious transactions could be recorded, causing an understatement of revenues and overstatement of receivables.
Correct Answer: C
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The most likely result of ineffective internal control policies and procedures in the revenue cycle is that final authorization of credit memos by personnel in the sales department could permit a salesman to sell, collect, and pocket the collection, then cover it up by issuing a credit memo. Final authorization of credit memos should be performed by an employee who is independent of the sales department such as the credit manager in the treasury department. Choice "a" is incorrect. The shipment of goods is an activity that takes place before the transaction is recorded. Irregularities in recording transactions in the subsidiary accounts therefore would have no impact on the timeliness of the goods being shipped.
Choice "b" is incorrect. If shipping documents are omitted, then the inventory levels would be overstated since the reduction of inventory would not be recorded. Choice "d" is incorrect. If fictitious transactions in the revenue cycle are recorded, then the impact on revenues and receivables would be the same; either both would be overstated (the most likely case) or both would be understated.
QUESTION 177
Which of the following questions would an auditor most likely include on an internal control questionnaire for notes payable?

A. Areassetsthatcollateralizenotespayablecriticallyneededfortheentity'scontinuedexistence? B. Aretwoormoreauthorizedsignaturesrequiredonchecksthatrepaynotespayable?
C. Are the proceeds from notes payable used for the purchase of noncurrent assets?
D. Are direct borrowings on notes payable authorized by the board of directors?
Correct Answer: D
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. An internal control questionnaire for notes payable would likely ask if direct borrowings on notes payable are authorized by the board of directors. Choice "a" is incorrect. Whether collateralized assets are critically needed for the entity's continued existence is not a part of the control environment related to notes payable. Choice "b" is incorrect. The requirement for two authorized signatures is part of the disbursements internal control system, not the notes payable system. Choice "c" is incorrect. Whether the proceeds of notes payable are used for current or noncurrent assets is not a part of the notes payable internal control system.
QUESTION 178
In auditing accounts payable, an auditor's procedures most likely would focus primarily on management's assertion of:
A. Existence.
B. Understandabilityandclassification. C. Completeness.
D. Valuation and allocation.
Correct Answer: C
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. When testing liabilities, an auditor generally is concerned about understatement (as opposed to overstatement, for assets). Therefore, in auditing accounts payable, an auditor's procedures most likely would focus primarily on management's assertion of completeness (if accounts payable is not complete it would be understated).
Choice "a" is incorrect. The assertion of existence is the primary focus of the auditor when auditing an asset account, not accounts payable.
Choice "b" is incorrect. The understandability and classification assertion is not the primary focus in the audit of accounts payable.
Choice "d" is incorrect. The assertion of valuation and allocation is not the main focus with respect to accounts payable. Good external evidence generally is available to support the amount, and allocation over more than one period generally is not required.

QUESTION 179
Which of the following statements extracted from a client's lawyer's letters concerning litigation, claims, and assessments most likely would cause the auditor to request clarification?
A. "Ibelievethatthepossibleliabilitytothecompanyisnominalinamount."
B. "Ibelievethattheactioncanbesettledforlessthanthedamagesclaimed." C. "I believe that the plaintiff's case against the company is without merit."
D. "I believe that the company will be able to defend this action successfully."
Correct Answer: B
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. The auditor is concerned with preventing an understatement of contingent liabilities. The auditor would therefore request clarification before determining that a reduction in such liability (from damages claimed to some lesser amount) is reasonable. Choices "a", "c", and "d" are incorrect. When a lawyer asserts that a contingent liability is immaterial ("nominal") or improbable ("without merit" and "successful defense likely"), it is unlikely that the auditor would require further clarification.
QUESTION 180
An auditor should trace corporate stock issuances and treasury stock transactions to the:
A. Numberedstockcertificates.
B. Articlesofincorporation.
C. Transfer agent's records.
D. Minutes of the board of directors.
Correct Answer: D
Section: Auditing and Attestation (II) (Volume D) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. The auditor should trace corporate stock issuances and treasury stock transactions to the minutes of the board of directors to make sure they were authorized. Choice "a" is incorrect. Numbered stock certificates for shares that are issued and outstanding would be in the hands of the stockholders.
Choice "b" is incorrect. Information about stock issuances and treasury stock transactions would not be included in the articles of incorporation. Generally only the

shares authorized and their par value would be included therein.
Choice "c" is incorrect. The transfer agent might confirm a transaction, but the auditor would not generally review the transfer agent's records.