AUDITING THEORY - 074: Process part 2 CMP

Test of Control and Substantive Test in the Conversion

1. To strengthen control procedures over the custody of heavy mobile equipment, the client would most likely
institute a policy requiring a periodic
a. Increase in insurance coverage.
b. Inspection of equipment and reconciliation with accounting records.
c. Verification of liens, pledges, and collateralizations.
d. Accounting for work orders.

2. To improve accountability for fixed asset retirements, management most likely would implement an internal
control structure that includes
a. Continuous analysis of the repairs and maintenance account.
b. Periodic inquiry of plant executives by internal auditors as to whether any plant assets have been retired.
c. Continuous utilization of serially numbered retirement work orders.
d. Periodic inspection of insurance policies by internal auditors.

3. From the auditor's point of view, inventory counts are more acceptable prior to the year-end, when
a. Internal control is deficient.
b. Accurate perpetual inventory records are maintained.
c. Inventory is slow moving.
d. Significant amounts of inventory are held on consignment.

4. Apex Manufacturing Corporation mass produces eight different products. The controller who is interested in
strengthening control procedures over the accounting for materials used in production would be most likely to
implement
a. An economic order quantity (EOQ) system.
b. A job order cost accounting system.
c. A perpetual inventory system.
d. A separation of duties among production personnel.

5. For several years, a client's physical inventory count has been lower than what was shown on the books at the
time of the count so that downward adjustments to the inventory account were required. Contributing to the
inventory problem could be deficiencies in internal control that led to the failure to record some
a. Purchases returned to vendors.
b. Sales returns received.
c. Sales discounts allowed.
d. Cash purchases.

6. When perpetual inventory records are maintained in quantities and in dollars, and internal control procedures
over inventory are deficient, the auditor would probably
a. Want the client to schedule the physical inventory count at the end of the year.
b. Insist that the client perform physical counts of inventory items several times during the year.
c. Increase the extent of tests for unrecorded liabilities at the end of the year.
d. Have to disclaim an opinion on the income statement that year.

7. Purchase cutoff procedures should be designed to test whether or not all inventory
a. Purchased and received before the year-end was recorded.
b. Was carried at the lower of cost or market on the year-end balance sheet.
c. Was paid for by the company on the year-end balance sheet.
d. Owned by the company is in the possession of the company.

8. In tests of property, plant, and equipment, the auditor tries to determine all of the following except the
a. Adequacy of the internal control.
b. Extent of property abandoned during the year.
c. Adequacy of replacement funds.
d. Reasonableness of depreciation.

9. An auditor has accounted for a sequence of inventory tags and is now going to trace information on a
representative number of tags to the physical inventory sheets. The purpose of this procedure is to obtain
assurance that
a. The final inventory is valued at cost.
b. All inventory represented by an inventory tag is listed on the inventory sheets.
c. All inventory represented by an inventory tag is bona fide.
d. Inventory sheets do not include untagged inventory items.

10. The physical count of inventory of a retailer was higher than shown by the perpetual records. Which of the
following could explain the difference?
a. Inventory items had been counted, but the tags placed on the items had not been taken off the items
AUDITING THEORY - 074: PROCESS 2 CMP
and added to the inventory accumulation sheets.
b. Credit memos for several items returned by customers had not been recorded.
c. No journal entry had been made on the retailer's books for several items returned to its suppliers.
d. An item purchased "FOB shipping point" had not arrived at the date of the inventory count and had not
been reflected in the perpetual records.

11. A client's physical count of inventories was higher than the inventory quantities per the perpetual records. This
situation could be the result of the failure to record
a. Sales.
b. Sales discounts.
c. Purchases.
d. Purchase returns.

12. The controller of Excello Manufacturing, Inc., wants to use ratio analysis to identify the possible existence of idle
equipment or the possibility that equipment has been disposed of without having been written off. Which of the
following ratios would best accomplish this objective?
a. Depreciation expense divided by book value of manufacturing equipment.
b. Accumulated depreciation divided by book value of manufacturing equipment.
c. Repairs and maintenance cost divided by direct labor costs.
d. Gross manufacturing equipment cost divided by units produced.

13. The accuracy of perpetual inventory records may be established, in part, by comparing inventory records with
a. Purchase requisitions.
b. Receiving reports.
c. Purchase orders.
d. Vendor payments.

14. The audit procedure of analyzing the repairs and maintenance accounts is primarily designed to provide evidence
in support of the audit proposition that all
a. Expenditures for plant assets have been recorded in the proper period.
b. Capital expenditures have been properly authorized.
c. Noncapitalizable expenditures have been properly expensed.
d. Expenditures for plant assets have been capitalized.

15. Which of the following explanations might satisfy an auditor who discovers significant debits to an accumulated
depreciation account?
a. Extraordinary repairs have lengthened the life of an asset.
b. Prior years' depreciation charges were erroneously understated.
c. A reserve for possible loss on retirement has been recorded.
d. An asset has been recorded at its fair value.

16. Which of the following activities is not common to the conversion cycle?
a. Maintaining perpetual inventory records.
b. Accounting for fixed asset disposals and retirements.
c. Implementing a just-in-time order entry system.
d. Recording depreciation allocations.

17. When an outside specialist has assumed full responsibility for taking the client's physical inventory, reliance on
the specialist's report is acceptable if
a. The auditor is satisfied about the specialist's reputation and competence.
b. Circumstances make it impracticable or impossible for the auditor either to do the work personally or to
observe the specialist's work.
c. The auditor performs the same tests and procedures as would have been applicable if the client's
employees took the physical inventory.
d. The auditor's report assumes full responsibility.

18. An auditor's tests of a client's cost accounting system are designed primarily to determine that
a. Quantities on hand have been computed based on acceptable methods that reasonably approximate
actual quantities on hand.
b. Physical inventories substantially agree with book inventories.
c. The system complies with generally accepted accounting principles and functions as planned.
d. Costs have been assigned properly to finished goods, work in process, and cost of goods sold.

19. Sanbor Corporation's parts inventory consists of thousands of different items that are small in value individually,
but quite significant in total. Sanbor could establish effective control over the parts by requiring

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a. An officer's approval of requisitions for inventory parts.
b. Maintaining inventory records for all parts included in the inventory.
c. Physical counts on a cycle basis rather than at year-end.
d. Separation of the storekeeping function from the production and inventory record-keeping functions.

20. When verifying debits to a manufacturing company's perpetual inventory records, an auditor would be most
interested in testing a sample of purchase
a. Approvals.
b. Requisitions.
c. Invoices.
d. Orders.

21. Assets may suffer an impairment in value for a variety of reasons, but not likely as a result of:
a. A corporate restructuring.
b. Slumping demand for uncompetitive products.
c. Significant increases in market share.
d. Obsolescence.

22. Which of the following is not likely a motive for management to manipulate the timing and amount of impaired
asset writedowns?
a. Steady increases in earnings per share over the past 5 years.
b. Income smoothing.
c. A "big bath."
d. An abnormally unprofitable year.

23. The audit of year-end physical inventories should include steps to verify that the client's purchases and sales
cutoffs were adequate. The audit steps should be designed to detect whether merchandise included in the
physical count at year-end was not recorded as a
a. Sale in the subsequent period.
b. Purchase in the current period.
c. Sale in the current period.
d. Purchase return in the subsequent period.

24. An auditor would be most likely to learn of slow-moving inventory through

a. Inquiry of sales personnel.
b. Inquiry of stores personnel.
c. Physical observation of inventory.
d. Review of perpetual inventory records.

25. Which of the following internal control efficiencies relates to factory equipment?
a. Checks issued in payment of purchases of equipment are not signed by the controller.
b. All purchases of factory equipment are required to be made by the department that needs the equipment.
c. Factory equipment replacements are generally made when estimated useful lives have expired.
d. Proceeds from sales of fully depreciated equipment are credited to other income.

26. When auditing fixed assets, an auditor attempts to determine all of the following except
a. Control risk.
b. Property abandoned during the year.
c. Adequacy of replacement funds.
d. Reasonableness of depreciation.

27. Which of the following is the best evidence that an entity owns real estate at the balance sheet date?
a. Title insurance policy.
b. Original deed.
c. Paid real estate tax bills.
d. Closing statement.

28. Which of the following procedures would least likely lead the auditor to detect unrecorded fixed asset disposals?
a. Examine insurance policies.
b. Review repairs and maintenance expense.
c. Review property tax files.
d. Scan invoices for fixed asset additions.

29. The auditor may conclude that depreciation charges are insufficient by noting
a. Insured values greatly in excess of book values.

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b. Large amounts of fully depreciated assets.
c. Continuous trade-ins of relatively new assets.
d. Excessive recurring losses on assets retired.

30. In violation of company policy, Lowell Company erroneously capitalized the cost of painting its warehouse. An
auditor would most likely detect this when
a. Discussing capitalization policies with Lowell's controller.
b. Examining maintenance expense accounts.
c. Observing that the warehouse had been painted.
d. Examining construction work orders that support items capitalized during the year.

Test of Controls and Substantive test in Financing Cycles

31. A company holds bearer bonds as a short-term investment. Responsibility for custody of these bonds and
submission of coupons for periodic interest collections probably should be delegated to the
a. Chief accountant.
b. Internal auditor.
c. Cashier.
d. Treasurer.

32. Of the following, which is the most efficient audit procedure for testing accrued interest earned on bond
investments?
a. Tracing interest declarations to an independent record book.
b. Recomputing interest earned.
c. Confirming interest rate with the issuer of the bonds.
d. Vouching the receipt and deposit of interest checks.

33. During the audit of a publicly held company, the auditor could obtain written confirmation regarding long-term
bond transactions from the
a. Bond holders.
b. Client's attorney.
c. Internal auditors.
d. Trustee.

34. The auditor's program for examining long-term debt should include
a. Verification of the existence of the bondholders.
b. Examination of any bond trust agreement.
c. Inspection of the accounts payable subsidiary ledger.
d. Investigation of credits to the bond interest income account.

35. Jones was engaged to audit the financial statements of Gamma Corporation, a June 30 year-end client. Having
completed testing 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 SEC Information Form.
d. Comparing recorded dividends with a standard financial reporting service's record of dividends.

36. A company has temporarily excess funds to invest. The board of directors decided to purchase marketable
securities and assigned the future purchase and sale decisions to a responsible financial executive. The best
person(s) to make periodic reviews of the investment activity would be
a. The investment committee of the board of directors.
b. The treasurer.
c. The corporate controller.
d. The chief operating officer of the company.

37. Which of the following is a responsibility that should not be assigned to only one employee?
a. Access to securities in the company's safe deposit box.
b. Custodianship of the cash working fund.
c. Reconciliation of bank statements.
d. Custodianship of tools and small equipment.

38. When no independent stock transfer agents are employed and the corporation issues its own stocks and
maintains stock records, canceled stock certificates should
a. Be defaced to prevent reissuance and attached to their corresponding stubs.
b. Not be defaced but segregated from other stock certificates and retained in a canceled certificates file.

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c. Be destroyed to prevent fraudulent reissuance.
d. Be defaced and sent to the secretary of state.

39. Which of the following is not one of the auditor's concerns in an examination of marketable securities?
a. To determine whether securities are authentic.
b. To determine whether securities are the property of the client.
c. To determine whether securities actually exist.
d. To determine whether securities are properly classified on the balance sheet.

40. When negotiable securities are of considerable volume, planning by the auditor is necessary to guard against
a. Unauthorized negotiation of the securities before they are counted.
b. Unrecorded sales of securities after they are counted.
c. Substitution of securities already counted for other securities which should be on hand but are not.
d. Substitution of authentic securities with counterfeit securities.

41. During its fiscal year, a company issued, at a discount, a substantial amount of first-mortgage bonds. When
performing audit work, the independent auditor
a. Confirms the existence of the bondholders.
b. Reviews the minutes for authorization.
c. Traces the net cash received from the issuance to the bonds payable account.
d. Inspects the records maintained by the bond trustee.

42. In the audit of a medium-sized manufacturing concern, which of the following areas would be expected to require
the least amount of audit time?
a. Revenue.
b. Assets.
c. Liabilities.
d. Owner's equity.

43. 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.

44. If a company employs a capital stock registrar and/or a transfer agent, the registrar or agent should be requested
to confirm directly to the auditor the number of shares of each class of stock
a. Surrendered and canceled during the year.
b. Authorized at the balance sheet date.
c. Issued and outstanding at the balance sheet date.
d. Authorized, issued, and outstanding during the year.

45. The auditor's program for testing long-term debt should include steps that require
a. Verifying the existence of the bondholders.
b. Examining any bond trust indenture.
c. Inspecting the accounts payable subsidiary ledger.
d. Investigating credits to bond interest income.

46. During the year under audit, a company has completed a private placement of a substantial amount of bonds.
Which of the following steps is the most important in the auditor's tests of existence?
a. Confirm the amount issued with the bond trustee.
b. Trace cash received from the issue to the accounting records.
c. Examine bond records maintained by the transfer agent.
d. Recompute annual interest cost and the effective yield.

47. During the course of an audit, an auditor observes that the recorded interest expense seems excessive in relation
to the balance in long-term debt. This observation could lead the auditor to suspect that
a. Long-term debt is understated.
b. Discount on bonds payable is overstated.
c. Long-term debt is overstated.
d. Premium on bonds payable is understated.

48. Which of the following information is most important when auditing shareholders’ equity?
a. Changes in the capital stock account are verified by an independent stock transfer agent.
b. Stock dividends and/or stock splits during the year were approved by the shareholders.

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c. Stock dividends are capitalized at par or stated value on the dividend declaration date.
d. Entries in the capital stock account can be traced to a resolution in the minutes of the board of directors'
meetings.
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