Unit IV Audit of the Investing and Financing

Cycle
QUESTIONS

IV – 1. The audit procedure of analyzing the repairs and maintenance accounts

is designed primarily to provide evidence in support of the audit
proposition that all

a. Expenditure for fixed 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 fixed assets have been capitalized.

IV – 2. When an entity has few property and equipment transactions during

the year, the continuing auditor usually carries out

a. A complete review of the related internal controls and performs tests of

controls on which the entity relies.
b. A complete review of the related internal controls and performs analytical
review tests to verify current-year additions to property and equipment
c. A preliminary review of the related internal controls and performs a
thorough examination of the balances at the beginning of the year.
d. A preliminary review of the related internal controls and performs extensive
tests of current-year property and equipment transactions.

IV – 3. An auditor may conclude that depreciation charges are insufficient if he or

she notes

a. Large amounts of fully depreciated assets.

b. Continuous trade-ins of relatively new assets.
c. Excessive recurring losses on retired assets.
d. Insured values greatly in excess of book values.

IV – 4. In violation of company policies, Lilac Company erroneously capitalized the

cost of painting its warehouse. The auditor examining Lilac’s financial
statements would be most likely to detect this when

a. Discussing capitalization policies with Lila’s controller.

b. Examining maintenance expense accounts.
 c. Noting, while observing the physical inventory being taken, that the
warehouse had been painted
d. Examining the construction work orders supporting items capitalized during
the year.

IV – 5. Equipment acquisitions that are misclassified as maintenance expense most

likely would be detected by an internal control that provides for

a. Segregation of duties of employees in the accounts payable department.

b. Independent verification of invoices for disbursements recorded as
equipment acquisitions.
c. Investigation of variances within a formal budgeting system.
d. Authorization by the board of directors of significant equipment acquisitions.

IV – 6. A company holds bearer bonds as a short-term investment. Responsibility for the

custody of these bonds and for the submission of coupons for periodic interest
collections probably should be delegated to the

a. Chief accountant
b. Internal auditor
c. Cashier
d. Treasurer

IV – 7. A company had temporarily excess funds to invest. The board of directors

decided
to purchase marketable securities, and it 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 the

a. Investment committee of the board of directors

b. Treasurer
c. Corporate controller
d. Chief operating officer

IV – 8. If an auditor is unable to inspect and count a client’s investment securities

until after the balance sheet date, the bank in which the securities are held in a
safe deposit box should be asked to.

a. Verify any differences between the contents of the box and balances in the
client’s subsidiary ledger.
 b. Provide a list of securities added to and removed from the box between the
balance sheet date and the security count date.
c. Confirm that there has been no access to the box between the balance sheet
date and the security count date.
d. Count the securities in the box so the auditor will have an independent
direct verification.

IV – 9. Which of the following would provide the best form of evidence pertaining to
the annual valuation of a long-term investment in which the independent
auditor’s client owns a 30 percent voting interest?

a. Market quotations of the investee company’s shares.

b. Current fair value of the investee company’s assets.
c. Historical cost of the investee company’s assets.
d. Audited financial statements of the investee company.

IV – 10. If a corporation employs no independent share transfer agents, and it

issues its own shares and maintains its share records, canceled share
certificates should?

a. Be defaced to prevent reissuance and be reattached to their corresponding

stubs.
b. Not be defaced but should be segregated from other share certificates and
retained in a canceled-certificates file.
c. Be destroyed to prevent fraudulent reissuance.
d. Be defaced and sent to the government office that issued the corporate
charter.

IV – 11. Which of the following controls is most likely to prevent the improper
disposition of equipment?

a. Separating duties between those authorized to dispose of equipment and

those authorized to approve removal work orders.
b. Using serial numbers to identify equipment that could be sold.
c. Periodically comparing removal work orders with authorizing
documentation.
d. Periodically analyzing scrap sales and the repairs and maintenance accounts.

IV – 12. A company makes a practice of investing excess short-terms cash in

marketable securities. A reliable test of the valuation of those securities is
 a. Comparing cost data with current market quotations.
b. Confirming securities held by the broker.
c. Recalculating investment carrying value using the equity method.
d. Calculating premium or discount amortization.

IV – 13. A company invests material amounts of idle cash in marketable securities.

The auditor has reason to believe that suboptimal use is being made of idle
cash. Which of the following procedures would provide the most
reliable evidence relative to this concern?

a. Computing rate of return earned on investments and comparing it with

alternative investments.
b. Reviewing minutes of the meetings of the company’s investment committee.
c. Confirming the security transactions and income received by contacting the
company’s independent share brokers.
d. Comparing actual with budgeted investment income earned.

IV – 14. No employee should be able to visit the corporate safe deposit box
containing investment securities without being accompanied by
another corporate employee. What consequence might follow if this rule
were not enforced?

a. An employee could pledge corporate investments as security for a short-

term personal bank loan.
b. An employee could steal securities and the theft would never be discovered.
c. It would be impossible to get a fidelity bond on the employee.
d. There would be no record of when company personnel visited the safe
deposit box.

IV – 15. In establishing the existence and ownership of a long-term investment in the

form of publicly traded shares, an auditor should inspect the securities or

a. Correspond with the investees company to verify the number of shares

owned.
b. Inspect the audited financial statements of the investee company.
c. Confirm the number of shares owned that are held by an independent
custodian.
d. Determine that the investment is carried at the lower of cost or market.
IV – 16. AUDIT OF INVESTMENTS

Item 1 through 3 represent audit objectives for investments. Below the audit
objectives is a listing of possible audit procedures. For each audit objective,
select the audits procedure that would primarily respond to the objective. Select
only one procedure for each audit objective. A procedure may be selected only
once, or not for all.

Audit Objectives for Investments

1. Investments are properly described and classified in the financial statements.

2. Recorded investments represent investments actually owned at the balance
sheet date.
3. Investments are properly valued at the balance sheet date.

Audit Procedures for Investments

A. Trace opening balances in the subsidiary ledger to prior year’s audit working
papers.

B. Determine that employees who are authorized to sell investments do not

have access to cash.

C. Examine supporting documents for a sample of investment transactions to

verify that prenumbered documents are used.

D. Determine that any impairment in the price of investments have been

properly recorded.

E. Verify the transfers from the current to the noncurrent investment portfolio
have been properly recorded.

F. Obtain positive confirmation as of the balance sheet date of investments

held by independent custodians.
 G. Trace investments transactions to minutes of the Board of Directors meetings
to determine that transactions were properly authorized.
IV – 17. AUDIT OF PROPERTY & EQUIPMENT

Items 1 through 3 represent audit objectives for property and equipment. Below
the audit objectives is a listing of possible audit procedures. For each audit
objective, select only one procedure for each audit objective. A procedure may
be selected only once, or not all.

Audit of Objectives for Property & Equipment

1. The entity has legal right to property and equipment acquired during the
year.
2. Recorded property and equipment represent assets that actually exist at the
balance sheet date.
3. Net property and equipment are property valued at balance sheet date.

Audit Procedures for Property & Equipment

A. Trace opening balances in the summary schedules to the prior year’s audit
working papers.

B. Review the provision for depreciation expense and determine that

depreciable lives and methods used in the current year are consistent with
those used in the prior year.

C. Determine that the responsibility for maintaining the property and

equipment records is segregated from the responsibility for custody of
property and equipment.

D. Examine deeds and title insurance certificates.

E. Perform cut-off tests to verify that property.

F. Determine that property and equipment is adequately insured.

 G. Physically examine all major property and equipment additions.

Answer Key

1. C
2. D
3. C
4. D
5. C
6. D
7. A
8. C
9. D
10. A
11. A
12. A
13. A
14. A
15. C

IV – 16. Answer:

1. Choice “ E “ is correct. The audit objective “ are investments properly described

and classified “ deals with presentation and disclosure. The auditor should verify
that transfers from the current to the noncurrent portfolio have been properly
recorded, classified and disclosed.

2. Choice “ F “ is the best answer for the audit objective “ do recorded investments
represent investments actually owned at the balance sheet date. ” The auditor
would want to confirm that, as of the balance sheet date, these investments are
actually owned by the client. This would normally be accomplished by conferring
with the independent custodian holding the client’s marketable securities.

3. Choice “ D “ is correct. The auditor objective “ whether investments are properly

valued at the balance sheet date “ deals with valuation and allocation. This
 would be best accomplished by determining whether any impairments in the
price of the investments have been properly recorded.

IV – 7. Answer:

1. Choice “ D “ is correct. This audit deals with management’s assertion

regarding rights. To determine whether the client has the legal right to
property and equipment acquired during the year, the best procedure is to
examine deeds and title insurance certificates.

2. Choice “ G “ is correct. This audit objective deals with management’s

assertion of existence. The best procedure to determine whether recorded
property and equipment represent assets that actually exist at the balance
sheet date would be to physically examine all major equipment and property
auditions.

3. Choice “ B “ is correct. This audit objective deals with valuation and

allocation. The best procedure to determine if property, plant and equipment
is properly valued at the balance sheet date would be to review the provision
for depreciation expense and determine whether the depreciable lives and
methods used in the current year are consistent with those used in a prior
year. This is done to ensure that the book value is properly reflected at year
end and to ensure that depreciation expense is allocated to the proper year.