Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !

tatement Accounts

Chapter 15 Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

True / False 'uestions

1' (otes receivable is a common t&pe o) long-term )inancing' True False

*' Long-term borro+ing should be properl& authori,ed' True False

-' .ne ma/or issue associated +ith long-term debt is the classi)ication o) the short-term portion o) long-term debt that is due in the ne0t &ear' True False

1' For most companies stoc"holders# e%uit& includes the )ollo+ing three accounts: pre)erred stoc" paid-in capital and retained earnings' True False

5' Three t&pes o) transactions usuall& occur in stoc"holders# e%uit&: issuance o) stoc" repurchase o) stoc" and pa&ment o) dividends' True False

2' The repurchase o) stoc" includes the reac%uisition o) stoc" 3treasur& stoc"4 but not the retirement o) stoc"' True False

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

5' The registrar is responsible )or preparing stoc" certi)icates and maintaining ade%uate stoc"holders# records' True False

6' The dividend-disbursing agent prepares and mails dividends chec"s to the stoc"holders as o) the date o) declaration' True False

7' !ubstantive anal&tical procedures can be used e0tensivel& to test revenue and e0pense accounts' True False

18' Income statement accounts must be accounted )or in accordance +ith 9AAP' True False

11' :hen auditing capital stoc" accounts the cuto)) assertion is the most important to consider' True False

1*' The occurrence assertion is being tested +hen the auditor vouches stoc" repurchases to the canceled stoc" certi)icates' True False

1-' There are t&picall& onl& a couple o) disclosure items that need to be considered )or stoc"holders# e%uit&' True False

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

11' 9enerall& all dividends that are declared and paid +ill be audited' True False

15' The auditor t&picall& begins an audit o) retained earnings b& obtaining a schedule o) account activit& )or the period' True False

(ultiple Choice 'uestions

12' !everal &ears ago Con+a& Inc' secured a conventional real estate mortgage loan' :hich o) the )ollo+ing audit procedures +ould least li"el& be per)ormed b& an auditor e0amining the mortgage balance; A' $0amine the current &ear#s canceled chec"s' <' =evie+ the mortgage amorti,ation schedule' C' Inspect public records o) lien balances' >' =ecompute mortgage interest e0pense'

15' The auditor can best veri)& a client#s bond sin"ing )und transactions and &ear-end balance b& A' =ecomputation o) interest e0pense interest pa&able and amorti,ation o) bond discount or premium' <' Con)irmation +ith individual holders o) retired bonds' C' Con)irmation +ith the bond trustee' >' $0amination and count o) the bonds retired during the &ear'

16' A control +hich ensures that long-term borro+ing is properl& initiated b& appropriate individuals addresses the control assertion o) A' .ccurrence' <' Authori,ation' C' Completeness' >' ?aluation'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

17' The primar& reason )or preparing a reconciliation bet+een interest-bearing obligations outstanding during the &ear and interest e0pense presented in the )inancial statements is to A' $valuate internal control over securities' <' >etermine the validit& o) prepaid interest e0pense' C' Ascertain the reasonableness o) imputed interest' >' >etect unrecorded liabilities'

*8' The auditor#s program )or the e0amination o) long-term debt should include steps that re%uire the A' ?eri)ication o) the e0istence o) the bond holders' <' $0amination o) an& bond agreement' C' Inspection o) the accounts pa&able subsidiar& ledger' >' Investigation o) credits to the bond interest income account'

*1' ?aluation and allocation is most li"el& an issue )or long-term debt i) A' <onds are sold on the open mar"et' <' <onds are issued at a discount or premium' C' The loans are )rom ban"s' >' The compan& has man& short-term leases'

**' =evie+ing notes paid or rene+ed a)ter the balance sheet date to determine i) there are unrecorded liabilities at &ear-end can be used to test the assertion o) A' $0istence' <' Completeness' C' =ights and obligations' >' ?aluation and allocation'

*-' All corporate capital stoc" transactions should ultimatel& be traced to the A' @inutes o) the board o) directors' <' Cash receipts /ournal' C' Cash disbursements /ournal' >' (umbered stoc" certi)icates'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

*1' A substantive strateg& is t&picall& used to audit stoc"holders# e%uit& because A' The number o) transactions is small' <' Controls over stoc"holders# e%uit& transactions t&picall& are +ea"' C' A reliance strateg& is most e))icient' >' A substantive strateg& li"el& +as used in prior &ears'

*5' An auditor usuall& obtains evidence o) stoc"holders# e%uit& transactions b& revie+ing the entit&#s A' @inutes o) the board o) directors# meetings' <' Trans)er agent#s records' C' Canceled stoc" certi)icates' >' Treasur& stoc" certi)icate boo"'

*2' The auditor is concerned +ith establishing that dividends are paid to stoc"holders o) the client corporation o+ning stoc" as o) the A' Issue date' <' >eclaration date' C' =ecord date' >' Pa&ment date'

*5' The auditor gathers evidence about dividends that are declared and paid primaril& because o) A' Concerns +ith violations o) corporate b&la+s or debt covenants' <' The large dollar value o) the transactions' C' The ease +ith +hich the transactions can be audited' >' Fraud concerns'

*6' In the audit o) a medium-si,ed manu)acturing concern +hich one o) the )ollo+ing areas can be e0pected to re%uire the least amount o) audit time; A' =etained earnings' <' =evenue' C' Assets' >' Liabilities'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

*7' An auditor compares revenues and e0penses reported )or the &ear being audited 3current &ear4 +ith those o) the prior &ear and investigates all changes e0ceeding 18A' <& this procedure the auditor +ould be most li"el& to learn that A' An increase in propert& ta0 rates has not been recogni,ed in the client#s accrual' <' The current &ear provision )or uncollectible accounts is inade%uate because o) +orsening economic conditions' C' Fourth %uarter pa&roll ta0es +ere not paid' >' The client changed its capitali,ation polic& )or small tools in the current &ear'

-8' In connection +ith the e0amination o) bonds pa&able an auditor +ould e0pect to )ind in a bond agreement A' The issue date and maturit& date o) the bond' <' The names o) the original subscribers to the bond issue' C' The &ield to maturit& o) the bonds issued' >' The compan&#s debt-to-e%uit& ratio at the time o) issuance'

-1' >uring the &ear under audit a compan& has completed a private placement o) a substantial amount o) bonds' :hich o) the )ollo+ing is the most important step in the auditor#s program )or the audit o) bonds pa&able; A' Con)irming the interest rate +ith the bond trustee' <' Tracing the cash received )rom the issue to the accounting records' C' $0amining the bond agreement )or a sin"ing )und provision' >' =ecomputing the annual interest cost and the e))ective &ield'

-*' A compan& issued bonds )or cash during the &ear under audit' To ascertain that this transaction +as properl& recorded the auditor#s best course o) action is to A' =e%uest a statement )rom the bond trustee as to the amount o) the bonds issued and outstanding' <' Con)irm the results o) the issuance +ith the under+riter or investment ban"er' C' Trace the cash received )rom the issuance to the accounting records' >' ?eri)& that the net cash received is credited to an account entitled B<onds Pa&able'B

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

--' >uring its )iscal &ear a compan& issued at a discount a substantial amount o) bonds' :hen per)orming audit +or" in connection +ith the bond issue the independent auditor should A' Con)irm the e0istence o) the bond holders' <' =evie+ the board o) directors# minutes )or authori,ation' C' Trace the net cash received )rom the issuance to the bond pa&able account' >' Inspect the records maintained b& the bond trustee'

-1' >uring the course o) an audit a CPA#s substantive anal&tical procedure provides an e0pected interest e0pense that is signi)icantl& higher than the amount recorded in the client#s accounting records' This observation +ould most li"el& lead the auditor to suspect that A' The client )ailed to record all debt' <' >iscount on <onds is misstated' C' Interest income is overstated' >' The client )ailed to record all interest e0pense'

-5' >uring an e0amination o) a public compan& the auditor should obtain +ritten con)irmation regarding bond transactions )rom the A' <ond bro"er' <' Client#s attorne&' C' Internal auditors' >' Trustee'

-2' In auditing long-term bonds pa&able an auditor most li"el& +ould A' Per)orm anal&tical procedures on the bond premium and discount accounts' <' $0amine documentation o) assets purchased +ith bond proceeds )or liens' C' Compare interest e0pense +ith the bonds pa&able amount )or reasonableness' >' Con)irm the e0istence o) individual bond holders at &ear-end'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

-5' >uring an audit :ic"s learns that the audit client +as granted a --month +aiver o) the repa&ment o) principal on the installment loan +ith <lan" <an" +ithout an e0tension o) the maturit& date +hich is one &ear in the )uture' :ith respect to this loan the audit program used b& :ic"s is least li"el& to include a veri)ication o) the A' Interest e0pense )or the &ear' <' <alloon pa&ment' C' Total liabilit& at &ear-end' >' Installment loan pa&ments'

-6' :hich audit procedure is most closel& related to management#s assertion regarding presentation and disclosure o) liabilities; A' Tracing cash received )rom a bond issue to the accounting records' <' Con)irmation +ith the bond trustee o) amounts o+ed on a private placement o) bonds' C' =evie+ing the rene+al o) a note pa&able immediatel& a)ter the balance sheet' >' Inspection o) public records o) lien balances'

-7' I) recorded interest e0pense is higher than the auditor#s e0pectation calculated using recorded debt all o) the )ollo+ing are potential e0planations e0cept that A' The client )ailed to record debt' <' >ebt +as recorded as e%uit&' C' The client used the )ace interest rate to calculate interest e0pense on a bond issued at a discount' >' The client used the )ace interest rate to calculate interest e0pense on a bond issued at a premium'

18' =evie+ing interest e0pense to e0amine pa&ments to debt holders not listed on the debt anal&sis schedule is a procedure that can be used to test the audit assertion o) A' .ccurrence' <' Completeness' C' Cuto))' >' Accurac&'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

11' >uring the course o) an audit a CPA observes that the recorded interest e0pense seems to be e0cessive in relation to the balance in the long-term debt account' This observation could lead the auditor to suspect that A' Long-term debt is understated' <' >iscount on bonds pa&able is overstated' C' Long-term debt is overstated' >' Premium on bonds pa&able is understated'

1*' T+o months be)ore &ear-end the boo""eeper erroneousl& recorded the receipt o) a longterm ban" loan b& a debit to cash and a credit to sales' :hich o) the )ollo+ing is the most e))ective procedure )or detecting this t&pe o) error; A' Anal&sis o) the notes pa&able /ournal' <' Anal&sis o) ban" con)irmation in)ormation' C' Preparation o) a &ear-end ban" reconciliation' >' Preparation o) a &ear-end ban" trans)er schedule'

1-' :here no independent stoc" trans)er agents are emplo&ed and the corporation issues its o+n stoc"s and maintains stoc" records canceled stoc" certi)icates should A' <e de)aced to prevent reissuance and attached to their corresponding stubs' <' (ot be de)aced but segregated )rom other stoc" certi)icates and retained in a canceled certi)icates )ile' C' <e destro&ed to prevent )raudulent reissuance' >' <e de)aced and sent to the !ecretar& o) !tate'

11' In per)orming tests concerning the granting o) stoc" options an auditor should A' Con)irm the transaction +ith the !ecretar& o) !tate in the state o) incorporation' <' ?eri)& the e0istence o) option holders in the entit&#s pa&roll records or stoc" ledgers' C' >etermine that su))icient treasur& stoc" is available to cover an& ne+ stoc" issued' >' Trace the authori,ation )or the transaction to a vote o) the board o) directors'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

15' $0amining cancelled stoc" certi)icates addresses the assertion o) A' .ccurrence' <' >isclosures' C' ?aluation' >' Completeness'

12' An audit o) stoc"holders# e%uit& ordinaril& should include A' Tracing individual dividend pa&ments to the capital stoc" records' <' =evie+ing minutes o) board meetings to determine the number o) shares outstanding' C' Con)irming shares outstanding +ith state o))icials' >' >etermining that dividend declarations compl& +ith debt agreements'

15' :hich audit procedure is most closel& related to management#s assertions about the presentation and disclosure o) stoc"holders# e%uit&; A' >etermining +hether restrictions have been imposed on retained earnings' <' Counting treasur& stoc" certi)icates' C' Inspecting minutes o) the board o) directors to veri)& that cash dividends +ere declared' >' $stablishing that treasur& stoc" is valued at cost'

16' An audit program )or the e0amination o) the retained earnings account should include a step that re%uires veri)ication o) the A' 9ain or loss resulting )rom disposition o) treasur& shares' <' @ar"et value used to charge retained earnings to account )or a t+o-)or-one stoc" split' C' Authori,ation )or both cash and stoc" dividends' >' Approval o) the ad/ustment to the beginning balance as a result o) a +rite-do+n o) an account receivable'

17' :hich o) the )ollo+ing transactions is an auditor most li"el& to e0amine +hen auditing the retained earnings account; A' Changing )rom one method o) depreciation to another' <' Ad/usting the percentage used to estimate the allo+ance )or doubt)ul accounts' C' Changing )rom the FIF. to LIF. method o) inventor& valuation' >' Correcting an error in depreciation in a prior &ear'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

58' <e)ore e0pressing an opinion concerning the results o) operations the auditor +ould most li"el& proceed +ith the e0amination o) the income statement b& A' Appl&ing a rigid measurement standard designed to test )or understatement o) net income' <' Anal&,ing the beginning and ending balance sheet inventor& amounts' C' @a"ing net income comparisons to published industr& trends and ratios' >' $0amining income statement accounts concurrentl& +ith the related balance sheet accounts'

51' @an& o) 9ranada Corporation#s convertible bond holders have converted their bonds into stoc" during the &ear under e0amination' The independent auditor should revie+ 9ranada Corporation#s statement o) cash )lo+s to ascertain that it sho+s A' .nl& cash used to reduce convertible debt' <' .nl& cash provided b& issuance o) stoc"' C' Cash provided b& the issuance o) stoc" and used to reduce convertible debt' >' (othing relating to the conversion because it does not a))ect cash'

5*' :hich o) the )ollo+ing is the most important consideration o) an auditor +hen e0amining the stoc"holders# e%uit& section o) a client#s balance sheet; A' Changes in the capital stoc" account are veri)ied b& an independent stoc" trans)er agent' <' !toc" dividends and/or stoc" splits during the &ear under audit +ere approved b& the stoc"holders' C' !toc" dividends are capitali,ed at par or stated value on the dividend declaration date' >' $ntries in the capital stoc" account can be traced to a resolution in the minutes o) the board o) directors# meetings'

5-' .verall anal&sis o) income statement accounts ma& bring to light errors omissions and inconsistencies not disclosed in the overall anal&sis o) balance sheet accounts' The income statement anal&sis can best be accomplished b& comparing monthl& A' Income statement ratios to balance sheet ratios' <' =evenue and e0pense account balances to the monthl& reported net income' C' Income statement ratios to published industr& averages' >' =evenue and e0pense account totals to the corresponding )igures o) the preceding &ears'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

51' .) the )ollo+ing +hich is the most important procedure that an auditor should use +hen ma"ing an overall revie+ o) the income statement; A' !elect sales and e0pense items and trace amounts to related supporting documents' <' Compare actual revenues and e0penses +ith the corresponding )igures o) the previous &ear and investigate signi)icant di))erences' C' .btain )rom the proper client representative inventor& certi)icates )or the beginning and ending inventor& amounts that +ere used to determine cost o) sales' >' Ascertain that the net income amount in the statement o) cash )lo+s agrees +ith the net income amount in the income statement'

!hort Ans)er 'uestions

55' Cou have been assigned the dut& o) auditing long-term debt and retained earnings )or &our client De&s Inc' >escribe the tests &ou +ould use to support management#s assertions regarding disclosure )or these accounts'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

52' $ri" =e"dahl senior-in-charge is auditing Doonce Dat)ood Inc'#s long-term debt )or the &ear ended >ecember -1' Long-term debt is composed o) t+o bond issues +hich are due in 18 and 15 &ears respectivel&' The debt is held b& t+o insurance companies' =e"dahl has e0amined the bond agreements )or each issue' The agreements provide that i) Doonce )ails to compl& +ith the covenants o) the contract the debt becomes pa&able immediatel&' =e"dahl identi)ied the )ollo+ing covenants +hen revie+ing the bond agreements: BThe debtor compan& shall endeavor to maintain a +or"ing capital ratio o) * to 1 at all times and in an& )iscal &ear )ollo+ing a )ailure to maintain said ratio the compan& shall restrict compensation o) o))icers to a total o) E258 888' .))icers include the chairperson o) the board and the president'B BThe debtor compan& shall "eep all propert& that is securit& )or these debt agreements insured against loss b& )ire to the e0tent o) 188 percent o) its actual value' Policies o) insurance comprising this protection shall be )iled +ith the trustee'B BThe compan& is re%uired to restrict 18 percent o) retained earnings )rom availabilit& )or pa&ing dividends'B BA sin"ing )und shall be established +ith the First @organ <an" o) Austin and semiannual pa&ments o) E588 888 shall be deposited in the )und' The ban" ma& at its discretion purchase bonds )rom either issue'B a' Provide an& audit steps that =e"dahl should conduct to determine i) the compan& is in compliance +ith the bond indentures' b' List an& reporting re%uirements that the )inancial statements or )ootnotes should include'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

55' For each o) the )ollo+ing substantive procedures )irst note +hether it is a test o) details o) transactions or a test o) details o) account balances' Then decide )or +hich assertion the test provides the best evidence' 1' Trace large cash receipts and pa&ments to the source documents and the general ledger' *' $0amine copies o) note and bond agreements' -' =ecompute accrued interest pa&able' 1' =evie+ debt activit& )or a )e+ da&s be)ore and a)ter &ear-end to determine +hether transactions are included in the proper period' 5' $0amine due dates on notes and bonds )or proper classi)ication bet+een current and long term debt'

56' Identi)& the three ma/or t&pes o) transactions that occur in stoc"holders# e%uit&'

57' Identi)& the )our ma/or assertions made regarding stoc"holders# e%uit& and describe one control activit& )or each'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

28' 9ive an e0ample o) ho+ the audit o) income statement accounts could be a))ected b& results o) audit +or" done in other areas o) the audit'

21' :hat "ind o) in)ormation +ould t&picall& be )ound on an income statement account anal&sis +or"ing paper; :hat "ind o) tests can an auditor per)orm using this in)ormation; :h& +ould an auditor conduct additional anal&sis on an income statement account;

(atching 'uestions

2*' @atch each o) the )ollo+ing controls +ith the assertion )or long-term debt that it supports' 1' Premiums and discounts on bond and notes pa&ables are properl& amorti,ed using the e))ective interest rate method *' A subsidiar& ledger is maintained that contains in)ormation about all the long-term debt and the amount recorded in this ledger is reconciled to the general ledger -' An& signi)icant debt commitments are approved b& the board o) directors or delegated e0ecutives 1' The portion o) long-term debt due in the ne0t &ear is classi)ied as a short-term liabilit&

?aluation FFFF .ccurrence and Authori,ation FFFF >isclosure Classi)ication FFFF Completeness FFFF

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

2-' @atch the balance sheet account +ith the income statement account that is t&picall& audited at the same time' 1' <onds Pa&able *' Propert& Plant and $%uipment -' Investments 1' Prepaid Insurance 5' Accounts =eceivable Investment income Interest e0pense Insurance e0pense <ad debt e0pense >epreciation e0pense FFFF FFFF FFFF FFFF FFFF

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

Chapter 15 Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts Ans+er De&

True / False 'uestions

1' (otes receivable is a common t&pe o) long-term )inancing' FAL!$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'( )nderstand t*e ty+es and features of long'term debt, -o+ic: Auditing "ong'-erm Debt

*' Long-term borro+ing should be properl& authori,ed' T*+$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(. Be familiar /it* key control acti%ities for long'term debt, -o+ic: Assertions and Related Control Acti%ities ' "ong'-erm Debt

-' .ne ma/or issue associated +ith long-term debt is the classi)ication o) the short-term portion o) long-term debt that is due in the ne0t &ear' T*+$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(. Be familiar /it* key control acti%ities for long'term debt, -o+ic: Assertions and Related Control Acti%ities ' "ong'-erm Debt

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

1' For most companies stoc"holders# e%uit& includes the )ollo+ing three accounts: pre)erred stoc" paid-in capital and retained earnings' FAL!$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(& )nderstand t*e ty+es of stock*olders0 e1uity transactions, -o+ic: Auditing Stock*olders0 !1uity

5' Three t&pes o) transactions usuall& occur in stoc"holders# e%uit&: issuance o) stoc" repurchase o) stoc" and pa&ment o) dividends' T*+$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(& )nderstand t*e ty+es of stock*olders0 e1uity transactions, -o+ic: Auditing Stock*olders0 !1uity

2' The repurchase o) stoc" includes the reac%uisition o) stoc" 3treasur& stoc"4 but not the retirement o) stoc"' FAL!$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(& )nderstand t*e ty+es of stock*olders0 e1uity transactions, -o+ic: Auditing Stock*olders0 !1uity

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

5' The registrar is responsible )or preparing stoc" certi)icates and maintaining ade%uate stoc"holders# records' FAL!$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(2 Be familiar /it* assessing control risk for stock*olders0 e1uity, -o+ic: Control Risk Assessment ' Stock*olders0 !1uity

6' The dividend-disbursing agent prepares and mails dividends chec"s to the stoc"holders as o) the date o) declaration' FAL!$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(2 Be familiar /it* assessing control risk for stock*olders0 e1uity, -o+ic: Control Risk Assessment ' Stock*olders0 !1uity

7' !ubstantive anal&tical procedures can be used e0tensivel& to test revenue and e0pense accounts' T*+$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Retained !arnings

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

18' Income statement accounts must be accounted )or in accordance +ith 9AAP' T*+$

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

11' :hen auditing capital stoc" accounts the cuto)) assertion is the most important to consider' FAL!$

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, -o+ic: Auditing Ca+ital'Stock Accounts

1*' The occurrence assertion is being tested +hen the auditor vouches stoc" repurchases to the canceled stoc" certi)icates' T*+$

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, -o+ic: Auditing Ca+ital'Stock Accounts

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

1-' There are t&picall& onl& a couple o) disclosure items that need to be considered )or stoc"holders# e%uit&' T*+$

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, -o+ic: Auditing Ca+ital'Stock Accounts

11' 9enerall& all dividends that are declared and paid +ill be audited' T*+$

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &' ( 3no/ *o/ to conduct substanti%e audit +rocedures for di%idends, -o+ic: Auditing Di%idends

15' The auditor t&picall& begins an audit o) retained earnings b& obtaining a schedule o) account activit& )or the period' T*+$

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Retained !arnings

15-*1

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts
(ultiple Choice 'uestions

12' !everal &ears ago Con+a& Inc' secured a conventional real estate mortgage loan' :hich o) the )ollo+ing audit procedures +ould least li"el& be per)ormed b& an auditor e0amining the mortgage balance; A' $0amine the current &ear#s canceled chec"s' <' =evie+ the mortgage amorti,ation schedule' C, Inspect public records o) lien balances' >' =ecompute mortgage interest e0pense'

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'( )nderstand t*e ty+es and features of long'term debt, "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Auditing "ong'-erm Debt -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15' The auditor can best veri)& a client#s bond sin"ing )und transactions and &ear-end balance b& A' =ecomputation o) interest e0pense interest pa&able and amorti,ation o) bond discount or premium' <' Con)irmation +ith individual holders o) retired bonds' C, Con)irmation +ith the bond trustee' >' $0amination and count o) the bonds retired during the &ear'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'( )nderstand t*e ty+es and features of long'term debt, "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Auditing "ong'-erm Debt -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15-**

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

16' A control +hich ensures that long-term borro+ing is properl& initiated b& appropriate individuals addresses the control assertion o) A' .ccurrence' -, Authori,ation' C' Completeness' >' ?aluation'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Risk Analysis Blooms: )nderstand Difficulty: !asy "earning #b$ecti%e: &'(. Be familiar /it* key control acti%ities for long'term debt, -o+ic: Assertions and Related Control Acti%ities ' "ong'-erm Debt

17' The primar& reason )or preparing a reconciliation bet+een interest-bearing obligations outstanding during the &ear and interest e0pense presented in the )inancial statements is to A' $valuate internal control over securities' <' >etermine the validit& o) prepaid interest e0pense' C' Ascertain the reasonableness o) imputed interest' ., >etect unrecorded liabilities'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'(. Be familiar /it* key control acti%ities for long'term debt, "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Assertions and Related Control Acti%ities ' "ong'-erm Debt -o+ic: Auditing Income Statement Accounts -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15-*-

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

*8' The auditor#s program )or the e0amination o) long-term debt should include steps that re%uire the A' ?eri)ication o) the e0istence o) the bond holders' -, $0amination o) an& bond agreement' C' Inspection o) the accounts pa&able subsidiar& ledger' >' Investigation o) credits to the bond interest income account'

AACSB: Communication AICPA BB: Industry AICPA FN: Measurement Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

*1' ?aluation and allocation is most li"el& an issue )or long-term debt i) A' <onds are sold on the open mar"et' -, <onds are issued at a discount or premium' C' The loans are )rom ban"s' >' The compan& has man& short-term leases'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

**' =evie+ing notes paid or rene+ed a)ter the balance sheet date to determine i) there are unrecorded liabilities at &ear-end can be used to test the assertion o) A' $0istence' -, Completeness' C' =ights and obligations' >' ?aluation and allocation'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15-*1

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

*-' All corporate capital stoc" transactions should ultimatel& be traced to the A, @inutes o) the board o) directors' <' Cash receipts /ournal' C' Cash disbursements /ournal' >' (umbered stoc" certi)icates'

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, -o+ic: Auditing Ca+ital'Stock Accounts

*1' A substantive strateg& is t&picall& used to audit stoc"holders# e%uit& because A, The number o) transactions is small' <' Controls over stoc"holders# e%uit& transactions t&picall& are +ea"' C' A reliance strateg& is most e))icient' >' A substantive strateg& li"el& +as used in prior &ears'

AACSB: Communication AICPA BB: Industry AICPA FN: Measurement Blooms: )nderstand Difficulty: !asy "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, "earning #b$ecti%e: &' ( 3no/ *o/ to conduct substanti%e audit +rocedures for di%idends, "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Ca+ital'Stock Accounts -o+ic: Auditing Di%idends -o+ic: Auditing Retained !arnings

15-*5

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

*5' An auditor usuall& obtains evidence o) stoc"holders# e%uit& transactions b& revie+ing the entit&#s A, @inutes o) the board o) directors# meetings' <' Trans)er agent#s records' C' Canceled stoc" certi)icates' >' Treasur& stoc" certi)icate boo"'

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, "earning #b$ecti%e: &' ( 3no/ *o/ to conduct substanti%e audit +rocedures for di%idends, "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Ca+ital'Stock Accounts -o+ic: Auditing Di%idends -o+ic: Auditing Retained !arnings

*2' The auditor is concerned +ith establishing that dividends are paid to stoc"holders o) the client corporation o+ning stoc" as o) the A' Issue date' <' >eclaration date' C, =ecord date' >' Pa&ment date'

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &' ( 3no/ *o/ to conduct substanti%e audit +rocedures for di%idends, -o+ic: Auditing Di%idends

15-*2

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

*5' The auditor gathers evidence about dividends that are declared and paid primaril& because o) A, Concerns +ith violations o) corporate b&la+s or debt covenants' <' The large dollar value o) the transactions' C' The ease +ith +hich the transactions can be audited' >' Fraud concerns'

AACSB: Communication AICPA BB: Industry AICPA FN: Measurement Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &' ( 3no/ *o/ to conduct substanti%e audit +rocedures for di%idends, -o+ic: Auditing Di%idends

*6' In the audit o) a medium-si,ed manu)acturing concern +hich one o) the )ollo+ing areas can be e0pected to re%uire the least amount o) audit time; A, =etained earnings' <' =evenue' C' Assets' >' Liabilities'

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Blooms: )nderstand Difficulty: !asy "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts -o+ic: Auditing Retained !arnings

15-*5

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

*7' An auditor compares revenues and e0penses reported )or the &ear being audited 3current &ear4 +ith those o) the prior &ear and investigates all changes e0ceeding 18A' <& this procedure the auditor +ould be most li"el& to learn that A' An increase in propert& ta0 rates has not been recogni,ed in the client#s accrual' <' The current &ear provision )or uncollectible accounts is inade%uate because o) +orsening economic conditions' C' Fourth %uarter pa&roll ta0es +ere not paid' ., The client changed its capitali,ation polic& )or small tools in the current &ear'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Risk Analysis Blooms: Analy7e Difficulty: !asy "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

-8' In connection +ith the e0amination o) bonds pa&able an auditor +ould e0pect to )ind in a bond agreement A, The issue date and maturit& date o) the bond' <' The names o) the original subscribers to the bond issue' C' The &ield to maturit& o) the bonds issued' >' The compan&#s debt-to-e%uit& ratio at the time o) issuance'

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: Remember Difficulty: 4 Medium "earning #b$ecti%e: &'( )nderstand t*e ty+es and features of long'term debt, "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Auditing "ong'-erm Debt -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15-*6

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

-1' >uring the &ear under audit a compan& has completed a private placement o) a substantial amount o) bonds' :hich o) the )ollo+ing is the most important step in the auditor#s program )or the audit o) bonds pa&able; A' Con)irming the interest rate +ith the bond trustee' -, Tracing the cash received )rom the issue to the accounting records' C' $0amining the bond agreement )or a sin"ing )und provision' >' =ecomputing the annual interest cost and the e))ective &ield'

AACSB: Communication AICPA BB: Industry AICPA FN: Measurement Blooms: Analy7e Difficulty: 4 Medium "earning #b$ecti%e: &'( )nderstand t*e ty+es and features of long'term debt, "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Auditing "ong'-erm Debt -o+ic: Substanti%e Procedures ' "ong'-erm Debt

-*' A compan& issued bonds )or cash during the &ear under audit' To ascertain that this transaction +as properl& recorded the auditor#s best course o) action is to A' =e%uest a statement )rom the bond trustee as to the amount o) the bonds issued and outstanding' <' Con)irm the results o) the issuance +ith the under+riter or investment ban"er' C, Trace the cash received )rom the issuance to the accounting records' >' ?eri)& that the net cash received is credited to an account entitled B<onds Pa&able'B

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15-*7

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

--' >uring its )iscal &ear a compan& issued at a discount a substantial amount o) bonds' :hen per)orming audit +or" in connection +ith the bond issue the independent auditor should A' Con)irm the e0istence o) the bond holders' -, =evie+ the board o) directors# minutes )or authori,ation' C' Trace the net cash received )rom the issuance to the bond pa&able account' >' Inspect the records maintained b& the bond trustee'

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

-1' >uring the course o) an audit a CPA#s substantive anal&tical procedure provides an e0pected interest e0pense that is signi)icantl& higher than the amount recorded in the client#s accounting records' This observation +ould most li"el& lead the auditor to suspect that A' The client )ailed to record all debt' <' >iscount on <onds is misstated' C' Interest income is overstated' ., The client )ailed to record all interest e0pense'

AACSB: Communication AICPA BB: "egal AICPA FN: Decision Making Blooms: Analy7e Difficulty: !asy "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15--8

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

-5' >uring an e0amination o) a public compan& the auditor should obtain +ritten con)irmation regarding bond transactions )rom the A' <ond bro"er' <' Client#s attorne&' C' Internal auditors' ., Trustee'

AACSB: Communication AICPA BB: Industry AICPA FN: Measurement Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

-2' In auditing long-term bonds pa&able an auditor most li"el& +ould A' Per)orm anal&tical procedures on the bond premium and discount accounts' <' $0amine documentation o) assets purchased +ith bond proceeds )or liens' C, Compare interest e0pense +ith the bonds pa&able amount )or reasonableness' >' Con)irm the e0istence o) individual bond holders at &ear-end'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15--1

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

-5' >uring an audit :ic"s learns that the audit client +as granted a --month +aiver o) the repa&ment o) principal on the installment loan +ith <lan" <an" +ithout an e0tension o) the maturit& date +hich is one &ear in the )uture' :ith respect to this loan the audit program used b& :ic"s is least li"el& to include a veri)ication o) the A' Interest e0pense )or the &ear' -, <alloon pa&ment' C' Total liabilit& at &ear-end' >' Installment loan pa&ments'

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

-6' :hich audit procedure is most closel& related to management#s assertion regarding presentation and disclosure o) liabilities; A' Tracing cash received )rom a bond issue to the accounting records' <' Con)irmation +ith the bond trustee o) amounts o+ed on a private placement o) bonds' C, =evie+ing the rene+al o) a note pa&able immediatel& a)ter the balance sheet' >' Inspection o) public records o) lien balances'

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Re+orting Blooms: Analy7e Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15--*

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

-7' I) recorded interest e0pense is higher than the auditor#s e0pectation calculated using recorded debt all o) the )ollo+ing are potential e0planations e0cept that A' The client )ailed to record debt' <' >ebt +as recorded as e%uit&' C' The client used the )ace interest rate to calculate interest e0pense on a bond issued at a discount' ., The client used the )ace interest rate to calculate interest e0pense on a bond issued at a premium'

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: Analy7e Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

18' =evie+ing interest e0pense to e0amine pa&ments to debt holders not listed on the debt anal&sis schedule is a procedure that can be used to test the audit assertion o) A' .ccurrence' -, Completeness' C' Cuto))' >' Accurac&'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: )nderstand Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15---

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

11' >uring the course o) an audit a CPA observes that the recorded interest e0pense seems to be e0cessive in relation to the balance in the long-term debt account' This observation could lead the auditor to suspect that A, Long-term debt is understated' <' >iscount on bonds pa&able is overstated' C' Long-term debt is overstated' >' Premium on bonds pa&able is understated'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Risk Analysis Blooms: Analy7e Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts -o+ic: Substanti%e Procedures ' "ong'-erm Debt

1*' T+o months be)ore &ear-end the boo""eeper erroneousl& recorded the receipt o) a longterm ban" loan b& a debit to cash and a credit to sales' :hich o) the )ollo+ing is the most e))ective procedure )or detecting this t&pe o) error; A' Anal&sis o) the notes pa&able /ournal' -, Anal&sis o) ban" con)irmation in)ormation' C' Preparation o) a &ear-end ban" reconciliation' >' Preparation o) a &ear-end ban" trans)er schedule'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15--1

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

1-' :here no independent stoc" trans)er agents are emplo&ed and the corporation issues its o+n stoc"s and maintains stoc" records canceled stoc" certi)icates should A, <e de)aced to prevent reissuance and attached to their corresponding stubs' <' (ot be de)aced but segregated )rom other stoc" certi)icates and retained in a canceled certi)icates )ile' C' <e destro&ed to prevent )raudulent reissuance' >' <e de)aced and sent to the !ecretar& o) !tate'

AACSB: Communication AICPA BB: Industry AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, -o+ic: Auditing Ca+ital'Stock Accounts

11' In per)orming tests concerning the granting o) stoc" options an auditor should A' Con)irm the transaction +ith the !ecretar& o) !tate in the state o) incorporation' <' ?eri)& the e0istence o) option holders in the entit&#s pa&roll records or stoc" ledgers' C' >etermine that su))icient treasur& stoc" is available to cover an& ne+ stoc" issued' ., Trace the authori,ation )or the transaction to a vote o) the board o) directors'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, -o+ic: Auditing Ca+ital'Stock Accounts

15' $0amining cancelled stoc" certi)icates addresses the assertion o) A, .ccurrence' <' >isclosures' C' ?aluation' >' Completeness'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, -o+ic: Auditing Ca+ital'Stock Accounts

15--5

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

12' An audit o) stoc"holders# e%uit& ordinaril& should include A' Tracing individual dividend pa&ments to the capital stoc" records' <' =evie+ing minutes o) board meetings to determine the number o) shares outstanding' C' Con)irming shares outstanding +ith state o))icials' ., >etermining that dividend declarations compl& +ith debt agreements'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, "earning #b$ecti%e: &' ( 3no/ *o/ to conduct substanti%e audit +rocedures for di%idends, -o+ic: Auditing Ca+ital'Stock Accounts -o+ic: Auditing Di%idends

15' :hich audit procedure is most closel& related to management#s assertions about the presentation and disclosure o) stoc"holders# e%uit&; A, >etermining +hether restrictions have been imposed on retained earnings' <' Counting treasur& stoc" certi)icates' C' Inspecting minutes o) the board o) directors to veri)& that cash dividends +ere declared' >' $stablishing that treasur& stoc" is valued at cost'

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Re+orting Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &'(5 3no/ *o/ to conduct substanti%e audit +rocedures for ca+ital stock, "earning #b$ecti%e: &' ( 3no/ *o/ to conduct substanti%e audit +rocedures for di%idends, "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Ca+ital'Stock Accounts -o+ic: Auditing Di%idends -o+ic: Auditing Retained !arnings

15--2

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

16' An audit program )or the e0amination o) the retained earnings account should include a step that re%uires veri)ication o) the A' 9ain or loss resulting )rom disposition o) treasur& shares' <' @ar"et value used to charge retained earnings to account )or a t+o-)or-one stoc" split' C, Authori,ation )or both cash and stoc" dividends' >' Approval o) the ad/ustment to the beginning balance as a result o) a +rite-do+n o) an account receivable'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Retained !arnings

17' :hich o) the )ollo+ing transactions is an auditor most li"el& to e0amine +hen auditing the retained earnings account; A' Changing )rom one method o) depreciation to another' <' Ad/usting the percentage used to estimate the allo+ance )or doubt)ul accounts' C' Changing )rom the FIF. to LIF. method o) inventor& valuation' ., Correcting an error in depreciation in a prior &ear'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Retained !arnings

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

58' <e)ore e0pressing an opinion concerning the results o) operations the auditor +ould most li"el& proceed +ith the e0amination o) the income statement b& A' Appl&ing a rigid measurement standard designed to test )or understatement o) net income' <' Anal&,ing the beginning and ending balance sheet inventor& amounts' C' @a"ing net income comparisons to published industr& trends and ratios' ., $0amining income statement accounts concurrentl& +ith the related balance sheet accounts'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

51' @an& o) 9ranada Corporation#s convertible bond holders have converted their bonds into stoc" during the &ear under e0amination' The independent auditor should revie+ 9ranada Corporation#s statement o) cash )lo+s to ascertain that it sho+s A' .nl& cash used to reduce convertible debt' <' .nl& cash provided b& issuance o) stoc"' C, Cash provided b& the issuance o) stoc" and used to reduce convertible debt' ., (othing relating to the conversion because it does not a))ect cash'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: . 8ard "earning #b$ecti%e: &'( )nderstand t*e ty+es and features of long'term debt, "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Auditing "ong'-erm Debt -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15--6

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

5*' :hich o) the )ollo+ing is the most important consideration o) an auditor +hen e0amining the stoc"holders# e%uit& section o) a client#s balance sheet; A' Changes in the capital stoc" account are veri)ied b& an independent stoc" trans)er agent' <' !toc" dividends and/or stoc" splits during the &ear under audit +ere approved b& the stoc"holders' C' !toc" dividends are capitali,ed at par or stated value on the dividend declaration date' ., $ntries in the capital stoc" account can be traced to a resolution in the minutes o) the board o) directors# meetings'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: . 8ard "earning #b$ecti%e: &'(9 Be familiar /it* key control acti%ities for stock*olders0 e1uity, -o+ic: Assertions and Related Control Acti%ities ' Stock*olders0 !1uity

5-' .verall anal&sis o) income statement accounts ma& bring to light errors omissions and inconsistencies not disclosed in the overall anal&sis o) balance sheet accounts' The income statement anal&sis can best be accomplished b& comparing monthl& A' Income statement ratios to balance sheet ratios' <' =evenue and e0pense account balances to the monthl& reported net income' C' Income statement ratios to published industr& averages' ., =evenue and e0pense account totals to the corresponding )igures o) the preceding &ears'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: Analy7e Difficulty: . 8ard "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

15--7

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

51' .) the )ollo+ing +hich is the most important procedure that an auditor should use +hen ma"ing an overall revie+ o) the income statement; A' !elect sales and e0pense items and trace amounts to related supporting documents' -, Compare actual revenues and e0penses +ith the corresponding )igures o) the previous &ear and investigate signi)icant di))erences' C' .btain )rom the proper client representative inventor& certi)icates )or the beginning and ending inventor& amounts that +ere used to determine cost o) sales' >' Ascertain that the net income amount in the statement o) cash )lo+s agrees +ith the net income amount in the income statement'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: Analy7e Difficulty: . 8ard "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

!hort Ans)er 'uestions

55' Cou have been assigned the dut& o) auditing long-term debt and retained earnings )or &our client De&s Inc' >escribe the tests &ou +ould use to support management#s assertions regarding disclosure )or these accounts' Proper classi)ication bet+een long- and current portions o) long-term debt is an important part o) disclosure' The auditor should veri)& the pa&ment dates o) the debt to ensure proper classi)ication' To test )or other long-term debt disclosure items the auditor could inspect loan agreements )or an& restrictive covenants that should be disclosed in the )inancial statement )ootnotes' The auditor should also loo" )or an& applicable restrictions on retained earnings +hich could arise )rom loan agreements or state la+'

AACSB: Communication AICPA BB: Industry AICPA FN: Re+orting Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, "earning #b$ecti%e: &' 3no/ *o/ to conduct substanti%e audit +rocedures for retained earnings, -o+ic: Auditing Retained !arnings -o+ic: Substanti%e Procedures ' "ong'-erm Debt

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

52' $ri" =e"dahl senior-in-charge is auditing Doonce Dat)ood Inc'#s long-term debt )or the &ear ended >ecember -1' Long-term debt is composed o) t+o bond issues +hich are due in 18 and 15 &ears respectivel&' The debt is held b& t+o insurance companies' =e"dahl has e0amined the bond agreements )or each issue' The agreements provide that i) Doonce )ails to compl& +ith the covenants o) the contract the debt becomes pa&able immediatel&' =e"dahl identi)ied the )ollo+ing covenants +hen revie+ing the bond agreements: BThe debtor compan& shall endeavor to maintain a +or"ing capital ratio o) * to 1 at all times and in an& )iscal &ear )ollo+ing a )ailure to maintain said ratio the compan& shall restrict compensation o) o))icers to a total o) E258 888' .))icers include the chairperson o) the board and the president'B BThe debtor compan& shall "eep all propert& that is securit& )or these debt agreements insured against loss b& )ire to the e0tent o) 188 percent o) its actual value' Policies o) insurance comprising this protection shall be )iled +ith the trustee'B BThe compan& is re%uired to restrict 18 percent o) retained earnings )rom availabilit& )or pa&ing dividends'B BA sin"ing )und shall be established +ith the First @organ <an" o) Austin and semiannual pa&ments o) E588 888 shall be deposited in the )und' The ban" ma& at its discretion purchase bonds )rom either issue'B a' Provide an& audit steps that =e"dahl should conduct to determine i) the compan& is in compliance +ith the bond indentures' b' List an& reporting re%uirements that the )inancial statements or )ootnotes should include' a' =e"dahl should per)orm the )ollo+ing audit steps to determine i) the compan& is in compliance +ith the bond indentures: G Calculate the +or"ing capital ratio to ensure that it is * to 1 at the end o) each month during the )iscal &ear' G I) the +or"ing capital ratio is less than * to 1 veri)& that the total compensation o) the chairperson and president is not more than E258 888' G Con)irm +ith the trustee that insurance policies protecting against )ire loss to the e0tent o) 188 percent o) value have been )iled' G Test retained earnings to ensure that 18 percent has been restricted )rom dividend pa&ments' G Con)irm +ith the First @organ <an" o) Austin that a sin"ing )und has been established and that the re%uired semiannual pa&ments have been made' G Con)irm +hether an& bonds have been repurchased' b' The )ollo+ing disclosures should be included in the )ootnotes o) the )inancial statements: G The amount interest rate and due date o) each bond issue' G The covenant restrictions on the bond indentures' G The amount o) debt due over each o) the ne0t )ive &ears'

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Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts
AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: !%aluate Difficulty: 4 Medium "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

55' For each o) the )ollo+ing substantive procedures )irst note +hether it is a test o) details o) transactions or a test o) details o) account balances' Then decide )or +hich assertion the test provides the best evidence' 1' Trace large cash receipts and pa&ments to the source documents and the general ledger' *' $0amine copies o) note and bond agreements' -' =ecompute accrued interest pa&able' 1' =evie+ debt activit& )or a )e+ da&s be)ore and a)ter &ear-end to determine +hether transactions are included in the proper period' 5' $0amine due dates on notes and bonds )or proper classi)ication bet+een current and long term debt' 1' Test o) details o) transactions-Completeness *' Test o) details o) account balances-=ights and .bligations -' Test o) details o) account balances-?aluation and Allocation 1' Test o) details o) transactions-Cuto)) 5' Test o) details o) transactions-Classi)ication

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: )nderstand Difficulty: . 8ard "earning #b$ecti%e: &'(6 3no/ *o/ to conduct substanti%e audit +rocedures for long'term debt, -o+ic: Substanti%e Procedures ' "ong'-erm Debt

15-1*

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

56' Identi)& the three ma/or t&pes o) transactions that occur in stoc"holders# e%uit&' The three ma/or t&pes o) transactions that occur in stoc"holders# e%uit& include 314 issuance o) stoc" 3*4 repurchase o) stoc" and 3-4 pa&ment o) dividends'

AACSB: Communication AICPA BB: Industry AICPA FN: Measurement Blooms: Remember Difficulty: !asy "earning #b$ecti%e: &'(& )nderstand t*e ty+es of stock*olders0 e1uity transactions, -o+ic: Auditing Stock*olders0 !1uity

57' Identi)& the )our ma/or assertions made regarding stoc"holders# e%uit& and describe one control activit& )or each' 1' .ccurrence-An o))icer o) the entit& ensures that ever& stoc" or dividend transaction complies +ith the corporate charter' *' Accurac&-!toc"holders# records are reconciled +ith the number o) shares outstanding' >ividends paid is reconciled +ith the total shares outstanding on the dividend record date' -' Authori,ation-!toc" and dividend transactions are approved b& the board o) directors' 1' ?aluation-!toc" issuances and repurchases and dividends are recorded b& the treasurer#s department at an amount that con)orms to 9AAP'

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Risk Analysis Blooms: )nderstand Difficulty: 4 Medium "earning #b$ecti%e: &'(9 Be familiar /it* key control acti%ities for stock*olders0 e1uity, -o+ic: Assertions and Related Control Acti%ities ' Stock*olders0 !1uity

15-1-

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts

28' 9ive an e0ample o) ho+ the audit o) income statement accounts could be a))ected b& results o) audit +or" done in other areas o) the audit' The results o) testing )or controls o) the various business processes can a))ect the audit o) the income statement accounts because an& +ea"ness in controls discovered +ill also have an e))ect on the amount o) substantive testing done )or the income statement accounts' Also misstatements )ound +hile completing tests o) details o) balance sheet accounts and their related income statement accounts could impl& that there are misstatements else+here in the income statement' >ue to the relationship bet+een the balance sheet and the income statement results )rom the audit +or" done on balance sheet accounts has meaning )or the related income statement accounts as +ell'

AACSB: Communication AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: )nderstand Difficulty: !asy "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

21' :hat "ind o) in)ormation +ould t&picall& be )ound on an income statement account anal&sis +or"ing paper; :hat "ind o) tests can an auditor per)orm using this in)ormation; :h& +ould an auditor conduct additional anal&sis on an income statement account; The +or"ing paper includes dates amounts descriptions and e0planations o) the account#s transactions' The auditor can vouch this in)ormation to supporting documentation and scan the +or"ing paper )or unusual amounts' These tests provide additional evidence about the reasonableness o) income statement accounts that are not veri)ied +hile auditing other business processes or accounts that contain sensitive in)ormation or unusual transactions' Additional anal&sis is also done on accounts used to complete the ta0 return'

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: 4 Medium "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

15-11

Chapter 15 - Auditing the Financing/Investing Process: Long-Term Liabilities !toc"holders# $%uit& and Income !tatement Accounts
(atching 'uestions

2*' @atch each o) the )ollo+ing controls +ith the assertion )or long-term debt that it supports' 1' Premiums and discounts on bond and notes pa&ables are properl& amorti,ed using the e))ective interest rate method *' A subsidiar& ledger is maintained that contains in)ormation about all the long-term debt and the amount recorded in this ledger is reconciled to the general ledger -' An& signi)icant debt commitments are approved b& the board o) directors or delegated e0ecutives 1' The portion o) long-term debt due in the ne0t &ear is classi)ied as a short-term liabilit&
AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Measurement Blooms: )nderstand Difficulty: 4 Medium "earning #b$ecti%e: &'(. Be familiar /it* key control acti%ities for long'term debt, -o+ic: Assertions and Related Control Acti%ities ' "ong'-erm Debt

?aluation 1 .ccurrence and Authori,ation / >isclosure Classi)ication 0 Completeness 1

2-' @atch the balance sheet account +ith the income statement account that is t&picall& audited at the same time' 1' <onds Pa&able *' Propert& Plant and $%uipment -' Investments 1' Prepaid Insurance 5' Accounts =eceivable Investment income Interest e0pense Insurance e0pense <ad debt e0pense >epreciation e0pense / 1 0 5 1

AACSB: Analytic AICPA BB: Critical -*inking AICPA FN: Decision Making Blooms: A++ly Difficulty: !asy "earning #b$ecti%e: &' 4 3no/ *o/ to assess control risk and conduct substanti%e audit +rocedures for income statement accounts, -o+ic: Auditing Income Statement Accounts

15-15