MCQ 22-16; 22-17

22-16 (Objective 22-2) The following multiple choice questions concern interest-bearing liabilities.
Choose the best response.

A. Which of the following controls will most likely justify reduced assessed level of control risk
for the completeness assertion for notes payable?
(1) The accounting staff reviews board of director minutes for any indication of any
transactions involving outstanding debt to make sure all borrowings are included in the
general ledger.
(2) All borrowings that exceed $500,000 require approval from the board of directors before
loan contracts can be finalized.
(3) Before approving disbursement of principal payments on notes payable, the treasurer
reviews terms in the note.
(4) Accounting maintains a detailed schedule of outstanding notes payable that is reconciled
monthly to the general ledger.

B. When an auditor observes that the recorded interest expense seems to be excessive in relation
to the balance in the bonds payable account, the auditor might suspect that
(1) discount on bonds payable is understated.
(2) bonds payable are understated.
(3) bonds payable are overstated.
(4) premium on bonds payable is overstated.

C. In the audit of notes payable, which balance-related audit objective is generally one of the
most important for the auditor to verify?
(1) Notes payable reflected on the balance sheet at the end of the year exist.
(2) Notes payable due to related parties are properly reflected on the balance sheet.
(3) Existing notes payable are included on the balance sheet as of year end.
(4) Notes payable are reflected at net realizable value as of the balance sheet date.

22-17 (Objectives 22-2, 22-3, 22-4) The following questions concern the audit of accounts in the
capital acquisition and repayment cycle. Choose the best response.

A. During an audit of a publicly held company, the auditor should obtain written confirmation
regarding debenture transactions from the
(1) debenture holders.
(2) client’s attorney.
(3) internal auditors.
(4) trustee.

B. Which of the following internal controls is least likely to reduce risks related to the
occurrence transaction-related audit objective for issuances of stock?
(1) The board of directors must approve the distribution of cash dividends.
(2) The issuance of any shares of stock must be preapproved by the board of directors.
(3) The company engages an independent registrar to issue stock certificates.
(4) The company maintains a capital stock certificate record that includes certificate number,
number of shares issued, issue date, and name of person to whom certificates are issued.

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 C. Which of the following audit procedures would be most relevant when examining the
completeness transaction-related audit objective for capital stock?
(1) The auditor examines minutes of the board of directors’ meetings to identify any
actions involving the issuance of capital stock.
(2) The auditor vouches entries in the client’s capital stock records to board minutes.
(3) Confirmations of new stock issuances are sent to the client’s stock transfer agent.
(4) The auditor traces entries of new stock issuances to the cash receipts journal.

Problem 22-25

22-25 (Objective 22-3, 22-4) Items 1 through 6 are common questions found in internal control
questionnaires used by auditors to obtain an understanding of internal control for owners’ equity. In
using the questionnaire for a client, a “yes” response indicates a possible internal control, whereas a
“no” indicates a potential deficiency.
1. Are all entries in the owners’ equity accounts authorized at the proper level in the
organization?
2. Are issues and retirements of stock authorized by the board of directors?
3. Does the company use the services of an independent registrar or transfer agent?
4. If an independent registrar and transfer agent are not used:
A. Are unissued certificates properly controlled?
B. Are cancelled certificates mutilated to prevent their reuse?
5. Are common stock master files and stock certificate books periodically reconciled with the
general ledger by an independent person?
6. Is an independent transfer agent used for disbursing dividends? If not, is an imprest dividend
account maintained?
Requirement:
A. For each of the preceding questions, state the purpose of the control.
B. For each of the preceding questions, identify the type of potential financial statement
misstatements if the control is not in effect.
C. For each of the potential misstatements in part b., list an audit procedure that the auditor can
use to determine whether a material misstatement exists.

Answer :
(a) (b) (c)
Misstatement of
equity of owners, Ascertain if
dividend organization uses
Ensure that all disbursement, and services of an
Are all entries in the owners’ equity records are capital or independent
accounts authorized at the proper maintained distribution to the registrar or transfer
1 level in the organization? properly wrong individual. agent
Review any
Ensure that the Misstatements with unissued
records are earnings per share certificates as well
Are issues and retirements of stock properly and/or equity of as cancelled
2 authorized by the board of directors? maintained. owners certificates

Does the company use the services General ledger and Misstatements with Follow posts from
3 of an independent registrar or records balances earnings per share the master file to

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 and/or equity of the certificates and
transfer agent? agree. owners. then the ledger

If an independent registrar and

Dividends need to
4 transfer agent are not used: Balance sheet
be reviewed to
misstatements of Review copy of the
a. Are unissued certificates properly ensure proper
dividends, paid dividends from
controlled? payment to the
unauthorized the agent.
appropriate
b. Are cancelled certificates payment.
individuals
mutilated to prevent their reuse?
Illegal cash Review any
Are common stock master files and payments and unissued
stock certificate books periodically Ensure stock is issue of certificates as well
reconciled with the general ledger by issued via board unauthorized as cancelled
5 an independent person? discretion. shares certificates.
Ensure the proper Balance sheet
authorization and misstatements of
Is an independent transfer agent used issuing of shares dividends, Verify the
for disbursing dividends? If not, is as well as payments to authenticity of all
an imprest dividend account retirement of unauthorized owner’s equity
6 maintained? shares. persons. account changes.

Problem 22-26
22-26 (Objectives 22-3, 22-4) The table below is an excerpt from Apple Inc.’s Statement of
Shareholders’ Equity for its fiscal year ended September 27, 2014:

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Required:
a. How would the auditor verify the balances as of September 28, 2013?
As the financial data is accumulated in the balance sheet the auditor in case he did not do the
previous year audit he/she must confirm the opening balances or refer to the predecessor
auditor, or if he/she could not then a disclaimer of an opinion might be necessary in the
auditor's report, otherwise he is carrying out responsibility about the fairness of the financial
statements including the opening balances, from previous year, as the auditor is responsible
up to the issuance of the audit report.

b. What would the auditor do to evaluate the amount shown as Net Income?
Financial statement audits are a routine part of closing your financial books. Audits help to
ensure the accuracy of the accounting data used to compile the statements as well as the
overall calculations. An income statement audit can help you isolate mathematical errors and
ledger discrepancies or give you peace of mind before you file the income statement during
closing.

Statement Calculations
The first step in auditing financial statements is to verify the summary calculations. Start with
the income section, confirming that the total revenue amount is equal to the sum of the
income lines. Repeat this process for the expense category. Manually calculate the difference
between the revenue and expense numbers to verify the equity section, as owner's equity is
simply the difference between the revenue and expenses.

Income Details
Once you determine that the calculations on the income statement itself are accurate, you
need to review the detail that contributes to the figures. Pull summary transaction reports from
the general ledger for each revenue account. Review the overall data on the summary reports
for accuracy. Run transaction-level reports for the accounts so that you can view the details to
confirm that the summary report figures are accurate. Each transaction-level report shows you
what has posted to the account. Compare the transactions in the ledger to the hard copy files,
such as invoices or check stubs that support the journal entries, to confirm that they were
posted correctly.

c. What sources of evidence might the auditor use to satisfy the occurrence objective for each of
the following?
(1) Repurchase of common stock
The repurchase of common or preferred shares, the timing of the repurchase, and the amount
to pay for the shares should all be approved by the board of directors.

Proper Record Keeping and Segregation of Duties

When a company maintains its own records of stock transactions and outstanding stock, the
internal controls must be adequate to ensure that:
a. Actual owners of the stock are recognized in the corporate records
b. The correct amount of dividends is paid to the stockholders owning the stock as of the
dividend record date
c. The potential for misappropriation of assets is minimized

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 (2) Share-based compensation
Documentation of such understanding might include (but is not limited to) the following
inquiries of management and its board of directors. The auditor should document:
a. The terms and conditions of the existing policies granting employee stock options,
paying close attention to terms allowing exercise prices that are not equal to the
market price on the grant date (as well as terms that delegate option award issuance
authority to management).
b. The extent the company uses third-party specialists in determining its fair value
measurements and disclosures.
c. The process for approving and communicating option awards to employees, ensuring
that the company determines that the grant date used is consistent with FAS 123(R).
Their understanding of the general terms of the stock compensation plan, reviewing
contractual terms, settlement alternatives, number of options available, and other
relevant terms must be examined.
d. The process for tracking stock option awards granted, exercises, forfeitures,
cancellations, and option expirations, along with the company's process used to
review plan documents and the accounting for each individual grant.
e. The process the company uses to measure and record the stock compensation
expense, including those personnel authorized to record such entry.
f. The process for identifying and effectuating modifications to existing award terms or
conditions, including those authorized personnel.

(3) Common shares issued

The equity accounts used depend upon the type of entity and what occurs within and outside
the organization. Examples include:
a. Has an incorporated company purchased treasury stock?
b. Does a commercial entity have unrealized gains or losses on available-for-sale
securities?
c. Does a nonprofit organization have donor-restricted contributions?
d. Does the government have restricted net positions?

d. How should the amounts shown as of September 27, 2014, relate to the amounts shown in
Apple’s balance sheet as of the same date?
These balance are calculated by verifying all above transactions

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