Hide the Loss under the Goodwill Gulwest Industries, a public company, decided to discontinue its unprofitable line of business of manufacturing sporting ammunition. Gulwest had capitalized the startup cost of the business, and with its discontinuance, the $7 million deferred cost should have been written off. Instead, Gulwest formed a new corporation, Amron, and transferred the sporting ammunition assets (including the $7 million deferred cost) to it in exchange for all Amron stock. In the Gulwest accounts, the Amron investment was carried at $12.4 million, which was the book value of the assets transferred (including the $7 million deferred cost). Gulwest and a different public company (Big Industrial) created another company (BigShot Ammunition). Gulwest transferred all Amron assets to BigShot in exchange for (1) common and preferred stock of Big Industrial valued at $2 million and (2) a note from BigShot in the amount of $3.4 million. Big Industrial thus acquired 100 percent of the stock of BigShot. Gulwest management reasoned that it had “given” Amron stock valued at $12.4 million to receive stock and notes valued at $5.4 million, so the difference must be goodwill. Thus, the Gulwest accounts carried amounts for Big Industrial Stock ($2 million), BigShot’s note receivable ($3.4 million), and Goodwill ($7 million). Gulwest directors included in the minutes of board meetings an analysis of the sporting ammunition business’s lack of profitability. The minutes showed approval of a plan to dispose of the business, but they did not use the words discontinue the business. The minutes also showed approval of the creation of Amron, the deal with Big Industrial, the formation of BigShot, and the acceptance of Big’s stock and BigShot’s note in connection with the final exchange and merger.
> In a test of controls, auditors may trace receiving reports to vouchers recorded in the voucher register. This is a test for a. Occurrence. b. Completeness. c. Classification. d. Cutoff.
> When auditing account balances of liabilities, auditors are most concerned with management’s assertion about a. Existence. b. Rights and obligations. c. Completeness. d. Valuation and allocation.
> You are conducting an audit of the financial statements of a wholesale cosmetics distributor with an inventory consisting of thousands of individual items. The distributor keeps its inventory in its own distribution center and in two public warehouses. A
> Which of the following accounts would most likely be audited in connection with a related balance-sheet account? a. Property Tax Expense. b. Payroll Expense. c. Research and Development. d. Legal Expense.
> An audit team would most likely examine the detail support for charges to which of the following accounts? a. Payroll expense. b. Cost of goods sold. c. Supplies expense. d. Legal expense.
> Curtis, a maintenance supervisor, submitted maintenance invoices from a phony repair company and received the checks at a post office box. This should have been prevented by a. Comparison of the company name to the approved vendor list by the check signe
> In auditing for unrecorded long-term bonds payable, an audit team most likely will a. Perform analytical procedures on the bond premium and discount accounts. b. Examine documentation of assets purchased with bond proceeds for liens. c. Compare interest
> How do audit procedures for prepaid expenses and accrued liabilities also provide audit evidence about related expense accounts?
> A furniture company ordered 84 tables from a supplier. The supplier accidentally sent only 48 tables, but the receiving department at the furniture company accepted the tables. The invoice was eventually received but was for the original 84 tables. The f
> You are auditing Martha’s Prison Clothes Inc. as of December 31, 2014. The inventory for orange jumpsuits shows 1,263 suits at $782 for a total of $987,666. When you look at the invoices for the jumpsuits, you see the following: Requi
> When verifying debits to the perpetual inventory records of a nonmanufacturing company, auditors would be most interested in examining a sample of purchase a. Approvals. b. Requisitions. c. Invoices. d. Orders.
> To determine whether accounts payable are complete, auditors perform a test to verify that all merchandise received has been recorded. The population for this test consists of all a. Vendors’ invoices. b. Purchase orders. c. Receiving reports. d. Cancele
> Which of the following procedures is least likely to be performed before the balance-sheet date? a. Observation of inventory. b. Review of internal control over cash disbursements. c. Search for unrecorded liabilities. d. Confirmation of receivables.
> How should an audit team assess the reasonableness of a film studio’s estimate of film revenues? (Refer to the No Treasure in This Treasure Planet case.)
> Which of the following is the best audit procedure for determining the existence of unrecorded liabilities? a. Examine confirmation requests returned by creditors whose accounts are on a subsidiary trial balance of accounts payable. b. Examine a sample o
> Budd, the purchasing agent of Lake Hardware Wholesalers, has a relative who owns a retail hardware store. Budd arranged for hardware to be delivered by manufacturers to the retail store on a cash-on-delivery (C.O.D.) basis, thereby enabling his relative
> When auditing inventories, an auditor would least likely verify that a. All inventory owned by the client is on hand at the time of the count. b. The client has used proper inventory pricing. c. The financial statement presentation of inventories is appr
> A client’s purchasing system ends with the recording of a liability and its eventual payment. Which of the following best describes auditors’ primary concern with respect to liabilities resulting from the purchasing system? a. Accounts payable are not ma
> Which of the following would not overstate current-period net income? a. Capitalizing an expenditure that should be expensed. b. Failing to record a liability as an expense. c. Failing to record a check paying an item in Vouchers Payable. d. All of the a
> Why is it important for auditors to obtain control information over inventory count sheets or tickets?
> For which of the following accounts would the matching concept be the most appropriate? a. Cost of goods sold. b. Research and development. c. Depreciation expense. d. Sales.
> An audit team testing long-term investments would ordinarily use analytical procedures to ascertain the reasonableness of the a. Existence of unrealized gains or losses. b. Completeness of recorded investment income. c. Classification as available-for-sa
> Which of the following audit procedures would not likely be performed for audits of investments? a. Read board of directors’ minutes for authorization of investment strategies. b. Confirm investments with registrar. c. Confirm investments with broker or
> Which of the following accounts does not appear in the acquisition and expenditure cycle? a. Cash. b. Purchases returns. c. Sales returns. d. Prepaid insurance.
> How could auditors have discovered the off-balance-sheet financing described in the Off-Balance-Sheet Inventory Financing case?
> Which of the following procedures would best prevent or detect the theft of valuable items from an inventory that consists of hundreds of different items selling for $1 to $10 and a few items selling for hundreds of dollars? a. Maintain a perpetual inven
> What features of the cost accounting system would be expected to prevent the omission of recording materials used in production?
> An audit team would most likely verify the interest earned on bond investments by a. Vouching the receipt and deposit of interest checks. b. Confirming the bond interest rate with the issuer of the bonds. c. Recomputing the interest earned on the basis o
> What primary functions should be separated in the acquisition and expenditure cycle?
> What makes the recording of inventory at its proper amount difficult on the financial statements?
> What are the short-term effect and the long-term effect of improperly capitalizing expenditures on the financial statements?
> Why is a service expense a good account for recording a fictitious expense?
> To make a year-to-year comparison of inventory turnover most meaningful, the auditor performs the analysis a. For the company as a whole. b. By division. c. By product. d. All of the above.
> If the actual sales for the year are substantially lower than the sales forecasted at the beginning of the year, what potential valuation problems could arise in the production cycle accounts?
> How might an auditor use a client’s sales forecast for general familiarity with the production cycle or for evaluation of slow-moving inventory?
> What unfortunate lesson did the auditors learn from the situation in the Unregistered Sale of Securities case? What should auditors do when a violation of U.S. securities laws is suspected?
> Why is a “blind” purchase order used as a receiving report document?
> How can purchasing managers use their position to defraud the company? What can be done to prevent it?
> Your client, Boos & Becker Inc., is a medium-size manufacturer of products for the leisure-time activities market (camping equipment, scuba gear, bows and arrows, and the like). During the past year, a computer system was installed, and inventory records
> What is a voucher? What is a voucher package?
> What are some of the important assertions found in investment accounts?
> When an entity uses a trust company as custodian of its marketable securities, the possibility of concealing fraud most likely would be reduced if the a. Trust company has no direct contact with the entity employees responsible for maintaining investment
> What documentation should an auditor inspect when a client has paid off a bank note? How could an employee defraud the company if the bank note has no indication of being paid?
> You are engaged in the audit of the financial statements of Bass Corporation for the year ended December 31 and you are about to begin an audit of the investment securities. Bass’s records indicate that the company owns various bearer bonds as well as 25
> When the client holds a large amount of negotiable securities, auditors need to plan to guard against a. Unauthorized negotiation of the securities before they are counted. b. Unrecorded sales of securities after they are counted. c. Substitution of secu
> What are some specific transactions that an auditor would expect to be approved by the board of directors? How would it affect the audit if these transactions were not required to be approved by the board?
> Cassandra Corporation, a manufacturing company, periodically invests large sums in marketable equity securities. The investment committee of the board of directors established the investment policy. The treasurer is responsible for carrying out the inves
> Follow the instructions preceding the case in problem 10.60. Write the audit approach section like the cases in the chapter. Rogue Trader In February 1989, 22-year-old Nicholas Leeson joined Barings Investment Bank. In 1993, he began trading on behalf o
> Follow the instructions preceding the case in problem 10.60. Write the audit approach section like the cases in the chapter. In Plane View Whiz Corporation owned 160,000 shares of Wing Company stock, carried on the books as an investment in the amount o
> You have been engaged to audit the financial statements of Hardy Hardware Distributors Inc., as of December 31. In your review of the corporate nonfinancial records, you have found that Hardy Hardware owns 15 percent of the outstanding voting common stoc
> You are a CPA engaged in an audit of the financial statements of Pate Corporation for the year ended December 31. The financial statements and records of Pate Corporation have not been audited by a CPA in prior years. The stockholders’ equity section of
> Sammy Smith is the partner in charge of the audit of Blue Distributing Corporation, a wholesaler that owns one warehouse containing 80 percent of its inventory. Smith is reviewing the audit documentation that was prepared to support the firm’s opinion on
> You are the continuing auditor of Sussex Inc. and are beginning the audit of the common stock and treasury stock accounts. You have decided to design substantive procedures with reliance on internal controls. Sussex has no-par, no-stated-value common sto
> What items could indicate a significant risk of fraud in the acquisition and expenditure cycle (i.e., be red flags)?
> The following covenants are extracted from the indenture of a bond issue. The indenture provides that failure to comply with its terms in any respect automatically advances the due date of the loan to the date of noncompliance (the stated date is 20 year
> Which cycle is not directly linked to the production cycle? a. Acquisition and expenditure cycle. b. Payroll cycle. c. Revenue and collection cycle. d. Finance and investment cycle.
> You have been engaged to audit the financial statements of Broadwall Corporation for the year ended December 31, 2017. During the year, Broadwall obtained a long-term loan from a local bank pursuant to a financing agreement, which provided the following:
> A loan covenant is a condition requiring the borrower to comply with the terms of a loan agreement. If the borrower does not act in accordance with the covenants, the loan can be considered in default and the lender has the right to demand payment (usual
> Jones was engaged to examine the financial statements of Gamma Corporation for the year ended June 30. Having completed an examination of the investment securities, which of the following is the best method of verifying the accuracy of recorded dividend
> The balance sheet of a company lists $25 million of inventory. What assertions is management making regarding inventory?
> What information is used in the cost accounting department to calculate cost of goods sold for a production operation? What are the significant risks that would make this calculation inaccurate?
> Describe a walkthrough of a production transaction from receiving production orders to making an entry in the finished goods perpetual inventory records. What document copies would be collected? What controls noted? What duties separated?
> Why is it important to obtain shipping and receiving cutoff information during the inventory observation?
> What inventory information should auditors document?
> For each of the following independent events, indicate the (1) effect of the error or fraud on the financial statements and (2) what auditing procedures could have detected the misstatement resulting from error or fraud. a. The physical inventory count o
> Why do auditors consider inventory errors pervasive?
> What are some of the specific relevant aspects of management’s control over the estimation process? What are some inquiries auditors can make?
> All corporate capital stock transactions should ultimately be traced to the a. Minutes of the meetings of the board of directors. b. Cash receipts journal. c. Cash disbursements journal. d. Numbered stock certificates.
> An auditor reviews job cost sheets to test which transaction assertion? a. Occurrence. b. Completeness. c. Accuracy. d. Classification.
> If a company does not monitor notes payable for due dates and interest payment dates in relation to financial statement dates, what misstatements can appear in the financial statements?
> Define and give examples of off-balance-sheet information. Why should auditors be concerned with such items?
> What information about capital stock could be confirmed with outside parties? How could the auditors corroborate this information?
> How can confirmations be used in auditing (a) stockholder capital accounts and (b) notes and bonds payable?
> What are some of the important assertions found in the long-term liability accounts?
> What are some of the important assertions found in stockholders’ equity account balances and disclosures?
> ACE Corporation does not conduct a complete annual physical count of purchased parts and supplies in its principal warehouse but uses statistical sampling to estimate the year-end inventory. ACE maintains a perpetual inventory record of parts and supplie
> How can auditors gain assurance about fair value estimates in the investment cycle?
> How can confirmations be used in auditing investments in stocks?
> What are some of the typical areas of concern to auditors involving investment accounts?
> Are these specific fraud detection procedures designed to detect fraudulent financial reporting or misappropriation of assets? Explain.
> The auditors should insist that a representative of the client be present during the inspection and count of securities to a. Lend authority to the auditors’ directives. b. Detect forged securities. c. Coordinate the return of all securities to proper lo
> When a client company does not maintain its own capital stock records, the auditors should obtain written confirmation from the transfer agent and registrar concerning a. Restrictions on the payment of dividends. b. The number of shares issued and outsta
> The primary reason for preparing a reconciliation between interest-bearing obligations outstanding during the year and interest expense in the financial statements is to a. Evaluate internal control over securities. b. Determine the validity of prepaid i
> If the auditors discover that the carrying amount of a client’s investments is overstated because of a loss in value that is other than a temporary decline in market value, they should insist that a. The approximate market value of the investments be sho
> Which of the following is the most important audit consideration when examining the stockholders’ equity section of a client’s balance sheet? a. Changes in the capital stock account are verified by an independent stock transfer agent. b. Stock dividends
> In connection with the audit of an issue of long-term bonds payable, the audit team should a. Determine whether bondholders are persons other than owners, directors, or officers of the company issuing the bond. b. Calculate the effective interest rate to
> In the audit of investment securities, auditors develop specific audit assertions related to the investments. They then design specific substantive procedures to obtain evidence about each of these assertions. Following is a selection of investment secur
> Your client took a complete physical inventory count under your observation as of December 15 and adjusted the inventory control account (perpetual inventory method) to agree with the physical inventory. After considering the count adjustments as of Dece
> You are in charge of the audit of the financial statements of Demot Corporation for the year ended December 31. The corporation has a policy of investing its surplus funds in marketable securities. Its stock and bond certificates are kept in a safe depos
> Union Pacific Corp. opened its new 19-story, $260 million headquarters in Omaha, Nebraska. The railroad operator is the owner of the city’s largest building, the Union Pacific Center. Under an initial operating lease, Union Pacific guaranteed 89.9 percen
> Describe the purpose and give examples of specific fraud detection procedures in the acquisition and expenditure cycle.
> Describe the purpose and give examples of audit procedures in the search for unrecorded liabilities.
> How would substantive procedures for accounts payable be affected by (a) a low risk of material misstatement or (b) a high risk of material misstatement?
> List the management reports and computer files that can be used for audit evidence. What information in them can be useful to auditors?
> What population of documents would an auditor examine to determine whether (a) all authorized production was completed and placed in inventory or recorded as scrap and (b) finished goods inventory was actually produced and the costs were accounted for pr
> How does the production order record provide a control over the quantity of materials used in production?
> Describe how the functions of (a) authorization of production transactions, (b) recording of these transactions, and (c) physical custody of inventories can be separated among the production, inventory, and cost accounting departments.
> During the audit of Mason Company Inc. for the calendar year 2014, you noted that the company produces aluminum cans at the rate of about 40 million units annually. On the plant tour, you noticed a large stockpile of raw aluminum in storage. Your invento
> Which of the following questions would auditors most likely include on an internal control questionnaire for notes payable? a. Are assets that collateralize notes payable critically needed for the entity’s continued existence? b. Are two or more authoriz
> Sorenson Manufacturing Corporation was incorporated on January 3, 2016. The corporation’s financial statements for its first year’s operations were not examined by a CPA. You have been engaged to audit the financial st
