Chapter 10: Finance and Investment Cycle

Question 1

Transactions in the finance and investment cycle ____. (Select all that apply)
- are more frequent than in other cycles
-may require third parties to control management
-are often large and complex
-include transactions that are difficult to value

Answer 1

-may require third parties to control management
-are often large and complex
-include transactions that are difficult to value

Question 2

Auditors typically approach audits of ____ transactions with a reliance approach.
- routine
- both routine and nonroutine
- nonroutine

Answer 2

routine

Question 3

Plans for asset purchases and business acquisitions are detailed in a(n) ____ budget.

Answer 3

capital

Question 4

Off-balance sheet transactions ____. (Select all that apply)
- include fixed price commitments
- often cause financial reporting and disclosure problems
- have been reduced by new accounting standards
- include capital leases but exclude operating leases

Answer 4

-include fixed price commitments
-often cause financial reporting and disclosure problems
-have been reduced by new accounting standards

• include capital leases but exclude operating leases (the opposite is true)

Question 5

Only high-ranking officers should have access to negotiable certificates and two people should be required to access the documents which is known as _____ or _____ in its strictest form, joint custody.

Answer 5

dual control

Question 6

Transactions in the finance and investment cycle ______.
(select all that apply)
-have resulted in many auditing standards being revoked
-must be understood by the client’s accountants
-have been a leading cause of financial statement restatements
-can be inherently risky for the auditor

Answer 6

-must be understood by the client’s accountants
-have been a leading cause of financial statement restatements
-can be inherently risky for the auditor

Question 7

Record keeping for many types of investments and intangibles ______. (Select all that apply)
- involve complex accounting standards
- are ripe areas for overstatement of liabilities
- are ripe areas for understatement of expenses
- require management estimates

Answer 7

• involve complex accounting standards
• are ripe areas for understatement of expenses
• require management estimates

Question 8

When auditing the financing and investment cycle, auditors usually ____.
- rely heavily on tests of controls and do substantive testing as needed
- do no tests of controls
- use more substantive testing procedures and rely less on tests of controls

Answer 8

use more substantive testing procedures and rely less on tests of controls

Question 9

Financial planning starts with the ____.
- capital budget
- cash flow forecast
- board of directors

Answer 9

cash flow forecast

Question 10

Which of the following statements are true? (Select all that apply)
- Government debentures are relatively complex to audit.
- There is not a “typical” finance and investment cycle that applies to all companies.
- The majority of companies in the U.S. are entirely equity financed.
- Investment type can have a huge influence on the effort required by the auditor.

Answer 10

• There is not a “typical” finance and investment cycle that applies to all companies.
• Investment type can have a huge influence on the effort required by the auditor.

Question 11

Off-balance sheet transactions include ____. (Select all that apply)
- repurchase agreements
- letters of credit
- endorsements on discounted notes
- all company stock options

Answer 11

• repurchase agreements
• letters of credit
• endorsements on discounted notes

Question 12

Common problems in the finance and investment cycle are often the result of failure to ______. (Select all that apply)
- appropriately adjust asset valuations as needed
- record operating leases as assets
- record and disclosure transactions
- properly amortize goodwill

Answer 12

• appropriately adjust asset valuations as needed
• record and disclosure transactions

Question 13

When it is not possible for one person to access a safe, cabinet or drawer, a strict form of dual control, known as __ ___ has been implemented.

Answer 13

joint custody

Question 14

Complex transactionsa are ____ the balance sheet.
- difficult to audit even if they reach
- only difficult to audit if they are kept off

Answer 14

• difficult to audit even if they reach

Question 15

Record keeping complications for many types of investments and intangibles arise from ___.
- maintenance of the accounts over time
- both the original recording and maintenance over time
- the original recording of transactions

Answer 15

• maintenance of the accounts over time

Question 16

Audits of accounting estimates generally take a(n) ____ approach.

Answer 16

substantive

Question 17

Difficult-to-value assets include ______. (Select all that apply)
-derivatives
-pension assets and liabilities
-assets acquired in exchange for services
-intangible assets
-debt and equity securities

Answer 17

-derivatives
-pension assets and liabilities
-intangible assets
-debt and equity securities

Question 18

One that can exert significant influence over another is a(n) ____ party.

Answer 18

related

Question 19

Problems in the finance and investment cycle can occur because ______. (Select all that apply)
-auditors fail to properly perform tests of controls
-transactions are infrequent
-of intentional errors in management estimates
-complex transactions make accounting difficult

Answer 19

-transactions are infrequent
-of intentional errors in management estimates
-complex transactions make accounting difficult

Question 20

Clauses in borrowing agreements intended to keep the borrower’s financial position at a level that will ensure repayment are called ______ ______.

Answer 20

loan covenants

Question 21

Complex transactions that can be used as vehicles to hide fraud include ______. (Select all that apply)
-long-term discounted notes payable
-mergers and acquisitions
-instruments with both debt and equity characteristics
-recording of long-term capital lease obligations

Answer 21

-mergers and acquisitions
-instruments with both debt and equity characteristics

Question 22

GAAP requires that impairments to asset values should normally be ___.
- recorded directly to stockholders’ equity
- footnoted but not recorded
- taken as losses when they occur

Answer 22

taken as losses when they occur

Question 23

The classification of a derivative instrument as a(n) ____ influences the presentation and characterization of fluctuations in value.

Answer 23

hedge

Question 24

Difficult-to-value assets include ______. (Select all that apply)
-financial instruments
-goodwill
-most loans and receivables
-investments in unique assets

Answer 24

• goodwill
• investments in unique assets
• financial instruuments

Question 25

Which of the following statements are correct? (Select all that apply) - A lack of controls in the finance and investment cycle can lead to significant extended procedures. - Auditors normally examine samples of significant finance and investment transactions for tests of controls. - Reliance on controls does not normally reduce the extent of substantive procedures on finance and investment cycle accounts. - Tests of controls in the finance and investment cycle for nonpublic clients may be limited to entity level.

Answer 25

- A lack of controls in the finance and investment cycle can lead to significant extended procedures. - Reliance on controls does not normally reduce the extent of substantive procedures on finance and investment cycle accounts. - Tests of controls in the finance and investment cycle for nonpublic clients may be limited to entity level.

Question 26

Auditors must ensure that a sale made to related parties is the equivalent of a(n) ___- ___ transaction.

Answer 26

arm's length

Question 27

An activity used because a specific standard control activity is not in place is called a(n) _____ control.

Answer 27

compensating

Question 28

Loan covenant violations ______. (Select all that apply) - cannot force a borrower into bankruptcy - may lead to an audit report modification - allow the lender to call the debt - may cause managers to misstate other accounts

Answer 28

-may lead to an audit report modification -allow the lender to call the debt -may cause managers to misstate other accounts

Question 29

Salvage values, security valuations, goodwill impairment and imputed interest rates are all examples of ____ ____.

Answer 29

accounting estimates

Question 30

Material misstatements can incur when ____. (Select all that apply) -companies have taken a "big bath" in a bad year -assets are overstated due to impairment -impairment write-offs have been delayed

Answer 30

-assets are overstated due to impairment -impairment write-offs have been delayed

Question 31

True or false: Authorization is a critical issue for most of the transactions in the financing and investing cycle.

Answer 31

True ## Footnote Because most of the transactions involve large amounts of cash or other assests

Question 32

The classification of a security as trading or ____ _____ _____ affects whether changes in value influence net income.

Answer 32

available for sale

Question 33

When considering controls over those who do record keeping in the finance and investment cycle ______. (Select all that apply) -auditors should ensure that upper management is responsible for the reconciliation function -hiring practices may be considered -employee turnover is a significant risk factor -evidence from prior audits can indicate employee competence levels

Answer 33

-hiring practices may be considered -employee turnover is a significant risk factor -evidence from prior audits can indicate employee competence levels

Question 34

True or false: Reliance on controls normally reduces the extent of auditors' substantive procedures on finance and investment cycle accounts.

Answer 34

False ## Footnote B/c transactions are often individually significant, each transaction is usually audited using substantive procedures

Question 35

In order to improve the bottom line, managers are motivated to classify securities as ______ when the market is doing well. - available for sale - trading - held to maturity

Answer 35

trading ## Footnote B/c unrealized gains will be included in income

Question 36

When auditing fair value measurements the auditor must determine if the valuation principles used are ______. (Select all that apply) -supported by documentation -one of the specific methods allowed under GAAP -consistently applied -properly disclosed

Answer 36

-supported by documentation -consistently applied -properly disclosed

Question 37

When auditing long-term liabilities and related accounting, the most important balance sheet assertions are ______. (Select all that apply) -valuation -existence or occurrence -presentation and disclosure -completeness

Answer 37

-presentation and disclosure -completeness

Question 38

The authorization for the purchase of large assets will likely reside in the ____. - board of director meeting minutes - capital budget - finance committee meeting minutes

Answer 38

capital budget

Question 39

The amount and terms of bonds payable, mortgages payable, and other formal debt instruments can be verified by reading the bond _____.

Answer 39

indenture

Question 40

Transactions in the financing and investment cycle ______. (Select all that apply) -occur infrequently -are for large dollar amounts -vary greatly in type -are recorded in a journal designed for those transactions

Answer 40

-occur infrequently -are for large dollar amounts -vary greatly in type

Question 41

When auditing employee share option plans, auditors must ______. (Select all that apply) -follow standards for auditing accounting estimates -ensure valuation is based on market value -ensure Board of Director approval of the plan -follow standards for auditing fair value estimates

Answer 41

-follow standards for auditing accounting estimates -ensure Board of Director approval of the plan -follow standards for auditing fair value estimates

Question 42

Market valuation is required for securities classified as ______. (Select all that apply) - held to maturity - trading - available for sale

Answer 42

- trading - available for sale

Question 43

ASC 718 requires that employee stock-based compensation plans be ______. (Select all that apply) -recorded when the award is granted -credited to paid-in-capital -recorded based on fair value accounting as defined in ASC 820 -expensed over the compensation period

Answer 43

-recorded when the award is granted -credited to paid-in-capital -expensed over the compensation period