CHAPTER 14 MULTIPLE CHOICE b To strengthen control procedures over the custody of heavy mobile equipment, the client would most likely institute a policy requiring a periodic a Increase in insurance coverage b Inspection of equipment and reconciliation with accounting records c Verification of liens, pledges, and collateralizations d Accounting for work orders (AICPA ADAPTED) c To improve accountability for fixed asset retirements, management most likely would implement an internal control structure that includes a Continuous analysis of the repairs and maintenance account b Periodic inquiry of plant executives by internal auditors as to whether any plant assets have been retired c Continuous utilization of serially numbered retirement work orders d Periodic inspection of insurance policies by internal auditors (AICPA ADAPTED) b From the auditor's point of view, inventory counts are more acceptable prior to the year-end, when a Internal control is deficient b Accurate perpetual inventory records are maintained c Inventory is slow moving d Significant amounts of inventory are held on consignment (AICPA ADAPTED) c Apex Manufacturing Corporation mass produces eight different products The controller who is interested in strengthening control procedures over the accounting for materials used in production would be most likely to implement a An economic order quantity (EOQ) system b A job order cost accounting system c A perpetual inventory system d A separation of duties among production personnel (AICPA ADAPTED) a For several years, a client's physical inventory count has been lower than what was shown on the books at the time of the count so that downward adjustments to the inventory account were required Contributing to the inventory problem could be deficiencies in internal control that led to the failure to record some a Purchases returned to vendors b Sales returns received c Sales discounts allowed d Cash purchases (AICPA ADAPTED) a When perpetual inventory records are maintained in quantities and in dollars, and internal control procedures over inventory are deficient, the auditor would probably a Want the client to schedule the physical inventory count at the end of the year b Insist that the client perform physical counts of inventory items several times during the year c Increase the extent of tests for unrecorded liabilities at the end of the year d Have to disclaim an opinion on the income statement that year (AICPA ADAPTED) 97 a a b c d Purchase cutoff procedures should be designed to test whether or not all inventory Purchased and received before the year-end was recorded Was carried at the lower of cost or market on the year-end balance sheet Was paid for by the company on the year-end balance sheet Owned by the company is in the possession of the company (AICPA ADAPTED) c In tests of property, plant, and equipment, the auditor tries to determine all of the following except the a Adequacy of the internal control b Extent of property abandoned during the year c Adequacy of replacement funds d Reasonableness of depreciation (AICPA ADAPTED) b An auditor has accounted for a sequence of inventory tags and is now going to trace information on a representative number of tags to the physical inventory sheets The purpose of this procedure is to obtain assurance that a The final inventory is valued at cost b All inventory represented by an inventory tag is listed on the inventory sheets c All inventory represented by an inventory tag is bona fide d Inventory sheets not include untagged inventory items (AICPA ADAPTED) b 10 The physical count of inventory of a retailer was higher than shown by the perpetual records Which of the following could explain the difference? a Inventory items had been counted, but the tags placed on the items had not been taken off the items and added to the inventory accumulation sheets b Credit memos for several items returned by customers had not been recorded c No journal entry had been made on the retailer's books for several items returned to its suppliers d An item purchased "FOB shipping point" had not arrived at the date of the inventory count and had not been reflected in the perpetual records (AICPA ADAPTED) c 11 A client's physical count of inventories was higher than the inventory quantities per the perpetual records This situation could be the result of the failure to record a Sales b Sales discounts c Purchases d Purchase returns (AICPA ADAPTED) d 12 The controller of Excello Manufacturing, Inc., wants to use ratio analysis to identify the possible existence of idle equipment or the possibility that equipment has been disposed of without having been written off Which of the following ratios would best accomplish this objective? a Depreciation expense divided by book value of manufacturing equipment b Accumulated depreciation divided by book value of manufacturing equipment c Repairs and maintenance cost divided by direct labor costs d Gross manufacturing equipment cost divided by units produced (AICPA ADAPTED) 98 b 13 The accuracy of perpetual inventory records may be established, in part, by comparing inventory records with a Purchase requisitions b Receiving reports c Purchase orders d Vendor payments (AICPA ADAPTED) d 14 The audit procedure of analyzing the repairs and maintenance accounts is primarily designed to provide evidence in support of the audit proposition that all a Expenditures for plant assets have been recorded in the proper period b Capital expenditures have been properly authorized c Noncapitalizable expenditures have been properly expensed d Expenditures for plant assets have been capitalized (AICPA ADAPTED) a 15 Which of the following explanations might satisfy an auditor who discovers significant debits to an accumulated depreciation account? a Extraordinary repairs have lengthened the life of an asset b Prior years' depreciation charges were erroneously understated c A reserve for possible loss on retirement has been recorded d An asset has been recorded at its fair value (AICPA ADAPTED) c 16 a b c d d 17 When an outside specialist has assumed full responsibility for taking the client's physical inventory, reliance on the specialist's report is acceptable if a The auditor is satisfied about the specialist's reputation and competence b Circumstances make it impracticable or impossible for the auditor either to the work personally or to observe the specialist's work c The auditor performs the same tests and procedures as would have been applicable if the client's employees took the physical inventory d The auditor's report assumes full responsibility (AICPA ADAPTED) d 18 An auditor's tests of a client's cost accounting system are designed primarily to determine that a Quantities on hand have been computed based on acceptable methods that reasonably approximate actual quantities on hand b Physical inventories substantially agree with book inventories c The system complies with generally accepted accounting principlesand functions as planned d Costs have been assigned properly to finished goods, work in process, and cost of goods sold Which of the following activities is not common to the conversion cycle? Maintaining perpetual inventory records Accounting for fixed asset disposals and retirements Implementing a just-in-time order entry system Recording depreciation allocations (AICPA ADAPTED) 99 d 19 Sanbor Corporation's parts inventory consists of thousands of different items that are small in value individually, but quite significant in total Sanbor could establish effective control over the parts by requiring a An officer's approval of requisitions for inventory parts b Maintaining inventory records for all parts included in the inventory c Physical counts on a cycle basis rather than at year-end d Separation of the storekeeping function from the production and inventory record-keeping functions (AICPA ADAPTED) c 20 When verifying debits to a manufacturing company's perpetual inventory records, an auditor would be most interested in testing a sample of purchase a Approvals b Requisitions c Invoices d Orders (AICPA ADAPTED) c 21 a b c d a 22 Which of the following is not likely a motive for management to manipulate the timing and amount of impaired asset writedowns? a Steady increases in earnings per share over the past years b Income smoothing c A "big bath." d An abnormally unprofitable year c 23 The audit of year-end physical inventories should include steps to verify that the client's purchases and sales cutoffs were adequate The audit steps should be designed to detect whether merchandise included in the physical count at year-end was not recorded as a a Sale in the subsequent period b Purchase in the current period c Sale in the current period d Purchase return in the subsequent period (AICPA ADAPTED) d 24 a b c d b 25 Which of the following internal control efficiencies relates to factory equipment? a Checks issued in payment of purchases of equipment are not signed by the controller b All purchases of factory equipment are required to be made by the department that needs the equipment c Factory equipment replacements are generally made when estimated useful lives have expired d Proceeds from sales of fully depreciated equipment are credited to other income (AICPA ADAPTED) 26 When auditing fixed assets, an auditor attempts to determine all of the following except a Control risk c Assets may suffer an impairment in value for a variety of reasons, but not likely as a result of: A corporate restructuring Slumping demand for uncompetitive products Significant increases in market share Obsolescence An auditor would be most likely to learn of slow-moving inventory through Inquiry of sales personnel Inquiry of stores personnel Physical observation of inventory Review of perpetual inventory records (AICPA ADAPTED) 100 b Property abandoned during the year c Adequacy of replacement funds d Reasonableness of depreciation (AICPA ADAPTED) c 27 Which of the following is the best evidence that an entity owns real estate at the balance sheet date? a Title insurance policy b Original deed c Paid real estate tax bills d Closing statement (AICPA ADAPTED) b 28 Which of the following procedures would least likely lead the auditor to detect unrecorded fixed asset disposals? a Examine insurance policies b Review repairs and maintenance expense c Review property tax files d Scan invoices for fixed asset additions (AICPA ADAPTED) c 29 a b c d The auditor may conclude that depreciation charges are insufficient by noting Insured values greatly in excess of book values Large amounts of fully depreciated assets Continuous trade-ins of relatively new assets Excessive recurring losses on assets retired (AICPA ADAPTED) d 30 In violation of company policy, Lowell Company erroneously capitalized the cost of painting its warehouse An auditor would most likely detect this when a Discussing capitalization policies with Lowell's controller b Examining maintenance expense accounts c Observing that the warehouse had been painted d Examining construction work orders that support items capitalized during the year (AICPA ADAPTED) SHORT ANSWER Explain the conversion cycle Answer: The conversion cycle encompasses the production of finished products for sale, and relates directly to two other cycles It uses resources and information provided by the expenditure/disbursement cycles and provides resources and information to the revenue/receipt cycle To control inventory recording what controls should management have in place? Answer: To avoid misstated or misplaced inventory used or transferred inventory should be recorded in the correct amounts, be recognized in the proper period, and be classified properly To control inventory recording, management could establish processing and recording procedures, prenumber and control material release forms and production orders, and maintain logs of inventory movement into and out of storerooms and production 101 How should management safeguard inventory from fraud or misappropriation? Answer: Access to inventory should be restricted to personnel authorized by management Management could establish physical control over inventory, maintain insurance, both for inventory and for inventory personnel in the form of fidelity bonds and segregate responsibility for handling inventory from inventory recording, cost accounting, and general accounting Management should also restrict access to production, cost accounting, and perpetual inventory records, preventing misuse, destruction, or loss of inventory or inventory records Explain the internal controls management can use to assure control over the transaction authorization of fixed assets Address the separate controls for transaction authorization, execution, and recording Answer: To control unauthorized transactions, management could develop written procedures for all additions, disposals, and retirements, and periodically compare scrap sale prices with published price lists Transaction Authorization – Prepare written procedures for all additions, disposals, and retirements Periodically compare prices received for scrap with published prices Transaction Execution – Establish procedures for operating, using, moving, and otherwise controlling fixed assets Restrict access to movable fixed assets Recording – Establish procedures for processing and recording fixed asset transaction Establish procedures for identifying fixed assets eligible for disposal Maintain detailed fixed assets records Periodically reconcile fixed asset records with existing assets and investigate differences Establish policies for determining depreciation methods and for calculating depreciation on all categories of fixed assets Describe the preliminary review process as it pertains to obtaining an understanding of a client’s inventory controls relating to inventory Answer: An auditor performs the preliminary review for inventory by reading the client’s procedures manuals andby interviewing client personnel who are responsible for perpetual inventory records, cost records, and inventory accounting Assuming the existing controls appear potentially reliable in assessing control risk below the maximum, an auditor proceeds by documenting the system PROBLEMS Complete the table below as it concerns to the related assertions and audit procedures of inventory and fixed assets accounts Assertions Existence or Occurrence Inventory Completeness 102 Fixed Assets Rights and Obligations Valuation or allocation Presentation and Disclosure Answer: Assertions Existence or Occurrence Completeness Rights and Obligations Valuation or allocation Presentation and Disclosure Inventory Observe physical inventory Confirm off-premises inventory Test cutoff Observe physical inventory Confirm off-premises inventory Test cutoff Perform analytical procedures Confirm off-premises inventory Test cutoff Review consignment and purchase commitments Test final priced inventory Review physical inventory for obsolete, slow moving, otherwise unsalable goods Compare statement presentation and disclosures with those required by GAAP Fixed Assets Observe asset additions Test cutoff Observe asset additions Test cutoff Perform analytical procedures Test additions Test cutoff Examine contracts and other documentation Verify accuracy of recorded fixed assets and depreciation expense Test additions and disposals Compare statement presentation and disclosures with those required by GAAP Complete the questionnaire with applicable questions that an auditor may use to address fixed assets control procedures Give at least two questions for each of the following categories: Fixed Asset Records Additions Disposals and Retirements Depreciation Answer, Yes, No, or N/A Question Answer: Students’ answers may include the following possibilities 103 Remarks Answer, Yes, No, or N/A Question Fixed Asset Records Are detailed records maintained for each class of fixed assets? Is responsibility for maintaining fixed asset records segregated from responsibility for physically controlling fixed assets and from general accounting? Are detailed records reconciled periodically with general ledger control accounts? Are procedures followed to determine whether recorded fixed assets actually exist? Is access to and the use of fixed assets restricted to authorized personnel? Is insurance coverage maintained and reviewed for all fixed assets? Are fixed assets physically safeguarded from deterioration and theft? Additions Do procedures require authorization by the board of directors or senior management for fixed asset additions? Are actual expenditures for fixed assets compared with amounts authorized? Are procedures established to assure that fixed assets purchased are delivered in accordance with orders placed? Are fixed asset additions promptly recorded in fixed asset records? Are fixed asset additions promptly reported to general accounting? Are insurance companies notified of fixed asset additions in order to increase insurance coverage? Is construction in progress – whether internally or externally contracted – authorized and periodically inspected? 104 Remarks Answer, Yes, No, or N/A Question Disposals and Retirements Do procedures require authorization by the board of directors or senior management for fixed asset disposals and retirements? Are procedures established to assure that the proceeds from fixed asset disposals are recorded properly and deposited? Are fixed asset disposals and retirements promptly record in fixed asset records? Are fixed asset additions promptly reported to general accounting for recording gains or losses? Are insurance companies notified of fixed asset disposals and retirements to assure that insurance coverage is altered accordingly? Depreciation Are procedures established to assure that additions are added to depreciation records and that disposals/retirements are deleted? Are procedures established to assure that depreciation is recorded only for those fixed assets actually in service during the period? Are procedures established for determining depreciation methods, estimated useful lives, and salvage values? 105 Remarks 106 ... additions Test cutoff Observe asset additions Test cutoff Perform analytical procedures Test additions Test cutoff Examine contracts and other documentation Verify accuracy of recorded fixed assets and. .. finished products for sale, and relates directly to two other cycles It uses resources and information provided by the expenditure/disbursement cycles and provides resources and information to the... proper period, and be classified properly To control inventory recording, management could establish processing and recording procedures, prenumber and control material release forms and production