Auditing and Assurance Services, 15e, Global Edition (Arens)
Chapter 19 Completing the Tests in the Acquisition and Payment Cycle: Verification of
Selected Accounts
1) Which of the following accounts is not associated with the acquisition and payment cycle?
A) Common stock
B) Property, plant and equipment
C) Accrued property taxes
D) Income tax expense
Answer: A
2) Which of the following expenses is not typically evaluated as part of the audit of the
acquisition and payment cycle?
A) Depreciation expense
B) Insurance expense
C) Estimated liability for warranties
D) Property tax expense
Answer: C
3) You are auditing the acquisition and payment cycle and note the presence of excessive
recurring losses on retired assets. You may conclude that:
A) insured values are greater than book values.
B) there are a large number of fully depreciated assets.
C) depreciation charges may by insufficient.
D) company has a policy of selling relatively new assets.
Answer: C
4) Which of the following would generally not be a component of the audit of the acquisition
and payment cycle?
A) Adequacy of controls over acquisitions of long-lived assets
B) Tracing disposals of long-lived assets to the fixed asset master file
C) Determining the adequacy of the funds available for capital expenditures
D) Reperformance of recorded depreciation expense
Answer: C
5) Normally it may be unnecessary to examine supporting documentation for each addition to
property, plant, and equipment, but it would be customary to verify:
A) all large transactions.
B) all unusual transactions.
C) a representative sample of typical additions.
D) all three of the above.
Answer: D
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6) The auditor must know the client's capitalization policies to determine whether acquisitions
are:
A)
Treated consistently with
those of the preceding
Recorded at historical cost year Necessary
Yes Yes Yes
B)
Treated consistently with
those of the preceding
Recorded at historical cost year Necessary
Yes No No
C)
Treated consistently with
those of the preceding
Recorded at historical cost year Necessary
No No No
D)
Treated consistently with
those of the preceding
Recorded at historical cost year Necessary
No Yes No
Answer: D
7) To be capitalized as part of property, plant and equipment, assets must:
A) have expected useful lives of more than one year.
B) not be acquired for resale.
C) be useful in multiple productive capacities within the organization.
D) A and B, but not C.
Answer: D
8) The primary accounting record for manufacturing equipment and other fixed assets is the:
A) depreciation ledger.
B) fixed asset master file.
C) asset inventory.
D) equipment roster.
Answer: B
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9) Which of the following statements about the audit of fixed assets is the least correct?
A) The primary accounting record for manufacturing equipment and other property, plant and
equipment is generally a fixed asset master file.
B) Manufacturing equipment and current assets are normally audited in the same fashion
regardless of the activity within a particular account.
C) The emphasis on auditing fixed assets is on verification of current-period acquisitions.
D) Failure to record the acquisition of a fixed asset affects the income statement until the assets
are fully depreciated.
Answer: B
10) You are the in-charge auditor for a company who has been an audit client for several years.
Which of the following is not a category of tests commonly associated with the audit of
manufacturing equipment?
A) Verification of depreciation expense
B) Analytical procedures
C) Verification of current-period disposals
D) Verification of the beginning balance in the equipment account
Answer: D
11) The audit procedure that requires an auditor to "foot the acquisition schedule" relates to
which balance-related audit objective?
A) Classification
B) Detail tie-in
C) Existence
D) Cut-off
Answer: B
12) You are auditing Manufacturing Company and testing the audit related objective of
completeness for the equipment accounts. Which of the following audit procedures is most likely
to achieve your objective?
A) Examine vendor invoices and receiving reports.
B) Physically examine assets.
C) Examine vendor invoices of closely related accounts such as repairs and maintenance.
D) Trace individual acquisitions to the fixed asset master file.
Answer: C
13) Which of the following audit procedures would be the most correct in determining the audit
objective of existence for the equipment account in the fixed asset master file?
A) Examine vendor invoices and receiving reports.
B) Review transactions near the balance sheet date.
C) Recalculate vendor invoices.
D) Examine vendor invoices for correct accounting treatment.
Answer: A
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14) The source of debits in the equipment account is the:
A) sales journal.
B) cash disbursements journal.
C) cash receipts journal.
D) acquisitions journal.
Answer: D
15) Failure to capitalize a fixed asset at the correct amount would impact which financial
statements until the company disposes of the asset?
A) The balance sheet only
B) The income statement only
C) The cash flow statement only
D) Both the income statement and the balance sheet
Answer: D
16) Which of the following tests are typically not necessary when auditing a client's schedule of
recorded disposals?
A) Footing the schedule
B) Tracing schedule totals to the general ledger
C) Tracing cost and accumulated depreciation of the disposals to the property master file
D) All of the above are necessary.
Answer: D
17) Which of the following is an analytical procedure to determine if there is idle equipment or
equipment that was disposed of but not written off?
A) Compare depreciation expense divided by gross equipment cost with previous years.
B) Compare gross manufacturing cost divided by some measure of production with previous
years.
C) Compare accumulated depreciation divided by gross equipment cost with previous years.
D) Compare annual repairs and maintenance accounts with previous years.
Answer: B
18) A set of records for each piece of equipment that includes descriptive information, date of
acquisition, original cost, current year depreciation, and accumulated depreciation is the:
A) acquisitions journal.
B) depreciation schedule.
C) fixed asset master file.
D) file of purchase requisitions.
Answer: C
19) When performing the test of details of balances, the balance-related audit objective of
classifications is closely related to the objective of:
A) accuracy.
B) detail tie-in.
C) existence.
D) completeness.
Answer: D
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20) In testing acquisitions the auditor needs to understand the appropriate accounting guidance
related to acquisition accounting. Which of the following is not an accounting consideration for
the auditor as regards to acquisition cost?
A) Inclusion of material transportation and installation costs
B) Recording of trade-in costs
C) Allocating costs when building and equipment are purchased at one price
D) Verifying that purchased equipment amounts correspond to the budgeted amount
Answer: D
21) Methods used to determine if there are legal encumbrances related to fixed assets include all
but which of the following?
A) Reading terms of loan and credit agreements
B) Reviewing loan confirmations received from banks
C) Having discussions with the client or sending letters to legal counsel
D) All of the above may be used to identify legal encumbrances.
Answer: D
22) The test of details of balances procedure to "examine vendors' invoices of closely related
accounts such as repairs to uncover items that should be property, plant, and equipment" satisfies
the audit objective of:
A) completeness.
B) detail tie-in.
C) cutoff.
D) existence.
Answer: A
23) The auditor's starting point for verifying disposals of property, plant, and equipment is the:
A) equipment account in the general ledger.
B) file of shipping documents.
C) client's schedule of recorded disposals.
D) equipment subsidiary ledger.
Answer: C
24) Improperly classifying a fixed asset by recording the amount in the repairs and maintenance
expense account will have an effect on which of the following financial statements until the asset
would normally have been depreciated?
A) The balance sheet
B) The income statement
C) The cash flow statement
D) Both the income statement and the balance sheet
Answer: D
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25) Because the failure to record disposals of property, plant, and equipment can significantly
affect the financial statements, the search for unrecorded disposals is essential. Which of the
following is not a procedure used to verify disposals?
A) Make inquiries of management and production personnel about the possibility of the disposal
of assets.
B) Review whether newly acquired assets replace existing assets.
C) Test the valuation of fixed assets recorded in prior periods.
D) Review plant modifications and changes in product line, taxes, or insurance coverage.
Answer: C
26) A major consideration in verifying the ending balance in fixed assets is the possibility of
existing legal encumbrances. Tests to identify possible legal encumbrances would satisfy the
audit objective of:
A) existence.
B) presentation and disclosure.
C) detail tie-in.
D) classification.
Answer: B
27) When auditing depreciation expense, the two major concerns related to the accuracy audit
objective are:
A) consistent application of depreciation method and useful lives.
B) consistent application of depreciation method and classification of assets.
C) correctness of calculations and consistent application of depreciation policies.
D) cost of the fixed asset and useful lives.
Answer: C
28) The auditor needs to gain reasonable assurance that the equipment accounts in the fixed asset
master file are not understated. Which of the following accounts would most likely be reviewed
in making that determination?
A) Depreciation expense
B) Repairs and maintenance expense
C) Gains/losses on sales and retirements
D) Cash
Answer: B
29) Changing circumstances may require a change in the useful life of an asset. When this
occurs, it involves a change in:
A) accounting estimate rather than a change in accounting principle.
B) accounting principle rather than a change in accounting estimate.
C) both accounting principle and accounting estimate.
D) neither accounting principle nor accounting estimate.
Answer: A
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30) The auditor normally does not need to test the accuracy or classification of fixed assets
recorded in prior periods if they are the continuing auditor because:
A) they are rarely material to the audit.
B) they rarely contain misstatements.
C) they are verified in previous audits.
D) they don't affect the balance sheet.
Answer: C
31) The auditor is examining the accounting entries made to the accumulated depreciation
account during the year and notices a significant amount of debits to the account. Which of the
following provides the most logical explanation?
A) Large number of asset retirements
B) Salvage values were revised downward
C) Useful lives were revised downward
D) Allocation of fixed overhead were revised
Answer: A
32) In determining the reasonableness of the client's amount for depreciation expense the auditor
is primarily concerned that the client has followed a consistent policy and the calculations are
correct. Which of the following audit objectives best addresses the above concerns?
A) Existence
B) Accuracy
C) Valuation
D) Allocation
Answer: B
33) Which of the following audit procedures would be least likely to lead the auditor to find an
unrecorded fixed asset disposal?
A) Examination of insurance policies
B) Review of repairs and maintenance expense
C) Review of property tax files
D) Scanning of invoices for fixed asset additions
Answer: B
34) The most common audit test to verify equipment additions is to:
A) examine vendors' invoices.
B) perform an inventory of the fixed assets.
C) confirm the additions with the vendors.
D) trace the vendor invoices to the cash disbursements journal.
Answer: A
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35) The auditor is testing for unrecorded retirements/disposals of equipment. Which of the
following audit procedures would the auditor most likely use?
A) Select items from the fixed asset master file and then physically locate them.
B) Examine the repairs and maintenance amount for large debits.
C) Compare current years depreciation expense with the previous year's depreciation expense.
D) Trace acquisition documents to the fixed asset master file.
Answer: A
36) The failure to capitalize a permanent asset, or the recording of an asset acquisition at the
improper amount, affects the balance sheet:
A) forever.
B) for the current period.
C) for the depreciable life of the asset.
D) until the firm disposes of the asset.
Answer: D
37) One of the primary objectives in examining the repairs and maintenance accounts is to obtain
evidence that:
A) expenditures of equipment have not been charged to expense.
B) the actual amount recorded is the same as the budgeted amount.
C) expenditures for equipment have been recorded in the proper period.
D) revenue expenditures made on behalf of equipment have been recorded in the proper period.
Answer: A
38) 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.
Answer: A
39) Which of the following accounts would normally not be a part of the acquisition and
payment cycle of Prepaid Insurance?
A) Cash
B) Insurance Payable
C) Insurance Expense
D) Prepaid Insurance
Answer: B
40) Which type of audit procedure would normally be sufficient for purposes of auditing prepaid
expenses and deferred charges?
A) Tests of controls
B) Tests of transactions
C) Tests of details of balances
D) Analytical procedures
Answer: D
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41) When an auditor recomputes the unexpired portion of prepaid insurance, they are satisfying
which audit objective?
A) Completeness
B) Existence
C) Accuracy and detail tie-in
D) Rights
Answer: C
42) A record of insurance policies in force and the due date of each policy is contained in the:
A) voucher register.
B) insurance register.
C) insurance expense account.
D) prepaid insurance account.
Answer: B
43) Insurance expense for the period is a function of which of the following?
A) The beginning prepaid balance, current premium payments and the ending prepaid balance
B) The beginning prepaid balance and the current period premium payments
C) The current period premium payments
D) The current period premium payments and the ending prepaid balance
Answer: A
44) In connection with a review of the prepaid insurance account, which of the following audit
procedures would you be least likely to use?
A) Recompute the portion of the premium that expired during the year.
B) Prepare excerpts of insurance policies for audit working papers.
C) Confirm premium rates with an independent insurance broker.
D) Examine support for premium payments.
Answer: C
45) Controls over the acquisition and recording of insurance are a part of which of the following
transaction cycles?
A) Inventory and warehousing cycle
B) Capitalization cycle
C) Treasury cycle
D) Acquisition and payment cycle
Answer: D
46) Which balance-related audit objective is not relevant to an audit of prepaid expenses?
A) Rights
B) Accuracy
C) Detail tie-in
D) Realizable value
Answer: D
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47) When auditing accrued property taxes:
A) the source for the debits to the liability account is the acquisitions journal.
B) realizable value is an important balance-related audit objective.
C) the ending balance in the account should be confirmed with the applicable taxing authority.
D) the most important consideration for the auditor is that the same portion of each tax payment
for the accrual that was used in the preceeding year is used in the current year.
Answer: D
48) The estimated unpaid obligations for services or benefits that have been received before the
balance sheet date are:
A) accounts payable.
B) accounts receivable.
C) unearned liabilities.
D) accrued liabilities.
Answer: D
49) When auditors verify accrued property taxes two audit objectives are especially significant.
These are:
A) completeness and accuracy.
B) completeness and net realizable value.
C) detail tie-in and completeness.
D) accuracy and classification.
Answer: A
50) When auditing accrued property taxes:
A) the auditors will generally only verify the larger payments since there are usually many
property tax payments.
B) property taxes should only be charged to one expense account.
C) the auditor begins by obtaining a schedule of property tax payments from the client.
D) the auditor must generally spend a considerable amount of time in this area.
Answer: C
51) The audit procedures used to verify accrued liabilities differ from those employed for the
verification of accounts payable because:
A) accrued liability balances are less material than accounts payable balances.
B) accrued liabilities at year end will become accounts payable during the following year.
C) evidence supporting accrued liabilities is non-existent, whereas evidence supporting accounts
payable is readily available.
D) accrued liabilities usually pertain to services of a continuing nature, whereas accounts payable
are the result of completed transactions.
Answer: D
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52) Which of the following audit tests both have the effect of simultaneously verifying balance
sheet and income statement accounts?
A) Analytical procedures and substantive tests of transactions
B) Tests of controls and substantive tests of transactions
C) Tests of details of balances and substantive tests of transactions
D) Tests of controls and analytical procedures
Answer: B
53) The most effective and efficient audit approach in the examination of the income statement
would be which of the following?
A) Examine income statement accounts concurrently with the related balance sheet accounts.
B) Compare company's components of net income to other businesses in the same industry.
C) Compare company's components of net income to the previous two years.
D) Examine changes in all balance sheet accounts.
Answer: A
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Short Answer Questions
1) Explain the audit objective allocation and why it is important to have accurate allocation
within the financial statements, particularly for property, plant, and equipment
Answer:
Allocation is the process of assigning a portion of the cost of an asset to a product or a period.
For example, calculating and then recording depreciation expense is an allocation process. It is
important to determine when an expenditure is an asset or a current period expense so that the
financial statements are fairly stated. If the client fails to follow accounting standards or fails to
calculate the allocation correctly, then financial statements can be materially misstated.
2) Describe the audit procedures used to verify the accuracy and detail tie-in objectives for
prepaid insurance.
Answer:
The accuracy objective is tested by verifying the amount of the insurance premium, the length of
the policy period, and the allocation of the premium to unexpired insurance. The amount of the
premium for a given policy and its time period can be verified at the same time by examining the
premium invoice or the confirmation from an insurance agent. After these two have been
verified, the client's calculations of unexpired insurance can be tested by recalculation. The
schedule of prepaid insurance can then be footed and the totals traced to the general ledger to
complete the detail tie-in tests.
3) Discuss the key internal controls for prepaid insurance that affect the auditor's extent of testing
of the prepaid insurance account.
Answer:
Internal controls for prepaid insurance and insurance expense can be conveniently divided into
three categories: controls over the acquisition and recording of insurance, controls over the
insurance register, and controls over the charge-off of insurance expense. Controls over the
acquisition and recording of insurance are a part of the acquisition and payment cycle and
include proper authorization for new insurance policies and payment of insurance premiums. An
insurance register, which is a record of insurance policies in force and the expiration date of each
policy, is an essential control to make sure that the company has adequate insurance at all times.
The control should include a provision for periodic review of the adequacy of the insurance
coverage by an independent qualified person. The detailed records of the information in the
insurance register should be verified by someone independent of the person preparing them.
Companies often have a closely related control which is to have a standard monthly journal entry
to reclassify prepaid insurance as insurance expense.
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4) Describe the two tests auditors can perform to test for the existence and omissions of
insurance policies in force.
Answer:
The verification of existence and tests for omissions of the insurance policies can be tested in one
of two ways: by examining a sample of insurance invoices and policies in force for comparison
to the schedule, or by obtaining a confirmation of insurance information from the company's
insurance agent.
5) What are several analytical procedures used in the audit of prepaid insurance and insurance
expense?
Answer:
1. Compare total prepaid insurance and insurance expense with previous years.
2. Compute the ratio of prepaid insurance to insurance expense and compare it with previous
years.
3. Compare the individual insurance policy coverage on the schedule of insurance obtained
from the client with the preceding year's schedule as a test of elimination of certain policies or a
change in insurance coverage.
4. Compare the computed prepaid insurance balance for the current year on a policy-by-policy
basis with that of the preceding year as a test of an error in the calculation.
5. Review the insurance coverage listed on the prepaid insurance schedule with an appropriate
client official or insurance broker for adequacy of coverage.
6) Property, plant, and equipment is normally audited in a different manner than current asset
accounts. State three reasons why this is so, and discuss the differences in how property, plant,
and equipment is audited compared to current assets.
Answer:
• There are usually fewer current period acquisitions of property, plant, and equipment than
current assets.
• The amount of any given acquisition is often material.
• The equipment is likely to be kept and maintained in the accounting records for several years.
Because of these three differences, the emphasis in auditing property, plant, and equipment is on
the verification of current period acquisitions rather than on the balance in the account carried
forward from the preceding year. In addition, the expected life of assets over one year requires
depreciation expense and accumulated depreciation accounts, which are verified as a part of the
audit of the assets.
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7) State four of the seven specific balance-related audit objectives for property, plant, and
equipment additions and, for each objective, describe one common test of details of balances.
Answer:
• Current-year acquisitions in the acquisitions schedule agree with related master file
amounts, and the total agrees with the general ledger (detail tie-in).(1) Foot the acquisitions
schedule, (2) trace the individual acquisitions to the master file for amounts and descriptions, and
(3) trace the total to the general ledger.
• Current-year acquisitions as listed exist (existence). (1)Examine vendors' invoices and
receiving reports and (2) physically examine assets.
• Existing acquisitions are recorded (completeness). (1) Examine vendors' invoices of closely
related accounts such as repairs and maintenance to uncover items that should be recorded as
equipment, and (2) review lease and rental agreements.
• Current-year acquisitions as listed are accurate (accuracy). Examine vendors' invoices.
• Current-year acquisitions as listed are correctly classified (classification).(1) Examine
vendors' invoices in various equipment accounts to uncover items that should be classified as
manufacturing or office equipment, part of buildings, or repairs, (2) examine vendors' invoices of
closely related accounts such as repairs to uncover items that should be recorded as equipment,
and (3) examine rent and lease expense for capitalizable leases.
• Current-year acquisitions are recorded in the correct period (cutoff). Review transactions
near the balance sheet date for correct period.
• The client has rights to current-year acquisitions (rights). Examine vendors' invoices.
8) The primary accounting record for property, plant, and equipment accounts is the fixed asset
master file. What is included for each fixed asset in the master file?
Answer:
Description of the asset
Date of acquisition
Original cost
Current year depreciation
Accumulated depreciation for the asset
9) The auditor receives the client's schedule of recorded disposals and then performs detail tie-in
tests of the recorded disposals schedule. What procedures does the auditor perform on the client's
schedule of recorded disposals?
Answer:
Footing the schedule
Tracing the totals on the schedule to the recorded disposals in the general ledger
Tracing the cost and accumulated depreciation of the disposals to the property master file
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10) In auditing depreciation expense, one of the auditor's concerns is determining that the client's
calculations are correct. In making this determination,the auditor must weigh four considerations.
List these four considerations.
Answer:
1. The useful life of current period acquisitions
2. The method of depreciation
3. The estimated salvage value
4. The policy of depreciating assets in the year of acquisition and disposition
11) In testing acquisitions, the auditor must understand the relevant accounting standards to
ensure the client adheres to accepted accounting practices for property, plant, and equipment.
Describe three of the auditor's concerns in this area.
Answer:
Inclusion of material transportation and installation cost as part of the asset's acquisition cost
Failure to properly record the trade-in of existing equipment
Client's capitalization policy to determine whether acquisitions are treated consistently with
those of the preceding year
Examine whether the client has the right to record the equipment as an asset (Capitalization of
leased equipment or classification of the equipment as an operating lease)
Correct classification among various equipment accounts
Improper inclusion of transactions that should be recorded as assets in repairs and maintenance
expense, lease expense, supplies, small tools, and similar accounts
12) When auditing disposals of property, plant, and equipment, the search for unrecorded
disposals is essential. State the four audit procedures frequently used for verifying disposals.
Answer:
• Review whether newly acquired assets replace existing assets
• Analyze gains and losses on the disposal of assets and miscellaneous income for receipts
from the disposal of assets
• Review plant modifications and changes in product lines, changes in major costly computer-
related equipment, property taxes, or insurance coverage for indications of deletions of
equipment
• Make inquiries of management and production personnel about the possibility of the disposal
of assets
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13) Discuss the key internal controls related to the disposal of property, plant, and equipment.
Answer:
The most important internal control over the disposal of property, plant, and equipment is the
existence of a formal method to inform management of the sale, trade-in, abandonment, or theft
of recorded machinery and equipment. Formal methods of tracking disposals and provisions for
proper authorization of the sale or other disposal of equipment help reduce the risk of
misstatement. There should also be adequate internal verification of recorded disposals to make
sure that assets are correctly removed from the accounting records.
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