CH 10

Chapter 10 - Finance and Investment Cycle
CHAPTER 10
Finance and Investment Cycle
LEARNING OBJECTIVES
Review
Checkpoints
Multiple Choice
Exercises,
Problems, and
Simulations
53, 59(*), 60(*)
1.
Describe the finance and investment cycle,

including typical source documents and
controls.
1, 2, 3, 4
23, 24, 26, 31
2.
Give examples of tests of controls over debt

and owners equity transactions and
investment transactions.
5, 6, 7, 8
22, 32, 42
47
3.
Describe substantive procedures for finance

and investment accounts.
9, 10, 11, 12,

13, 14, 15, 16,
17
25, 27, 28, 29, 30,

33, 34, 35, 37, 38,
39, 40, 41, 43, 44,
45, 46
48(*), 49, 50(*),

51, 52(*), 53(*),
54, 55, 56, 57
4.
Describe common errors and frauds in the

accounting for capital transactions and
investments, and design audit and
investigation procedures for detecting them.
18, 19, 20, 21
36
48(*), 49, 50(*),

51, 52(*), 53(*),
54, 55, 56, 57, 58,
59(*), 60(*), 61
(*)Items relates to multiple learning objectives
SOLUTIONS FOR REVIEW CHECKPOINTS

10.1
The authorization for investments usually takes place at the highest levels of the organization. An
investment philosophy may be stated or endorsed by the board of directors and specific authorization for
each transaction may come from the CEO or CFO. Such investments may involve millions of dollars and
may be instrumental to the strategic objectives of the organization, commanding the authorization of senior
management
10.2
Actions by the board of directors or finance committee are usually required as authorization for notes
payable. Auditors would want to read all minutes of the board and executive committees, extracting copies
of all financial matters, including notes payable authorizations.
10-1
Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.

10.3
10.4
To obtain relevant audit data about investment securities, auditors procedures include:
Inspecting the securities in the presence of a responsible client officer.
Personally examining the securities while other negotiable fund sources are sealed off or are being
examined simultaneously.
Obtaining a written statement from the clients representative that the securities were returned
intact.
Obtaining the information by confirmation from an independent party (e.g., trustee) who holds the
securities.
A controlled count of the clients investment securities consists of the audit teams gaining access to the
securities in the presence of a responsible client officer. The count is first controlled by simultaneously
counting or sealing off other negotiable funds (such as securities held as collateral) and second by the
auditors personally conducting the count. When the count is completed, the auditors should obtain a
written statement from the clients officer that the securities were returned intact.
A securities count working paper should include a record of the name of the company represented by the
certificate, the interest rate for bonds, the dividend rate for preferred stocks, the due date for bonds, the
serial numbers on the certificates, the face value of bonds, the number or face amount of bonds and stock
shares, and notes on the name of the owner shown on the face of the certificate or on the endorsements on
the back (should be the client company).
10.5
A compensating control for finance and investment cycle accounts is a control feature used when the
company does not specify a standard control procedure (such as strict separation of functional
responsibilities). In the area of finance and investment, the compensating control feature is the involvement
of two or more persons in each kind of important functional responsibility.
If involvement by multiple persons is not specified, then oversight or review can be substituted. For
example, the board of directors can authorize purchase of securities or creation of a partnership. The CFO
or CEO can carry out the transactions, have custody of certificates and agreements, manage the partnership
or the portfolio of securities, oversee the record keeping, and make the decisions about valuations and
accounting (authorizing the journal entries). These are rather normal management activities, and they
combine several responsibilities. The compensating control can exist in the form of periodic reports to the
board of directors, oversight by the investment committee of the board, and internal audit involvement in
making a periodic reconciliation of securities certificates in a portfolio with the amounts and descriptions
recorded in the accounts.
10.6
According to auditing standards (SAS 57, AU 342) specific relevant aspects of control over the production
of accounting estimates include:
Management communication of the need for proper accounting estimates.

Accumulation of relevant, sufficient, and reliable data for estimates.
Preparation of estimates by qualified personnel.
Adequate review and approval by appropriate levels of authority.
Comparison of prior estimates with subsequent results to assess the reliability of the estimation
outcomes.
Consideration by management of whether particular accounting estimates are consistent with the
companys operational plans.
10-2
Education.

Auditors can make these inquiries:
Who prepares estimates?

When are they prepared?
What data is used?
Who reviews and approves the estimates?
Have you compared prior estimates with subsequent actual events?
10.7
When a company has produced an estimate of an investment valuation based on a nonmonetary exchange,
an auditor can look at the companys tax return to check on consistent tax treatment.
10.8
Transactions in long-term debt, capital stock, paid-in capital, and retained earnings are usually not tested as
a matter of an internal control evaluation. These transactions are generally audited completely by reference
to authorizations, tracing them to events reflected in the accounts and related disclosures, and by vouching
to cash receipts and disbursements and other formal documentation for verification of the transaction
amounts. Subjecting these transactions to detailed audit procedures is explained by the great importance of
these transactions and their limited number.
10.9
Some of the typical assertions found in owners equity descriptions and account balances are:
10.10
The number of shares shown as issued is in fact issued.
No other shares (including options, warrants, and the like) have been issued and not recorded or
reflected in the accounts and disclosures.
The accounting is proper for options, warrants, and other stock issue plans, and related disclosures
are adequate.
The valuation of shares issued for noncash consideration is proper in conformity with accounting
principles.
The board of directors has authorized all owners equity transactions.
Some of the important assertions found in the long-term liability accounts are:
All material long-term liabilities are recorded.
Liabilities are properly classified according to their current or long-term status. The current
portion of long-term debt is properly valued and classified.
New long-term liabilities and debt extinguishments are properly authorized.
Terms, conditions, and restrictions relating to noncurrent debt are adequately disclosed.
Disclosures of maturities for the next five years and the capital and operating lease disclosures are
accurate and adequate.
All important contingencies are either accrued in the accounts or disclosed in footnotes.
Liabilities are appropriate valued.
10-3
Education.
10.11
a.
Confirmations for stockholder equity: Capital stock may be subject to confirmation when
independent registrars and transfer agents are employed. Such agents are responsible for knowing the
number of shares authorized and issued and for keeping lists of stockholders names. The basic information
about capital stock, such as number of shares, classes of stock, preferred dividend rates, conversion terms,
dividend payments, shares held in the company name, expiration dates, and terms of warrants and stock
dividends and splits, can be confirmed with the independent agents. Many of these items can be
corroborated by the auditors own inspection and reading of stock certificates, charter authorizations,
directors minutes, and registration statements. However, when there are no independent agents, most audit
evidence is gathered by vouching stock record documents (such as certificate book stubs). When
circumstances call for extended procedures, information on outstanding stock (very small, closely held
companies) may be confirmed directly with the holders.
b.
Notes and bonds payable: Written confirmations are usually obtained from the independent
parties. If the notes are payable to banks, the standard bank confirmation may be used. Formal debt
instruments can be confirmed by letter to the holder or his or her agent. The confirmation requests should
include questions of amount, interest rate, due date, collateral, restrictive covenants, and other terms. To aid
in the search for unrecorded liabilities, confirmation requests should be sent to lenders with whom the
company has done business in the recent past even if no liability balance is shown at the confirmation date.
10.12
The information that can be confirmed when independent registrars and transfer agents are utilized by the
client include the items as features of interest in the answer to review question 10.9. Many of these items
can be corroborated by the auditors inspecting the reports from these agents, reading the minutes of the
directors, and reading prospectuses.
10.13
Off-balance-sheet information refers to information that relates to obligations and commitments assumed
by the clients that do not appear on the balance sheet as current or long-term liabilities. Such information
should be disclosed by the client in the footnotes to the financial statements. Therefore, the auditors must
be alert to these items and gather evidence that will allow the auditors to determine whether the footnote
disclosure is adequate. Such information includes leases, endorsements on discounted notes or others
obligations, guarantees, repurchase or remarketing agreements, commitments to purchase at fixed prices,
commitments to sell at fixed prices, legal judgment, litigation, and pending litigation.
10.14
If a company does not monitor notes payable for due dates and interest payment dates in relation to
financial statement dates, these misstatements can appear in the financial statements:
Understated interest expense and understated current liabilities resulting from failure to accrue
interest expense.
Understated current liabilities and overstated long-term debt resulting from failure to classify the
current portion of long-term debt in current liabilities.
10.15Specific assertions typical of investment account balances are that:

Investment securities are on hand or are held in safekeeping by a trustee.
The accounting for investment cost and market value is appropriate.
Controlling investments are accounted for by the equity method.
Investment income has been received and recorded.
Investments are adequately classified and described in the balance sheet, including disclosures of
restrictions, pledges, or liens.
10-4
Education.
10.16
Some of the typical areas for concern in the investment accounts are:
Valuation of investments at cost, market, or value impairment that is other than temporary.
Determination of significant influence relationship for equity method investments.
Impairment of goodwill.
Capitalization and continuing valuation of intangibles and deferred charges.
Propriety, effectiveness, and risk disclosure of derivative securities used as a hedge of exposure to
changes in fair value (fair value hedge), variability in cash flows (cash flow hedge), or fluctuations in
foreign currency.
Determination of the fair value of derivatives and securities, including valuation models and the
reasonableness of key assumptions.
Realistic distinctions of research, feasibility, and production milestones for capitalization of software
development costs.
Adequate disclosure of restrictions, pledges, or liens related to investment assets.
10.17
Securities held by trustees or brokers should be confirmed, and the confirmation request should seek the
same descriptive information as that obtained in a physical inspection by the auditor. That is, the name of
the company, number and class of shares, and any restrictions on the stock. The broker can also confirm the
market value and the trading activity in the securities for the period.
10.18
The unfortunate auditors learned that they should know about the requirements of the securities acts, they
should use experts in the area if they do not have expertise themselves, and they can ask the SEC for advice
in advance.
When suspecting violation of U.S. securities laws (SEC), an auditor should take the factual and descriptive
information to a competent attorney for review and an opinion. Auditors can advise company management
to consult with the SEC about the necessity for conforming to the law in connection with contemplated
transactions.
10.19
Auditors could discover the off-balance-sheet financing described in Case 10.2 (Off-Balance Sheet
Inventory Financing) by (1) making inquiries about large and unusual financing transactions, (2) noticing
the large sale transaction when performing analytical comparisons of monthly or seasonal sales, (3)
examining the sales contract, (4) discussing with management the business purpose of the transaction, and
(5) inquiring in secretary of state records for identification of customer company incorporators and
registered agent.
10.20
Related parties might inflate values with spurious transactions, finally putting them in financial statements
of an auditee (Go for the Gold case).
10-5
Education.

10.21
First, it is essential that the auditors have expertise in the clients industry. When such expertise is lacking,
the auditors must secure the necessary knowledge by hiring knowledgeable personnel or a consultant with
the appropriate knowledge. Second, the auditor must take into account the historical nature of films of this
type. While management may expect one film to be as successful as recent films of a similar genre, the
auditor must take into account the full range of successful and unsuccessful films. A statistical analysis
could generate a range of values, which the auditor may use. Within this range, the auditor would likely
take a conservative estimate. This may be at odds with management who may want to take a more
aggressive approach to the revenue estimate. Third, the auditors must analyze the assumptions used by
management to reach their estimates. These assumptions may be based on overly optimistic projection of
ticket sales, DVD sales, and other merchandising agreements.
SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS

10.22
a.
b.
c.
Incorrect
Incorrect
Correct
d.
Incorrect
Because of the large amounts of the items, a substantive approach is preferred.

Auditors can never ignore internal controls.
Controls must be reviewed (and tested for public companies); however, a
substantive approach is preferred.
This would be the least effective approach.
10.23
a.
b.
c.
d.
Correct
Incorrect
Incorrect
Incorrect
This is the purpose of covenants.

The covenants are to protect the lender.
Auditors are not involved in structuring client transactions.
The board of directors should protect the shareholders from too much debt.
10.24
a.
b.
c.
d.
Incorrect
Incorrect
Correct
Incorrect
This is a related party, but the definition is incomplete.

This is the complete definition.
10.25
a.
b.
Incorrect
Incorrect
c.
d.
Incorrect
Correct
This ignores accruals.

This procedure does not lend itself to statistical sampling because of the low
volume of transactions.
This also ignores dividends receivable.
Independent evidence from an outside dividend reporting service is the best
evidence for existence, completeness, and valuation.
a.
b.
c.
Incorrect
Incorrect
Correct
d.
Incorrect
a.
b.
c.
d.
Incorrect
Incorrect
Incorrect
Correct
10.26
10.27
This should be prevented by controls, not the audit.

See answer (a).
The danger is that someone might move securities so the auditor counts them
twice.
This is a danger, but audits cannot be relied upon to detect counterfeit securities.
Related parties can own the bonds, but their ownership must be disclosed.
This is not the responsibility of external auditors.
This is not a primary responsibility of external auditors.
Among the choices available, obtaining an opinion from legal counsel is the best
response. The legality of a bond issue is important although not the only
important thing.
10-6
Education.
10.28
a.
b.
c.
d.
Incorrect
Incorrect
Incorrect
Correct
A company does not necessarily need to use a transfer agent.

These are usually approved by directors.
Stock dividends are recorded at fair market value.
Capital stock transactions are important by definition, and the directors should
have approved all of them.
10.29
c.
Correct
Losses on investment should be recorded in the accounts and shown in the

financial statements. (Losses on trading securities in the income statement; loss
on available-for-sale securities in the equity section.)
10.30
a.
b.
c.
Incorrect
Incorrect
Incorrect
d.
Correct
This is a substantive test that has little to do with controls.

Prepaid expense would have to be calculated based on the payment date.
This might provide evidence regarding imputed interest expense, but only if all
liabilities are recorded. Imputed interest generally requires a detailed test
considering the specific terms of the debt.
Detect unrecorded liabilities is the best response, but remember that the
procedure might be ineffective if the interest expense on an unrecorded liability
is also unrecorded.
a.
Incorrect
b.
c.
d.
Incorrect
Incorrect
Correct
a.
Correct
b.
c.
Incorrect
Incorrect
d.
Incorrect
a.
Incorrect
b.
Correct
c.
Incorrect
d.
Incorrect
a.
Correct
b.
Incorrect
c.
Incorrect
d.
Incorrect
Capital stock transactions are important by definition, and the directors should
have approved all of them.
Sales of stock should be traced to cash receipts, but not necessarily other
transactions.
Purchases of treasury stock should be traced to cash disbursements, but not
sales.
If shares are sold, the numbered certificates will not be available.
a.
b.
c.
d.
Incorrect
Incorrect
Correct
Incorrect
Stock splits have no effect on retained earnings.

This would not go to beginning balance of retained earnings.
These should be authorized by the board of directors.
Gain or loss on treasury stock transactions should be audited.
10.31
10.32
10.33
10.34
10.35
This is somewhat true because the bank wont let the auditor in without
permission. However, (d) is more important.
It is unlikely that either would be able to detect forged securities.
The auditor could do this without the client.
A client representative should be present to acknowledge return so the auditor
will not be accused of theft.
Stock certificates should be defaced but retained so the auditors can actually see
the canceled certificate.
See (a).
The defaced certificates should be retained so the auditors can see that they have
not been issued.
See (c).
Registrar/transfer agent has no record of restrictions on the payment of
dividends.
The number of shares issued and outstanding is the record kept by the
registrar/transfer agent.
Registrar/transfer agent has no record of guarantees of preferred stock
liquidation value.
Registrar/transfer agent has no record of the number of shares subject to
agreements to repurchase.
10-7
Education.
10.36
10.37
10.38
10.39
10.40
a.
Correct
To conceal fraud related to marketable securities, collusion between those

responsible for record keeping and custody would be required. The possibility of
collusion is reduced if no direct contact between responsible parties exists.
b.
c.
d.
Incorrect
Incorrect
Incorrect
Securities must be registered in the name of the company.

Custody and authorization are incompatible duties.
How the trust company secures the assets has nothing to do with preventing
fraud at the company.
a.
b.
c.
Incorrect
Incorrect
Correct
d.
Incorrect
This ignores accruals.

The interest earned depends on the effective rate, not the face rate.
The audit program for long-term investments includes making an independent
computation of revenue (such as dividends and interest). For example, bond
certificates contain information about interest rates, payment dates, issue date,
and face amount that the auditor can use to recalculate bond interest earned,
including amounts accrued but not collected, during the period the auditee has
held the investment.
See (a).
a.
b.
Incorrect
Incorrect
c.
d.
Incorrect
Correct
a.
Incorrect
b.
Correct
c.
d.
Incorrect
Incorrect
a.
b.
c.
Incorrect
Incorrect
Correct
d.
Incorrect
Banks do not open safe deposit boxes.

Auditors normally do not rely on tests of transactions for securities. The auditor
normally needs to count the certificates.
Banks do not know what is added to or removed from safety deposit boxes.
Securities should be inspected simultaneously with the verification of cash and
the count of other liquid assets to prevent transfers among asset categories for
the purpose of concealing a shortage. If this procedure is not possible but the
securities are kept by a custodian in a bank safe deposit box, the client may
instruct the custodian that no one is to have access to the securities unless in the
presence of the auditor. Thus, when finally inspecting the securities, the auditor
may conclude that they represent what was on hand at the balance-sheet date.
This is not a suitable objective for analytical procedures because gains and
losses can result from unique circumstances.
The auditor may develop expectations regarding the completeness assertion for
unrecorded investment income from stocks by using dividend records published
by standard investment advisory services to recompute dividends received.
Interest income from bond investments can be calculated from interest rates and
payment dates noted on the certificates. Income from equity-based investments
can be estimated from audited financial statements of the investees. Thus,
applying an expected rate of return to the net investment amount may be an
effective means of estimating total investment income.
The auditor must evaluate managements plans for the securities.
This is not a suitable objective for analytical procedures because market prices
are volatile and difficult to predict.
If bonds are unrecorded, nothing will show up in bond premium or discount.
This has nothing to do with completeness of bonds payable.
The recorded interest expense should reconcile with the outstanding bonds
payable. If interest expense appears excessive relative to the recorded bonds
payable, unrecorded long-term liabilities may exist.
If the payable account is incomplete, the bond will not be on the listing the
auditor uses to select confirmations.
10-8
Education.
10.41
a.
b.
Incorrect
Correct
Held-to-maturity debt is recorded at cost.

By reconciling interest expense with interest-bearing obligations, the auditor
verifies the amount of outstanding liabilities. If interest expense is excessive in
relation to the long-term debt, unrecorded interest-bearing obligations may be
outstanding.
The auditor is usually less concerned about existence than completeness.
If the bond is unrecorded, it will not be in the ledger.
c.
d.
Incorrect
Incorrect
10.42
a.
b.
c.
d.
Incorrect
Incorrect
Incorrect
Correct
This is a management decision.

This might be a good cash disbursements control, but (d) is more important.
This is a management decision.
Control is enhanced when different persons or departments authorize, record,
and maintain custody of assets for a class of transactions. Authorization of notes
payable transactions is best done by the board of directors.
10.43
d.
Correct
Events such as the renewal of the note payable do not require adjustment of the
financial statements but may require disclosure. Accordingly, the auditor should
determine that the renewal had essentially the same terms and conditions as the
recorded debt at year-end. A significant change may affect the presentation of
notes payable such as a reclassification from short term to long term.
10.44
a.
b.
Incorrect
Correct
c.
Incorrect
d.
Incorrect
Review of minutes for authorization is an important audit procedure.

The registrar would not have information related to the investor or market
information.
The broker in particular would have information on the sale of investments to
the client.
Determining market value is an important audit procedure.
10.45
a.
b.
c.
d.
Incorrect
Incorrect
Correct
Incorrect
Review of minutes for authorization is an important audit procedure.

The registrar would have record of stock sold.
Market price is not important in valuing shareholders equity.
Obtaining management representation is an important procedure.
10.46
a.
b.
Incorrect
Correct
c.
Incorrect
d.
Incorrect
There is no evidence that the certificates are forgeries.

The main concern is that someone sold the IBM securities (in order to use the
cash) and repurchased the securities at a later date. This may have been done for
personal use or for the company.
There is no evidence that the securities are not properly presented on the balance
sheet.
The fact that there is a certificate for IBM stock indicates that the company still
owns 100 shares of IBM.
10-9
Education.
SOLUTIONS FOR EXERCISES, PROBLEMS, AND SIMULATIONS

10.47
Internal Control Questionnaire for Equity Investments

The three questions in the problem can be called environment questions. Questions specific to
management assertions are:
Existence or Occurrence
a.
Are marketable securities investment transactions supported by invoices from brokers or other
documents supporting securities not obtained through brokers?
b.
For investments held by the company, are CUSIP numbers recorded for each certificate and are the
CUSIP numbers periodically compared to the securities being held?
Completeness
c.
Do the cash disbursements procedures contain directions for identifying and accounting for
investments in marketable securities?
d.
Are subsidiary records of investments kept? Are they reconciled periodically with a control
account? Are sales proceeds analyzed to account for gains and losses?
Rights and Obligations
e.
Are securities recorded in the companys name or in broker accounts in the company name?
Valuation or Allocation
f.
Are investments representing control over investees accounted for by the equity method?
g.
Does the controller approve investment security transactions for proper calculation of interest
purchased in bond transactions, special terms of options, warrants, and other features of complicated
investment securities?
h.
Does the controllers office receive notice of dividends declared in companies in which
investments are held so accounting can match the proper period? Do accountants have instructions to
accrue interest to the date of the financial statements?
Presentation and Disclosure
i.
Does the board of directors, vice president of finance, or treasurer indicate in writing the intent of
the management in connection with classifying investment securities?
10-10
Education.
10.48
Investment Securities
a.
The objectives (specific assertions) for the audit of investment securities are to obtain evidence
regarding the:
b.
The following audit procedures should be undertaken with respect to the audit evidence for
existence and cost valuation of Basss held-to-maturity investment securities:
c.
Existence of the investment securities at the balance-sheet date.

Ownership of the investment securities.
Accurate cost and market value of the investment securities.
Proper classification of the investment securities.
Proper presentation and disclosure of the investment securities in the financial statements.
Proper recognition of interest income.
Proper recognition of investment gains and losses.
Inspect and count securities in the companys safe and safe deposit box.
Examine brokers statements to obtain assurance that all transactions were recorded.
Examine documents in support of purchases and sales of investment securities.
Inspect the minutes of the board of directors meetings.
Obtain a client representation letter that confirms the clients representations concerning
the held-to-maturity investment securities.
Verify the calculation of interest income.
Review the propriety of the presentation and disclosure of the securities in the financial
statements.
Make certain that the client representation letter includes the proper assertions concerning
the securities portfolio.
The following audit procedures should be undertaken with respect to the audit evidence regarding
Basss controlling equity investment in Commercial Industrial, Inc.
Inspect and count securities in the companys safe and safe deposit box.
Examine documents in support of purchases and sales of investment securities.
Inspect the minutes of the board of directors meetings.
Review the audited financial statements of the (25 percent) investee.
Verify that the equity method of accounting was used for carrying value of the investment
in Commercial Industrial.
Obtain a client representation letter that confirms the clients representations concerning
the controlling interest.
Verify the calculation equity method income.
Review the propriety of the presentation and disclosure of the securities in the financial
statements.
Make certain that the client representation letter includes the proper assertions concerning
the controlling interest.
10-11
Education.

d.
Audit procedures should be undertaken with respect to obtaining audit evidence about the
classification of held-to-maturity securities in the Bass portfolio? (Hint: Review the audit program in
Appendix 10B-3.)
Determine the proper classification of securities in the categories of held-to-maturity,

available-for-sale, and trading securities.
(a)
(b)
(c)
(d)
(e)
Determine whether facts support managements intent to hold securities to maturity.

(a)
(b)
(c)
e.
Determine the companys financial position, working capital requirements,

results of operations, debt agreements, guarantees, and applicable laws and
regulations.
Study the companys cash flow forecasts.
Obtain written management representations confirming proper classification
with regard to intent and ability.
Suppose the held-to-maturity portfolio (excluding the investment in Commercial Industrial, Inc.)
is carried at cost in the amount of $3,450,000. Audit procedures with respect to obtaining audit
evidence about the market (fair) value of this portfolio might include:
Determine whether the securities are actively traded in a broad market.
Determine an audit valuation of fair value when appropriate.

(a)
(b)
f.
Inquire about managements intent regarding classifications.

Study written records of investment strategies.
Review records of past investment activities and transactions.
Review instructions to portfolio managers.
Study minutes of the investment committee of the board of directors.
Obtain published market quotations.

Obtain market prices from broker-dealers who are market makers in particular
securities.
Suppose the auditor determines that the held-to-maturity portfolio (excluding the investment in
Commercial Industrial, Inc.) has an aggregate market (fair) value of $2,970,000. Audit procedures
with respect to obtaining audit evidence regarding a value impairment that might be other than
temporary? (Hint: Review the audit program in Appendix 10B-3.)
Determine whether value impairments are other than temporary by considering evidence of
the following:
(a) Fair value is materially below cost.
(b) The value decline is due to specific adverse conditions.
(c) The value decline is industry or geographically specific.
(d) Management does not have both the intent and ability to hold the security long
enough for a reasonable hope of value recovery.
(e) The fair value decline has existed for a long time.
(f) A debt security has been downgraded by a rating agency.
(g) The financial condition of the issuer has deteriorated.
(h) Dividends of interest payments have been reduced or eliminated.
10-12
Education.

10.49
Lease Accounting
a.
b.
10.50
Union Pacific would prefer accounting for the lease as an operating lease for a number of reasons:
The charge to income for interest and depreciation under capital lease is higher in early
years than rent expense charged for an operating lease.
Treating the lease as an operating lease reduces the asset base and improves return on
assets.
Treating the lease as an operating lease avoids recording the debt for a capital lease,
which results in a lower debt to equity ratio.
The auditor would need to review an independent estimate of the value of the building and of its
expected useful life. The auditor would also review the terms of the lease for life, renewal options,
rental rate, additional rental costs, and so on. The auditor may also want to confirm the terms of
the lease with the lessor. Finally, the auditor would test the clients calculations for the lease
treatment under SFAS 13 and obtain representation from the client that the assumptions are
appropriate.
Securities Examination and Count

a.
Instructions to be given to the assistant regarding the examination of the securities kept in the safe
deposit box include the following:
(1)
A copy of the clients inventory of the contents box should be obtained and used in
connection with the inspection of the securities. Comparing the contents of the box and
the inventory will provide assurance that all securities listed in the inventory are on hand.
(The validity of the inventory will be determined by examination of the transactions
pertaining to investments.) The copy of the inventory, after being checked, should be
added to the audit documentation as evidence of work performed.
(2)
The banks record of persons entering the deposit box should be examined to determine
that only authorized persons have had access to the box and that there was no entry to the
box between December 31 and January 11. Entry to the box between those dates may be
an indication that a security was returned to safekeeping after being borrowed at
year-end. The security may have been borrowed and used as collateral to obtain cash to
cover a shortage at December 31.
(3)
The assistant should be instructed to insist that the treasurer be present while the
securities are being examined. The treasurers presence will deter any future claim that, if
a security is missing at a later date, the assistant took it.
(4)
The following details of the securities should be examined:

(a)
The name of the registered owner (Demot Corp.) appearing on each security
other than bearer bonds should be noted.
(b)
The dates stamped on stock certificates giving the dates that the certificates were
prepared should be noted and subsequently compared with cash disbursements.
10-13
Education.
b.
(c)
The name of the corporation issuing the security and the class of the security
(Class A, Par Value, 1st Preferred, etc.) should be noted for assurance that a
lower priced security (perhaps somewhat similar in corporate name or a different
security of the issuing corporation) has not been substituted for a higher priced
security.
(d)
The face value of bonds and the number of shares represented by each stock
certificate should be compared with the inventory to determine that the entire
amount of the corporations holdings of each security is on hand.
(e)
The serial numbers of the securities should be compared with those on the
inventory and, for those securities carried over from the prior year, compared
with the serial numbers of securities listed in the prior-year audit documentation.
A change in serial numbers that cannot be properly explained may be an
indication of manipulation of the securities.
(f)
The certificate should be read to ascertain that interest rates and payment dates
for bonds and the dividend rates and payment dates, if given, for preferred
stocks. This information may be used later in the verification of investment
income.
(g)
Bonds should be examined to determine maturity dates. Maturity dates are

needed for checking the computation of the amortization of bond premiums or
discounts.
(h)
Coupon bonds should be inspected to determine that no past due interest

coupons are unclipped and all future interest coupons are attached.
(i)
The assistant should be alert for any obvious alterations to securities or forged
certificates.
(j)
The assistant should also examine the reverse side of the certificates to
determine whether they have been endorsed for transfer. The presence of an
endorsement may be an indication that the security had been converted
temporarily for some use, perhaps fraudulent, in the past.
(k)
Any worthless securities on hand should also be examined and compared with
the clients inventory and with prior audit documentation. Any missing securities
should be noted for subsequent follow-up to determine that the client had
received the funds derived from the sale or redemption of securities deemed
worthless in error.
The treasurers entry into the safe deposit box on January 4 violated the auditors control over
liquid assets that must be counted simultaneously or kept under control until counted to avoid the
substitution of a counted asset for an uncounted asset in an attempt to conceal a shortage. The
auditor would probably apply the following additional procedures:
(1)
(2)
(3)
(4)
(5)
Reconcile bank balances at both year-end and at the count date.

Obtain a bank confirmation as of the count date.
Examine cash entries between year-end and the count date for any unusual entries.
Examine all investment transactions taking place between the balance-sheet date and the
count date to verify the amount of the investments at the balance-sheet date.
If the client keeps a large fund of cash on hand, make a surprise count of the cash fund.
10-14
Education.

(6)
(7)
10.51
Audit Objectives and Procedures for Investments

1.
2.
Investments are properly described and classified in the financial statements.

e.
(best)
Verify that transfers from the trading portfolio to the held-to-maturity

investment portfolio have been properly recorded.
g.
(possible)
Trace investment transactions to minutes of the board of directors

meetings to determine that transactions were properly authorized
(especially for the portfolio classification).
Recorded investments represent investments actually owned at the balance-sheet date.

f.
3.
Obtain positive confirmations as of the balance-sheet date of investments held by

independent custodians.
Investments are properly valued at the balance-sheet date.

d.
10.52
Review the transactions since year-end relating to any other assets, such as mortgages
owned, to determine whether any substitutions have been made.
Visit the Chamber of Commerce and take a look at the photograph.
Determine whether any other-than-temporary impairments in the carrying value of

investments have been properly recorded.
Intangibles
1.
a. Machinery
Patents
17,000
17,000
To transfer cost of improving machinery to the fixed asset account

Cost of Goods Sold
Patents
4,000
4,000
To record straight-line amortization of patents for the year

b. Inspect the patent document and vouch to the work orders for machinery improvement.
Recalculate amortization of patent.
2.
a. Licensing Agreement No. 2

Revenue Received in Advance
1,000
1,000
To record unearned revenue in a deferred credit account

b. Vouch transaction to the documentation to support the receipt of revenue. Vouch cash to deposit
in bank account.
3.
a. Retained Earnings
Licensing Agreement No. 1
30,000
30,000
To record the 60% loss caused by the explosion in the prior year. Correction of an accounting
error of the prior year. Write-off of damage due to flood.
10-15
Education.
b. Vouch to insurance documents for claims. Review local news for evidence of explosion and/or
flood.
4.
a. Cost of Goods Sold

Licensing Agreement No. 2
5,000
5,000
To record amortization for the year on straight-line basis, 10-year life

b. Recalculate amortization.
5.
Goodwill
24,000
24,000
To correct the accounting error of last year of improperly capitalizing an expense item
b. Review goodwill account. Vouch to original calculation of goodwill to ensure all expenses in
the account are capital expenses.
6.
a. Equipment
Accounts Receivable Nontrade
Leasehold Improvements
8,500
2,500
11,000
To record equipment in the proper account and to record a receivable for the real estate taxes
Amortization Expense Current Year
Amortization ExpenseError Correction
Leasehold Improvements
1,500
1,500
3,000
To record current amortization and correct the error of failure to record amortization of leasehold
improvements on a straight-line, 10-year basis. No adjustment to depreciation of equipment
because it was acquired in December.
b. Vouch transaction to purchase order for equipment and work orders for leasehold
improvements. Recalculate amortizations.
7.
Organizational Expenses
29,000
29,000
To write off organizational expenses improperly capitalized in prior period

b. Vouch transaction to original expenses for proper amounts. Review Retained earnings for
propriety of other items.
10-16
Education.
10.53
Loan Covenants
Note to instructor: Students may wish to reference http://www.loanuniverse.com/covenant.html in
responding to this question.
a.
Banks usually add covenants to accomplish the following objectives:
b.
Maintain loan quality.

Keep adequate cash flow.
Preserve equity.
As a measure to improve the weakness in a borrower with a known weakness in its capital
structure.
Keep an updated picture of the borrowers financial performance and condition
Common loan covenants

Things that the borrower must do:
(1)
Maintain hazard insurance/content insurance.

b.
To ensure that if the collateral is damages the company will be reimbursed and can
pay off the loan. The borrower is required to keep insurance coverage on the
plant/equipment or inventory in order to safeguard against the catastrophic loss of
collateral.
c. Confirm insurance with the insurance company; review insurance policy at client.
(2)
Maintain key-person life insurance.

b.
To protect the lenders from loses incurred by the loss of a key employee . This
insures the life of the indispensable owner or manager without whom the company
could not continue. The lender usually gets an assignment of the policy.
c. Confirm insurance with the insurance company; review insurance policy at client
(3)
Make all payments of taxes /fees /licenses.

b.
To protect the lender from government seizure of property. Borrower agrees to

keep those expenses up-to-date as failure to pay would result on the assets of the
company being encumbered by a lien from the government, which would take
precedence to the one from the bank.
c.
(4)
Review cancelled checks for payments.
Provide financial information on borrower and guarantor.

b.
Protect the lender from non-payment due to deteriorating financial condition.

Borrower agrees to submit financial statements for the continuing assessment by the
bank. Financial statements are usually submitted yearly while account receivable can
be required every month.
10-17
Education.
c.
(5)
Review financial information; review financial reports of guarantor (if any); confirm
with lender the receipt of financial information.
Maintain a certain level in key financial ratios.

The borrower is required to maintain a certain level in key financial ratios such as:
(a)
(b)
(c)
(d)
Minimum quick and current ratios (liquidity)

Minimum Return On Assets And Return On Equity (profitability)
Minimum equity, minimum working capital
Maximum debt to worth (leverage)
b. Financial ratios provide an analysis of the financial condition of the borrower and
help the lender determine the likelihood of repayment. In addition, the borrower
might be prevented from doing certain things via loan covenants.
c. Review ratios; vouch numbers used in ratio calculations to the source information
(6)
Make no change of management or merger without prior approval.

b. Guarantees the continuing existence of your borrower and will impede the
deterioration of financial condition due to merger with an unknown entity.
c. Compare organizational charts with prior years; review minutes of the board of
directors meetings; review local news sources.
(7)
Obtain no more loans without prior approval.

b. Ensures that the company does not take on excessive debt affecting the quality of the
original loan.
c. Review long term debt accounts and interest expense accounts.
(8)
Make no dividends/withdrawals or limited dividend withdrawals.

b. In situations in which the net worth is being eroded by the extraction of capital in the
form of dividends or stockholders withdrawal, the lender might find it necessary to
restrict the amount of money that can be taken out of the company. In subchapter-S
corporations, it is not uncommon to limit withdrawals to the owners tax liability.
c. Review dividend account; review cash disbursements for payments to registrar or to
investors.
D. It is important for an auditor to ensure that the client is in compliance with debt covenents because if
the client is in violation of the debt covenants the lender may be able to call the debt (i.e. ask for
immediate payment). Such a demand for cash, if the amount is large, may create a going concern
issue for the client.
10-18
Education.
10.54
Long-Term Financing Agreement

a.
The procedures you should employ in examining the Broadwall loans are as follows:
b.
Broadwalls financial statements should disclose the following information concerning the loans
from its president:
10.55
Obtain an understanding of the business purpose of the loans made by the president.
Confirm the loans, including terms, by direct communication.
Recompute interest expense and interest payable.
Review minutes of meetings of the board of directors for proper authorization.
Verify payments made during the year and transactions after the year-end.
Read the notes to the financial statements regarding the loan agreements and evaluate the
adequacy of disclosure and compliance with restrictions.
Obtain a management representation letter.
The nature of the related-party relationship.

The dollar amounts of the loans.
Amounts due the president and, if not otherwise apparent, the terms and manner of
settlement.
Bond Indenture Covenants

In each case any actual failure to comply would need to be reported in a footnote to the statements in view
of the possible serious consequences of advancing the maturity date of the loan. The individual audit steps
follow:
10.56
1.
Check balance sheets at beginning and through the previous fiscal year for working capital ratio. If
under 2:1, check compensation of officers for compliance with limitation.
2.
Examine clients copies of insurance policies or certificates of insurance for compliance with the
covenant, preparing schedule of book value, appraised or estimated actual value, and coverage for
report. Confirm policies held with trustee.
3.
Examine vouchers supporting tax payments on all property covered by the indenture. By reference
to the local tax laws and the vouchers, determine that all taxes have been paid before the
penalty-free period expired. If vouchers in any case are inadequate, confirm with trustee who
holds the tax receipts.
Common Stock and Treasury Stock: Substantive Audit Procedures

Common Stock
Treasury Stock
Existence
(a)
Verify authorized shares with reference

to corporate charter.
(b)
Confirm outstanding shares with

owners.
(c)
Count outstanding shares as shown in

the stock record book stubs.
(a)
Inspect the certificates held as

treasury stock.
10-19
Education.
(d)
Verify authorization in board minutes

to issue new shares.
(e)
Obtain written representations about

the number of shares authorized,
issued, and outstanding.
Completeness
(f)
Reconcile the number of shares:

Issued Treasury = Outstanding
Same
Valuation
(g)
Vouch amount of paid-in capital to

cash receipts.
(b)
Vouch amounts recorded for

purchase to cash disbursements and
amounts received on resale to cash
receipts. Recalculate gain (loss)
and trace to retained earnings or
other capital account.
(c)
Read the financial statements,

particularly the schedule of capital
changes and the footnotes to
determine whether the treasury
stock amounts (including gains and
losses) are properly classified and
described.
GAAP disclosure
10.57
(h)
Read the financial statements and

footnotes to determine whether all
numbers of shares, terms, and
descriptions are accurate.
(i)
Vouch stock option and profit-sharing

plan disclosures to contracts and plan
documents.
Stockholders Equity
a.
(1)
The audit plan for the examination of Pate Corporations Capital Stock account would
include the following procedures:
(a)
(Presentation and disclosure audit assertions.) Examine the articles of

incorporation, the bylaws, and the minutes of the board of directors from the
inception of the corporation to determine the provisions or decisions relating to
the capital stock such as classes of stock, par value or stated value, authorized
number of shares, authorization of the sale of new issues or additional sales of
unissued stock, declarations of stock split ups and dividends in the form of cash
or stock, and granting of stock options or stock rights.
10-20
Education.
(b)
(Existence and completeness audit assertions.) Examine the stock certificate

stub book and determine whether the total of the open stubs agrees with the
Capital Stock account in the general ledger. Examine canceled stock certificates
that are generally attached to the corresponding stub. Information on the stubs
regarding the number of shares, date, and so on for both outstanding and
canceled stock certificates should be compared with the Capital Stock account.
All certificate numbers should be accounted for.
(c)
(Valuation assertion.) Analyze the Capital Stock account from the corporations
inception and audit all entries. Trace all transactions involving the transfer of
cash either to the cash receipts or the cash disbursements records. If property
other than cash was received in exchange for capital stock, trace the recording of
the property in the proper asset account and consider the reasonableness of the
valuation placed on the property. If the analysis of the Capital Stock account
discloses that the corporation has engaged in treasury stock transactions,
determine that the increases or decreases in net assets resulting from these
transactions have not been placed in the Retained Earnings account.
(2)
The audit procedures to be applied to the examination of the Capital Contributed in

Excess of Par Value account are usually applied at the same time that the Capital Stock
account is being examined because the two accounts are interrelated. The account should
be analyzed and the entries audited when the related entries in the Capital Stock account
are audited.
(3)
The following audit procedures would be applied to the Retained Earnings account:
(a)
(Valuation assertion.) Analyze the account from its inception. Consider the
validity of the amounts representing income or loss that were closed from the
Profit and Loss account.
(b)
(Valuation assertion.) Any charges or credits made directly to the Retained

Earnings account should be investigated and their treatment reviewed in relation
to generally accepted accounting principles.
(c)
(Presentation and disclosure assertion.) Actions of the board of directors that

affected retained earnings should be traced to the account analysis.
(d)
(Presentation and disclosure assertion.) Conditions, such as loan covenants or

contingent liabilities, which were uncovered during the audit that might require
or make desirable the placing of restrictions on retained earnings, should be
brought to the clients attention, and provision should be made for proper
disclosure in the financial statements.
(e)
(Valuation objective.) Entries recording cash or stock dividends should be

traced to the minutes of the board of directors for authorization and to the Cash
account or the Capital Stock account. A separate computation should be made by
auditors of the total amount of dividends paid based upon their schedules of
outstanding stock as an overall test of the reliability of the distributions. If stock
dividends have been distributed, the amount removed from retained earnings
should be reviewed for compliance with generally accepted accounting
principles.
10-21
Education.
b.
10.58
In conducting the audit, the auditors audit retained earnings as they do other items on the balance
sheet for several reasons. A principal reason is that this part of the audit is an assurance or double
check that no important item was overlooked in the examination of the accounts that were the
contra or balancing part of the entry recorded in Retained Earnings. An example of an important
item that may be overlooked would be a balance sheet account that was closed during the year
under audit and the ledger card for the account removed from the general ledger current file.
Another reason is that, although the entry in the contra account may have been examined, the
auditors may have overlooked that the balancing part of the entry was to Retained Earnings, a
treatment that may have been contrary to generally accepted accounting principles; their
examination of retained earnings would bring this noncompliance to their attention.
Intercompany and Interpersonal Investment Relations

This case is intended to evoke discussion of significant controlling interests in investments.
a.
The issues revolve around

(1)
Conflicts of interest. Students should recognize the apparent existence of non-armslength transactions in the transfer prices of products to Hardy Hardware from Hardy
Products. However, whether the prices are not equivalent to market prices is not certain.
Hardy Hardware may outperform the rest of the industry for other reasons, and Hardy
Products net of 1 percent on sales may be characteristic of its business (although the 1
percent is extremely low). The brothers have no apparent conflict between themselves.
Any conflict would have to be perceived as being between the brothers and the public
shareholders.
(2)
The criterion presumption for using the equity method is a 20 percent stock ownership,
and Hardy Hardwares ownership amounts to only 15 percent. However, other controlling
influences are at work, namely, James Hardys effective control of Hardy Hardware (20
percent) and his consequent ability to dictate the voting of the 15 percent interest in
Hardy Products.
b.
Some might say that this interrelationship of investments constitutes a significant controlling
influence that, although not vested entirely in the investor corporation (Hardy Hardware), certainly
operates to the benefit of Hardy Hardware. Whether to insist on the equity method in this case
represents a difficult decision as the former auditor apparently found out.
c.
The auditor should seek to compare the transfer prices to market-determined prices for the same or
similar goods. The possibility exists that Hardy Products is charging break-even prices to that
Hardy Hardware can show better operating results.
10-22
Education.
d.
10.59
Adequate disclosure in this case is not an easy issue. Certain SEC rules require disclosure of
transactions with controlling persons. Hardy Hardware will certainly have to observe SEC
regulations in statements filed with the Commission, and the auditor might protect herself or
himself as well as serve the public shareholders by insisting on similar disclosures in the annual
report. The related-party transaction disclosures specified in FASB statements and auditing
standards would be appropriate.
Related-Party Transaction Goodwill
Audit Approach
Objective: Obtain evidence of the valuation of assets given in exchange for stock and notes to find the
proper valuation of recorded goodwill.
Control: Control rests with the management and accounting estimates of the value of the assets given in
exchange. Estimates of this type should be made with faithfulness to the underlying nature of the assets and
their proper valuation.
Tests of Controls: Auditors should determine the extent of management involvement in major investment
and disposal transactions. Studying the minutes of the board and internal correspondence can help
contribute this information. All other procedures bear directly on the substantive valuation evidence.
Audit of balance: Because the Amron stock asset valuation was based on the transfer of the ammunition
business assets to the new corporation, the underlying composition and book value of the assets should be
determined in detail. This work should reveal that the Amrons stock carrying value included the deferred
cost amount of $7 million. The hard part is discerning that the business purpose of the transactions is to get
out of the sporting ammunition manufacturing business. If the auditors concentrate on the flow of the
transaction and dont get the big picture, they might miss the event of discontinuance.
The Big Industrial-Gulwest transaction appears to be clear. Gulwest received stock and a note with total
value of $5.4 million. Piercing the veil of the intervening corporate creation transactions and transfers,
Gulwest gave assets that were on its original books at $12.4 million.
Discovery Summary
The evidence of value received and cost given indicated a loss of $7 million. Auditors may need to be
perceptive and a bit clever to identify it directly with the discontinued line of business, or even to call it
discontinued. Nevertheless, they were able to identify the amount as a loss and force its recognition in
the Gulwest income statement. The spurious goodwill was removed from the Gulwest balance sheet.
10.60
Related-Party Transaction Valuation

Audit Approach
Objective: Obtain evidence to determine the proper valuation of asset exchanges involving noncash
property.
Audit of balances: Upon knowing the date of the transaction purchasing the airplane from Wing and the
number of Wing shares transferred, the auditors can look up the quoted market price in newspapers or other
library sources for market price history. Finding the market price should determine the proper amount to
record for the airplane.
10-23
Education.

Auditors should have a list of all subsidiary companies and should be able to recognize the Mexican
subsidiary as a related party. With this relationship, the amount of the transaction price is suspect. However,
efforts can be made to obtain new and used airplane prices to determine whether the $3,750,000 price to the
Mexican subsidiary bore any relation to observable airplane valuations.
If the value were $3,750,000, the gain exists in the transaction with the subsidiary, subject to elimination
in consolidation. This gain, if any, should not be offset against the loss from the exchange with Wing.
Discovery Summary
The auditors were astute. They found that the market value of the Wing stock was $2,520,000 and insisted
that the airplane be valued at $3 million instead of $3,750,000, thus making the loss on the exchange of
Wing stock $750,000 larger. They also made sure that the subsequent gain on the sale to the Mexican
subsidiary was eliminated in consolidation, awaiting any future profit confirmation by a sale to an outside
party.
10.61
Lack of Controls over Investments

AUDIT APPROACH
Objective: To obtain evidence that trades recorded are valid and authorized (existence or occurrence
assertion).
Control: Several controls were missing at Baring Group.
Leeson should have had a clear reporting line to a person of authority. Due to a reorganization, the
two groups that might have had responsibility each thought he was reporting to the other one.
Long and short positions should always be balanced. Leeson could be unbalanced during the day
but was supposed to be balanced at the end of each day.
Trading limits should have been strictly enforced. Because Leeson appeared to be profitable,
trades of amounts over his limits were overlooked.
The Credit Control department should have approved loans to clients, which Leeson used to
hide losses.
Internal audit reports should be followed up on.
Reconciliations of funds remitted to trades made should have been completed and balanced daily.
Tests of controls: Auditors should:
Obtain large trades and examine them for proper authorization.

Examine reconciliations and Baringss follow up of unreconciled items.
Ask for follow-up reports related to internal audit findings.
Compare trades to authorization limits.
Examine loans to clients for credit authorization.
Audit of balances: The auditors should confirm the large balances in the loans to clients account. They
should also examine the details of account 88888 for authorization of transactions.
10-24
Education.
Discovery Summary
In January 1995, The Singapore International Monetary Exchange (SIMEX) queried Baring on the size of
their positions on the exchange. SIMEX specifically questioned irregularities in the margining of account
88888. Baring responded in a letter assuring SIMEX of the adequacy of funds to support the positions and
made it clear that the entire assets of Baring Group were available to meet its financial obligations to
SIMEX. Also in January 1995, Coopers & Lybrand, Singapore discovered a discrepancy of 7.7 billion
between SIMEX and Baring accounts. Within a few days, six different versions of how the receivable had
arisen were circulated among Baring senior management. On February 23, Leeson went missing. The
liabilities he left behind totaled $1.3 billionmore than the entire capital and reserves of Baring. He was
arrested in March in a German airport. On December 2, a Singapore court sentenced him to six and a half
years. I dont think of myself as a criminal, Leeson said before his trial.
10-25
Education.

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Chapter 10 - Finance and Investment Cycle

Describe the finance and investment cycle,

23, 24, 26, 31

Give examples of tests of controls over debt

Describe substantive procedures for finance

9, 10, 11, 12,

25, 27, 28, 29, 30,

48(*), 49, 50(*),

Describe common errors and frauds in the

18, 19, 20, 21

48(*), 49, 50(*),

(*)Items relates to multiple learning objectives

SOLUTIONS FOR REVIEW CHECKPOINTS

Chapter 10 - Finance and Investment Cycle

Inspecting the securities in the presence of a responsible client officer.

Management communication of the need for proper accounting estimates.

Chapter 10 - Finance and Investment Cycle

Who prepares estimates?

The number of shares shown as issued is in fact issued.

The board of directors has authorized all owners equity transactions.

All material long-term liabilities are recorded.

New long-term liabilities and debt extinguishments are properly authorized.

Liabilities are appropriate valued.

Chapter 10 - Finance and Investment Cycle

10.15Specific assertions typical of investment account balances are that:

Chapter 10 - Finance and Investment Cycle

Determination of significant influence relationship for equity method investments.

Capitalization and continuing valuation of intangibles and deferred charges.

Adequate disclosure of restrictions, pledges, or liens related to investment assets.

Chapter 10 - Finance and Investment Cycle

SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS

Because of the large amounts of the items, a substantive approach is preferred.

This is the purpose of covenants.

This is a related party, but the definition is incomplete.

This ignores accruals.

This should be prevented by controls, not the audit.

Chapter 10 - Finance and Investment Cycle

A company does not necessarily need to use a transfer agent.

Losses on investment should be recorded in the accounts and shown in the

This is a substantive test that has little to do with controls.

Stock splits have no effect on retained earnings.

Chapter 10 - Finance and Investment Cycle

To conceal fraud related to marketable securities, collusion between those

Securities must be registered in the name of the company.

This ignores accruals.

Banks do not open safe deposit boxes.

Chapter 10 - Finance and Investment Cycle

Held-to-maturity debt is recorded at cost.

This is a management decision.

Review of minutes for authorization is an important audit procedure.

Review of minutes for authorization is an important audit procedure.

There is no evidence that the certificates are forgeries.

Chapter 10 - Finance and Investment Cycle

SOLUTIONS FOR EXERCISES, PROBLEMS, AND SIMULATIONS

Internal Control Questionnaire for Equity Investments

Chapter 10 - Finance and Investment Cycle

Existence of the investment securities at the balance-sheet date.

Chapter 10 - Finance and Investment Cycle

Determine the proper classification of securities in the categories of held-to-maturity,

Determine whether facts support managements intent to hold securities to maturity.

Determine the companys financial position, working capital requirements,

Determine whether the securities are actively traded in a broad market.

Determine an audit valuation of fair value when appropriate.

Inquire about managements intent regarding classifications.

48(), 49, 50(),

48(), 49, 50(),