Question 1

Erik Rekdahl, senior-in-charge, is auditing Koonce Katfood, Inc.'s long-term debt for the year ended December 31. Long-term debt is composed of two bond issues, which are due in 10 and 15 years, respectively. The debt is held by two insurance companies. Rekdahl has examined the bond agreements for each issue. The agreements provide that if Koonce fails to comply with the covenants of the contract, the debt becomes payable immediately. Rekdahl identified the following covenants when reviewing the bond agreements:
"The debtor company shall endeavor to maintain a working capital ratio of 2 to 1 at all times, and in any fiscal year following a failure to maintain said ratio, the company shall restrict compensation of officers to a total of $650,000. Officers include the chairperson of the board and the president."
"The debtor company shall keep all property that is security for these debt agreements insured against loss by fire to the extent of 100 percent of its actual value. Policies of insurance comprising this protection shall be filed with the trustee."
"The company is required to restrict 40 percent of retained earnings from availability for paying dividends."
"A sinking fund shall be established with the First Morgan Bank of Austin, and semiannual payments of $500,000 shall be deposited in the fund. The bank may, at its discretion, purchase bonds from either issue."
a. Provide any audit steps that Rekdahl should conduct to determine if the company is in compliance with the bond indentures.
b. List any reporting requirements that the financial statements or footnotes should include.

Accepted Answer

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Question 2

Overall analysis of income statement accounts may bring to light errors, omissions, and inconsistencies not disclosed in the overall analysis of balance sheet accounts. The income statement analysis can best be accomplished by comparing:

Accepted Answer

The best way to analyze the income statement accounts is to compare the revenue and expense account totals to the corresponding figures of the preceding years. This comparison allows for the identification of any unusual fluctuations or trends that may indicate errors or inconsistencies. Choice A is incorrect because comparing income statement ratios to balance sheet ratios may not provide a clear picture of the errors and inconsistencies. Choice B is incorrect because comparing revenue and expense account balances to monthly net income may not reveal the long-term issues. Choice C is incorrect because comparing income statement ratios to published industry averages may not take into account the company's unique circumstances.

Question 3

Identify the four major assertions made regarding stockholders' equity and describe one control activity for each.

Accepted Answer

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Question 4

Of the following, which is an important procedure that an auditor should use when making an overall review of the income statement?

Accepted Answer

Comparing actual revenues and expenses with the corresponding figures of the previous year and investigating significant differences is an important procedure that an auditor should use when making an overall review of the income statement. This helps to identify any unusual or unexpected items that may require further investigation. Obtaining a schedule of the retained earnings activity for the period, obtaining inventory certificates, or ascertaining the net income amount in the statement of cash flows are important procedures, but they are not directly related to reviewing the income statement as a whole.

Question 5

Match each of the following controls with the assertion for long-term debt that it supports.
-A subsidiary ledger is maintained that contains information about all the long-term debt and the amount recorded in this ledger is reconciled to the general ledger

Accepted Answer

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Question 6

Which of the following is an important consideration of an auditor when examining the stockholders' equity section of an entity's balance sheet?

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Question 7

Match each of the following controls with the assertion for long-term debt that it supports.
-The portion of long-term debt due in the next year is classified as a short-term liability

Accepted Answer

The control of "classification" supports the assertion that the portion of long-term debt due in the next year is classified as a short-term liability.

Question 8

What kind of information would typically be found on an income statement account analysis working paper? What kind of tests can an auditor perform using this information? Why would an auditor conduct additional analysis on an income statement account?

Accepted Answer

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Question 9

Which of the following transactions is an auditor most likely to examine when auditing the retained earnings account?

Accepted Answer

Retained earnings account is affected by prior period adjustments, which include correcting errors made in previous periods such as the correction of an error in depreciation. Changing the depreciation method, estimating the allowance for doubtful accounts, or inventory valuation methods do not affect the retained earnings directly.

Question 10

Match each of the following controls with the assertion for long-term debt that it supports.
-Premiums and discounts on bond and notes payables are properly amortized using the effective interest rate method

Accepted Answer

The assertion of accuracy, valuation, and allocation is supported by properly amortizing premiums and discounts on bond and notes payables using the effective interest rate method.

Question 11

Which audit procedure is most closely related to management's assertions about the presentation of stockholders' equity?

Accepted Answer

Determining whether restrictions have been imposed on retained earnings is directly related to the presentation of stockholders' equity, as it affects how equity is reported and disclosed in the financial statements.

Question 12

Match each of the following controls with the assertion for long-term debt that it supports.
-Any significant debt commitments are approved by the board of directors or delegated executives

Accepted Answer

This control supports the assertion of occurrence and authorization, as it ensures that significant debt commitments have been properly approved by the appropriate authorities.

Question 13

Many of Granada Corporation's convertible bond holders have converted their bonds into stock during the year under examination. The independent auditor should review Granada Corporation's statement of cash flows to ascertain that it shows:

Accepted Answer

The conversion of bonds into stock is a non-cash transaction and does not affect the company's cash flows. Therefore, it should not be reflected in the statement of cash flows.

Question 14

An audit program for the examination of the retained earnings account should include a step that requires verification of the:

Accepted Answer

Verification of the authorization for both cash and stock dividends is essential in auditing the retained earnings account because dividends directly affect retained earnings by reducing the amount available. The authorization process ensures that dividends are properly approved and recorded, impacting the retained earnings balance.

Question 15

Give an example of how the audit of income statement accounts could be affected by results of audit work done in other areas of the audit.

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Question 16

Match the balance sheet account with the income statement account that is typically audited at the same time.
-Bonds Payable

Accepted Answer

Bonds payable are a long-term liability that typically incurs interest expense, which is an income statement account that is typically audited at the same time as bond payable.

Question 17

Identify the three major types of transactions that occur in stockholders' equity.

Accepted Answer

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Question 18

For each of the following substantive procedures, first note whether it is a test of details of transactions or a test of details of account balances. Then decide for which assertion the test provides the best evidence.
1. Trace large cash receipts and payments to the general ledger.
2. Examine copies of note, bond, and financing lease agreements.
3. Recompute accrued interest payable.
4. Review debt activity for a few days before and after year-end to determine whether transactions are included in the proper period.
5. Examine due dates on notes and bonds for proper classification between current and long-term debt.

Accepted Answer

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Question 19

You have been assigned the duty of auditing long-term debt and retained earnings for Keys, Inc. Describe the tests you would use to support management's assertions regarding presentation for these accounts.

Accepted Answer

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Question 20

Before expressing an opinion concerning the results of operations, the auditor would most likely proceed with the examination of the income statement by:

Accepted Answer

Examining income statement accounts concurrently with the related balance sheet accounts ensures that the financial statements are consistent and accurate. This approach also allows the auditor to identify potential misstatements or errors in both the income statement and balance sheet, which could affect the overall accuracy of the financial statements. Applying a rigid measurement standard or comparing net income to industry trends may be helpful in certain circumstances, but they do not provide the auditor with a comprehensive view of the financial statements. Analyzing inventory amounts may be relevant for certain industries, but it is not necessarily relevant for all companies.

Quiz 15: Auditing the Financinginvesting Process: Long-Term Liabilities, Stockholders' Equity, and Income Statement Accounts