Question 1

Transactions between companies and related entities must be eliminated in consolidation or fully disclosed in the financial statements.

Accepted Answer

According to accounting rules, transactions between companies and related entities must be eliminated in consolidation to avoid double-counting of assets and liabilities. Alternatively, if they are not eliminated, they must be fully disclosed in the financial statements to provide transparency and avoid misleading information.

Question 2

If a specialist is used by client management to value the assets of the target company,the auditor will most likely evaluate all of the following characteristics of the expert,except for which of the following?

Accepted Answer

While the fees and billings of the expert may be a concern to client management, it is not a significant factor for the auditor when evaluating the specialist's work. The auditor is more concerned with the expert's credentials, methodologies, and independence as these have a direct impact on the valuation of the target company's assets.

Question 3

An auditor must understand the business processes of the client to adequately test management's decisions surrounding the impairment of goodwill.

Accepted Answer

An auditor must have knowledge and understanding of the business processes of the client to assess and evaluate management's decisions regarding the impairment of goodwill. This involves analyzing financial data, assessing the accuracy of management estimates, and closely examining the underlying factors that affect the value and potential impairment of goodwill. Failure of the auditor to have a thorough understanding of the business processes may result in inadequacies in the audit and an incorrect or incomplete opinion on the financial statements. Therefore, it is crucial for the auditor to possess the necessary knowledge and expertise in the business processes of the client to appropriately test management's goodwill impairment decisions.

Question 4

The acquisition of an entity or division may be performed through which of the following forms of consideration?

Accepted Answer

The question does not mention any limitations on the forms of consideration for the acquisition. Therefore, the best choice is D, which includes all possible forms of consideration: cash, stock, and/or contingencies. This allows for more flexibility and negotiation in the acquisition process.

Question 5

An example of a liability that requires significant judgments about certain events is the pension obligation.

Accepted Answer

The pension obligation requires significant judgments about certain events such as estimating the assumed rate of return on plan assets, projecting future salaries and benefits, mortality rates, and other factors that affect the present value of the pension obligation. These estimates can have a significant impact on the amount of the liability recorded on the financial statements.

Question 6

Related entity transactions transpire only between entities and individuals.

Accepted Answer

Related entity transactions can occur between entities themselves, without the involvement of individuals. For example, if two companies owned by the same parent company conduct a financial transaction with each other, it would be considered a related entity transaction.

Question 7

The purchase of another company or division must be recorded on which basis?

Accepted Answer

The purchase of another company or division must be recorded on the purchase basis. This involves recording the assets and liabilities of the acquired entity at their fair market value on the acquisition date, along with any goodwill or gain recognized from the transaction. The pooling of interests method is no longer allowed under generally accepted accounting principles (GAAP) and the push down basis is used for financial reporting purposes by the acquired company, not the acquirer. The merger basis is not a recognized accounting method.

Question 8

The SEC requires that personal use of a company's assets by officers be disclosed in the financial statements.

Accepted Answer

The SEC does require that personal use of a company's assets by officers be disclosed in the financial statements. This is important for transparency and to ensure that shareholders are aware of any potential conflicts of interest. Failure to disclose personal use of company assets can result in penalties and legal action by the SEC.

Question 9

Related entity transactions are fraudulent in nature.

Accepted Answer

Related entity transactions are not inherently fraudulent; they can be legitimate business dealings. However, they require careful scrutiny to ensure they are conducted at arm's length and are properly disclosed to prevent potential conflicts of interest or fraud.

Question 10

Bonds are reported on the financial statements net of premium or discount.

Accepted Answer

Bonds are reported on the financial statements net of premium (if the bond was issued at a premium, meaning the selling price was higher than the face value) or discount (if the bond was issued at a discount, meaning the selling price was lower than the face value). The premium or discount is amortized over the life of the bond and affects the amount of interest expense reported each period.

Question 11

Which of the following best represents a complex valuation issue in the acquisition of a new entity?

Accepted Answer

Fair market value takes into account various factors, such as the current economic environment, supply and demand, and future growth potential, which can make the valuation of an entity more complex than simply using the carrying or book value. Factors such as intangible assets, goodwill, and contingent liabilities may also need to be considered in determining the fair market value. The liquidation value is typically used to determine the minimum value of an entity in a forced sale scenario and may not accurately reflect the true value of the entity going concern basis.

Question 12

Financial statement disclosure of significant customers is necessary due to the inherent risks involved.

Accepted Answer

Disclosure of significant customers is necessary for investors and stakeholders to understand the revenue concentration and potential risks involved if these customers were to reduce or end their business with the company. It is important for transparency and to make informed decisions about investment and financial stability.

Question 13

Auditors must control the client's information system in order to adequately identify related party entity transactions.

Accepted Answer

Auditors do not control the client's information system, but rather gain an understanding of it to appropriately identify and assess the risks of related party entity transactions.

Question 14

Companies will not consolidate an entity where ownership is significantly less than 50% because of the variable interest entity rules.

Accepted Answer

Variable interest entity (VIE) rules allow companies to consolidate an entity even if they own less than 50% if they have significant control or influence over the entity's activities and financial decisions.

Question 15

An example of a restriction in a bond indenture is the use of a trustee to disburse funds.

Accepted Answer

A restriction in a bond indenture typically refers to covenants or conditions placed on the issuer, such as limits on additional debt or requirements to maintain certain financial ratios, not the use of a trustee to disburse funds.

Question 16

The auditors must notify the SEC of any related party transactions discovered during testing.

Accepted Answer

Auditors are not required to notify the SEC directly of related party transactions; they report their findings to the company's management and audit committee.

Question 17

Goodwill impairment is a measurement problem that should be addressed when?

Accepted Answer

Goodwill impairment should be addressed upon significant adverse change in the business environment, such as a decline in market value or changes in management. This is required by accounting standards and is an important step in accurately valuing assets and recognizing potential losses. A scheduled and consistent basis or in conjunction with recording restructuring liabilities may not capture the true state of the business environment and thus not reflect the accurate value of goodwill. Initial measurement in accordance with SFAS No.146 is important, but ongoing assessments are also necessary.

Question 18

It is important that the audit team tests the relationship of a client with other entities in order to determine whether a variable interest entity exists that must be consolidated.

Accepted Answer

Testing the relationship of a client with other entities is necessary to determine the existence of a variable interest entity that should be consolidated. Failure to identify such entities may result in the financial statements being misstated.

Question 19

An auditor must calculate the actuarial estimates for the client to record an accurate pension liability.

Accepted Answer

An auditor's role is to review and verify the accuracy of financial statements, not to calculate actuarial estimates. Actuarial estimates are typically calculated by actuaries, who specialize in assessing financial risks and uncertainties.

Question 20

Which of the following will management of the acquiring company typically engage to determine,for reporting purposes,the value of assets and liabilities of the target company?

Accepted Answer

An appraiser is typically engaged by the acquiring company to determine the value of the assets and liabilities of the target company for reporting purposes. An appraiser can help determine the fair market value of the target company's assets, such as real estate, inventory, and equipment, as well as its liabilities, such as debt and accounts payable. This information is important for the acquiring company to properly account for the acquisition and to make informed decisions regarding the target company's future operations. Actuaries, transfer agents, and underwriters are not typically engaged for this purpose.

Quiz 14: Audit of Longer-Term Liabilities, equity, acquisitions, and Related-Entity Transactions, long-Term Liabilities, and Equity