AICPA AICPA Certifications CPA-TEST Questions & Answers

• Question 881:

  In auditing a client's retained earnings account, an auditor should determine whether there are any restrictions on retained earnings that result from loans, agreements, or state law. This procedure is designed to corroborate management's financial statement assertions with respect to:

  A. Transactions and events.

  B. Account balances.

  C. Presentation and disclosure.

  D. Audit risk and materiality.

  Correct Answer: C

  Explanation:

  Choice "c" is correct. Restrictions on retained earnings should be shown as appropriations in the financial

  statements. An auditor attempts to determine whether any such restrictions exist to verify that proper

  disclosures (i.e., retained earnings appropriations) have been made.

  Choices "a" and "b" are incorrect. Retained earnings appropriations restrict the company from paying

  dividends in excess of the unappropriated portion of retained earnings. This relates to presentation and

  disclosure, not to transactions, events, or balances.

  Choice "d" is incorrect. Audit risk and materiality are not financial statement assertions.

• Question 882:

  The primary responsibility of a bank acting as registrar of capital stock is to:

  A. Ascertain that dividends declared do not exceed the statutory amount allowable in the state of incorporation.

  B. Account for stock certificates by comparing the total shares outstanding to the total in the shareholders subsidiary ledger.

  C. Act as an independent third party between the board of directors and outside investors concerning mergers, acquisitions, and the sale of treasury stock.

  D. Verify that stock is issued in accordance with the authorization of the board of directors and the articles of incorporation.

  Correct Answer: D

  Explanation:

  Choice "d" is correct. Large companies often use a registrar to provide registration services and maintain

  the stockholder list. The primary responsibility of the registrar is to verify that stock is issued only with

  proper authorization.

  Choice "a" is incorrect. The company's board of directors bears responsibility for proper declaration of

  dividends, not the stock registrar.

  Choice "b" is incorrect. Since the company's management is responsible for maintaining accurate

  accounting records, a responsible company employee (not the registrar) would periodically compare the

  recorded number of shares outstanding (per company records) with the total in the shareholders'

  subsidiary ledger (per the registrar).

  Choice "c" is incorrect. A registrar does not have the described responsibility with respect to mergers,

  acquisitions, and the sale of treasury stock.

• Question 883:

  When a client company does not maintain its own stock records, the auditor should obtain written confirmation from the transfer agent and registrar concerning:

  A. Restrictions on the payment of dividends.

  B. The number of shares issued and outstanding.

  C. Guarantees of preferred stock liquidation value.

  D. The number of shares subject to agreements to repurchase.

  Correct Answer: B

  Explanation:

  Choice "b" is correct. When a client company does not maintain its own stock records, the auditor should

  request the transfer agent and registrar to confirm the number of shares issued and outstanding.

  Choice "a" is incorrect. Restrictions on the payment of dividends should be in the board minutes, or

  possibly confirmed by the bank if the restrictions are due to outstanding loan(s).

  Choice "c" is incorrect. Guarantees of preferred stock liquidation value should be in the board minutes or

  the stock redemption agreement.

  Choice "d" is incorrect. The number of shares subject to agreements to repurchase should be in the board

  minutes and in any repurchase agreements.

• Question 884:

  An auditor should trace corporate stock issuances and treasury stock transactions to the:

  A. Numbered stock certificates.

  B. Articles of incorporation.

  C. Transfer agent's records.

  D. Minutes of the board of directors.

  Correct Answer: D

  Explanation:

  Choice "d" is correct. The auditor should trace corporate stock issuances and treasury stock transactions

  to the minutes of the board of directors to make sure they were authorized.

  Choice "a" is incorrect. Numbered stock certificates for shares that are issued and outstanding would be in

  the hands of the stockholders.

  Choice "b" is incorrect. Information about stock issuances and treasury stock transactions would not be

  included in the articles of incorporation. Generally, only the shares authorized and their par value would be

  included therein.

  Choice "c" is incorrect. The transfer agent might confirm a transaction, but the auditor would not generally

  review the transfer agent's records.

• Question 885:

  Which of the following statements extracted from a client's lawyer's letters concerning litigation, claims, and assessments most likely would cause the auditor to request clarification?

  A. "I believe that the possible liability to the company is nominal in amount."

  B. "I believe that the action can be settled for less than the damages claimed."

  C. "I believe that the plaintiff's case against the company is without merit."

  D. "I believe that the company will be able to defend this action successfully."

  Correct Answer: B

  Explanation:

  Choice "b" is correct. The auditor is concerned with preventing an understatement of contingent liabilities.

  The auditor would therefore request clarification before determining that a reduction in such liability (from

  damages claimed to some lesser amount) is reasonable.

  Choices "a", "c", and "d" are incorrect. When a lawyer asserts that a contingent liability is immaterial

  ("nominal") or improbable ("without merit" and "successful defense likely"), it is unlikely that the auditor

  would require further clarification.

• Question 886:

  In auditing accounts payable, an auditor's procedures most likely would focus primarily on management's assertion of:

  A. Existence.

  B. Understandability and classification.

  C. Completeness.

  D. Valuation and allocation.

  Correct Answer: C

  Explanation: Choice "c" is correct. When testing liabilities, an auditor generally is concerned about understatement (as opposed to overstatement, for assets). Therefore, in auditing accounts payable, an auditor's procedures most likely would focus primarily on management's assertion of completeness (if accounts payable is not complete it would be understated). Choice "a" is incorrect. The assertion of existence is the primary focus of the auditor when auditing an asset account, not accounts payable. Choice "b" is incorrect. The understandability and classification assertion is not the primary focus in the audit of accounts payable. Choice "d" is incorrect. The assertion of valuation and allocation is not the main focus with respect to accounts payable. Good external evidence generally is available to support the amount, and allocation over more than one period generally is not required.

• Question 887:

  Which of the following questions would an auditor most likely include on an internal control questionnaire for notes payable?

  A. Are assets that collateralize notes payable critically needed for the entity's continued existence?

  B. Are two or more authorized signatures required on checks that repay notes payable?

  C. Are the proceeds from notes payable used for the purchase of noncurrent assets?

  D. Are direct borrowings on notes payable authorized by the board of directors?

  Correct Answer: D

  Explanation:

  Choice "d" is correct. An internal control questionnaire for notes payable would likely ask if direct

  borrowings on notes payable are authorized by the board of directors.

  Choice "a" is incorrect. Whether collateralized assets are critically needed for the entity's continued

  existence is not a part of the control environment related to notes payable.

  Choice "b" is incorrect. The requirement for two authorized signatures is part of the disbursements internal

  control system, not the notes payable system.

  Choice "c" is incorrect. Whether the proceeds of notes payable are used for current or noncurrent assets is

  not a part of the notes payable internal control system.

• Question 888:

  The most likely result of ineffective internal control policies and procedures in the revenue cycle is that:

  A. Irregularities in recording transactions in the subsidiary accounts could result in a delay in goods shipped.

  B. Omission of shipping documents could go undetected, causing an understatement of inventory.

  C. Final authorization of credit memos by personnel in the sales department could permit an employee defalcation scheme.

  D. Fictitious transactions could be recorded, causing an understatement of revenues and overstatement of receivables.

  Correct Answer: C

  Explanation: Choice "c" is correct. The most likely result of ineffective internal control policies and procedures in the revenue cycle is that final authorization of credit memos by personnel in the sales department could permit a salesman to sell, collect, and pocket the collection, then cover it up by issuing a credit memo. Final authorization of credit memos should be performed by an employee who is independent of the sales department such as the credit manager in the treasury department. Choice "a" is incorrect. The shipment of goods is an activity that takes place before the transaction is recorded. Irregularities in recording transactions in the subsidiary accounts therefore would have no impact on the timeliness of the goods being shipped. Choice "b" is incorrect. If shipping documents are omitted, then the inventory levels would be overstated since the reduction of inventory would not be recorded. Choice "d" is incorrect. If fictitious transactions in the revenue cycle are recorded, then the impact on revenues and receivables would be the same; either both would be overstated (the most likely case) or both would be understated.

• Question 889:

  An auditor should request that an audit client send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide:

  A. The opinion of a specialist as to whether loss contingencies are possible, probable, or remote.

  B. A description of litigation, claims, and assessments that have a reasonable possibility of unfavorable outcomes.

  C. An objective appraisal of management's controls adopted for identifying and evaluating legal matters.

  D. The corroboration of the information furnished by management concerning litigation, claims, and assessments.

  Correct Answer: D

  Explanation:

  Choice "d" is correct. The primary reason for an auditor to request that the audit client send a letter of

  inquiry to its attorneys is to provide corroboration of the information furnished by management concerning

  litigation, claims and assessments.

  Choice "a" is incorrect. The letter of inquiry is used to corroborate information furnished by management.

  The likelihood of loss contingencies occurring is only one item addressed in this correspondence, but it is

  not the primary purpose of the request.

  Choice "b" is incorrect. The description of litigation, claims and assessments that have a reasonable

  possibility of unfavorable outcomes should be provided by management, not the attorneys.

  Choice "c" is incorrect. The attorneys do not give an appraisal of management's controls adopted for

  identifying and evaluating legal matters.

• Question 890:

  Which of the following is not an audit procedure that the independent auditor would perform concerning litigation, claims, and assessments?

  A. Obtain assurance from management that it has disclosed all unasserted claims that the lawyer has advised are probable of assertion and must be disclosed.

  B. Confirm directly with the client's lawyer that all claims have been recorded in the financial statements.

  C. Inquire of and discuss with management the controls adopted for identifying, evaluating, and accounting for litigation, claims, and assessments.

  D. Obtain from management a description and evaluation of litigation, claims, and assessments existing at the balance sheet date.

  Correct Answer: B

  Explanation: Choice "b" is correct. The independent auditor would not confirm directly with the client's lawyer that all claims have been recorded in the financial statements. Management has the responsibility to include all claims in the financial statements, not the lawyers. The purpose of a legal letter is to obtain outside corroboration of the information furnished by management concerning litigation, claims, and assessments. Choice "a" is incorrect. The auditor should obtain assurance from management that it has disclosed all unasserted claims that the lawyer has advised are probable of assertion and must be disclosed. Choice "c" is incorrect. The auditor should inquire of and discuss with management the controls adopted for identifying, evaluating, and accounting for litigation, claims, and assessments. Choice "d" is incorrect. The auditor should obtain from management a description and evaluation of litigation, claims, and assessments existing at the balance sheet date.