Auditing and Assurance Services, 16e (Arens/Elder/Beasley)
Chapter 22 Audit of the Capital Acquisition and Repayment Cycle
22.1 Learning Objective 22-1
1) Which of the following statements is correct regarding the capital acquisition and payment
cycle?
A) Bonds are frequently issued by companies in small amounts.
B) There are relatively few transactions and each transaction is typically highly material.
C) A primary emphasis in auditing debt is on existence.
D) Audit procedures for notes payable and interest income are often performed simultaneously.
2) The capital acquisition and repayment cycle does not include
A) payment of interest.
B) payment of dividends.
C) payment of vendor invoices.
D) acquisition of capital through interest-bearing debt.
3) Which of the following statements regarding the capital acquisition and repayment cycle is
most correct?
A) A relatively few transactions affect the cycle, and most are smaller amounts.
B) A large numbers of transactions affect the cycle, and most are smaller amounts.
C) A relatively few transactions affect the cycle, and most are highly material.
D) A large number of transaction affect the cycle, and most are highly material.
4) The primary audit objectives to focus on when auditing accounts in the capital acquisition and
repayment cycle are
A) accuracy and completeness.
B) accuracy and existence.
C) completeness and valuation.
D) accuracy and valuation.
5) Performance materiality is often set at a(n) ________ level for notes payable.
A) high
B) moderate
C) low
D) unknown
6) When auditing interest-bearing debt, the auditor should ________ verify the related interest
expense and interest payable.
A) not
B) attempt to
C) simultaneously
D) never
7) Assessed control risk and results of substantive tests of transactions are normally unimportant
for designing tests of details of balances for which of the following accounts?
A) accounts receivable
B) inventory
C) accounts payable
D) notes payable
8) In the audit of the transactions and amounts in the capital acquisition and repayment cycle, the
auditor must take great care in making sure that the significant legal requirements affecting the
financial statements have been properly fulfilled and
A) any violations are reported to the SEC.
B) are adequately disclosed in the financial statements.
C) must issue a disclaimer if they haven’t been fulfilled.
D) any departures from the agreements are made with management’s knowledge and consent.
9) All corporations must have
A) preferred stock.
B) capital stock.
C) paid-in capital in excess of par.
D) dividends payable.
10) List the four characteristics of the capital acquisition and repayment cycle that make it
unique from other cycles.
11) List six accounts in the capital acquisition and repayment cycle commonly found on balance
sheets of corporations. What characteristics do these accounts have in common that distinguish
them from other accounts?
12) One unique characteristic of the capital acquisition and repayment cycle is that relatively few
transactions affect the account balances, but each transaction is often highly material in amount.
13) Auditors seldom learn about the capital acquisition and repayment cycle when gaining an
understanding of the client’s business and industry.
14) When auditing the capital acquisition and repayment cycle, it is common to verify each
transaction taking place in the cycle for the entire year as a part of verifying the balance sheet
accounts.
15) There is an indirect relationship between the interest and dividends accounts and debt and
equity.
22.2 Learning Objective 22-2
1) Which of the following is not an objective of the auditor’s examination of notes payable?
A) to determine whether internal controls are adequate
B) to determine whether client’s financing arrangements are effective and efficient
C) to determine whether transactions regarding the principal and interest of notes are properly
authorized
D) to determine whether the liability for notes and related interest expense and accrued liabilities
are properly stated
2) Responsibility for the issuance of new notes payable would normally be vested in the
A) board of directors.
B) purchasing department.
C) accounting department.
D) accounts payable department.
3) An auditor is determining whether an issuance of notes payable for cash was correctly
recorded. Her best course of action would be to
A) confirm with the bond trustee as to the amount of bonds issued.
B) confirm with the underwriter as to the appropriate market yield on the bonds.
C) trace the cash received from the proceeds to the accounting records.
D) verify that the amount was included in a footnote disclosure.
4) The auditor’s independent estimate of interest expense from notes payable uses average
interest rates and
A) average notes payable outstanding.
B) year-end notes payable outstanding.
C) only notes payable above the level of materiality.
D) only notes payable to major lenders.
5) The tests of details of balances procedure which requires the auditor to trace the totals of the
notes payable list to the general ledger satisfies the audit objective of
A) accuracy.
B) existence.
C) detail tie-in.
D) completeness.
6) The audit objective to determine that notes payable in the schedule actually exist is verified by
the test of details of balances procedure to
A) foot the notes payable list.
B) confirm notes payable.
C) recalculate interest expense.
D) examine the balance sheet for proper disclosure of noncurrent portions.
7) Actual interest expense is significantly higher than the auditor’s estimate. This would most
likely lead the auditor to conclude that the client has not
A) recorded all long-term interest bearing debt in the accounting records.
B) recorded all interest expense paid or accrued.
C) properly accounted for the discount of bonds payable account.
D) properly recorded interest income.
8) You are auditing the long-term notes payable account for a client. Which of the following
audit procedures would you most likely employ?
A) Compare interest expense recorded by the client with the notes payable account for
reasonableness.
B) Confirm bonds payable with individual bond holders.
C) Perform analytical procedures on the bond discount or premium account.
D) Examine bond documents for the presence of hybrid securities.
9) The two most important balance-related audit objectives for notes payable are
A) completeness and detail tie-in.
B) completeness and valuation.
C) accuracy and valuation.
D) accuracy and completeness.
10) Which of the following audit tests would provide evidence regarding the balance-related
audit objective of existence for an audit of notes payable?
A) Examine due dates on duplicate copies of notes.
B) Examine balance sheet for proper presentation and disclosure of notes payable.
C) Examine corporate minutes for loan approval.
D) Foot the notes payable list for notes payable and accrued interest.
11) Which of the following balance-related audit objectives is not applicable to the audit of notes
payable?
A) realizable value
B) detail tie-in
C) cutoff
D) classification
12) When there are not numerous transactions involving notes payable during the year, the
normal starting point for the audit of notes payable is
A) a schedule of notes payable and accrued interest prepared by the audit team.
B) a schedule of notes payable and accrued interest obtained from the client.
C) a schedule of only those notes with unpaid balances at the end of the year prepared by the
client.
D) the notes payable account in the general ledger.
13) The tests of details of balances procedure which requires the auditor to examine notes paid
after year-end to determine whether they were liabilities at the balance sheet date is an attempt to
satisfy the audit objective of
A) existence.
B) completeness.
C) accuracy.
D) classification.
14) The audit objective that requires that existing notes payable be included in the notes payable
schedule is satisfied by performing which of the following audit procedures?
A) Confirm notes payable.
B) Trace the total of the notes payable schedule to the general ledger.
C) Review the notes payable schedule to determine whether any are related parties.
D) Review the bank reconciliation for new notes credited directly to the bank account by the
bank.
15) The audit objective that requires the auditor to determine that notes payable on the notes
payable schedule are properly classified can be tested by performing the procedure to
A) confirm notes payable.
B) examine corporate minutes for loan approval.
C) examine notes, minutes, and bank confirmations for restrictions.
D) review the notes to determine whether any are with related parties.
16) During the course of an audit, a CPA observes that the recorded interest expense seems to be
excessive in relation to the balance in the long-term debt account. This observation could lead
the auditor to suspect that
A) long-term debt is understated.
B) discount on bonds payable is overstated.
C) long-term debt is overstated.
D) premium on bonds payable is understated.
17) To determine if notes payable are included in the proper period, the auditor should
A) trace the cash received from the issuance to the accounting records.
B) examine duplicate copies of notes to determine whether the notes were dated on or before the
balance sheet date.
C) examine duplicate copies of notes for principal and interest rates.
D) trace the individual notes payable to the master file.
18) In the audit of notes payable, it is common to include tests of principal and interest payments
as a part of the audit of the acquisitions and payment cycle because the payments are in the cash
disbursements journal that is being sampled. It is also normal to test these transactions as part of
the capital acquisitions and repayment cycle because
A) it is not unusual for the auditor to duplicate a process, thereby gathering a larger quantity of
evidence.
B) replicating the evidence will provide the auditor with a higher level of assurance.
C) the tests done in the acquisitions and payments cycle will look only at the cash credit side so
the tests done in the capital acquisitions and repayment cycle will look at the debit side of the
transaction.
D) due to the infrequency of these transactions, in many cases no transactions involving notes
payable are included in the sample tests of acquisitions and payments.
19) Which of the following is not an important control over notes payable?
A) There is proper authorization over the issuance of new notes payable.
B) Notes payable are issued when the business climate is favorable.
C) Adequate controls exist over repayment of interest and principal.
D) There exist proper documents and records.
20) Which of the following is an accurate statement regarding the audit of the capital acquisition
and repayment schedule?
A) When internal controls over notes payable are deficient, auditors are required to confirm the
notes payable.
B) As auditors perform tests of details of balances for balance-related audit objectives, the
evidence obtained helps satisfy the notes payable presentation and disclosure requirements.
C) The normal starting point for the audit of notes payable is a list of fixed asset acquisitions.
D) The schedule of notes payable and accrued interest must be prepared regardless of the number
of transactions involved.
21) Which balance-related audit objective is important for uncovering both errors and fraud?
A) completeness
B) existence
C) accuracy
D) detail tie-in
22) Why are substantive analytical procedures essential for notes payable?
23) What are the two most important balance-related audit objectives in notes payable?
24) Identify three substantive analytical procedures commonly performed for notes payable.
25) The starting point for the audit of notes payable is a schedule of notes payable and accrued
interest. Discuss the information typically included in the schedule.
26) You are employing tests of details of balances for notes payable and interest expense.
Describe below specific audit procedures you would perform for the balance-related audit
objectives of detail tie-in and existence. List at least two for each objective.
27) Discuss the four key controls over notes payable.
28) Discuss the overall objectives of the audit of notes payable.
29) Notes payable are generally for a period of sixty days or less.
30) When performing substantive analytical procedures for notes payable, if actual interest
expense is materially larger than the auditor’s expectation, one possible cause would be interest
payments on unrecorded notes payable.
31) The balance-related audit objective realizable value is not applicable when auditing notes
payable.
32) The three most important balance-related audit objectives for notes payable are existence,
realizable value, and accuracy.
33) The audit procedure “Foot the notes payable list and trace the totals to the general ledger” is
performed when verifying the accuracy objective for notes payable.
34) The audit procedure “Review the notes to determine whether any are related party notes or
accounts payable” is performed when verifying the classification objective for notes payable.
35) If loans require significant restrictions on the activities of the company, they must be
disclosed in the footnotes.
22.3 Learning Objective 22-3
1) Which of the following would generally not need to be approved by the board of directors?
A) issuing capital stock
B) repurchasing capital stock
C) declaration of a dividend
D) payment of a dividend