15-30 You are retained by Columbia Corporation to audit its financial statements for the fiscal year ended June 30. Your consideration of internal control indicates a fairly satisfactory condition, although there are not enough employees to permit an extensive separation of duties. The company is one of the smaller units in its industry, but it has realized net income of about $500,000 in each of the last three years.

Near the end of your fieldwork, you overhear a telephone call received by the president of the company while you are discussing the audit with him. The telephone conversation indicates that on May 15 of the current year the Columbia Corporation made an accommodation endorsement of a 60-day $430,000 note issued by a major customer, Brill Corporation, to its bank. The purpose of the telephone call from Brill was to inform your client that the note had been paid at the maturity date. You had not been aware of the existence of the note before overhearing the telephone call.

Required:

1. From an ethical standpoint, do you think the auditors would be justified in acting on information acquired in this manner?
2. Should the balance sheet as of June 30 disclose the contingent liability? Give reasons for your answer.
3. Prepare a list of auditing procedures that might have brought the contingency to light. Explain fully the likelihood of detection of the accommodation endorsement by each procedure listed.

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a. Which of the following is least likely to be an audit objective for debt?

(1) Determine the existence of recorded debt.

(2) Establish the completeness of recorded debt.

(3) Determine that the client has rights to receive proceeds relating to the redemption of debt.

(4) Determine that the valuation of debt is in accordance with generally accepted accounting principles.

b. The auditors would be most likely to find unrecorded long-term liabilities by analyzing:

(1) Interest payments.

(2) Discounts on long-term liabilities.

(3) Premiums on long-term liabilities.

(4) Recorded long-term liability accounts.

c. A likely reason that consideration of client compliance with debt provisions is important to an audit is that violation of such debt provisions may affect the total recorded:

(1) Number of debt restrictions.

(2) Current liabilities.

(3) Long-term assets.

(4) Capital stock.

d. A transfer agent and a registrar are most likely to provide the auditor with evidence on:

(1) Restrictions on the payment of accounts payable.

(2) Shares issued and outstanding.

(3) Preferred stock liquidation value.

(4) Transfers occurring between management and related parties.

e. The audit procedure of confirmation is least appropriate with respect to:

(1) The trustee of an issue of bonds payable.

(2) Holders of common stock.

(3) Holders of notes receivable.

(4) Holders of notes payable.

f. An auditor is most likely to trace treasury stock purchase transactions to the:

(1) Numbered stock certificates on hand.

(2) Articles of incorporation.

(3) Year’s interest expense.

(4) Minutes of the audit committee.

g. In the continuing audit of a manufacturing company of medium size, which of the following areas would you expect to require the least amount of audit time?

(1) Owners’ equity.

(2) Revenue.

(3) Assets.

(4) Liabilities.

h. The auditors can best verify a client’s bond sinking fund transactions and year-end balance by:

(1) Recomputation of interest expense, interest payable, and amortization of bond discount or premium.

(2) Confirmation with individual holders of retired bonds.

(3) Confirmation with the bond trustee.

(4) Examination and count of the bonds retired during the year.

i. The auditors’ program for the examination of long-term debt should include steps that require the:

(1) Verification of the existence of the bondholders.

(2) Examination of copies of debt agreements.

(3) Inspection of the accounts payable subsidiary ledger.

(4) Investigation of credits to the bond interest income account.

j. All corporate capital stock transactions should ultimately be traced to the:

(1) Minutes of the board of directors.

(2) Cash receipts journal.

(3) Cash disbursements journal.

(4) Numbered stock certificates.

k. Which of the following is most likely to be an audit objective in the audit of owners’ equity?

(1) Establish that recorded owners’ equity includes all long-term debt and equity balances.

(2) Determine that common stock is valued at current market value.

(3) Determine that the presentation and disclosure of owners’ equity are appropriate.

(4) Determine that the existence of recorded owner’s equity is in conformity with equity accounting rule valuations.

l. In an audit of a sole proprietorship, a common difficulty is lack of:

(1) Segregation of personal net worth and business capital.

(2) Availability of the owner.

(3) Agreement as to the distribution between retained earnings and owners’ capital.

(4) Proper measures of dividends.

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

(1) Are assets that collateralize notes payable critically needed for the entity’s continued existence?

(2) Are two or more authorized signatures required on checks that repay notes payable?

(3) Are the proceeds from notes payable used for the purchase of noncurrent assets?

(4) Are direct borrowings on notes payable authorized by the board of directors?

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

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

(2) Account for stock certificates by comparing the total shares outstanding to the total in the shareholders’ subsidiary ledger.

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

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

o. Where an independent stock transfer agent is not employed and the corporation issues its own stocks and maintains stock records, canceled stock certificates should:

(1) Be defaced to prevent reissuance and attached to their corresponding stubs.

(2) Not be defaced but segregated from other stock certificates and retained in a canceled certificates file.

(3) Be destroyed to prevent fraudulent reissuance.

(4) Be defaced and sent to the secretary of state.

p. An auditor most likely would inspect loan agreements under which an entity’s inventories are pledged to support management’s financial statement assertion of:

(1) Presentation and disclosure.

(2) Valuation or allocation.

(3) Existence or occurrence.

(4) Completeness.

q. An auditor usually obtains evidence of stockholders’ equity transactions by reviewing the entity’s:

(1) Minutes of board of directors meetings.

(2) Transfer agent’s records.

(3) Canceled stock certificates.

(4) Treasury stock certificate book.