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Chapter 13: Audit of Long-Lived Assets and

Related Expense Accounts

Student: ___________________________________________________________________________

1. Improper recording of a capital lease as an operating lease is an inherent risk


associated with the audit of property, plant, and equipment.
True False

2. A major risk associated with property, plant, and equipment is that of the innovative
methods of manipulating earnings by recording invalid amounts to asset accounts.
True False

3. Asset impairment is assessed by the audit team for assets in the manufacturing
environment, but not for office equipment and buildings.
True False

4. The auditor should determine whether property and equipment have reasonable
useful lives.
True False

5. Gains on the sale of equipment usually signal the auditor that the lives of the assets
are too long.
True False

6. In the audit of the depreciation methods and possible impairment of manufacturing


equipment, the auditor tours the facility during operations to determine if any of the
machines are idle.
True False

7. Internal controls over fixed assets should ensure that all purchases are authorized.
True False
8. A first-time audit of the property, plant, and equipment accounts will involve additional
work on the part of the auditor to test the opening balances.
True False

9. The client should have methods in place to identify the impairment of significant
assets.
True False

10. The auditor typically tests management's estimate of the impaired value of a fixed
asset through the analysis of the future undiscounted cash flows of the asset.
True False

11. The auditor would be most likely to request a schedule of repairs and maintenance
expense to satisfy the auditor about the presentation and disclosure assertions for fixed
assets.
True False

12. The auditor would be most likely to request a schedule of repairs and maintenance
expense to satisfy the auditor about the completeness assertion for fixed assets.
True False

13. The auditor should perform detailed tests of labor charges when the client company
constructs its own assets.
True False

14. The auditor should be aware of material asset additions that are in remote locations
and physically observe such assets.
True False

15. The auditor would conclude that the client was not depreciating the cost of fixed
assets rapidly enough if there were a large number of losses on the disposals of assets.
True False
16. Asset impairment is not typically assessed by the independent auditor, but is
assessed by the internal auditor.
True False

17. Knowledge of business conditions is not crucial to the auditor's identification of the
potential for impairment of assets as the auditor must focus attention on the accounting
rules.
True False

18. When a decision is made to discontinue an operation, the net assets should be
written down to a best estimate of net realizable value.
True False

19. A corporation should always anticipate and record gains on the disposal of assets.
True False

20. Once the auditor obtains a fixed asset additions schedule from the client, testing of
the existence of the additions must immediately ensue to ensure effectiveness.
True False

21. Strong internal control activities in the fixed assets cycle include the use of
identification tags secured to assets for proper tracking.
True False

22. Reclamation expenses associated with the use of the land in a mining operation
should be estimated, accrued, and allocated to depletion costs over time.
True False

23. When testing a client's additions to an asset for research and development, the
auditor must remember that such costs should be amortized over the lesser of their legal
lives or useful lives.
True False
24. Bluewire Technologies, Inc. obtained a patent for its MegaK2000 product five years
ago and should expense the entire amount of the unamortized balance if MegaK2000 is
no longer sold.
True False

25. Accounting principles allow goodwill to be held on the books of a company


indefinitely and not amortized over time.
True False

26. An auditor will read the footnotes related to discontinued operations to ensure that,
among other things, the justification of the decision and the write-down of assets are
adequately disclosed.
True False

27. The auditor must be aware of management's motivations to present financial


information in a certain light when leases are utilized.
True False

28. Companies always enter into lease agreements to finance the purchase of expensive
assets over time.
True False

29. The accounting for leases is often misapplied in order to achieve off-balance sheet
financing.
True False

30. Title transfer by the end of a lease is one of the criteria for capital lease recognition.
True False

31. A bargain purchase option is a good indicator that an arrangement should be


accounted for as an operating lease.
True False
32. Auditors will perform an analysis of leases using FAS Statement No. 13 and FASB ASC
840 criteria to substantiate the accounting treatment.
True False

33. Auditors often recalculate the present value of capital lease agreements to assess
the valuation of recorded liabilities.
True False

34. U.S. accounting principles require that lease agreements are treated as capital leases
if all of the four criteria apply.
True False

35. Leases that qualify as operating are expensed as rent each period.
True False

36. It is simple for auditors to test the costs capitalized for discovery of natural resources
because only successful efforts may be recorded
True False

37. The cost of defending patents may not be capitalized.


True False

38. Changes in the ages of equipment may be identified by analyzing depreciation


expense as a percent of assets.
True False

39. Companies often increase depreciation and impairment expenses through


manipulation in order to increase profits.
True False
40. If the beginning balance of property, plant and equipment is established through
previous audit work, the test of property accounts usually can be limited to selected
tests of property additions and disposals during the year.
True False

41. In testing property, plant and equipment the scope and extent of testing can vary
based on the complexity of assets utilized, the difficulty of estimating useful life, and the
risk associated with the client.
True False

42. Intangible assets are amortized over the remaining legal life of patents or copyrights
associated with the asset or their useful life.
True False

43. The auditor should be aware of the possibility that management may be
manipulating earnings by inappropriately expensing capital items or inappropriately
capitalizing expense items.
True False

44. Asset losses or impairment are recognized when they occur, while asset gains are not
recognized until realized.
True False

45. Property, plant and equipment is written down when its value becomes impaired and
may be written back up if its value go up at a later date.
True False

46. Which one of the following is not a risk associated with property, plant, and
equipment.
A. obsolescence of assets
B. impairment of assets
C. incomplete recording of disposals
D. sum-of-years digits depreciation
47. All of the following represent risks associated with fixed assets and related expenses
except
A. Incomplete recording of asset disposals
B. Environmental liabilities or claims related to violations of safety and protection
regulations
C. Failure to properly recognize impairment in value
D. All represent risks

48. If the audit team notes the client has made a significant change in its product line
which requires that new equipment be purchased, that may be an indication of
A. book value.
B. scrap value.
C. impaired value.
D. depreciation value.

49. Auditors test management's estimates of impaired value through reference to which
of the following?
A. economic plans.
B. evidence of fair market value.
C. estimated cash flow.
D. All of the above.

50. The tour of the manufacturing plant may best assist the auditor in identifying which
of the following?
A. that all purchases are authorized.
B. machinery that is inoperative in the production cycle.
C. management's impairment strategy.
D. estimates of depreciation expense.

51. When a company decides to dispose of a particular line of operation by selling it to


another company, the related assets should
A. be written up in anticipation of a gain on disposal.
B. be considered scrap material.
C. be held at historical cost.
D. be written down on the expectation of a loss on disposal.
52. Which one of the following procedures is most appropriate for testing proper
authorization for major capital projects?
A. examination of proper recording of the equipment.
B. examination of board of directors minutes.
C. examination of the cash budget.
D. examination of useful lives.

53. When testing fixed assets for the reasonableness of the client's estimated useful
lives, the audit team should do which of the following?
A. consult the IRS code for regulated lives.
B. make the decision for the client upon purchase.
C. understand the economics of the client's business.
D. compare them with other clients in different industries.

54. Analytical estimation of depreciation by the auditor is an important audit test


because it does which of the following?
A. it signals which additions will be vouched.
B. it yields statistical precision in sampling.
C. it is a good starting point for determining additional procedures.
D. it gives the auditor an indication of the impaired balances existing in financial
statements.

55. If the auditor determines that beginning balances of fixed assets have not changed
from previously audited amounts, much of the testing for existence can be accomplished
by which of the following?
A. sampling receiving reports.
B. inquiring of management.
C. vouching current period additions.
D. recomputing depreciation.

56. Which of the following is the best example of a fixed asset that will be physically
inspected by the auditor in the period under audit?
A. An adding machine acquired in the current period.
B. A warehouse purchased three years previously.
C. An office building constructed in the current period.
D. Desktop computers purchased in the previous period.
57. The first-time audit of a company with property, plant, and equipment may cause the
auditor to do which of the following?
A. request a complete physical inventory of the certain items in the account.
B. start fresh with an audit as of the end of the period.
C. send a confirmation to a sample of equipment suppliers.
D. review original invoices of immaterial equipment purchased during the period.

58. Which one of the following procedures would provide the best evidence about the
original cost of a piece of equipment?
A. fixed asset schedule
B. purchase invoice
C. receiving report
D. inquiry of the purchasing agent

59. Management may determine that an asset is impaired through the use of which of
the following?
A. discounted cash flows.
B. internal rate of return.
C. Black Scholes modeling.
D. acid test ratios.

60. Which method might an auditor utilize in testing depletion expense?


A. using analytical procedures.
B. observation of the physical count.
C. obtaining management representation.
D. estimating the useful life of the natural resource.

61. The audit of the repairs and maintenance expense account is extremely important as
it helps the auditor to determine if
A. depreciation expense includes charges for repairs.
B. the net book value of assets achieves precision.
C. items that should be included as assets are charged as expenses.
D. all repairs and maintenance expenses add value to the assets.
62. The best approach to determine whether a capital lease has been "kept off the
books" is to do which of the following?
A. review all capital lease agreements that have been recorded.
B. examine the canceled checks for all recorded capital leases.
C. review all major lease agreements to determine whether there are other leases to be
capitalized.
D. physically examine the asset and trace it to the general ledger.

63. A test of controls to determine proper authorization for the addition of a major piece
of equipment would include all of the following except
A. examination of purchase agreements.
B. review of minutes of the board of directors' meetings.
C. review of approvals by a capital budgeting committee.
D. examination of the identification tags attached to equipment.

64. An estimate of the reasonableness of depreciation expense and accumulated


depreciation may be accomplished by performing which of the following?
A. tests of controls.
B. substantive tests of transactions.
C. analytical review procedures.
D. management inquiry.

65. Analytical review procedures for depreciation expense and accumulated depreciation
would include all of the following ratios except
A. current depreciation as a percentage of previous year assets.
B. fixed assets as a percentage of previous year assets.
C. depreciation expense as a percentage of assets each year.
D. average age of assets.

66. Analytical procedures for depreciation expense and accumulated depreciation would
include all of the following ratios except
A. current depreciation as a percentage of previous year depreciation.
B. fixed assets as a percentage of previous year assets.
C. accumulated depreciation as a percentage of gross assets each year.
D. average cost of assets.
67. Which is the primary assertion tested in conjunction with the obtaining of evidence
regarding impairment?
A. Valuation.
B. Cutoff.
C. Existence.
D. Rights.

68. Cloud Company determines that the future undiscounted cash flow generated from
the use of its fleet of small aircraft are less than carrying values. For impairment
purposes, an auditor would wish to further obtain evidence regarding which of the
following?
A. parts inventory for the aircraft.
B. an economic outlook for the company's stock.
C. an independent valuation of the aircraft.
D. the historical cost of the aircraft.

69. Which of the following is a term used to describe management's recognition that a
significant portion of fixed assets is no longer as productive as had originally been
expected?
A. asset depreciation.
B. asset amortization.
C. asset impairment.
D. asset disposal.

70. In a tour of a client's manufacturing facility, the auditor is most likely attempting to
satisfy the which of the following assertions related to long-lived assets?
A. cutoff.
B. existence.
C. rights.
D. presentation.

71. The auditor selects a sample of asset disposals and examines the sales
documentation evidencing disposal of the equipment and recomputes gain or loss on the
disposal. This audit steps primarily tests which of the following assertions for the
equipment account?
A. existence assertion.
B. presentation assertion.
C. rights assertion.
D. valuation assertion.
72. Which one of the following does not constitute probable relationships between
accounts?
A. Equipment and depreciation.
B. Patent and amortization.
C. Assets under capital leases and amortization.
D. Oil reserves and depreciation.

73. Which of the following represents a primary audit concern for errors in the recording
of intangible assets?
A. Capitalized research and development costs.
B. Amortization of patents.
C. Capitalized costs to successfully defend a patent.
D. Amortization of franchise fees.

74. Which of the following meets the criteria for a capitalized lease under GAAP in the
U.S.?
A. The present value of the future minimum payments is $90,000 and the fair value is
$110,000.
B. The lessee can purchase the asset for an amount that is greater than fair vale at the
end of the lease.
C. The lease term is ten years and the useful life of the asset is 11 years.
D. Title does not transfer by the end of the lease term.

75. As it relates to property, plant and equipment, what specific risk relating to earnings
management do the auditors assess?
A. Equipment has been initially recorded at cost.
B. Depreciation has been recorded using accelerated methods.
C. Repairs and maintenance have been expensed rather than included as assets.
D. Useful lives have been extended without justification.

76. The auditor performs tests on property, plant and equipment to determine if assets
have been pledged as collateral or title has transferred primarily to assess which
assertions?
A. Valuation and completeness.
B. Rights and disclosure.
C. Obligations and legality.
D. Cutoff and accuracy.
77. An auditor wishes to test the net valuation of the equipment in the financial
statements of a client. How will the auditor best perform this testing?
A. Vouch the recorded equipment to an invoice supporting the cost of the equipment
when originally purchased.
B. Compare the ID number on the fixed asset schedule to the identification tag on the
asset itself.
C. Recalculate annual depreciation expense for major additions and a sample of all other
equipment.
D. Confirm material equipment with customers.

78. Which of the following procedures would evidence the client's control over the
existence of machinery and equipment?
A. Useful lives are only entered into the system by the controller.
B. Impairment testing takes place in accordance with a formal assessment of business
changes and events as they relate to fixed assets.
C. Fixed assets are assigned a control identification number and that number is
permanently affixed to the asset for periodic inventory.
D. Only the CFO can enter additions into the fixed asset module of the system.

79. Leases in the U.S. should be capitalized on the books of the client if it meets one of
four conditions. Which of the following is not one of those four conditions.
A. the lease contract transfers ownership.
B. the lease contains a bargain purchase option.
C. the lease term covers at least 80% of the useful life of the asset.
D. the present value of the minimum lease payments is at least equal to 90% of the
assets fair market value.

80. If a lease does not meet at least one of four conditions described in U.S. GAAP, then
it is classified as which of the following?
A. capital lease.
B. operating lease.
C. direct financing lease.
D. sales-type lease.

81. As natural resources are used up the client has to recognize which of the following?
A. depreciation expense.
B. depletion expense.
C. amortization expense.
D. reclamation expense.
82. After a natural resource such as gas or coal is used up by the client, the client is
responsible for restoring the land to its original condition. What is the cost of this
restoration called?
A. depreciation expense.
B. depletion expense.
C. amortization expense.
D. reclamation expense.

83. Which of the following are estimates used by natural resource companies in
recognizing costs over the life of the resource, e.g., oil or coal?
A. reserves.
B. depletion rate.
C. reclamation expense.
D. both A and B.
E. all of the above.

84. Capitalized natural resources, e.g., oil or coal, are usually written off over what period
of time?
A. over a period not to exceed 40 years.
B. over an allocated useful life.
C. as assets are taken from the ground.
D. any of the above.

85. In evaluating control risk and effectiveness for fixed assets, controls should be
designed for numerous purposes. Which of the following is not a usual control for fixed
assets?
A. identify existing assets, inventory them, and reconcile physical inventory with the
property ledger.
B. periodically reassess the appropriateness of depletion categories.
C. identify obsolete or scrapped equipment and write it down to scrap value.
D. periodically review management strategy and systematically assess the impairment
of assets.
E. all of the above are usual controls for fixed assets.
86. In evaluating control risk and effectiveness for intangible assets, controls should be
designed for numerous purposes. Which of the following is not a usual control for
intangible assets?
A. ensure that decisions are appropriately made as to when to capitalize or expense
research and development expenditures.
B. develop amortization schedules that reflect the remaining useful life of patents or
copyrights associated with the assets.
C. identify and account for intangible asset impairment.
D. all of the above are usual controls for intangible assets.

87. Which of the following assertions are addressed by examining purchase agreements
and minutes of board of director’s meeting?
A. existence.
B. rights.
C. valuation.
D. both A and B.
E. all of the above.

88. Decommission costs for fixed assets, e.g., a power plant, must be recognized over
what period of time?
A. when the plant is built.
B. over the life of the plant.
C. when the plant is decommissioned.
D. Either B or C is acceptable.

89. Periodically clients discontinue a particular line of operation by shutting down or


selling a line of business or a company, which usually occurs over at least several
months. In these situations the client is to write down net assets to a best estimate of
net realizable value and do which of the following?
A. recognize a loss.
B. recognize a gain.
C. recognize a loss or a gain.
D. not recognize any gain or loss.

90. Useful methods to evaluate asset impairment of long-lived assets usually would not
include which of the following?
A. current market values of similar assets.
B. estimated future economic benefits to be derived from the asset.
C. an independent assessment of the value of the asset.
D. all of the above are useful in valuing impairment.
91. Repairs and maintenance

Why would the auditor be concerned about the repairs and maintenance account in
relation to property plant and equipment?

92. Property plant & equipment evidence - additions

Specify the evidence the auditor would review to satisfy himself or herself about each of
the following assertions concerning property, plant, and equipment additions.

A. Valuation at historical cost.


B. Existence.
C. Presentation on balance sheet.
D. Rights.

93. Audit approach for lease

Describe the general audit approach for leases.


94. Capital leases

Identify the four criteria that have been provided under U.S. GAAP that the auditor will
use to assess capital lease treatment.

95. Earnings management

Describe earnings management by an organization and discuss the implications of fixed


asset accounting on earnings management.

96. Asset impairment

Describe what asset impairment is, why the auditor is concerned about it, and how it is
dealt with by the auditor.
97. Intangible assets - patents

Discuss what an intangible asset is and some audit procedures concerning patents that
the auditor might use in connection with it.
Chapter 13: Audit of Long-Lived Assets and Related
Expense Accounts Key

1. Improper recording of a capital lease as an operating lease is an inherent risk


associated with the audit of property, plant, and equipment.
TRUE

2. A major risk associated with property, plant, and equipment is that of the innovative
methods of manipulating earnings by recording invalid amounts to asset accounts.
TRUE

3. Asset impairment is assessed by the audit team for assets in the manufacturing
environment, but not for office equipment and buildings.
FALSE

4. The auditor should determine whether property and equipment have reasonable
useful lives.
TRUE

5. Gains on the sale of equipment usually signal the auditor that the lives of the assets
are too long.
FALSE

6. In the audit of the depreciation methods and possible impairment of manufacturing


equipment, the auditor tours the facility during operations to determine if any of the
machines are idle.
TRUE

7. Internal controls over fixed assets should ensure that all purchases are authorized.
TRUE
8. A first-time audit of the property, plant, and equipment accounts will involve additional
work on the part of the auditor to test the opening balances.
TRUE

9. The client should have methods in place to identify the impairment of significant
assets.
TRUE

10. The auditor typically tests management's estimate of the impaired value of a fixed
asset through the analysis of the future undiscounted cash flows of the asset.
FALSE

11. The auditor would be most likely to request a schedule of repairs and maintenance
expense to satisfy the auditor about the presentation and disclosure assertions for fixed
assets.
FALSE

12. The auditor would be most likely to request a schedule of repairs and maintenance
expense to satisfy the auditor about the completeness assertion for fixed assets.
TRUE

13. The auditor should perform detailed tests of labor charges when the client company
constructs its own assets.
TRUE

14. The auditor should be aware of material asset additions that are in remote locations
and physically observe such assets.
TRUE

15. The auditor would conclude that the client was not depreciating the cost of fixed
assets rapidly enough if there were a large number of losses on the disposals of assets.
TRUE
16. Asset impairment is not typically assessed by the independent auditor, but is
assessed by the internal auditor.
FALSE

17. Knowledge of business conditions is not crucial to the auditor's identification of the
potential for impairment of assets as the auditor must focus attention on the accounting
rules.
FALSE

18. When a decision is made to discontinue an operation, the net assets should be
written down to a best estimate of net realizable value.
TRUE

19. A corporation should always anticipate and record gains on the disposal of assets.
FALSE

20. Once the auditor obtains a fixed asset additions schedule from the client, testing of
the existence of the additions must immediately ensue to ensure effectiveness.
FALSE

21. Strong internal control activities in the fixed assets cycle include the use of
identification tags secured to assets for proper tracking.
TRUE

22. Reclamation expenses associated with the use of the land in a mining operation
should be estimated, accrued, and allocated to depletion costs over time.
TRUE

23. When testing a client's additions to an asset for research and development, the
auditor must remember that such costs should be amortized over the lesser of their legal
lives or useful lives.
FALSE
24. Bluewire Technologies, Inc. obtained a patent for its MegaK2000 product five years
ago and should expense the entire amount of the unamortized balance if MegaK2000 is
no longer sold.
TRUE

25. Accounting principles allow goodwill to be held on the books of a company


indefinitely and not amortized over time.
TRUE

26. An auditor will read the footnotes related to discontinued operations to ensure that,
among other things, the justification of the decision and the write-down of assets are
adequately disclosed.
TRUE

27. The auditor must be aware of management's motivations to present financial


information in a certain light when leases are utilized.
TRUE

28. Companies always enter into lease agreements to finance the purchase of expensive
assets over time.
FALSE

29. The accounting for leases is often misapplied in order to achieve off-balance sheet
financing.
TRUE

30. Title transfer by the end of a lease is one of the criteria for capital lease recognition.
TRUE

31. A bargain purchase option is a good indicator that an arrangement should be


accounted for as an operating lease.
FALSE
32. Auditors will perform an analysis of leases using FAS Statement No. 13 and FASB ASC
840 criteria to substantiate the accounting treatment.
TRUE

33. Auditors often recalculate the present value of capital lease agreements to assess
the valuation of recorded liabilities.
TRUE

34. U.S. accounting principles require that lease agreements are treated as capital leases
if all of the four criteria apply.
FALSE

35. Leases that qualify as operating are expensed as rent each period.
TRUE

36. It is simple for auditors to test the costs capitalized for discovery of natural resources
because only successful efforts may be recorded
FALSE

37. The cost of defending patents may not be capitalized.


FALSE

38. Changes in the ages of equipment may be identified by analyzing depreciation


expense as a percent of assets.
TRUE

39. Companies often increase depreciation and impairment expenses through


manipulation in order to increase profits.
FALSE
40. If the beginning balance of property, plant and equipment is established through
previous audit work, the test of property accounts usually can be limited to selected
tests of property additions and disposals during the year.
TRUE

41. In testing property, plant and equipment the scope and extent of testing can vary
based on the complexity of assets utilized, the difficulty of estimating useful life, and the
risk associated with the client.
TRUE

42. Intangible assets are amortized over the remaining legal life of patents or copyrights
associated with the asset or their useful life.
TRUE

43. The auditor should be aware of the possibility that management may be
manipulating earnings by inappropriately expensing capital items or inappropriately
capitalizing expense items.
TRUE

44. Asset losses or impairment are recognized when they occur, while asset gains are not
recognized until realized.
TRUE

45. Property, plant and equipment is written down when its value becomes impaired and
may be written back up if its value go up at a later date.
FALSE

46. Which one of the following is not a risk associated with property, plant, and
equipment.
A. obsolescence of assets
B. impairment of assets
C. incomplete recording of disposals
D. sum-of-years digits depreciation
47. All of the following represent risks associated with fixed assets and related expenses
except
A. Incomplete recording of asset disposals
B. Environmental liabilities or claims related to violations of safety and protection
regulations
C. Failure to properly recognize impairment in value
D. All represent risks

48. If the audit team notes the client has made a significant change in its product line
which requires that new equipment be purchased, that may be an indication of
A. book value.
B. scrap value.
C. impaired value.
D. depreciation value.

49. Auditors test management's estimates of impaired value through reference to which
of the following?
A. economic plans.
B. evidence of fair market value.
C. estimated cash flow.
D. All of the above.

50. The tour of the manufacturing plant may best assist the auditor in identifying which
of the following?
A. that all purchases are authorized.
B. machinery that is inoperative in the production cycle.
C. management's impairment strategy.
D. estimates of depreciation expense.

51. When a company decides to dispose of a particular line of operation by selling it to


another company, the related assets should
A. be written up in anticipation of a gain on disposal.
B. be considered scrap material.
C. be held at historical cost.
D. be written down on the expectation of a loss on disposal.
52. Which one of the following procedures is most appropriate for testing proper
authorization for major capital projects?
A. examination of proper recording of the equipment.
B. examination of board of directors minutes.
C. examination of the cash budget.
D. examination of useful lives.

53. When testing fixed assets for the reasonableness of the client's estimated useful
lives, the audit team should do which of the following?
A. consult the IRS code for regulated lives.
B. make the decision for the client upon purchase.
C. understand the economics of the client's business.
D. compare them with other clients in different industries.

54. Analytical estimation of depreciation by the auditor is an important audit test


because it does which of the following?
A. it signals which additions will be vouched.
B. it yields statistical precision in sampling.
C. it is a good starting point for determining additional procedures.
D. it gives the auditor an indication of the impaired balances existing in financial
statements.

55. If the auditor determines that beginning balances of fixed assets have not changed
from previously audited amounts, much of the testing for existence can be accomplished
by which of the following?
A. sampling receiving reports.
B. inquiring of management.
C. vouching current period additions.
D. recomputing depreciation.

56. Which of the following is the best example of a fixed asset that will be physically
inspected by the auditor in the period under audit?
A. An adding machine acquired in the current period.
B. A warehouse purchased three years previously.
C. An office building constructed in the current period.
D. Desktop computers purchased in the previous period.
57. The first-time audit of a company with property, plant, and equipment may cause the
auditor to do which of the following?
A. request a complete physical inventory of the certain items in the account.
B. start fresh with an audit as of the end of the period.
C. send a confirmation to a sample of equipment suppliers.
D. review original invoices of immaterial equipment purchased during the period.

58. Which one of the following procedures would provide the best evidence about the
original cost of a piece of equipment?
A. fixed asset schedule
B. purchase invoice
C. receiving report
D. inquiry of the purchasing agent

59. Management may determine that an asset is impaired through the use of which of
the following?
A. discounted cash flows.
B. internal rate of return.
C. Black Scholes modeling.
D. acid test ratios.

60. Which method might an auditor utilize in testing depletion expense?


A. using analytical procedures.
B. observation of the physical count.
C. obtaining management representation.
D. estimating the useful life of the natural resource.

61. The audit of the repairs and maintenance expense account is extremely important as
it helps the auditor to determine if
A. depreciation expense includes charges for repairs.
B. the net book value of assets achieves precision.
C. items that should be included as assets are charged as expenses.
D. all repairs and maintenance expenses add value to the assets.
62. The best approach to determine whether a capital lease has been "kept off the
books" is to do which of the following?
A. review all capital lease agreements that have been recorded.
B. examine the canceled checks for all recorded capital leases.
C. review all major lease agreements to determine whether there are other leases to be
capitalized.
D. physically examine the asset and trace it to the general ledger.

63. A test of controls to determine proper authorization for the addition of a major piece
of equipment would include all of the following except
A. examination of purchase agreements.
B. review of minutes of the board of directors' meetings.
C. review of approvals by a capital budgeting committee.
D. examination of the identification tags attached to equipment.

64. An estimate of the reasonableness of depreciation expense and accumulated


depreciation may be accomplished by performing which of the following?
A. tests of controls.
B. substantive tests of transactions.
C. analytical review procedures.
D. management inquiry.

65. Analytical review procedures for depreciation expense and accumulated depreciation
would include all of the following ratios except
A. current depreciation as a percentage of previous year assets.
B. fixed assets as a percentage of previous year assets.
C. depreciation expense as a percentage of assets each year.
D. average age of assets.

66. Analytical procedures for depreciation expense and accumulated depreciation would
include all of the following ratios except
A. current depreciation as a percentage of previous year depreciation.
B. fixed assets as a percentage of previous year assets.
C. accumulated depreciation as a percentage of gross assets each year.
D. average cost of assets.
67. Which is the primary assertion tested in conjunction with the obtaining of evidence
regarding impairment?
A. Valuation.
B. Cutoff.
C. Existence.
D. Rights.

68. Cloud Company determines that the future undiscounted cash flow generated from
the use of its fleet of small aircraft are less than carrying values. For impairment
purposes, an auditor would wish to further obtain evidence regarding which of the
following?
A. parts inventory for the aircraft.
B. an economic outlook for the company's stock.
C. an independent valuation of the aircraft.
D. the historical cost of the aircraft.

69. Which of the following is a term used to describe management's recognition that a
significant portion of fixed assets is no longer as productive as had originally been
expected?
A. asset depreciation.
B. asset amortization.
C. asset impairment.
D. asset disposal.

70. In a tour of a client's manufacturing facility, the auditor is most likely attempting to
satisfy the which of the following assertions related to long-lived assets?
A. cutoff.
B. existence.
C. rights.
D. presentation.

71. The auditor selects a sample of asset disposals and examines the sales
documentation evidencing disposal of the equipment and recomputes gain or loss on the
disposal. This audit steps primarily tests which of the following assertions for the
equipment account?
A. existence assertion.
B. presentation assertion.
C. rights assertion.
D. valuation assertion.
72. Which one of the following does not constitute probable relationships between
accounts?
A. Equipment and depreciation.
B. Patent and amortization.
C. Assets under capital leases and amortization.
D. Oil reserves and depreciation.

73. Which of the following represents a primary audit concern for errors in the recording
of intangible assets?
A. Capitalized research and development costs.
B. Amortization of patents.
C. Capitalized costs to successfully defend a patent.
D. Amortization of franchise fees.

74. Which of the following meets the criteria for a capitalized lease under GAAP in the
U.S.?
A. The present value of the future minimum payments is $90,000 and the fair value is
$110,000.
B. The lessee can purchase the asset for an amount that is greater than fair vale at the
end of the lease.
C. The lease term is ten years and the useful life of the asset is 11 years.
D. Title does not transfer by the end of the lease term.

75. As it relates to property, plant and equipment, what specific risk relating to earnings
management do the auditors assess?
A. Equipment has been initially recorded at cost.
B. Depreciation has been recorded using accelerated methods.
C. Repairs and maintenance have been expensed rather than included as assets.
D. Useful lives have been extended without justification.

76. The auditor performs tests on property, plant and equipment to determine if assets
have been pledged as collateral or title has transferred primarily to assess which
assertions?
A. Valuation and completeness.
B. Rights and disclosure.
C. Obligations and legality.
D. Cutoff and accuracy.
77. An auditor wishes to test the net valuation of the equipment in the financial
statements of a client. How will the auditor best perform this testing?
A. Vouch the recorded equipment to an invoice supporting the cost of the equipment
when originally purchased.
B. Compare the ID number on the fixed asset schedule to the identification tag on the
asset itself.
C. Recalculate annual depreciation expense for major additions and a sample of all other
equipment.
D. Confirm material equipment with customers.

78. Which of the following procedures would evidence the client's control over the
existence of machinery and equipment?
A. Useful lives are only entered into the system by the controller.
B. Impairment testing takes place in accordance with a formal assessment of business
changes and events as they relate to fixed assets.
C. Fixed assets are assigned a control identification number and that number is
permanently affixed to the asset for periodic inventory.
D. Only the CFO can enter additions into the fixed asset module of the system.

79. Leases in the U.S. should be capitalized on the books of the client if it meets one of
four conditions. Which of the following is not one of those four conditions.
A. the lease contract transfers ownership.
B. the lease contains a bargain purchase option.
C. the lease term covers at least 80% of the useful life of the asset.
D. the present value of the minimum lease payments is at least equal to 90% of the
assets fair market value.

80. If a lease does not meet at least one of four conditions described in U.S. GAAP, then
it is classified as which of the following?
A. capital lease.
B. operating lease.
C. direct financing lease.
D. sales-type lease.

81. As natural resources are used up the client has to recognize which of the following?
A. depreciation expense.
B. depletion expense.
C. amortization expense.
D. reclamation expense.
82. After a natural resource such as gas or coal is used up by the client, the client is
responsible for restoring the land to its original condition. What is the cost of this
restoration called?
A. depreciation expense.
B. depletion expense.
C. amortization expense.
D. reclamation expense.

83. Which of the following are estimates used by natural resource companies in
recognizing costs over the life of the resource, e.g., oil or coal?
A. reserves.
B. depletion rate.
C. reclamation expense.
D. both A and B.
E. all of the above.

84. Capitalized natural resources, e.g., oil or coal, are usually written off over what period
of time?
A. over a period not to exceed 40 years.
B. over an allocated useful life.
C. as assets are taken from the ground.
D. any of the above.

85. In evaluating control risk and effectiveness for fixed assets, controls should be
designed for numerous purposes. Which of the following is not a usual control for fixed
assets?
A. identify existing assets, inventory them, and reconcile physical inventory with the
property ledger.
B. periodically reassess the appropriateness of depletion categories.
C. identify obsolete or scrapped equipment and write it down to scrap value.
D. periodically review management strategy and systematically assess the impairment
of assets.
E. all of the above are usual controls for fixed assets.
86. In evaluating control risk and effectiveness for intangible assets, controls should be
designed for numerous purposes. Which of the following is not a usual control for
intangible assets?
A. ensure that decisions are appropriately made as to when to capitalize or expense
research and development expenditures.
B. develop amortization schedules that reflect the remaining useful life of patents or
copyrights associated with the assets.
C. identify and account for intangible asset impairment.
D. all of the above are usual controls for intangible assets.

87. Which of the following assertions are addressed by examining purchase agreements
and minutes of board of director’s meeting?
A. existence.
B. rights.
C. valuation.
D. both A and B.
E. all of the above.

88. Decommission costs for fixed assets, e.g., a power plant, must be recognized over
what period of time?
A. when the plant is built.
B. over the life of the plant.
C. when the plant is decommissioned.
D. Either B or C is acceptable.

89. Periodically clients discontinue a particular line of operation by shutting down or


selling a line of business or a company, which usually occurs over at least several
months. In these situations the client is to write down net assets to a best estimate of
net realizable value and do which of the following?
A. recognize a loss.
B. recognize a gain.
C. recognize a loss or a gain.
D. not recognize any gain or loss.

90. Useful methods to evaluate asset impairment of long-lived assets usually would not
include which of the following?
A. current market values of similar assets.
B. estimated future economic benefits to be derived from the asset.
C. an independent assessment of the value of the asset.
D. all of the above are useful in valuing impairment.
91. Repairs and maintenance

Why would the auditor be concerned about the repairs and maintenance account in
relation to property plant and equipment?

Some clients might be motivated to record some asset purchases as an expense in order
to reduce taxable income. The most common audit approach to address the
completeness assertion of recorded assets is to request a schedule of repair and
maintenance expense. All items over a specified amount can be examined to see
whether they are properly classified as an expense or should be capitalized as PP&E.

92. Property plant & equipment evidence - additions

Specify the evidence the auditor would review to satisfy himself or herself about each of
the following assertions concerning property, plant, and equipment additions.

A. Valuation at historical cost.


B. Existence.
C. Presentation on balance sheet.
D. Rights.

A. Examine vendor invoices and canceled checks.


B. Examine receiving reports and possibly the assets themselves.
C. Review requisition or work order and description of addition to determine if it benefits future periods or
if it extends the life of the existing asset.
D. Examine vendor invoices, deeds and canceled checks.
93. Audit approach for lease

Describe the general audit approach for leases.

The audit approach for leases starts, as it does for all other accounts, with an analysis of
controls the company uses to assure proper recording of leases. A general audit
approach for leases is as follows:
1. Obtain copies of lease agreements, read the agreements, and develop a schedule of
lease expenditures, bargain purchases, and so on.
2. Review the lease expense account, then select entries to the account and determine if
there are entries that are not covered by the leases identified in Step 1. Review to
determine if the expenses are properly accounted for.
3. Review the four criteria from SFAS #13 and FASB ASC 840 and determine if any of the
leases meet the requirement of capital leases.
4. For all capital leases, determine that the assets and lease obligations are recorded at
their present value. Determine the economic life of the asset. Calculate amortization
expense and interest expenses, and determine any adjustments to correct the financial
statements. Consider bargain purchase agreements to determine the economic life for
depreciation purposes.
5. Develop a schedule of all future lease obligations or test the client’s schedule by
reference to underlying lease agreements to determine that the schedule is correct.
6. Review the client’s disclosure of lease obligations to determine that it is in accordance
with GAAP.

94. Capital leases

Identify the four criteria that have been provided under U.S. GAAP that the auditor will
use to assess capital lease treatment.

If any of the following four criteria provided by the FASB are met, the lease is capitalized:

1. Present value of the leased asset is at least 90% of the fair market value.
2. The lessee can acquire the asset at a bargain purchase option at the end of the lease.
3. The lease term covers at least 75% the asset's useful life.
4. Ownership transfers to the lessee by the end of the lease.
95. Earnings management

Describe earnings management by an organization and discuss the implications of fixed


asset accounting on earnings management.

Earnings management is the fraudulent manipulation of accounting estimates by


management in order to achieve earnings goals over extended periods. This may be
performed through management's pushing of expenses to subsequent periods or the
building of excessive liabilities in periods of enhanced earnings.

Fixed assets is an area that has seen abuse. Changes in the estimates of useful lives and
residual values by management may push expenses out over a longer period of time,
increasing income incrementally. Management might also capitalize costs that do not
meet GAAP criteria and increase net income substantially in the period they are incurred.
Another area of misapplication includes the treating of capital leases as operating leases,
which inappropriately keeps debt off of the balance sheet.

96. Asset impairment

Describe what asset impairment is, why the auditor is concerned about it, and how it is
dealt with by the auditor.

Asset impairment deals with management’s recognition that a significant portion of fixed
assets is no longer as productive as had originally been expected. When assets are so
impaired, the assets should be written down to their expected economic value.

While many companies have excellent controls over processes, they tend not to have the
same level of control over periodic assessment of impairment of assets. Thus a major
audit task is to develop a systematic approach to continuously review the overall
composition of an entity’s asset base in light of current and planned production and
technological and competitive developments in the client’s industry.

The financial reporting objective is to value assets at their economic benefit to the
organization and to write them down when that value has been impaired. Two
approaches developed by FASB useful in providing evidence of valuation when assets are
impaired are (1) estimating future economic benefits to be derived from the asset, and
(2) obtaining an independent assessment of the value of the asset and to compare it
with carrying amount. The first approach is often used with assets such as goodwill, and
the second one for assets such as equipment.

If the fair value of the asset is less than the carrying amount of the asset an impairment
has taken place and an impairment loss would be recognize. If subsequently the asset
increases in fair value, such increase would not be recognized.
97. Intangible assets - patents

Discuss what an intangible asset is and some audit procedures concerning patents that
the auditor might use in connection with it.

An intangible asset is one that lacks physical substance, such as patents.

Patents are recognized when purchased at cost. However, if patents are developed
through research and development cost then recognition rules are more complex.
Research and development costs for new products are expensed until the time when
there is a viable product and a plan to bring it to market. Legal costs for obtaining and
defending a patent can be capitalized if the defense is successful, but would be
expensed otherwise. The costs of patents are amortized over the lesser of their legal or
useful lives. Auditors also should evaluate the adequacy of management’s procedures in
evaluating patent impairment and adjustment when it occurs.