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# Practice Questions in Finance

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Part One -Please provide as much detail and information when answering the questions.
1. Explain what drives a company's return on common equity.

2. The process of discounting and compounding are related. Explain this relationship.

3. What is the major difference between a negotiated purchase and a competitive bid purchase?

4. How does a firm's tax rate affect its cost of capital? What is the effect of the flotation costs associated with a new security issue?

5. Distinguish between financial risk and interest rate risk as these terms are commonly used in discussions of cash management.

Part II: This part can be done in Excel or Word

1. You lend a friend \$15,000, for which your friend will repay you \$37,313 at the end of five years. What interest rate are you charging your "friend"?

2. The common stock of Bouncy-Bob Moore Co. is selling for \$33.84. The stock recently paid dividends of \$3 per share and has a projected growth rate of 8.5 percent. If you purchase the stock at the market price, what is your expected rate of return?

3. The target capital structure for Jowers Manufacturing is 50 percent common stock, 15 percent preferred stock, and 35 percent debt. If the cost of common equity for the firm is 20 percent, the cost of preferred stock is 12 percent, and the before-tax cost of debt is 10 percent, what is Jower's cost of capital? The firm's marginal tax rate is 34 percent.

4. If a firm buys on trade credit terms of 2/10, net 60 and decides to forgo the trade credit discount and pay on the net day, what is the effective annualized cost of forgoing the discount?

5. Mo-Lee's Sportswear is considering building a new factory to produce soccer equipment. This project would require an initial cash outlay of \$10,000,000 and will generate annual free cash inflows of \$2,500,000 per year for eight years. Calculate the project's NPV given:

a. A required rate of return of 9 percent
b. A required rate of return of 11 percent
c. A required rate of return of 13 percent
d. A required rate of return of 15 percent

Part III: This part can be done in Excel or Word

1. HBM, Inc. has the following capital structure:

Assets \$400,000 Debt \$140,000
Preferred stock 20,000
Common stock 240,000

The common stock is currently selling for \$15 a share, pays a cash dividend of
\$0.75 per share, and is growing annually at 6 percent. The preferred stock pays a \$9 cash dividend and currently sells for \$91 a share. The debt pays interest of 8.5 percent annually, and the firm is in the 30 percent marginal tax bracket.

a. What is the after-tax cost of debt?
b. What is the cost of preferred stock?
c. What is the cost of common stock?
d. What is the firm's weighted-average cost of capital?

#### Solution Preview

Practice Questions
(Note: ^ stands for raised to the power of)
Part One -Please provide as much detail and information when answering the questions.
1. Explain what drives a company's return on common equity.

We can use Du Pont Analysis for answering this question.

Return on equity (ROE) can be decomposed as follows:
ROE = Net income/Total equity
= Net income/Total equity x Total assets/Total assets
= Net income/Total assets x Total assets/Total equity
= ROA x Equity multiplier

Return on assets (ROA) can be decomposed as follows:
ROA = Net income/Total assets x Sales/Sales
= Net income/Sales x Sales/Total assets
= Profit margin x Total Assets turnover

Putting it all together gives the Du Pont identity:
ROE = ROA x Equity multiplier
= Profit margin x Total asset turnover x Equity multiplier

Return on Equity thus has three parts:

- Operating efficiency (Profit margin)

- Asset use efficiency (Total asset turnover)

- Financial leverage (Equity multiplier)

2 The process of discounting and compounding are related. Explain this relationship.
The concept of compounding is that of interest on interest. Compounding involves future value resulting from compound interest. Its compliment, discounting, is used for calculating Present value- value today of a dollar to be received in the future.
Discounting future cash flows converts them into present value dollars. Compounding present cash flows converts them into future value dollars.
Discounting is the inverse of compounding. In discounting, we divide a future cash flow by (1+r) ^n where r is the discount rate and n is the number of periods after which the cash would be received, to arrive at its present value. In compounding, we divide a present cash flow by (1+r) ^n where r is the interest rate and n is the number of periods after which the cash invested would be received, to arrive at the future value.

3 What is the major difference between a negotiated purchase and a competitive bid purchase?
In a negotiated purchase, the firm that requires funds contacts an investment banker and begins the sequence of steps that lead to the final distribution of the securities that will be offered. The price that the investment banker pays for the securities is "negotiated" with the issuing firm.
In a competitive-bid purchase, the investment banker and underwriting syndicate are selected by an auction process. The syndicate willing to pay the greatest dollar amount per new security to the issuing firm wins the competitive bid. This means that it will ...

#### Solution Summary

Answers to questions on common equity, discounting and compounding, negotiated purchase and a competitive bid purchase, cost of capital, financial risk and interest rate risk, expected rate of return, target capital structure, trade credit terms, weighted-average cost of capital.

\$2.19

## Auditing Practice Final Exam

Hello. I need help with the ones I have not completed below. The ones with an X next to the answer are already answered and do not need to be looked at.

I also need some indication as to why you answered each question the way you did.

Thanks.

-----------------

Enter X in the appropriate box
Standards and related topics
1. Which of the following best describes which is meant by the term generally accepted auditing standards?
a. Procedures to be used to gather evidence to support financial statements.
b. Measures of the quality of the auditor's performance.
X c. Pronouncements issued by the Auditing Standards Board.
d. Rules acknowledged by the accounting profession because of their universal application.

2. Although the scope of audits of recipients of federal financial assistance in accordance with federal audit regulations varies, these audits generally have which of the following elements in common?
a. The auditor is to determine whether the federal financial assistance has been administered in accordance with applicable laws and regulations.
b. The materiality levels are lower and are determined by the government entities that provided the federal financial assistance to the recipient.
c. The auditor should obtain written management representations that the recipient's internal auditors will report their findings objectively without fear of political repercussions.
d. The auditor is required to express both positive and negative assurance that illegal acts that could have a material effect on the recipient's financial statements are disclosed to the inspector general.

3. In reporting under Government Auditing Standards, an auditor most likely would be required to report a falsification of accounting records directly to a federal inspector general when the falsification is
a. Discovered after the auditor's report has been made available to the federal inspector general and the public
b. Reported by the auditor to the audit committee as a significant deficiency in internal control
c. Voluntarily disclosed to the auditor by low level personnel as a result of the auditor's inquiries
d. Communicated by the auditor to the auditee and the auditee fails to make a required report of the matter

Planning
1. An auditor's engagement letter most likely would include
a. Management's acknowledgement of its responsibility for maintaining effective internal control
b. The auditor's preliminary assessment of the risk factors relating to misstatements arising from fraudulent financial reporting
c. A reminder that management is responsible for illegal acts committed by employees
d. A request for permission to contact the client's lawyer for assistance in identifying litigation, claims, and assertions

2. An auditor obtains knowledge about a new client's business and its industry to
a. Make constructive suggestions concerning improvements to the client's internal control
b. Develop an attitude of professional skepticism concerning management's financial statements assertions
c. Evaluate whether the aggregation of known misstatements causes the financial statements taken as a whole to be materially misstated
X d. Understand the events and transactions that may have an effect on the client's financial statements.

3. Which of the following factors most likely would lead a CPA to conclude that a potential audit engagement should be rejected?
a. The details of most recorded transactions are not available after a specified period of time
b. Internal control activities requiring the segregation of duties are subject to management override
c. It is unlikely that sufficient competent evidence is available to support an opinion on the financial statements
d. Management has a reputation for consulting with several accounting firms about significant accounting issues.

4. Which of the following procedures would an auditor most likely include in the planning phase of a financial statement audit?
a. Obtain an understanding of the entity's risk assessment process
X b. Identify specific internal control activities designed to prevent fraud
c. Evaluate the reasonableness of the entity's accounting estimates
d. Perform cutoff tests of the entity's sales and purchases.

Contingencies

1. A successor auditor most likely would make specific inquiries of the predecessor auditor regarding
a. Specialized accounting principles of the client's industry
b. The competency of the client's internal audit staff
c. The uncertainty inherent in applying sampling procedures
d. Disagreements with management as to auditing procedures

2. The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the
a. Evidence to be gathered to provide a sufficient basis for the auditor's opinion
b. Procedures to be undertaken to discover litigation, claims, and assessments
c. Pending legal matters to be included in the inquiry of the client's attorney
d. Timing of inventory observation procedures to be performed.

3. An auditor should design the written audit program so that
a. All material transactions will be selected for substantive testing
b. Substantive tests prior to the balance sheet date will be minimized
X c. The audit procedures selected will achieve specific audit objectives
d. Each account balance will be tested under either tests of controls or tests of transactions.

4. Which of the following statements is not correct about materiality?
a. The concept of materiality recognizes that some matters are important for fair presentation of financial statements in accordance with GAAP, while other matters are not important
b. An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements
c. An auditor's consideration of materiality is influenced by the auditor's perception of the needs of a reasonable person who will rely on the financial statements
d. Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments.

5. Because an audit in accordance with generally accepted auditing standards is influenced by the possibility of material misstatements, the auditor should conduct the audit with and attitude of
a. Objective judgment
c. Professional responsiveness
d. Professional skepticism

6. Which of the following factors most likely would heighten an auditor's concern about the risk of fraudulent financial reporting?
a. Large amounts of liquid assets that are easily convertible into cash
b. Low growth and profitability as compared to other entities in the same industry
c. Financial management's participation in the initial selection of accounting principles
d. An overly complex organizational structure involve unusual lines of authority

7. An auditor who discovers that a client's employees paid small bribes to municipal offices most likely would withdraw from the engagement if
a. The payments violated the client's policies regarding the prevention of illegal acts
b. The client receives financial assistance from a federal government agency
c. Documentation that is necessary to prove that bribes were paid does not exist
d. Management fails to take the appropriate remedial action

Internal Controls - General

1. Which of the following most likely would not be considered an inherent limitation of the potential effectiveness of an entity's internal control?
a. Incompatible duties
b. Management override
c. Mistakes in judgment
d. Collusion among employees

2. When considering internal control, an auditor should be aware of the concept of reasonable assurance, which recognizes that
X a. Internal control policies and procedures may be ineffective due to mistakes in judgment and personal carelessness
b. Adequate safeguards over access to assets and records should permit an entity to maintain proper accountability
c. Establishing and maintaining internal control is an important responsibility of management
d. The cost of an entity's internal control should not exceed the benefits expected to be derived

3. Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when
a. External policies established by parties outside the entity affect its accounting practices
b. Management is dominated by one individual who is also a shareholder
c. Internal auditors have direct access to the board of directors and the entity's management
d. The audit committee is active in overseeing the entity's financial reporting policies.

4. Which of the following auditor concerns most likely could be so serious that the auditor concludes that a financial statement audit cannot be conducted?
a. The entity has no formal written code of conduct
b. The integrity of the entity's management is suspect
c. Procedures requiring segregation of duties are subject to management override
X d. Management fails to modify prescribed controls for changes in condition.

5. An auditor uses the knowledge provided by the understanding of internal control and the final assessed level of control risk primarily to determine the nature, timing, and extent of the
X a. Tests of controls
b. Compliance tests
c. Attribute tests
d. Substantive tests

6. In planning an audit of certain accounts, an auditor may conclude that specific procedures used to obtain an understanding of an entity's internal control need not be included because of the auditor's judgments about materiality and assessments of
a. Control risk
b. Detection risk
c. Sampling risk
d. Inherent risk

7. Assessing control risk at below the maximum level most likely would involve
a. Performing more extensive substantive tests with larger sample sizes than originally planned
b. Reducing inherent risk for most of the assertions relevant to significant account balances
c. Changing the timing of substantive tests by omitting interim-date testing and performing the tests at year end
d. Identifying specific internal control policies and procedures relevant to specific assertions.

8. An auditor may compensate for a weakness in internal control by increasing the
a. Level of detection risk
b. Extent of tests of controls
c. Preliminary judgment about audit risk
d. Extent of analytical procedures

9. Tracing shipping documents to prenumbered sales invoices provides evidence that
a. No duplicate shipments or billings occurred
b. Shipments to customers were properly invoiced
c. All goods ordered by customers were received
d. All prenumbered sales invoices were accounted for

10. An auditor suspects that a client's cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditor would most likely compare the
a. Dates checks are deposited per bank statements with the dates remittance credits are recorded
b. Daily cash summaries with the sums of the cash receipts journal
c. Individual bank deposit slips with the details of the monthly bank statements
d. Dates uncollectible accounts are authorized to be written off with the dates the write-offs are actually recorded

Internal Control - Transaction Cycles

1. Proper segregation of functional responsibilities in an effective internal control structure calls for separation of the functions of
a. Authorization, payment, and recording.
b. Authorization, recording, and custody.
c. Custody, execution and reporting.
d. Authorization, execution, and payment.

2. Which of the following controls most likely would be effective in offsetting the tendency of sales personnel to maximize sales volume at the expense of high bad debt write-offs?
b. Shipping documents and sales invoices are matched by an employee who does not have authority to write off bad debts.
X c. Employees involved in the credit-granting function are separated from the sales function.
d. Subsidiary accounts receivable records are reconciled to the control account by an employee independent of the authorization of credit.

3.      Which of the following procedures would an auditor most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet?
a.      Observe the consistency of the employees' use of cash registers and tapes.
c.      Trace the deposits in the cash receipts journal to the cash balance in the general ledger.
d.      Compare the cash balance in the general ledger with the bank confirmation request.

4.      Which of the following questions would most likely be included in an internal control questionnaire concerning the completeness assertion for purchases?
a.      Is an authorized purchase order required before the receiving department can accept a shipment or the vouchers payable department can record a voucher?
b.      Are purchase requisitions prenumbered and independently matched with vendor invoices?
c.      Is the unpaid voucher file periodically reconciled with inventory records by an employee who does not have access to purchase requisitions?
d.      Are purchase orders, receiving reports, and vouchers prenumbered and periodically accounted for?

5. An auditor generally tests the segregation of duties related to inventory by
a.      Personal inquiry and observation.
b.      Test counts and cutoff procedures.
c.      Analytical procedures and invoice recomputation.
d.      Document inspection and reconciliation.

Substantive tests and tests for fraud

1. When auditing financial statements and finding indications of a possible misappropriation of assets, independent auditors should
a. Determine which accounts are affected and the amount by which they are overstated or understated.
b. Determine the methods by which the misappropriation was carried out.
c. Identify a person(s) who are likely responsible for the misappropriation and obtain evidence about some other fraud indications in their work.
X d. All of the above.

2. An unenlightened management can increase the probability of fraud in the company by
a. Diversifying authority throughout divisions and subsidiaries in the organization.
b. Measuring performance and awarding bonuses based on short-term operating results.
c. Giving employees performance feedback that considers positive and constructive praise along with critical and negative observations on their work.
d. Establishing work teams that share responsibilities, performance, and bonuses based on collective efforts.

3. If the amount of a check is altered by an employee after it has cleared the bank, the change can be detected by
a. comparing the amount written on the check face to the amount written in the cash disbursements journal.
b. comparing the magnetic imprint of the amount paid to the amount written on the check face.
c. examining the endorsement on the back of the check.
d. comparing the check number on the face of the check to the check number in the cash disbursements journal.

4. Which of the following would be consistent with an employee taking cash receipts from customers on account?
a. The total of the accounts receivable subsidiary ledger balances is less than the accounts receivable control account.
b. The total of the accounts receivable subsidiary ledger balances is greater than the accounts receivable control account.
c. Total cash receipts from customers for the month are less than credit sales for the month.
d. Total cash receipts from customers for the month are greater than credit sales for the month.

5. Alpha Brewery Corporation recorded sales through January 4, 2005, dating them December 31, 2004. This situation is an example of a violation of which of the following control assertions?
a. Existence or occurrence.
b. Completeness.
c. Presentation and disclosure.
d. Valuation or allocation.

6. Which of the following is not a valid reason for an auditor deciding not to send accounts receivable confirmations:
a. The balance is immaterial.
b. Confirmations would be ineffective.
c. The client requests alternative procedures be performed instead.
d. Other procedures provide sufficient competent evidence.

7. To determine whether sales transactions have been recorded in the proper accounting period the auditor performs cutoff tests. Which of the following best describes the overall approach used when performing cutoff tests?
a. Ascertain that management has included in the representation letter a statement that transactions have been accounted for in the proper accounting period.
X b. Analyze transactions occurring within a few days before and after year end.
c. Confirm yearend transactions with regular customers.
d. Examine cash receipts in the subsequent period.

8. Which of the following accounts would most likely be reviewed by the auditor to gain reasonable assurance that additions to the equipment (fixed asset) account are not understated?
a. Depreciation expense.
b. Gain on disposal of equipment.
c. Accounts payable.
d. Repairs and maintenance expense.

9. Which of the following procedures would an auditor most likely perform in searching for unrecorded payables?
a. Reconcile receiving reports with related cash payments made just prior to year-end.
b. Contrast the ratio of accounts payable to purchases with the prior year's ratio.
X c. Vouch a sample of creditor balances to supporting invoices, receiving reports, and purchase orders.
d. Compare cash payments occurring after the balance sheet date with the accounts payable trial balance.

10. Which of the following is not an acceptable method of determining inventory cost under GAAP?
a. FIFO.
b. LIFO.
c. Standard Cost.
d. All the above are acceptable.

11. Counting inventory on the warehouse floor and tracing the count to the inventory compilation provides evidence to support which management assertion?
a. Existence or occurrence.
b. Completeness.
c. Rights and obligations.
d. Valuation or allocation.

12. Related party transactions
a. must be valued as if they were arm's length.
b. must be assumed to be valued differently than if they were arm's length.
c. must be disclosed in the financial statements.
d. must be disclosed in the financial statements and the auditor's report.

General

1. Small and Tall, CPAs, completed the December 31, 2005 audit of Big Company on February 10, 2006. After the report was issued, it came to the attention of Small and Tall, CPAs, that an outstanding lawsuit against Big Company was settled for materially more than recorded in the December 31, 2005 financial statements. The amount recorded in the financial statements represented the best estimate of management and the company's attorneys at the time the audit was completed. Based on this new information, Small and Tall, CPAs should
a. Determine whether persons are currently relying on the audit report.
b. Advise the client to make appropriate changes in the financial statements and reissue them.
c. Notify each member of the board of directors of Big Company.
d. Take no action since the event took place after the audit report was issued.

2. An entity's income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts. The auditor most likely could have detected this irregularity by
a. Tracing a sample of journal entries to the general ledger.
b. Evaluating the effectiveness of the internal control policies and procedures.
X c. Investigating the reconciliations between controlling accounts and subsidiary records.
d. Performing analytical procedures designed to disclose differences from expectations.

3. Analytical procedures used in the overall review stage of an audit generally include
a. Considering unusual or unexpected account balances that were not previously identified.
b. Performing tests of transactions to corroborate management's financial statement assertions.
c. Gathering evidence concerning account balances that have not changed from the prior year.
d. Retesting control procedures that appeared to be ineffective during the assessment of control risk.

4. Which of the following procedures should an auditor generally perform regarding subsequent events?
a. Compare the latest available interim financial statements with the financial statements being audited.
b. Send second requests to the client's customers who failed to respond to initial accounts receivable confirmation requests.
c. Communicate material weaknesses in internal control to the client's audit committee.
d. Review the cut-off bank statements for several months after the year-end.

5. Which of the following is an audit procedure that an auditor most likely would perform concerning litigation, claims, and assessments?
a. Request the client's attorney to evaluate whether the client's pending litigation, claims, and assessments indicate a going concern problem.
b. Examine the legal documents in the client's attorney's possession concerning litigation, claims, and assessments to which the attorney has devoted substantive attention.
c. Discuss with management its policies and procedures adopted for evaluating and accounting for litigation, claims, and assessments.
d. Confirm directly with the client's attorney that all litigation, claims, and assessments have been recorded or disclosed in the financial statements.

6. Which of the following events occurring after the issuance of an auditor's report most likely would cause the auditor to make further inquiries about the previously issued financial statements?
a. An uninsured natural disaster occurs that may affect the entity's ability to continue as a going concern.
b. A contingency is resolved that had been disclosed in the audited financial statements.
c. New information is discovered concerning undisclosed lease transactions of the audited period.
d. A subsidiary is sold that accounts for 25% of the entity's consolidated net income.

7. In which of the following circumstances would an auditor be most likely to express an adverse opinion?
a. The chief executive officer refuses the auditor access to minutes of board of directors' meetings.
b. Tests of controls show that the entity's internal control structure is so poor that it cannot be relied upon.
c. The financial statements are not in conformity with the FASB Statements regarding the capitalization of leases.
d. Information comes to the auditor's attention that raises substantial doubt about the entity's ability to continue as a going concern.

8. In which of the following circumstances would a CPA who audits AB Corporation lack independence?
a. The CPA and AB's president are both on the Board of Directors of COD Corporation.
b. The CPA and AB's president each own 25% of FOB Corporation, a closely held company.
c. The CPA has an automobile loan from AB, a financial institution. The loan is collateralized by the automobile.
d. The CPA reduced AB's usual audit fee by 40% prior to the audit because AB's financial condition was unfavorable.

9. According to the ethical standards of the profession, which of the following acts is generally prohibited?
a. Purchasing a product from a third party and reselling it to a client.
b. Writing a financial management newsletter promoted and sold by a publishing company.
X c. Accepting a commission for recommending a product to an audit client.
d. Accepting engagements obtained through the efforts of third parties.

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