E1. Alpha Corporation is going to sell additional shares of its stock.

Which of the following

would constitute valid consideration for the purchase of those additional shares?
a. Services already performed.
b. Services that are agreed to be performed later.
c. Both of the above.
d. None of the above.

E2. In forecasting purchases of inventory for a firm, all of the following are useful except:
a. Knowledge of the behavior of business cycles.
b. Internal allocations of costs to different segments of the firm.
c. Information on the seasonal variations in demand.
d. Econometric modeling.

E3. A reduction in economic activity will be displayed by all of the following except:
a. Decreased housing starts.
b. Increase in the quantity of unemployment claims.
c. Reduction in the amount of luxury purchases.
d. Increase in personal travel.

E4. If a movie theater increases ticket prices for the matinee shows by 10% and the quantity
of tickets demanded decreases by 5% then the demand for matinee movie tickets is:
a. Inelastic.
b. Elastic.
c. Unitary.
d. Not related to the change in price.

E5. Which of the following cash management techniques focuses on cash disbursements?
a. Lockbox system.
b. Zero-balance account.
c. Preauthorized checks.
d. Depository transfer checks.

E6. Which of the following definitions best characterizes benchmarking?

a. A technique that examines product and process attributes to identify areas for
improvements.
b. The comparison of existing activities with the best levels of performance in other
similar organizations.
c. The development of the most effective methods of completing tasks in a particular
industry.
d. The complete redesign of a process within an organization.

E7. Which of the following is true about activity-based costing?

a. It should not be used with process or job costing.
b. It can be used only with process costing.
c. It can be used only with job costing.
d. It can be used with either process or job costing.
E8. Which of the following is an example of vouching?
a. Trace inventory purchases from the acquisitions journal to supporting
invoices.
b. Trace selected sales invoices to the sales journal.
c. Trace details of employee paychecks to the payroll journal.
d. All of the above are examples of vouching.

E9. Before performing a review of a nonpublic entity’s financial statements, an accountant

should
a. complete a series of inquiries concerning the entity’s procedures for recording,
classifying, and summarizing transactions.
b. obtain a sufficient level of knowledge of the accounting principles and practices of
the industry in which the entity operates.
c. inquire whether management has omitted substantially all of the disclosures
required by generally accepted accounting principles.
d. apply analytical procedures to provide limited assurance that no material
modifications should be made to the financial statements.

E10. Inherent risk is _______ related to detection risk and _______ related to the amount of
audit evidence.
a. directly, inversely.
b. directly, directly.
c. inversely, inversely.
d. inversely, directly.

A1. Beta Corporation is considering establishing a lockbox system. The bank will charge
P300,000 annually for the service, which will save the firm approximately P150,000 in
processing costs. The lockbox system will reduce the float for cash receipts by 2 days.
Assuming that the average daily cash receipts are equal to P4,000,000, and short-term
interest costs are 4%, calculate the benefit or loss from adopting the lock-box system.
a. P300,000 loss.
b. P150,000 loss.
c. P120,000 benefit.
d. P170,000 benefit.

A2. During 2007, Life Lab supplied hospitals with a comprehensive diagnostic kit for P1,200.
At a volume of 80,000 kits, Life had fixed costs of P10,000,000 and a profit before
income taxes of P2,000,000. Due to an adverse legal decision, Life’s 2008 liability
insurance increased by P12,000,000 over 2007. Assuming the volume and other costs
are unchanged, what should the 2008 price be if Life is to make the same P2,000,000
profit before income taxes?
a. P1,200.
b. P1,350.
c. P1,500.
d. P2,400.

A3. For the year ended December 31, 2007, Charlie Company incurred direct costs of
P5,000,000 based on a particular course of action during the year. If a different course of
 action had been taken, direct costs would have been P4,000,000. In addition, Charlie’s
2007 fixed costs were P900,000. The incremental cost was
a. P100,000.
b. P900,000.
c. P1,000,000.
d. P1,900,000.

A4. The following information was taken from the accounting records of Delta Corporation for
the year ended December 31, 2007:

Raw materials purchased, P800,000; Increase in raw materials inventory, P40,000;

Direct labor cost, P500,000; Factory overhead, P600,000; Decrease in work in process
inventory, P30,000; and Increase in finished goods inventory, P60,000.

Cost of goods sold in 2007 should be:

a. P1,830,000
b. P1,850,000
c. P1,950,000
d. P2,030,000

A5. The auditor is concerned that a client is failing to bill customers for shipments. An audit
procedure that would gather relevant evidence would be to
a. select a sample of duplicate sales invoices and trace each to related shipping
documents.
b. trace a sample of shipping documents to related duplicate sales invoices.
c. trace a sample of Sales Journal entries to the Accounts Receivable subsidiary
ledger.
d. compare the total of the Schedule of Accounts Receivable with the balance of the
Accounts Receivable account in the general ledger.

A6. The five steps in applying materiality are listed below in random order.
1. Estimate the combined misstatement.
2. Estimate the total misstatement in the segment.
3. Set preliminary judgment about materiality.
4. Allocate preliminary judgment about materiality to segments.
5. Compare combined estimate with preliminary judgment about
materiality.
The correct sequence from start to finish would be
a. 1 2 5 4 3.
b. 3 4 2 1 5.
c. 4 3 1 5 2.
d. 5 1 3 2 4.

A7. The cashier diverted cash received over the counter from a customer to his own use
and wrote off the receivable as a bad debt. Select the control that should have
prevented the error.
a. Aging schedules of accounts receivable are prepared periodically and reviewed by
a responsible official.
b. Journal entries are approved by a responsible official.
c. Receipts are given directly to the cashier by the person who opens the mail.
d. Remittance advices, letters, or envelopes that accompany receipts are separated
and given directly to the accounting department.

A8. With respect to a small company’s system of purchasing supplies, an auditor’s primary
 concern should be to obtain satisfaction that supplies ordered and paid for have been
a. requested by and approved by authorized individuals who have no incompatible
duties.
b. used in the course of business and solely for business purposes during the year
under audit.
c. received, counted, and checked to quantities and amounts on purchase orders and
invoices.
d. properly recorded as assets and systematically amortized over the estimated
useful life of the supplies.

A9. Which of the following is an effective internal accounting control measure that
encourages receiving department personnel to count and inspect all merchandise
received?
a. Quantities ordered are excluded from the receiving department copy
of the purchase order.
b. Vouchers are prepared by accounts payable department personnel only after they
match item counts on the receiving report with the purchase order.
c. Receiving department personnel are expected to match and reconcile the receiving
report with the purchase order.
d. Internal auditors periodically examine, on a surprise basis, the receiving
department copies of receiving reports.

A10. When an auditor encounters a situation involving more than one of the conditions
requiring a departure from a standard unqualified report, the auditor should modify his
or her opinion for each condition unless one has the effect of neutralizing the others. In
which of the following situations would the auditor not include more than one
modification in the report?
a. There is a material scope limitation, and the auditor is not independent.
b. There is a material GAAP violation, and the auditor is not independent.
c. There is a material scope limitation, and there is substantial doubt about the
company’s ability to continue as a going concern.
d. There is a substantial doubt about the company’s ability to continue as a going
concern, and information about the causes of the uncertainties is not adequately
disclosed in a footnote.

Items 1 and 2 are based on the following information:

 Operational budgets are used by a retail company for planning and controlling its
business activities. Data regarding the company’s monthly sales for the last 6 months of
the year and its projected collection patterns are shown below:

The cost of merchandise averages 40% of its selling price. The company’s policy is to
maintain an inventory equal to 25% of the next month’s forecasted sales. The inventory
balance at cost is P800,000 as of June 30.

Forecasted Sales
July P 7,750,000
August 7,500,000
September 8,250,000
October 8,000,000
November 8,500,000
December 9,000,000

Types of Sales
Cash sales 20%
Credit sales 80%

Collection Pattern for Credit Sales

In the month of sale 40%
In the first month following the sale 57%
Uncollectible 3%

D1. The budgeted cost of the company’s purchases for the month of August would be
a. P3,025,000
b. P3,050,000
c. P3,075,000
d. P3,187,500

D2. The company’s total cash receipts from sales and collections on account that would be
budgeted for the month of September would be
a. P7,575,000
b. P7,710,000
c. P7,938,000
d. P8,565,000

D3. The capital accounts of the Sierra and Tango Partnership on September 30 were:
Sierra, capital (75% profit percentage) P1,400,000
Tango, capital (25% profit percentage) 600,000
P2,000,000
The partnership assets and liabilities have book values equal to their fair values. On
October 1, Roger was admitted to a 40% interest in the partnership, when he purchased
40% of each existing partner’s capital for P1,200,000, paid directly to Sierra and Tango.
The capital balance of each partner after Roger’s admission assuming that revaluation is
recorded should be:
a. Sierra, P1,290,000; Tango, P510,000; Roger, P1200,000.
b. Sierra, P666,667; Tango, P666,667; Roger, P666,667.
c. Sierra, P840,000; Tango, P360,000; Roger, P800,000.
d. Sierra, P840,000; Tango, P510,000; Roger, P800,000.

D4. Which of the following statements is most correct?

 a. Since debt capital is riskier than equity capital, the cost of debt is always greater than the
WACC.
b. Because of the risk of bankruptcy, the cost of debt capital is always higher than the cost
of equity capital.
c. If a company assigns the same cost of capital to all of its projects regardless of the
project’s risk, then it follows that the company will generally reject too many safe projects
and accept too many risky projects.
d. Because you are able to avoid flotation costs, the cost of retained earnings is generally
lower than the cost of external equity.

D5. Oscar Consolidated has two divisions of equal size: a computer division and a restaurant
division. Stand-alone restaurant companies typically have a cost of capital of 8 percent,
while stand-alone computer companies typically have a 12 percent cost of capital. Oscar’s
restaurant division has the same risk as a typical restaurant company, and its computer
division has the same risk as a typical computer company. Consequently, Oscar estimates
that its composite corporate cost of capital is 10 percent. The company’s consultant has
suggested that they use an 8 percent hurdle rate for the restaurant division and a 12 percent
hurdle rate for the computer division. However, Oscar has chosen to ignore its consultant,
and instead, chooses to assign a 10 percent cost of capital to all projects in both divisions.
Which of the following statements is most correct?
a. While Oscar’s decision to not risk adjust its cost of capital will lead it to accept more
projects in its computer division and fewer projects in its restaurant division, this should
not affect the overall value of the company.
b. Oscar’s decision to not risk adjust means that it is effectively subsidizing its restaurant
division, which means that its restaurant division is likely to become a larger part of the
overall company over time.
c. Oscar’s decision to not risk adjust means that the company will accept too many projects
in the computer business and too few projects in the restaurant business. This will lead
to a reduction in the overall value of the company.
d. Statements a and b are correct.

D6. Your assistant has just completed an analysis of two mutually exclusive projects. You must
now take her report to a board of directors meeting and present the alternatives for the
board’s consideration. To help you with your presentation, your assistant also constructed a
graph with NPV profiles for the two projects. However, she forgot to label the profiles, so
you do not know which line applies to which project. Of the following statements regarding
the profiles, which one is most reasonable?
a. If the two projects have the same investment cost, and if their NPV profiles intersect
once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a
NPV versus IRR conflict is not likely to exist.
b. If the two projects’ NPV profiles intersect once, in the upper left quadrant, at a discount
rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict,
irrespective of the relative sizes of the two projects, in any meaningful, practical sense
(that is, a conflict that will affect the actual investment decision).
c. If one of the projects has a NPV profile that intersects the X-axis twice, hence the project
appears to have two IRRs, your assistant must have made a mistake.
d. Whenever a conflict between NPV and IRR exist, then, if the two projects have the same
initial cost, the one with the steeper NPV profile probably has less rapid cash flows.
However, if they have identical cash flow patterns, then the one with the steeper profile
probably has the lower initial cost.

D7. On the last day of the fiscal year, the cash disbursements clerk drew a company check
on bank A and deposited the check in the company account in bank B to cover a
 previous theft of cash. The disbursement has not been recorded. The auditor will best
detect this form of kiting by
a. examining the composition of deposits in both bank A and bank B subsequent to
year-end.
b. examining paid checks returned with the bank statement of the next accounting
period after year-end and trace each to accounting records for proper recording.
c. preparing, from the cash disbursements records, a summary of bank transfers for
one week prior to and subsequent to year-end.
d. comparing the detail of cash receipts as shown by the client’s cash receipts records
with the detail on the confirmed duplicate deposit tickets for three days prior to and
subsequent to year-end.

D8. 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.

D9. In describing the cycle approach to segmenting an audit, which of the following
statements is not true?
a. All general ledger accounts and journals are included at least once.
b. Some journals and general ledger accounts are included in more than one cycle.
c. The “capital acquisition and repayment” cycle is closely related to the “acquisition of
goods and services and payment” cycle.
d. The “inventory and warehousing” cycle may be audited at any time during the
engagement since it is unrelated to the other cycles.

D10. Which of the following statements is not true?

a. Inclusion of an account receivable from a customer in the accounts receivable trial
balance when there is no receivable from that customer violates the existence
objective.
b. Failure to include an account receivable from a customer in the accounts receivable
trial balance when a receivable exists violates the completeness objective.
c. The accounts receivable listing should include one total for all receivables from
customers and officers.
d. Individual accounts receivable on a listing of accounts receivable should be the same
in the accounts receivable master file and the total should equal the general ledger
control account.

TIE-BREAKERS
C1. An individual receives an income of P30,000 per month, and spends P25,000. An
increase in income of P5,000 per month occurs, and the individual spends P28,000. The
individual’s marginal propensity to save is
a. 0.2
b. 0.4
c. 0.6
d. 0.8

C2. Which of the following statements is most correct?

a. The weighted average cost of capital for a given capital budget level is a weighted
average of the marginal cost of each relevant capital component that makes up the
firm’s target capital structure.
b. The weighted average cost of capital is calculated on a before-tax basis.
c. An increase in the risk-free rate is likely to increase the marginal costs of both debt and
equity financing.
d. Statements a and c are correct.

C3. Which of the following statements is incorrect?

a. Assuming a project has normal cash flows, the NPV will be positive if the IRR is less
than the cost of capital.
b. If the multiple IRR problem does not exist, any independent project acceptable by the
NPV method will also be acceptable by the IRR method.
c. If IRR = k (the cost of capital), then NPV = 0.
d. NPV can be negative if the IRR is positive.

C4. When the client fails to make adequate disclosure in the body of the statements or in the
related footnotes, it is the responsibility of the auditor to
a. inform the reader that disclosure is not adequate, and to issue a qualified or an
adverse opinion.
b. inform the reader that disclosure is not adequate, and to issue an unqualified or
qualified opinion.
c. present the information in the audit report and issue an unqualified or qualified
opinion.
d. present the information in the audit report and to issue a qualified or an adverse
opinion.

C5. Which of the following is not a reason why the auditor requests that the client provide a
letter of representation?
a. Professional auditing standards requires the auditor to obtain a letter of
representation.
b. It impresses upon management its responsibility for the accuracy of the information
in the financial statements.
c. It provides written documentation of the oral responses already received to inquiries
of management.
d. It provides written documentation which is a higher quality of evidence than
management’s oral responses to inquiries.

C6. Which of the following errors would be least likely to be discovered during the tests of
the bank reconciliation?
 a. Payment to an employee for more hours than he worked.
b. Cash received by the client subsequent to the balance sheet date was recorded as
cash receipts in the current year.
c. The existence of payments on notes payable that were debited directly to the bank
balance by the bank but were not entered in the client’s records.
d. Deposits recorded in the cash receipts records near the end of the year, deposited
in the bank, and included in the bank reconciliation as a deposit in transit.

C7. If an auditor “proves” the bank statement in the month subsequent to the balance sheet
date, it is primarily a test for
a. errors.
b. omissions.
c. both a and b.
d. intentional misstatements.

C8. The engagement and report on debt compliance letters should be limited to compliance
matters that the auditor is qualified to evaluate. Which of the following engagements
would be inappropriate for the CPA to attempt to evaluate?
a. Determining whether the client has properly restricted its business activities to the
requirements of an agreement.
b. Determining whether principal and interest payments were made when due.
c. Determining whether the proper limitations were maintained on dividends, working
capital, and debt ratios.
d. Determining whether the accounting records were adequate for conducting an
ordinary audit.