Instruction: Shade the letter of the correct answer. Erasures are not allowed.
1. What is the primary objective in verifying prepaid expenses?
a. Verify that payments were made through company bank accounts
Not the main audit goal
b. Ensure the payments are recorded as assets until consumed or expired
The core objective is proper deferral and recognition in the correct period
c. Confirm prepayments directly with suppliers
Confirmation is only one possible procedure
d. Ensure that all prepayments are classified as current assets
Not all prepayments are current assets (some can be noncurrent)
2. The greatest risk of overstatement in prepaid expenses occurs when:
a. Services are received but not yet paid for c. Payments are made after services are received
This would understate liabilities, not Timing is normal, not inherently risky for
overstate assets. overstatement.
b. Payments are made in advance for d. Expenses are paid on the due date each month
services never received Timing is normal, not inherently risky for
Recording fictitious benefits overstates overstatement.
assets.
3. Which procedure would provide the most reliable evidence of existence for a prepaid rent balance?
a. Inspect proof of payment c. Review the lease contract
Contract shows agreement, not necessarily
Payment doesn’t prove the benefit still
current asset existence.
exists.
b. Perform analytical procedures d. Confirm the balance with the landlord
Analytics are less persuasive. External confirmation is more reliable than
internal documents.
4. If a client records travel advances to employees as prepaid expenses but does not require
liquidation of unused amounts, which risk arises?
a. Understatement of liabilities c. Overstatement of assets
Not relevant here Advances not cleared could be personal use,
inflating assets.
b. Overstatement of revenues d. Understatement of expenses
Not relevant here Could also happen, but the more direct risk is
overstated assets.
5. If the auditor notes that certain prepayments are non-refundable, what is the implication for audit testing?
a. The amortization schedule must still reflect the expiration of benefits.
Even non-refundable prepayments must be amortized over the period of benefit.
b. They should be excluded from valuation testing. - Valuation testing is necessary.
c. They should be tested for rights and obligations only. - Other assertions like valuation still apply.
d. Choices A and B are correct.
6. If a prepaid expense relates to a contract that has been terminated early, the unamortized balance should:
a. Remain in assets until the end of original term
Would overstate assets.
b. Be written off to expense immediately
, No future benefit exists; asset must be expensed.
c. Be transferred to accounts receivable
Not collectible unless refund due.
d. Both B and C are correct
7. During substantive testing of prepayments, an auditor finds that a large prepayment is recorded for a
supplier that has since gone bankrupt. This primarily raises concern about:
a. Rights and Obligations c. Completeness
The right to receive goods or services still exists Completeness is unrelated; the
legally, but recoverability is doubtful transaction is already recorded
b. Valuation d. Cut-off
If the supplier is bankrupt, the prepayment may no l Cut-off is not in question; the iss
be recoverable, creating a valuation issue collectibility/value
8. When a company prepays an expense to avoid a price increase, the auditor’s main concern is:
a. Classification c. Cut-off
Need to ensure classification between current
and noncurrent if benefit extends beyond 12
months
b. Rights and obligations d. Completeness
9. Which of the following would provide the most persuasive evidence about the valuation of prepaid
expenses?
a. Analytical procedures comparing prepayments to prior periods.
Analytical review helps identify unusual trends, but does not directly confirm valuation.
b. Recalculation of the amortization schedule prepared by the client.
Recalculation is useful for recorded amounts but won’t detect unrecorded prepayments; contracts
still need to be inspected.
c. Inspection of supplier contracts and invoices to determine coverage periods.
Inspection of contracts and invoices provides direct, reliable evidence about the timing and extent
of the prepaid benefit.
d. Inquiry of the accounting staff on their expense allocation policy.
Inquiry alone is weak evidence—needs corroboration.
10.The most effective substantive procedure to verify the rights assertion for prepaid rent is to:
a. Inspect the lease agreement. c. Recalculate rent amortization.
The lease agreement is the primary evidence Valuation
of the entity’s right to occupy the property for a
prepaid period.
b. Send a confirmation to the landlord. d. Compare to prior year balances.
Existence Analytical review
11.An auditor notes a significant prepaid expense recorded in December but relating entirely to the next
year. What is the most appropriate substantive response?
a. Confirm the payment with the bank c. Propose reclassification to current
Bank confirmation proves payment occurred assets and adjust expenses
but does not address misclassification
1. What is the primary objective in verifying prepaid expenses?
a. Verify that payments were made through company bank accounts
Not the main audit goal
b. Ensure the payments are recorded as assets until consumed or expired
The core objective is proper deferral and recognition in the correct period
c. Confirm prepayments directly with suppliers
Confirmation is only one possible procedure
d. Ensure that all prepayments are classified as current assets
Not all prepayments are current assets (some can be noncurrent)
2. The greatest risk of overstatement in prepaid expenses occurs when:
a. Services are received but not yet paid for c. Payments are made after services are received
This would understate liabilities, not Timing is normal, not inherently risky for
overstate assets. overstatement.
b. Payments are made in advance for d. Expenses are paid on the due date each month
services never received Timing is normal, not inherently risky for
Recording fictitious benefits overstates overstatement.
assets.
3. Which procedure would provide the most reliable evidence of existence for a prepaid rent balance?
a. Inspect proof of payment c. Review the lease contract
Contract shows agreement, not necessarily
Payment doesn’t prove the benefit still
current asset existence.
exists.
b. Perform analytical procedures d. Confirm the balance with the landlord
Analytics are less persuasive. External confirmation is more reliable than
internal documents.
4. If a client records travel advances to employees as prepaid expenses but does not require
liquidation of unused amounts, which risk arises?
a. Understatement of liabilities c. Overstatement of assets
Not relevant here Advances not cleared could be personal use,
inflating assets.
b. Overstatement of revenues d. Understatement of expenses
Not relevant here Could also happen, but the more direct risk is
overstated assets.
5. If the auditor notes that certain prepayments are non-refundable, what is the implication for audit testing?
a. The amortization schedule must still reflect the expiration of benefits.
Even non-refundable prepayments must be amortized over the period of benefit.
b. They should be excluded from valuation testing. - Valuation testing is necessary.
c. They should be tested for rights and obligations only. - Other assertions like valuation still apply.
d. Choices A and B are correct.
6. If a prepaid expense relates to a contract that has been terminated early, the unamortized balance should:
a. Remain in assets until the end of original term
Would overstate assets.
b. Be written off to expense immediately
, No future benefit exists; asset must be expensed.
c. Be transferred to accounts receivable
Not collectible unless refund due.
d. Both B and C are correct
7. During substantive testing of prepayments, an auditor finds that a large prepayment is recorded for a
supplier that has since gone bankrupt. This primarily raises concern about:
a. Rights and Obligations c. Completeness
The right to receive goods or services still exists Completeness is unrelated; the
legally, but recoverability is doubtful transaction is already recorded
b. Valuation d. Cut-off
If the supplier is bankrupt, the prepayment may no l Cut-off is not in question; the iss
be recoverable, creating a valuation issue collectibility/value
8. When a company prepays an expense to avoid a price increase, the auditor’s main concern is:
a. Classification c. Cut-off
Need to ensure classification between current
and noncurrent if benefit extends beyond 12
months
b. Rights and obligations d. Completeness
9. Which of the following would provide the most persuasive evidence about the valuation of prepaid
expenses?
a. Analytical procedures comparing prepayments to prior periods.
Analytical review helps identify unusual trends, but does not directly confirm valuation.
b. Recalculation of the amortization schedule prepared by the client.
Recalculation is useful for recorded amounts but won’t detect unrecorded prepayments; contracts
still need to be inspected.
c. Inspection of supplier contracts and invoices to determine coverage periods.
Inspection of contracts and invoices provides direct, reliable evidence about the timing and extent
of the prepaid benefit.
d. Inquiry of the accounting staff on their expense allocation policy.
Inquiry alone is weak evidence—needs corroboration.
10.The most effective substantive procedure to verify the rights assertion for prepaid rent is to:
a. Inspect the lease agreement. c. Recalculate rent amortization.
The lease agreement is the primary evidence Valuation
of the entity’s right to occupy the property for a
prepaid period.
b. Send a confirmation to the landlord. d. Compare to prior year balances.
Existence Analytical review
11.An auditor notes a significant prepaid expense recorded in December but relating entirely to the next
year. What is the most appropriate substantive response?
a. Confirm the payment with the bank c. Propose reclassification to current
Bank confirmation proves payment occurred assets and adjust expenses
but does not address misclassification
