1. Clear Sky Aviation credits prepayments of air travel to a deferred revenue account until the travel service is provided, at which point it transfers the appropriate amount to sales revenue. A problem with its control system means that the proper allocation of revenue between sales revenue recorded in the profit and loss and the deferred revenue account balance in the balance sheet does not always occur. The auditor is considering conducting additional substantive testing to test whether the sales transactions have been properly classified.

What is the impact if controls are not working properly and deferred revenue is not correctly moved to sales revenue? Choose all that apply.

a) Liabilities may be understated

b) Assets may be overstated

c) Revenue may be understated

d) No impact on revenue or deferred revenue

e) Liabilities may be overstated

f) Liquidity ratios are negatively impacted

2. Cheap-as-Chips stocks thousands of items in inventory that range in value from $1 to $100. The inventory on hand represents a material portion of current assets. The merchandise items change according to the season and the promotional theme adopted by the stores' management for the year. Merchandise is ordered up to four months in advance from Chinese and Korean suppliers. These special orders require Cheap-as-Chips to give the suppliers substantial deposits upon placement of the orders.

Which of the following statements accurately describe the inherent risks for Cheap-as-Chips? Choose all that apply.

a) Material balance of inventory increases inherent risk

b) Seasonal change of inventory items decreases inherent risk

c) Overseas suppliers increase inherent risk

d) Ordering merchandise four months in advance increases inherent risk

e) Substantial deposits required by suppliers increases inherent risk

f) Special orders decrease inherent risk