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Chapter 06 - Internal Control in a Financial Statement Audit

Chapter 06 Internal Control in a Financial Statement Audit


True / False Questions

1. The concept of internal control includes IT systems and manual systems. True False

2. The auditor must understand internal control before assessin inherent ris!. True False

". The e#tent of an entity$s use of IT can affect any of the components of internal control. True False

%. &ne of the ris!s associated 'ith internal control from IT is potential loss of data. True False

(. Internal control consists of si# components. True False

6. Internal control includes monitorin of controls. True False

). A reliance strate y is used 'hen control ris! has been set at the ma#imum le*el. True False

+. A substanti*e strate y is used 'hen control ris! has been set at the ma#imum le*el. True False

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Chapter 06 - Internal Control in a Financial Statement Audit

,. &nce a le*el of control ris! has been established- it cannot be chan ed. True False

10. Tests of controls must be performed if control ris! is set belo' the ma#imum le*el. True False

Multiple Choice Questions

11. A primary purpose of internal controls is to A. Form a basis for e*aluatin employees .. /onitor production 0uality C. A*oid clerical errors 1. /eet ob2ecti*es of maintainin sound documents and records and accurate financial reportin

12. Internal controls are not desi ned to pro*ide reasonable assurance that A. Transactions are e#ecuted in accordance 'ith mana ement$s authori3ation .. 4mbe33lement 'ill be eliminated C. Access to assets is permitted only in accordance 'ith mana ement$s authori3ation 1. Amounts recorded for assets is compared 'ith the actual e#istin assets at reasonable inter*als

1". The basic concept of internal control 'hich reco ni3es that the cost of internal control should not e#ceed the benefits e#pected to be deri*ed is !no'n as A. 5easonable assurance .. /ana ement responsibility C. 6imited liability 1. /ana ement by e#ception

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Chapter 06 - Internal Control in a Financial Statement Audit

1%. An auditor 'ould most li!ely be concerned 'ith internal control policies and procedures that pro*ide reasonable assurance about the A. 4fficiency of mana ement$s decision-ma!in process .. Appropriate prices that the entity should char e for its products C. /ethods of assi nin production tas!s to employees 1. 4ntity$s ability to accurately process and summari3e financial data

1(. /ana ement$s attitude to'ard a ressi*e financial reportin and its emphasis on meetin pro2ected profit oals most li!ely 'ould si nificantly influence an entity$s control en*ironment 'hen A. 4#ternal policies established by parties outside the entity affect its accountin practices .. /ana ement is dominated by one indi*idual C. Internal auditors ha*e direct access to the board of directors and the entity$s mana ement 1. The audit committee is acti*e in o*erseein the entity$s financial reportin policies

16. /ana ement philosophy and operatin style most li!ely 'ould ha*e a si nificant influence on an entity$s control en*ironment 'hen A. The internal auditor reports directly to mana ement .. /ana ement is dominated by one indi*idual C. Accurate mana ement 2ob descriptions delineate specific duties 1. The audit committee acti*ely o*ersees the financial reportin process

1). 7roper monitorin 'ithin an internal control frame'or! includes all of the follo'in e#cept A. An e#ternal auditor .. An effecti*e audit committee C. An internal audit department 1. The internal re*enue ser*ice

1+. An entity$s control acti*ities include all of the follo'in e#cept A. 7erformance re*ie's .. Information processin C. 4#ternal auditor$s tests of controls 1. Se re ation of duties

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Chapter 06 - Internal Control in a Financial Statement Audit

1,. 7otential benefits of an entity$s controls in an IT en*ironment include all of the follo'in e#cept A. 5eduction in the ris! that controls 'ill be circum*ented .. /ore accurate accountin estimates C. Consistent application of predefined business rules 1. /ore timely information

20. An entity$s information system infrastructure refers to A. 8ard'are components .. 7ro rammers C. Soft'are 1. 1ata pro*ided by the system

21. Auditors are most li!ely to ather audit e*idence solely usin substanti*e procedures A. If transactions are recurrin .. For non-recurrin - unusual transactions C. If control ris! is *ery lo' 1. If the entity has a 'ell-desi ned automated system

22. 7roper se re ation of functional responsibilities in an effecti*e system of internal control calls for separation of the functions of A. Authori3ation- e#ecution- and payment .. Authori3ation- recordin - and custody C. Custody- e#ecution- and reportin 1. Authori3ation- payment- and recordin

2". Factors that the auditor should consider as increasin the effecti*eness of the audit committee include all of the follo'in e#cept 'hether A. It is independent of mana ement .. It is comprised almost e#clusi*ely of members of mana ement- ensurin detailed !no'led e of the company$s operations C. It as!s mana ement difficult 0uestions 1. It interacts re ularly 'ith internal auditors

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Chapter 06 - Internal Control in a Financial Statement Audit

2%. The documentation of an auditor$s understandin of internal controls A. Is optional .. /ust be e#clusi*ely in either narrati*e- 0uestionnaire- or flo'chart form C. /ust include flo'charts 1. Can use any combination of narrati*es- 0uestionnaire- or flo'charts

2(. A 'ell-prepared flo'chart should ma!e it easier for the auditor to A. 7repare audit procedure manuals .. 7repare detailed 2ob descriptions C. 7erform 'al!throu hs 1. Assess the de ree of accuracy of financial data

26. A flo'chart is most fre0uently used by an auditor in connection 'ith the A. 7reparation of enerali3ed computer audit pro rams .. 5e*ie' of the client$s internal controls C. 9se of statistical samplin in performin an audit 1. 7erformance of analytical procedures of account balances

2). An ad*anta e of usin systems flo'charts to document information about internal control instead of usin internal control 0uestionnaires is that systems flo'charts A. Identify 'hether se re ation of duties pre*ent collusion .. 7ro*ide a *isual depiction of clients$ acti*ities C. Indicate 'hether controls are operatin effecti*ely 1. 5educe the need to obser*e clients$ employees performin routine tas!s

2+. :hich of the follo'in audit tests 'ould be re arded as a test of controls; A. Tests of the specific items ma!in up the balance in a i*en eneral led er account .. Tests comparin in*entory pricin to *endors$ in*oices C. Tests of the si natures on canceled chec!s to the board of director$s authori3ations 1. Tests of the additions to property- plant- and e0uipment by physical inspections

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Chapter 06 - Internal Control in a Financial Statement Audit

2,. The independent auditor selects se*eral transactions in each functional area and traces them throu h the entire system- payin special attention to e*idence about 'hether or not the control acti*ities are in operation. This is an e#ample of a<n= A. Analytical procedure .. Test of controls C. Substanti*e procedure 1. Functional test

"0. To obtain e*idential matter about control ris!- an auditor selects tests from a *ariety of techni0ues includin A. In0uiry .. Analytical procedures C. Calculation 1. Confirmation

"1. :hich of the follo'in procedures most li!ely 'ould pro*ide an auditor 'ith e*idence about 'hether an entity$s internal control is suitably desi ned to pre*ent or detect material misstatements; A. Scannin the 2ournals produced by the internal control system .. 7erformin analytical procedures usin data a re ated at a hi h le*el C. >ouchin a sample of transactions directly related to the controls 1. &bser*in the entity$s personnel applyin the controls

"2. 5eports on ser*ice or ani3ations typically A. 7ro*ide reasonable assurance that their financial statements are free of material misstatements .. 4nsure that the client 'ill not ha*e any misstatements in areas related to the ser*ice or ani3ation$s acti*ities C. 4nsure that the client is billed correctly 1. Assess 'hether the ser*ice or ani3ation$s controls are suitably desi ned to achie*e internal control ob2ecti*es

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Chapter 06 - Internal Control in a Financial Statement Audit

"". :here computer processin is used in si nificant accountin applications- internal control acti*ities may be defined by classifyin control acti*ities into t'o types? eneral and A. Administrati*e .. Specific C. Application 1. Authori3ation

"%. :hich of the follo'in input controls is a numeric *alue computed to pro*ide assurance that the ori inal *alue has not been altered in construction or transmission; A. 8ash total .. 7arity chec! C. 4ncryption 1. Chec! di it

"(. @eneral controls include all of the follo'in e#cept A. &r ani3ational controls .. 1ata *alidation controls C. Access security controls 1. Application system ac0uisition controls

"6. A limit test is a A. Test to ensure that a numerical *alue does not e#ceed some predetermined *alue .. Chec! to ensure that the *alue in a field falls 'ithin an allo'able ran e of *alues C. Chec! to ensure that the data in a field ha*e the proper arithmetic si n 1. Chec! on a field to ensure that it contains either all numeric or alphabetic characters

"). A field test is a A. Test to ensure that a numerical *alue in a field does not e#ceed some predetermined *alue .. A chec! to ensure that the *alue in a field falls 'ithin an allo'able ran e of *alues C. A chec! to ensure that the data in a field ha*e the proper arithmetic si n 1. A chec! on a field to ensure that it contains either all numeric or alphabetic characters

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Chapter 06 - Internal Control in a Financial Statement Audit

"+. An auditor$s primary consideration re ardin an entity$s internal controls is 'hether the policies and procedures A. Affect the financial statement assertions .. 7re*ent mana ement o*erride C. 5elate to the control en*ironment 1. 5eflect mana ement$s philosophy and operatin style

",. In e*aluatin internal control- the auditor is basically concerned that the system pro*ides reasonable assurance that A. &perational efficiency has been achie*ed in accordance 'ith mana ement plans .. 4rrors and fraud ha*e been pre*ented or detected C. Controls ha*e not been circum*ented by collusion 1. /ana ement can not o*erride the system

%0. &f the follo'in statements about an internal control system- 'hich one is correct; A. The maintenance of the system of internal control is an important responsibility of the internal auditor .. Administrati*e controls relate directly to the safe uardin of assets C. .ecause of the costAbenefit relationship- tests of controls may be applied on a test basis in some circumstances 1. :ell desi ned internal control acti*ities al'ays pre*ent collusion amon employees

%1. The concept of reasonable assurance in the conte#t of an entity$s internal controls reco ni3es that A. Auditors may fail to detect material misstatements .. 7roper internal controls uarantee that material misstatements 'ill not occur C. 7roper internal controls preclude fraud 1. The costs of some controls may be too hi h to implement in relation to potential benefits

%2. An effecti*e control en*ironment A. Allo's mana ement to identify all rele*ant ris!s .. Creates a commitment to competence C. @uarantees that all controls are follo'ed as prescribed 1. 5e0uires an internal audit department

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Chapter 06 - Internal Control in a Financial Statement Audit

%". The control en*ironment component of internal controls includes all of the follo'in e#cept A. /ana ement$s operatin style .. Access to computer pro rams C. &r ani3ational structure 1. 8uman resource policies and practices

%%. Information and communication includes all of the follo'in e#cept A. Identifyin and recordin all *alid transactions .. 1eterminin the time period in 'hich transactions occurred C. Communicatin price chan es to customers 1. 7roperly presentin transactions and related disclosures in the financial statements

%(. An or ani3ational structure is important for all of the follo'in reasons e#cept A. 4nsurin proper monitorin .. 1efinin areas of authority C. Creatin clear lines of reportin 1. 4nsurin a proper commitment to controls

%6. The ris! assessment component of internal controls refers to A. The auditor$s assessment of control ris! .. The auditor$s assessment of client ris! C. The entity$s identification and analysis of ris!s rele*ant to achie*ement of its ob2ecti*es 1. The entity$s monitorin of the potential for material misstatements

%). As opposed to a manual control- an automated control A. Can ne*er be circum*ented .. Should function consistently in the absence of pro ram chan es C. Beed not be tested by the auditor 1. /ust be tested usin the same techni0ues as a manual control

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Chapter 06 - Internal Control in a Financial Statement Audit

%+. An IT specialist is least li!ely to be necessary 'hen A. 1ata is shared e#tensi*ely amon systems .. The entity participates hea*ily in electronic commerce C. The system has not chan ed from the prior year 1. Si nificant audit e*idence is in electronic form

%,. In plannin an audit of a ne' client- an auditor most li!ely 'ould consider the methods used to process accountin information because such methods A. Influence the desi n of internal controls .. Affect the auditor$s plannin materiality le*els C. Assist in e*aluatin the planned audit assertions 1. 1etermine the auditor$s acceptable le*el of audit ris!

(0. A substanti*e strate y differs from a reliance strate y in that a substanti*e strate y includes A. Increased implementation of detailed tests of transactions and balances .. 4#tra tests of controls C. Increased emphasis on *erbal representations from mana ement 1. Settin control ris! at a minimum le*el

(1. :hich of the follo'in statements concernin control ris! is correct; A. Assessin control ris! and obtainin an understandin of an entity$s internal controls may be performed concurrently .. :hen control ris! is at the ma#imum le*el- an auditor is re0uired to document the basis for that assessment C. Control ris! may be assessed sufficiently lo' to eliminate substanti*e procedure for si nificant transaction classes 1. :hen assessin control ris! an auditor should not consider e*idence obtained in prior audits about the operation of control acti*ities

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Chapter 06 - Internal Control in a Financial Statement Audit

(2. Assessin control ris! at belo' the ma#imum most li!ely 'ould in*ol*e? A. Chan in the timin of substanti*e procedures by omittin interim testin and performin the tests at year-end .. Identifyin specific internal controls rele*ant to specific assertions C. 7erformin more e#tensi*e substanti*e procedures 'ith lar er sample si3es than ori inally planned 1. 5educin inherent ris! for most of the assertions rele*ant to si nificant account balances

(". In the audit of financial statements- an auditor$s primary consideration re ardin an internal control policy or procedure is 'hether the policy or procedure A. 5eflects mana ement$s philosophy and operatin style .. Affects mana ement$s financial statement assertions C. 7ro*ides ade0uate safe uards o*er access to assets 1. 4nhances mana ement$s decision-ma!in processes

(%. :hich of the follo'in most li!ely 'ould not be considered an inherent limitation of the potential effecti*eness of an entity$s internal controls; A. Incompatible duties .. /ana ement o*erride C. /ista!es in 2ud ment 1. Collusion amon employees

((. It is important for the C7A to consider the competence of the audit clients$ employees because their competence bears directly and importantly upon the A. CostAbenefit relationship of the system of internal control .. Achie*ement of the ob2ecti*es of the system of internal control C. Comparison of recorded accountability 'ith assets 1. Timin of the tests to be performed

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Chapter 06 - Internal Control in a Financial Statement Audit

(6. As part of ainin an initial understandin internal control- an auditor is re0uired to do all of the follo'in - e#cept? A. Consider factors that affect the ris! of material misstatement .. Ascertain 'hether internal control policies and procedures ha*e been placed in operation C. Identify the types of potential misstatements that can occur 1. &btain !no'led e about the operatin effecti*eness of the internal control

(). 4ffecti*e internal control in a small company that has an insufficient number of employees to permit proper di*ision of responsibilities can best be enhanced by A. 4mployment of temporary personnel to aid in the separation of duties .. 1irect participation by the o'ner of the business in the record-!eepin acti*ities of the business C. 4n a in a C7A to perform monthly boo!!eepin 1. 1ele ation of full- clear-cut responsibility to each employee for the functions assi ned to each

(+. The independent auditor should ac0uire an understandin of the internal audit function as it relates to the assessment of control ris! because A. Internal auditors$ audit pro rams- audit documents- and reports can eliminate the need for the independent auditor$s staff .. The procedures performed by the internal audit staff may eliminate the independent auditor$s need for an e#tensi*e study and e*aluation of internal control C. The 'or! performed by internal auditors may be a factor in determinin the nature- timin and e#tent of the independent auditor$s procedures 1. The understandin of the internal audit function is an important substanti*e procedure to be performed by the independent auditor

(,. In obtainin an understandin of an entity$s internal control in a financial statement audit of a non-public company- an auditor is not obli ated to A. 1etermine 'hether the control acti*ities ha*e been placed in operation .. 7erform procedures to understand the desi n of the internal control policies C. 1ocument the understandin of the entity$s internal control components 1. Search for si nificant deficiencies in the operation of the internal control

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Chapter 06 - Internal Control in a Financial Statement Audit

60. After completin the preliminary phase of the re*ie' of internal control- the auditor decides not to rely on the system to restrict substanti*e procedures. 1ocumentation may be limited to the auditor$s A. 9nderstandin of the internal control .. 5easons for decidin not to e#tend the re*ie' C. .asis for concludin that errors and fraud 'ill be pre*ented 1. Completed internal control 0uestionnaire

61. In an audit of financial statements in accordance 'ith enerally accepted auditin standards- an auditor is re0uired to A. Identify specific internal control acti*ities rele*ant to mana ement$s financial statement assertions .. 7erform tests of controls to e*aluate the effecti*eness of the entity$s accountin system C. 1etermine 'hether procedures are suitably desi ned to pre*ent or detect material misstatements 1. 1ocument the auditor$s understandin of the entity$s internal control

62. For a comple# IT system- auditors are least li!ely to use 'hich of the follo'in 'hen documentin their understandin of internal controls; A. Barrati*es .. Internal control 0uestionnaires C. Flo'charts 1. &r ani3ation charts

6". Assessin A. Identifyin .. Concludin C. 7erformin 1. Analy3in

control ris! belo' ma#imum in*ol*es all of the follo'in e#cept specific controls to rely on that controls are ineffecti*e tests of controls the achie*ed le*el of control ris! after performin tests of controls

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Chapter 06 - Internal Control in a Financial Statement Audit

6%. :hen an auditor increases the planned assessed le*el of control ris! because certain control acti*ities 'ere determined to be ineffecti*e- the auditor 'ould most li!ely increase the A. 4#tent of tests of details .. 6e*el of inherent ris! C. 4#tent of tests of controls 1. 6e*el of detection ris!

6(. :hich of the follo'in procedures most li!ely 'ould be included as part of an auditor$s tests of controls; A. Inspection .. 5econciliation C. Confirmation 1. Analytical procedures

66. An auditor is least li!ely to test the internal controls that pro*ide for A. Appro*al of the purchase and sale of mar!etable securities .. Classification of re*enue and e#pense transactions by product line C. Se re ation of the functions of recordin disbursements and reconcilin the ban! account 1. Comparison of recei*in reports and *endors$ in*oices 'ith purchase orders

6). For certain controls- such as se re ation of duties- documentary e*idence may not e#ist. An auditor 'ould most li!ely test the procedures by A. 5eperformance and corroboration .. &bser*ation and in0uiry C. Inspection and *ouchin 1. Confirmation and recomputation

6+. :al!throu hs usually in*ol*e all of the follo'in audit procedures e#cept A. 5eperformance .. In0uiry C. &bser*ation 1. Inspection

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Chapter 06 - Internal Control in a Financial Statement Audit

6,. .efore applyin substanti*e procedures to the details of accounts at an interim date <a date prior to the balance sheet date=- an auditor should A. Assess control ris! at the ma#imum for the assertions embodied in the accounts selected for interim testin .. 1etermine that the accounts selected for interim testin are not material to the financial statements ta!en as a 'hole C. Consider the a*ailability of information at a later date that 'ill be necessary for the auditor$s procedures <e. .- electronic data= 1. &btain 'ritten representations from mana ement that all financial records and related data 'ill be made a*ailable

)0. A hi h detection ris! strate y includes all of the follo'in e#cept A. Interim testin .. 5educed testin of transactions C. 8ea*y reliance on analytical procedures as substanti*e procedures 1. Audit 'or! only completed at year-end

)1. The auditor should consider all of the follo'in 'hen decidin 'hether substanti*e procedures 'ill be performed at an interim date e#cept A. The le*el of control ris! .. Schedulin conflicts in the audit firm that ma!e interim testin more con*enient C. :hether business conditions 'ill chan e after the interim date 1. The ability to e#amine the remainin period

)2. If auditors conduct substanti*e procedures as of 10A"1 for an entity 'ith a 12A"1 year-end A. Additional tests are seldom conducted for the remainin period .. Additional control tests are re0uired in the remainin period C. The client$s controls li!ely are ineffecti*e 1. Additional tests li!ely 'ill be performed in the remainin period

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Chapter 06 - Internal Control in a Financial Statement Audit

)". .ased on a study and e*aluation completed at an interim date- the auditor concludes that no si nificant internal control 'ea!nesses e#ist. The records and procedures 'ould most li!ely be tested a ain at year-end if A. Compliance tests 'ere not performed by the internal auditor durin the remainin period .. The internal control system pro*ides a basis for reliance in reducin the e#tent of substanti*e procedures C. The auditor used nonstatistical samplin durin interim compliance testin 1. In0uiries and obser*ations lead the auditor to belie*e that conditions 'ithin the internal control system ha*e chan ed

)%. :hich of the follo'in statements is correct concernin an auditor$s communication of internal control related matters <si nificant deficiencies= noted in an audit; A. The auditor may issue a 'ritten report to the audit committee representin that no si nificant deficiencies 'ere noted durin the audit .. Si nificant deficiencies should be recommunicated each year- e*en if the audit committee has ac!no'led ed its understandin of such deficiencies C. Si nificant deficiencies that are material 'ea!nesses should be reported separately from other si nificant deficiencies 1. The auditor may choose to communicate si nificant internal control-related matters either durin the course of the audit or after the audit is concluded

)(. The auditor$s communication of material 'ea!nesses in internal control for a nonpublic company is A. 5e0uired to enable the auditor to state that the e#amination has been made in accordance 'ith enerally accepted auditin standards .. The principle reason for studyin and e*aluatin the system of internal controls C. Incidental to the auditor$s ob2ecti*e of formin an opinion as to the fair presentation of the financial statements 1. 5e0uired to be documented in a formal 'ritten report to the board of directors or the board$s audit committee

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Chapter 06 - Internal Control in a Financial Statement Audit

)6. Si nificant deficiencies are matters that come to an auditor$s attention that should be communicated to an entity$s audit committee because they represent A. 1isclosures of information that si nificantly contradict the auditor$s oin concern assumption .. /aterial fraud or ille al acts perpetrated by hi h-le*el mana ement C. Si nificant desi n fla's in internal controls or poor implementation of internal controls 1. /anipulation or falsification of accountin records or documents from 'hich financial statements are prepared

)). All of the follo'in are si nificant deficiencies e#cept A. Absence of appropriate re*ie's of transactions .. 4*idence of 'illful 'ron doin by lo'er-le*el employees C. Inade0uate pro*isions for safe uardin assets 1. In*entory is hi hly sub2ect to obsolescence

)+. The normal se0uence of documents and operations on a 'ell-prepared systems flo'chart is A. Top to bottom and left to ri ht .. .ottom to top and left to ri ht C. Top to bottom and ri ht to left 1. .ottom to top and ri ht to left

),. :hen preparin a record of a client$s internal control- the independent auditor sometimes uses a systems flo'chart- 'hich can best be described as a A. 7ictorial presentation of the flo' of instructions in a client$s internal computer system .. 1ia ram 'hich clearly indicates an or ani3ation$s internal reportin structure C. @raphic illustration of the flo' of operations 'hich is used to replace the auditor$s internal control 0uestionnaire 1. Symbolic representation of a system or series of se0uential processes

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Chapter 06 - Internal Control in a Financial Statement Audit

+0. :hich of the follo'in is not a characteristic of a batch processed computer system; A. The collection of li!e transactions 'hich are sorted and processed se0uentially a ainst a master file .. Ceypunchin of transactions- follo'ed by machine processin C. The production of numerous printouts 1. The postin of a transaction- as it occurs- to se*eral files- 'ithout intermediate printouts

+1. :hich of the follo'in is a eneral control that 'ould most li!ely assist an entity 'hose systems analyst left the entity in the middle of a ma2or pro2ect; A. @randfather-father-son record retention .. Input and output *alidation routines C. Systems documentation 1. Chec! di it *erification

+2. A customer intended to order 100 units of product D,601%- but incorrectly ordered none#istent product D,601(. :hich of the follo'in controls most li!ely 'ould detect this error; A. Chec! di it *erification .. 5ecord count C. 8ash total 1. 5edundant data chec!

+". Assume that an auditor estimates that 10-000 chec!s 'ere issued durin the accountin period. If an IT application control 'hich performs a limit chec! for each chec! re0uest is to be sub2ected to the auditor$s test data approach- the sample should include A. Appro#imately 1-000 test items .. A number of test items determined by the auditor to be sufficient under the circumstances C. A number of test items determined by the auditor$s reference to the appropriate samplin tables 1. &ne transaction

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Chapter 06 - Internal Control in a Financial Statement Audit

+%. After obtainin an understandin of internal controls and assessin control ris! of an entity- an auditor decided not to perform tests of controls for purposes of the audit. The auditor most li!ely decided that A. The a*ailable e*idential matter obtained throu h tests of controls 'ould not support an increased le*el of control ris! .. A reduction in the assessed le*el of control ris! is 2ustified for certain financial statement assertions C. It 'ould be inefficient to perform tests of controls that 'ould result in a reduction in planned substanti*e procedures 1. The assessed le*el of inherent ris! e#ceeded the assessed le*el of control ris!

+(. After the auditor has prepared a flo'chart of the internal controls surroundin sales and e*aluated the desi n of the system- the auditor 'ould perform tests of controls on all control acti*ities A. 1ocumented in the flo'chart .. Considered to be 'ea!nesses that mi ht allo' errors to enter the accountin system C. That the auditor plans to rely on 1. That 'ould aid in pre*entin fraud

+6. As the acceptable le*el of detection ris! increases- an auditor may chan e the A. Assessed le*el of control ris! from belo' the ma#imum to the ma#imum le*el .. Assurance pro*ided by tests of controls by usin a lar er sample si3e than planned C. Timin of substanti*e procedures from year-end to an interim date 1. Bature of substanti*e procedures from less effecti*e to more effecti*e procedures

+). In a properly desi ned internal control system- the same employee may be permitted to A. 5ecei*e and deposit chec!s and also appro*e 'rite-offs of customer accounts .. Appro*e *ouchers for payment and also si n chec!s C. 5econcile the ban! statements and also recei*e and deposit cash 1. Si n chec!s and also cancel supportin documents

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Chapter 06 - Internal Control in a Financial Statement Audit

++. A procedure that 'ould most li!ely be used by an auditor in performin tests of control acti*ities that in*ol*e se re ation of functions and that lea*e no transaction trail is A. Inspection .. &bser*ation C. 5eperformance 1. 5econciliation

+,. 1urin consideration of internal control in a financial statement audit of a nonpublic company- an auditor is not obli ated to A. Search for si nificant deficiencies in the operation of internal control .. 9nderstand the internal control en*ironment and the information system C. 1etermine 'hether the controls rele*ant to audit plannin ha*e been placed in operation 1. 7erform procedures to understand the desi n of internal control

,0. Audit e*idence concernin proper se re ation of duties ordinarily is best obtained by A. 7reparation of a flo'chart of duties performed by a*ailable personnel .. In0uirin 'hether control acti*ities operated consistently throu hout the period C. 5e*ie'in 2ob descriptions prepared by the 7ersonnel 1epartment 1. 1irect personal obser*ation of the employees 'ho apply control acti*ities

,1. :hile substanti*e procedures may support the accuracy of underlyin records- these tests fre0uently pro*ide no affirmati*e e*idence of se re ation of duties because A. Substanti*e procedures rarely uarantee the accuracy of the records if only a sample of the transactions has been tested .. The records may be accurate e*en thou h they are maintained by persons ha*in incompatible functions C. Substanti*e procedures relate to the entire period under audit- but compliance tests ordinarily are confined to the period durin 'hich the auditor is on the client$s premises 1. /any computeri3ed procedures lea*e no audit trail of 'ho performed them- so substanti*e procedures may necessarily be limited to in0uiries and obser*ation of office personnel

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Chapter 06 - Internal Control in a Financial Statement Audit

,2. .efore applyin principal substanti*e procedures to the details of asset and liability accounts at an interim date- the auditor should A. Assess the difficulty in controllin audit ris! for the remainder of the period .. In*esti ate si nificant fluctuations that ha*e occurred in the asset and liability accounts since the pre*ious balance sheet date C. Select only those accounts 'hich can effecti*ely be sampled durin year-end audit 'or! 1. Consider the compliance tests that must be applied at the balance sheet date to e#tend the audit conclusions reached at the interim date

,". :hen communicatin internal control-related matters noted in an audit of a nonpublic company- an auditor$s report issued on si nificant deficiencies should indicate that A. 4rrors or fraud may occur and not be detected because there are inherent limitations in any internal control system .. The issuance of an un0ualified opinion on the financial statements may depend on correcti*e follo'-up action C. The deficiencies noted 'ere not detected 'ithin a timely period by employees in the normal course of performin their assi ned functions 1. The purpose of the audit 'as to report on the financial statements and not to pro*ide assurance on internal control

,%. The pro ram flo'chartin symbol representin a decision is a A. Trian le .. Circle C. 5ectan le 1. 1iamond

Short Answer Questions

6-21

Chapter 06 - Internal Control in a Financial Statement Audit

,(. Internal control has become a *ery important focus for publicly traded and pri*ately-held companies ali!e. Internal control is intended to accomplish at least four ob2ecti*es and consists of fi*e components of internal control. 6ist the four ob2ecti*es and fi*e components of internal control.

,6. :hat are t'o potential benefits and t'o potential ris!s of usin IT for an entity$s internal control;

,). In terms of an audit- define substanti*e strate y and reliance strate y. Include in your definition ho' the different strate ies relate to internal control. :hich strate y 'ould best relate to a lo'er control ris!;

,+. 1escribe the limitations of internal control. :hy do limitations on internal control e#ist;

6-22

Chapter 06 - Internal Control in a Financial Statement Audit

,,. :hat are four potential tools a*ailable to the auditor for documentin their understandin of a client$s system of internal control;

100. :hat are some typical types of e*idence that may be collected in testin a client$s internal controls;

101. :hy mi ht an auditor decide to test controls at an interim date;

102. :hile performin an audit on the internal controls o*er financial reportin for Air:a*es Corporation- your audit team finds 'hat it considers to be a si nificant deficiency. Air:a*es is a lar e- pri*ate company. :hat steps 'ould you ta!e to communicate this findin ;

6-2"

Chapter 06 - Internal Control in a Financial Statement Audit

10". 1ata capture occurs throu h source documentation- direct data entry- or a combination of the t'o. 6ist three purposes of data capture controls.

10%. :hat are the differences bet'een document flo'charts- system flo'charts- and pro ram flo'charts;

6-2%

Chapter 06 - Internal Control in a Financial Statement Audit

Chapter 06 Internal Control in a Financial Statement Audit Ans'er Cey

True / False Questions

1. The concept of internal control includes IT systems and manual systems. TRUE

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

2. The auditor must understand internal control before assessin inherent ris!. FA SE

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +

". The e#tent of an entity$s use of IT can affect any of the components of internal control. TRUE

AACSB: Analytic AICPA BB: "e&eraging (ec)nology AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

6-2(

Chapter 06 - Internal Control in a Financial Statement Audit

%. &ne of the ris!s associated 'ith internal control from IT is potential loss of data. TRUE

AACSB: Analytic AICPA BB: "e&eraging (ec)nology AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

(. Internal control consists of si# components. FA SE

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: -

6. Internal control includes monitorin of controls. TRUE

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: -

). A reliance strate y is used 'hen control ris! has been set at the ma#imum le*el. FA SE

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: .

6-26

Chapter 06 - Internal Control in a Financial Statement Audit

+. A substanti*e strate y is used 'hen control ris! has been set at the ma#imum le*el. TRUE

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: .

,. &nce a le*el of control ris! has been established- it cannot be chan ed. FA SE

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: !asy "earning #$%ecti&e: +/

10. Tests of controls must be performed if control ris! is set belo' the ma#imum le*el. TRUE

AACSB: Analytic AICPA BB: "e&eraging (ec)nology AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: !asy "earning #$%ecti&e: +/

Multiple Choice Questions

6-2)

Chapter 06 - Internal Control in a Financial Statement Audit

11. A primary purpose of internal controls is to A. Form a basis for e*aluatin employees .. /onitor production 0uality C. A*oid clerical errors !" /eet ob2ecti*es of maintainin sound documents and records and accurate financial reportin

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: + "earning #$%ecti&e: 0

12. Internal controls are not desi ned to pro*ide reasonable assurance that A. Transactions are e#ecuted in accordance 'ith mana ement$s authori3ation #" 4mbe33lement 'ill be eliminated C. Access to assets is permitted only in accordance 'ith mana ement$s authori3ation 1. Amounts recorded for assets is compared 'ith the actual e#istin assets at reasonable inter*als

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Com*re)ension Di iculty: !asy "earning #$%ecti&e: 0

1". The basic concept of internal control 'hich reco ni3es that the cost of internal control should not e#ceed the benefits e#pected to be deri*ed is !no'n as A" 5easonable assurance .. /ana ement responsibility C. 6imited liability 1. /ana ement by e#ception

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Com*re)ension Di iculty: !asy "earning #$%ecti&e: 0 "earning #$%ecti&e: 1

6-2+

Chapter 06 - Internal Control in a Financial Statement Audit

1%. An auditor 'ould most li!ely be concerned 'ith internal control policies and procedures that pro*ide reasonable assurance about the A. 4fficiency of mana ement$s decision-ma!in process .. Appropriate prices that the entity should char e for its products C. /ethods of assi nin production tas!s to employees !" 4ntity$s ability to accurately process and summari3e financial data

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: 2 "earning #$%ecti&e: 1

1(. /ana ement$s attitude to'ard a ressi*e financial reportin and its emphasis on meetin pro2ected profit oals most li!ely 'ould si nificantly influence an entity$s control en*ironment 'hen A. 4#ternal policies established by parties outside the entity affect its accountin practices #" /ana ement is dominated by one indi*idual C. Internal auditors ha*e direct access to the board of directors and the entity$s mana ement 1. The audit committee is acti*e in o*erseein the entity$s financial reportin policies

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: -

16. /ana ement philosophy and operatin style most li!ely 'ould ha*e a si nificant influence on an entity$s control en*ironment 'hen A. The internal auditor reports directly to mana ement #" /ana ement is dominated by one indi*idual C. Accurate mana ement 2ob descriptions delineate specific duties 1. The audit committee acti*ely o*ersees the financial reportin process

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: "earning #$%ecti&e: 1

6-2,

Chapter 06 - Internal Control in a Financial Statement Audit

1). 7roper monitorin 'ithin an internal control frame'or! includes all of the follo'in e#cept A. An e#ternal auditor .. An effecti*e audit committee C. An internal audit department !" The internal re*enue ser*ice

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: "earning #$%ecti&e: 1

1+. An entity$s control acti*ities include all of the follo'in e#cept A. 7erformance re*ie's .. Information processin C" 4#ternal auditor$s tests of controls 1. Se re ation of duties

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: "earning #$%ecti&e: 1

1,. 7otential benefits of an entity$s controls in an IT en*ironment include all of the follo'in e#cept A. 5eduction in the ris! that controls 'ill be circum*ented #" /ore accurate accountin estimates C. Consistent application of predefined business rules 1. /ore timely information

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

6-"0

Chapter 06 - Internal Control in a Financial Statement Audit

20. An entity$s information system infrastructure refers to A" 8ard'are components .. 7ro rammers C. Soft'are 1. 1ata pro*ided by the system

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: ' "earning #$%ecti&e: 1

21. Auditors are most li!ely to ather audit e*idence solely usin substanti*e procedures A. If transactions are recurrin #" For non-recurrin - unusual transactions C. If control ris! is *ery lo' 1. If the entity has a 'ell-desi ned automated system

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: ++ "earning #$%ecti&e: .

22. 7roper se re ation of functional responsibilities in an effecti*e system of internal control calls for separation of the functions of A. Authori3ation- e#ecution- and payment #" Authori3ation- recordin - and custody C. Custody- e#ecution- and reportin 1. Authori3ation- payment- and recordin

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: 1

6-"1

Chapter 06 - Internal Control in a Financial Statement Audit

2". Factors that the auditor should consider as increasin the effecti*eness of the audit committee include all of the follo'in e#cept 'hether A. It is independent of mana ement #" It is comprised almost e#clusi*ely of members of mana ement- ensurin detailed !no'led e of the company$s operations C. It as!s mana ement difficult 0uestions 1. It interacts re ularly 'ith internal auditors

AACSB: Communications AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: -

2%. The documentation of an auditor$s understandin of internal controls A. Is optional .. /ust be e#clusi*ely in either narrati*e- 0uestionnaire- or flo'chart form C. /ust include flo'charts !" Can use any combination of narrati*es- 0uestionnaire- or flo'charts

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Re*orting Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: 3

2(. A 'ell-prepared flo'chart should ma!e it easier for the auditor to A. 7repare audit procedure manuals .. 7repare detailed 2ob descriptions C" 7erform 'al!throu hs 1. Assess the de ree of accuracy of financial data

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +"earning #$%ecti&e: 3

6-"2

Chapter 06 - Internal Control in a Financial Statement Audit

26. A flo'chart is most fre0uently used by an auditor in connection 'ith the A. 7reparation of enerali3ed computer audit pro rams #" 5e*ie' of the client$s internal controls C. 9se of statistical samplin in performin an audit 1. 7erformance of analytical procedures of account balances

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +"earning #$%ecti&e: 3

2). An ad*anta e of usin systems flo'charts to document information about internal control instead of usin internal control 0uestionnaires is that systems flo'charts A. Identify 'hether se re ation of duties pre*ent collusion #" 7ro*ide a *isual depiction of clients$ acti*ities C. Indicate 'hether controls are operatin effecti*ely 1. 5educe the need to obser*e clients$ employees performin routine tas!s

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +"earning #$%ecti&e: 3

2+. :hich of the follo'in audit tests 'ould be re arded as a test of controls; A. Tests of the specific items ma!in up the balance in a i*en eneral led er account .. Tests comparin in*entory pricin to *endors$ in*oices C" Tests of the si natures on canceled chec!s to the board of director$s authori3ations 1. Tests of the additions to property- plant- and e0uipment by physical inspections

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +/

6-""

Chapter 06 - Internal Control in a Financial Statement Audit

2,. The independent auditor selects se*eral transactions in each functional area and traces them throu h the entire system- payin special attention to e*idence about 'hether or not the control acti*ities are in operation. This is an e#ample of a<n= A. Analytical procedure #" Test of controls C. Substanti*e procedure 1. Functional test

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +/

"0. To obtain e*idential matter about control ris!- an auditor selects tests from a *ariety of techni0ues includin A" In0uiry .. Analytical procedures C. Calculation 1. Confirmation

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +/

"1. :hich of the follo'in procedures most li!ely 'ould pro*ide an auditor 'ith e*idence about 'hether an entity$s internal control is suitably desi ned to pre*ent or detect material misstatements; A. Scannin the 2ournals produced by the internal control system .. 7erformin analytical procedures usin data a re ated at a hi h le*el C. >ouchin a sample of transactions directly related to the controls !" &bser*in the entity$s personnel applyin the controls

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +/

6-"%

Chapter 06 - Internal Control in a Financial Statement Audit

"2. 5eports on ser*ice or ani3ations typically A. 7ro*ide reasonable assurance that their financial statements are free of material misstatements .. 4nsure that the client 'ill not ha*e any misstatements in areas related to the ser*ice or ani3ation$s acti*ities C. 4nsure that the client is billed correctly !" Assess 'hether the ser*ice or ani3ation$s controls are suitably desi ned to achie*e internal control ob2ecti*es

AACSB: Communications AICPA BB: Industry AICPA FN: Re*orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: +2

"". :here computer processin is used in si nificant accountin applications- internal control acti*ities may be defined by classifyin control acti*ities into t'o types? eneral and A. Administrati*e .. Specific C" Application 1. Authori3ation

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: +-

"%. :hich of the follo'in input controls is a numeric *alue computed to pro*ide assurance that the ori inal *alue has not been altered in construction or transmission; A. 8ash total .. 7arity chec! C. 4ncryption !" Chec! di it

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: +-

6-"(

Chapter 06 - Internal Control in a Financial Statement Audit

"(. @eneral controls include all of the follo'in e#cept A. &r ani3ational controls #" 1ata *alidation controls C. Access security controls 1. Application system ac0uisition controls

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: +-

"6. A limit test is a A" Test to ensure that a numerical *alue does not e#ceed some predetermined *alue .. Chec! to ensure that the *alue in a field falls 'ithin an allo'able ran e of *alues C. Chec! to ensure that the data in a field ha*e the proper arithmetic si n 1. Chec! on a field to ensure that it contains either all numeric or alphabetic characters

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: +-

"). A field test is a A. Test to ensure that a numerical *alue in a field does not e#ceed some predetermined *alue .. A chec! to ensure that the *alue in a field falls 'ithin an allo'able ran e of *alues C. A chec! to ensure that the data in a field ha*e the proper arithmetic si n !" A chec! on a field to ensure that it contains either all numeric or alphabetic characters

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: +-

6-"6

Chapter 06 - Internal Control in a Financial Statement Audit

"+. An auditor$s primary consideration re ardin an entity$s internal controls is 'hether the policies and procedures A" Affect the financial statement assertions .. 7re*ent mana ement o*erride C. 5elate to the control en*ironment 1. 5eflect mana ement$s philosophy and operatin style

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: + "earning #$%ecti&e: 2

",. In e*aluatin internal control- the auditor is basically concerned that the system pro*ides reasonable assurance that A. &perational efficiency has been achie*ed in accordance 'ith mana ement plans #" 4rrors and fraud ha*e been pre*ented or detected C. Controls ha*e not been circum*ented by collusion 1. /ana ement can not o*erride the system

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: + "earning #$%ecti&e: 0 "earning #$%ecti&e: 2

6-")

Chapter 06 - Internal Control in a Financial Statement Audit

%0. &f the follo'in statements about an internal control system- 'hich one is correct; A. The maintenance of the system of internal control is an important responsibility of the internal auditor .. Administrati*e controls relate directly to the safe uardin of assets C" .ecause of the costAbenefit relationship- tests of controls may be applied on a test basis in some circumstances 1. :ell desi ned internal control acti*ities al'ays pre*ent collusion amon employees

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: 0

%1. The concept of reasonable assurance in the conte#t of an entity$s internal controls reco ni3es that A. Auditors may fail to detect material misstatements .. 7roper internal controls uarantee that material misstatements 'ill not occur C. 7roper internal controls preclude fraud !" The costs of some controls may be too hi h to implement in relation to potential benefits

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: 0 "earning #$%ecti&e: 1

%2. An effecti*e control en*ironment A. Allo's mana ement to identify all rele*ant ris!s #" Creates a commitment to competence C. @uarantees that all controls are follo'ed as prescribed 1. 5e0uires an internal audit department

AACSB: !t)ics AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: "earning #$%ecti&e: 1

6-"+

Chapter 06 - Internal Control in a Financial Statement Audit

%". The control en*ironment component of internal controls includes all of the follo'in e#cept A. /ana ement$s operatin style #" Access to computer pro rams C. &r ani3ational structure 1. 8uman resource policies and practices

AACSB: !t)ics AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: "earning #$%ecti&e: 1

%%. Information and communication includes all of the follo'in e#cept A. Identifyin and recordin all *alid transactions .. 1eterminin the time period in 'hich transactions occurred C" Communicatin price chan es to customers 1. 7roperly presentin transactions and related disclosures in the financial statements

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: "earning #$%ecti&e: 1

%(. An or ani3ational structure is important for all of the follo'in reasons e#cept A. 4nsurin proper monitorin .. 1efinin areas of authority C. Creatin clear lines of reportin !" 4nsurin a proper commitment to controls

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Com*re)ension Di iculty: ,oderate "earning #$%ecti&e: "earning #$%ecti&e: 1

6-",

Chapter 06 - Internal Control in a Financial Statement Audit

%6. The ris! assessment component of internal controls refers to A. The auditor$s assessment of control ris! .. The auditor$s assessment of client ris! C" The entity$s identification and analysis of ris!s rele*ant to achie*ement of its ob2ecti*es 1. The entity$s monitorin of the potential for material misstatements

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: "earning #$%ecti&e: 1

%). As opposed to a manual control- an automated control A. Can ne*er be circum*ented #" Should function consistently in the absence of pro ram chan es C. Beed not be tested by the auditor 1. /ust be tested usin the same techni0ues as a manual control

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: '

%+. An IT specialist is least li!ely to be necessary 'hen A. 1ata is shared e#tensi*ely amon systems .. The entity participates hea*ily in electronic commerce C" The system has not chan ed from the prior year 1. Si nificant audit e*idence is in electronic form

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: ' "earning #$%ecti&e: 1

6-%0

Chapter 06 - Internal Control in a Financial Statement Audit

%,. In plannin an audit of a ne' client- an auditor most li!ely 'ould consider the methods used to process accountin information because such methods A" Influence the desi n of internal controls .. Affect the auditor$s plannin materiality le*els C. Assist in e*aluatin the planned audit assertions 1. 1etermine the auditor$s acceptable le*el of audit ris!

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: ' "earning #$%ecti&e: . "earning #$%ecti&e: 1

(0. A substanti*e strate y differs from a reliance strate y in that a substanti*e strate y includes A" Increased implementation of detailed tests of transactions and balances .. 4#tra tests of controls C. Increased emphasis on *erbal representations from mana ement 1. Settin control ris! at a minimum le*el

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: .

6-%1

Chapter 06 - Internal Control in a Financial Statement Audit

(1. :hich of the follo'in statements concernin control ris! is correct; A" Assessin control ris! and obtainin an understandin of an entity$s internal controls may be performed concurrently .. :hen control ris! is at the ma#imum le*el- an auditor is re0uired to document the basis for that assessment C. Control ris! may be assessed sufficiently lo' to eliminate substanti*e procedure for si nificant transaction classes 1. :hen assessin control ris! an auditor should not consider e*idence obtained in prior audits about the operation of control acti*ities

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: ,oderate "earning #$%ecti&e: . "earning #$%ecti&e: 3 "earning #$%ecti&e: 4

(2. Assessin control ris! at belo' the ma#imum most li!ely 'ould in*ol*e? A. Chan in the timin of substanti*e procedures by omittin interim testin and performin the tests at year-end #" Identifyin specific internal controls rele*ant to specific assertions C. 7erformin more e#tensi*e substanti*e procedures 'ith lar er sample si3es than ori inally planned 1. 5educin inherent ris! for most of the assertions rele*ant to si nificant account balances

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: ,oderate "earning #$%ecti&e: ++ "earning #$%ecti&e: +0 "earning #$%ecti&e: . "earning #$%ecti&e: 4

6-%2

Chapter 06 - Internal Control in a Financial Statement Audit

(". In the audit of financial statements- an auditor$s primary consideration re ardin an internal control policy or procedure is 'hether the policy or procedure A. 5eflects mana ement$s philosophy and operatin style #" Affects mana ement$s financial statement assertions C. 7ro*ides ade0uate safe uards o*er access to assets 1. 4nhances mana ement$s decision-ma!in processes

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: . "earning #$%ecti&e: 1

(%. :hich of the follo'in most li!ely 'ould not be considered an inherent limitation of the potential effecti*eness of an entity$s internal controls; A" Incompatible duties .. /ana ement o*erride C. /ista!es in 2ud ment 1. Collusion amon employees

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: 1

((. It is important for the C7A to consider the competence of the audit clients$ employees because their competence bears directly and importantly upon the A. CostAbenefit relationship of the system of internal control #" Achie*ement of the ob2ecti*es of the system of internal control C. Comparison of recorded accountability 'ith assets 1. Timin of the tests to be performed

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Com*re)ension Di iculty: ,oderate "earning #$%ecti&e: 1

6-%"

Chapter 06 - Internal Control in a Financial Statement Audit

(6. As part of ainin an initial understandin internal control- an auditor is re0uired to do all of the follo'in - e#cept? A. Consider factors that affect the ris! of material misstatement .. Ascertain 'hether internal control policies and procedures ha*e been placed in operation C. Identify the types of potential misstatements that can occur !" &btain !no'led e about the operatin effecti*eness of the internal control

AACSB: Communications AICPA BB: "egal AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: 1

(). 4ffecti*e internal control in a small company that has an insufficient number of employees to permit proper di*ision of responsibilities can best be enhanced by A. 4mployment of temporary personnel to aid in the separation of duties #" 1irect participation by the o'ner of the business in the record-!eepin acti*ities of the business C. 4n a in a C7A to perform monthly boo!!eepin 1. 1ele ation of full- clear-cut responsibility to each employee for the functions assi ned to each

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: 1

6-%%

Chapter 06 - Internal Control in a Financial Statement Audit

(+. The independent auditor should ac0uire an understandin of the internal audit function as it relates to the assessment of control ris! because A. Internal auditors$ audit pro rams- audit documents- and reports can eliminate the need for the independent auditor$s staff .. The procedures performed by the internal audit staff may eliminate the independent auditor$s need for an e#tensi*e study and e*aluation of internal control C" The 'or! performed by internal auditors may be a factor in determinin the nature- timin and e#tent of the independent auditor$s procedures 1. The understandin of the internal audit function is an important substanti*e procedure to be performed by the independent auditor

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Com*re)ension Di iculty: ,oderate "earning #$%ecti&e: 1 "earning #$%ecti&e: 4

(,. In obtainin an understandin of an entity$s internal control in a financial statement audit of a non-public company- an auditor is not obli ated to A. 1etermine 'hether the control acti*ities ha*e been placed in operation .. 7erform procedures to understand the desi n of the internal control policies C. 1ocument the understandin of the entity$s internal control components !" Search for si nificant deficiencies in the operation of the internal control

AACSB: Communications AICPA BB: "egal AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +/ "earning #$%ecti&e: 1 "earning #$%ecti&e: 3

6-%(

Chapter 06 - Internal Control in a Financial Statement Audit

60. After completin the preliminary phase of the re*ie' of internal control- the auditor decides not to rely on the system to restrict substanti*e procedures. 1ocumentation may be limited to the auditor$s A" 9nderstandin of the internal control .. 5easons for decidin not to e#tend the re*ie' C. .asis for concludin that errors and fraud 'ill be pre*ented 1. Completed internal control 0uestionnaire

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: 1 "earning #$%ecti&e: 3

61. In an audit of financial statements in accordance 'ith enerally accepted auditin standards- an auditor is re0uired to A. Identify specific internal control acti*ities rele*ant to mana ement$s financial statement assertions .. 7erform tests of controls to e*aluate the effecti*eness of the entity$s accountin system C. 1etermine 'hether procedures are suitably desi ned to pre*ent or detect material misstatements !" 1ocument the auditor$s understandin of the entity$s internal control

AACSB: Communications AICPA BB: "egal AICPA FN: Re*orting Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: 1 "earning #$%ecti&e: 3

6-%6

Chapter 06 - Internal Control in a Financial Statement Audit

62. For a comple# IT system- auditors are least li!ely to use 'hich of the follo'in 'hen documentin their understandin of internal controls; A" Barrati*es .. Internal control 0uestionnaires C. Flo'charts 1. &r ani3ation charts

AACSB: Communications AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: 3

6". Assessin A. Identifyin #" Concludin C. 7erformin 1. Analy3in

control ris! belo' ma#imum in*ol*es all of the follo'in e#cept specific controls to rely on that controls are ineffecti*e tests of controls the achie*ed le*el of control ris! after performin tests of controls

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: 4

6%. :hen an auditor increases the planned assessed le*el of control ris! because certain control acti*ities 'ere determined to be ineffecti*e- the auditor 'ould most li!ely increase the A" 4#tent of tests of details .. 6e*el of inherent ris! C. 4#tent of tests of controls 1. 6e*el of detection ris!

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: ,oderate "earning #$%ecti&e: ++ "earning #$%ecti&e: 4

6-%)

Chapter 06 - Internal Control in a Financial Statement Audit

6(. :hich of the follo'in procedures most li!ely 'ould be included as part of an auditor$s tests of controls; A" Inspection .. 5econciliation C. Confirmation 1. Analytical procedures

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +/

66. An auditor is least li!ely to test the internal controls that pro*ide for A. Appro*al of the purchase and sale of mar!etable securities #" Classification of re*enue and e#pense transactions by product line C. Se re ation of the functions of recordin disbursements and reconcilin the ban! account 1. Comparison of recei*in reports and *endors$ in*oices 'ith purchase orders

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +/

6). For certain controls- such as se re ation of duties- documentary e*idence may not e#ist. An auditor 'ould most li!ely test the procedures by A. 5eperformance and corroboration #" &bser*ation and in0uiry C. Inspection and *ouchin 1. Confirmation and recomputation

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +/

6-%+

Chapter 06 - Internal Control in a Financial Statement Audit

6+. :al!throu hs usually in*ol*e all of the follo'in audit procedures e#cept A" 5eperformance .. In0uiry C. &bser*ation 1. Inspection

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: +/

6,. .efore applyin substanti*e procedures to the details of accounts at an interim date <a date prior to the balance sheet date=- an auditor should A. Assess control ris! at the ma#imum for the assertions embodied in the accounts selected for interim testin .. 1etermine that the accounts selected for interim testin are not material to the financial statements ta!en as a 'hole C" Consider the a*ailability of information at a later date that 'ill be necessary for the auditor$s procedures <e. .- electronic data= 1. &btain 'ritten representations from mana ement that all financial records and related data 'ill be made a*ailable

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: ++ "earning #$%ecti&e: +0

6-%,

Chapter 06 - Internal Control in a Financial Statement Audit

)0. A hi h detection ris! strate y includes all of the follo'in e#cept A. Interim testin .. 5educed testin of transactions C. 8ea*y reliance on analytical procedures as substanti*e procedures !" Audit 'or! only completed at year-end

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: ++ "earning #$%ecti&e: +0

)1. The auditor should consider all of the follo'in 'hen decidin 'hether substanti*e procedures 'ill be performed at an interim date e#cept A. The le*el of control ris! #" Schedulin conflicts in the audit firm that ma!e interim testin more con*enient C. :hether business conditions 'ill chan e after the interim date 1. The ability to e#amine the remainin period

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: ++ "earning #$%ecti&e: +0

)2. If auditors conduct substanti*e procedures as of 10A"1 for an entity 'ith a 12A"1 year-end A. Additional tests are seldom conducted for the remainin period .. Additional control tests are re0uired in the remainin period C. The client$s controls li!ely are ineffecti*e !" Additional tests li!ely 'ill be performed in the remainin period

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: ++ "earning #$%ecti&e: +0

6-(0

Chapter 06 - Internal Control in a Financial Statement Audit

)". .ased on a study and e*aluation completed at an interim date- the auditor concludes that no si nificant internal control 'ea!nesses e#ist. The records and procedures 'ould most li!ely be tested a ain at year-end if A. Compliance tests 'ere not performed by the internal auditor durin the remainin period .. The internal control system pro*ides a basis for reliance in reducin the e#tent of substanti*e procedures C. The auditor used nonstatistical samplin durin interim compliance testin !" In0uiries and obser*ations lead the auditor to belie*e that conditions 'ithin the internal control system ha*e chan ed

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: ,oderate "earning #$%ecti&e: +0

)%. :hich of the follo'in statements is correct concernin an auditor$s communication of internal control related matters <si nificant deficiencies= noted in an audit; A. The auditor may issue a 'ritten report to the audit committee representin that no si nificant deficiencies 'ere noted durin the audit .. Si nificant deficiencies should be recommunicated each year- e*en if the audit committee has ac!no'led ed its understandin of such deficiencies C. Si nificant deficiencies that are material 'ea!nesses should be reported separately from other si nificant deficiencies !" The auditor may choose to communicate si nificant internal control-related matters either durin the course of the audit or after the audit is concluded

AACSB: Communications AICPA BB: Industry AICPA FN: Re*orting Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +'

6-(1

Chapter 06 - Internal Control in a Financial Statement Audit

)(. The auditor$s communication of material 'ea!nesses in internal control for a nonpublic company is A. 5e0uired to enable the auditor to state that the e#amination has been made in accordance 'ith enerally accepted auditin standards .. The principle reason for studyin and e*aluatin the system of internal controls C" Incidental to the auditor$s ob2ecti*e of formin an opinion as to the fair presentation of the financial statements 1. 5e0uired to be documented in a formal 'ritten report to the board of directors or the board$s audit committee

AACSB: Communications AICPA BB: Industry AICPA FN: Re*orting Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +'

)6. Si nificant deficiencies are matters that come to an auditor$s attention that should be communicated to an entity$s audit committee because they represent A. 1isclosures of information that si nificantly contradict the auditor$s oin concern assumption .. /aterial fraud or ille al acts perpetrated by hi h-le*el mana ement C" Si nificant desi n fla's in internal controls or poor implementation of internal controls 1. /anipulation or falsification of accountin records or documents from 'hich financial statements are prepared

AACSB: Communications AICPA BB: Industry AICPA FN: Re*orting Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +'

6-(2

Chapter 06 - Internal Control in a Financial Statement Audit

)). All of the follo'in are si nificant deficiencies e#cept A. Absence of appropriate re*ie's of transactions .. 4*idence of 'illful 'ron doin by lo'er-le*el employees C. Inade0uate pro*isions for safe uardin assets !" In*entory is hi hly sub2ect to obsolescence

AACSB: Communications AICPA BB: Industry AICPA FN: Decision ,aking Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +'

)+. The normal se0uence of documents and operations on a 'ell-prepared systems flo'chart is A" Top to bottom and left to ri ht .. .ottom to top and left to ri ht C. Top to bottom and ri ht to left 1. .ottom to top and ri ht to left

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +.

),. :hen preparin a record of a client$s internal control- the independent auditor sometimes uses a systems flo'chart- 'hich can best be described as a A. 7ictorial presentation of the flo' of instructions in a client$s internal computer system .. 1ia ram 'hich clearly indicates an or ani3ation$s internal reportin structure C. @raphic illustration of the flo' of operations 'hich is used to replace the auditor$s internal control 0uestionnaire !" Symbolic representation of a system or series of se0uential processes

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +.

6-("

Chapter 06 - Internal Control in a Financial Statement Audit

+0. :hich of the follo'in is not a characteristic of a batch processed computer system; A. The collection of li!e transactions 'hich are sorted and processed se0uentially a ainst a master file .. Ceypunchin of transactions- follo'ed by machine processin C. The production of numerous printouts !" The postin of a transaction- as it occurs- to se*eral files- 'ithout intermediate printouts

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: +-

+1. :hich of the follo'in is a eneral control that 'ould most li!ely assist an entity 'hose systems analyst left the entity in the middle of a ma2or pro2ect; A. @randfather-father-son record retention .. Input and output *alidation routines C" Systems documentation 1. Chec! di it *erification

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +-

+2. A customer intended to order 100 units of product D,601%- but incorrectly ordered none#istent product D,601(. :hich of the follo'in controls most li!ely 'ould detect this error; A" Chec! di it *erification .. 5ecord count C. 8ash total 1. 5edundant data chec!

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +-

6-(%

Chapter 06 - Internal Control in a Financial Statement Audit

+". Assume that an auditor estimates that 10-000 chec!s 'ere issued durin the accountin period. If an IT application control 'hich performs a limit chec! for each chec! re0uest is to be sub2ected to the auditor$s test data approach- the sample should include A. Appro#imately 1-000 test items .. A number of test items determined by the auditor to be sufficient under the circumstances C. A number of test items determined by the auditor$s reference to the appropriate samplin tables !" &ne transaction

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: A**lication Di iculty: ,oderate "earning #$%ecti&e: +-

+%. After obtainin an understandin of internal controls and assessin control ris! of an entity- an auditor decided not to perform tests of controls for purposes of the audit. The auditor most li!ely decided that A. The a*ailable e*idential matter obtained throu h tests of controls 'ould not support an increased le*el of control ris! .. A reduction in the assessed le*el of control ris! is 2ustified for certain financial statement assertions C" It 'ould be inefficient to perform tests of controls that 'ould result in a reduction in planned substanti*e procedures 1. The assessed le*el of inherent ris! e#ceeded the assessed le*el of control ris!

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: 5ard "earning #$%ecti&e: . "earning #$%ecti&e: 1 "earning #$%ecti&e: 4

6-((

Chapter 06 - Internal Control in a Financial Statement Audit

+(. After the auditor has prepared a flo'chart of the internal controls surroundin sales and e*aluated the desi n of the system- the auditor 'ould perform tests of controls on all control acti*ities A. 1ocumented in the flo'chart .. Considered to be 'ea!nesses that mi ht allo' errors to enter the accountin system C" That the auditor plans to rely on 1. That 'ould aid in pre*entin fraud

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: . "earning #$%ecti&e: 1 "earning #$%ecti&e: 4

+6. As the acceptable le*el of detection ris! increases- an auditor may chan e the A. Assessed le*el of control ris! from belo' the ma#imum to the ma#imum le*el .. Assurance pro*ided by tests of controls by usin a lar er sample si3e than planned C" Timin of substanti*e procedures from year-end to an interim date 1. Bature of substanti*e procedures from less effecti*e to more effecti*e procedures

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: 5ard "earning #$%ecti&e: +0 "earning #$%ecti&e: . "earning #$%ecti&e: 4

+). In a properly desi ned internal control system- the same employee may be permitted to A. 5ecei*e and deposit chec!s and also appro*e 'rite-offs of customer accounts .. Appro*e *ouchers for payment and also si n chec!s C. 5econcile the ban! statements and also recei*e and deposit cash !" Si n chec!s and also cancel supportin documents

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: 1

6-(6

Chapter 06 - Internal Control in a Financial Statement Audit

++. A procedure that 'ould most li!ely be used by an auditor in performin tests of control acti*ities that in*ol*e se re ation of functions and that lea*e no transaction trail is A. Inspection #" &bser*ation C. 5eperformance 1. 5econciliation

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: +/ "earning #$%ecti&e: 1

+,. 1urin consideration of internal control in a financial statement audit of a nonpublic company- an auditor is not obli ated to A" Search for si nificant deficiencies in the operation of internal control .. 9nderstand the internal control en*ironment and the information system C. 1etermine 'hether the controls rele*ant to audit plannin ha*e been placed in operation 1. 7erform procedures to understand the desi n of internal control

AACSB: Communications AICPA BB: "egal AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: +/ "earning #$%ecti&e: 1 "earning #$%ecti&e: 3

,0. Audit e*idence concernin proper se re ation of duties ordinarily is best obtained by A. 7reparation of a flo'chart of duties performed by a*ailable personnel .. In0uirin 'hether control acti*ities operated consistently throu hout the period C. 5e*ie'in 2ob descriptions prepared by the 7ersonnel 1epartment !" 1irect personal obser*ation of the employees 'ho apply control acti*ities

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: +/ "earning #$%ecti&e: 1

6-()

Chapter 06 - Internal Control in a Financial Statement Audit

,1. :hile substanti*e procedures may support the accuracy of underlyin records- these tests fre0uently pro*ide no affirmati*e e*idence of se re ation of duties because A. Substanti*e procedures rarely uarantee the accuracy of the records if only a sample of the transactions has been tested #" The records may be accurate e*en thou h they are maintained by persons ha*in incompatible functions C. Substanti*e procedures relate to the entire period under audit- but compliance tests ordinarily are confined to the period durin 'hich the auditor is on the client$s premises 1. /any computeri3ed procedures lea*e no audit trail of 'ho performed them- so substanti*e procedures may necessarily be limited to in0uiries and obser*ation of office personnel

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: +/

,2. .efore applyin principal substanti*e procedures to the details of asset and liability accounts at an interim date- the auditor should A" Assess the difficulty in controllin audit ris! for the remainder of the period .. In*esti ate si nificant fluctuations that ha*e occurred in the asset and liability accounts since the pre*ious balance sheet date C. Select only those accounts 'hich can effecti*ely be sampled durin year-end audit 'or! 1. Consider the compliance tests that must be applied at the balance sheet date to e#tend the audit conclusions reached at the interim date

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: ++ "earning #$%ecti&e: +0

6-(+

Chapter 06 - Internal Control in a Financial Statement Audit

,". :hen communicatin internal control-related matters noted in an audit of a nonpublic company- an auditor$s report issued on si nificant deficiencies should indicate that A. 4rrors or fraud may occur and not be detected because there are inherent limitations in any internal control system .. The issuance of an un0ualified opinion on the financial statements may depend on correcti*e follo'-up action C. The deficiencies noted 'ere not detected 'ithin a timely period by employees in the normal course of performin their assi ned functions !" The purpose of the audit 'as to report on the financial statements and not to pro*ide assurance on internal control

AACSB: Communications AICPA BB: "egal AICPA FN: Re*orting Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: +'

,%. The pro ram flo'chartin symbol representin a decision is a A. Trian le .. Circle C. 5ectan le !" 1iamond

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: A**lication Di iculty: 5ard "earning #$%ecti&e: +.

Short Answer Questions

6-(,

Chapter 06 - Internal Control in a Financial Statement Audit

,(. Internal control has become a *ery important focus for publicly traded and pri*ately-held companies ali!e. Internal control is intended to accomplish at least four ob2ecti*es and consists of fi*e components of internal control. 6ist the four ob2ecti*es and fi*e components of internal control. &b2ecti*es of internal control include reliability of financial reportin - effecti*eness and efficiency of operations- compliance 'ith applicable la's and re ulations and safe uardin of assets. The fi*e components of internal control are the control en*ironment- the entity$s ris! assessment process- the information system and related business processes rele*ant to financial reportin and communication- control acti*ities and monitorin of controls.

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: 0 "earning #$%ecti&e: -

6-60

Chapter 06 - Internal Control in a Financial Statement Audit

,6. :hat are t'o potential benefits and t'o potential ris!s of usin IT for an entity$s internal control; Student answers should include two $ene%its and two ris&s %rom %ollowin'( .enefits Consistent application of predefined business rules and performance of comple# calculations in processin lar e *olumes of transactions or data. 4nhancement of the timeliness- a*ailability- and accuracy of information. Facilitation of additional analysis of information. 4nhancement of the ability to monitor the performance of the entity$s acti*ities and its policies and procedures. 5eduction in the ris! that controls 'ill be circum*ented. 4nhancement of the ability to achie*e effecti*e se re ation of duties by implementin security controls in applications- databases- and operatin systems. 5is!s 5eliance on systems or pro rams that inaccurately process data- process inaccurate data- or both. 9nauthori3ed access to data that may result in destruction of data or improper chan es to data- includin the recordin of unauthori3ed or none#istent transactions or inaccurate recordin of transactions. 9nauthori3ed chan es to data in master files. 9nauthori3ed chan es to systems or pro rams. Failure to ma!e necessary chan es to systems or pro rams. Inappropriate manual inter*ention. 7otential loss of data.

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: '

6-61

Chapter 06 - Internal Control in a Financial Statement Audit

,). In terms of an audit- define substanti*e strate y and reliance strate y. Include in your definition ho' the different strate ies relate to internal control. :hich strate y 'ould best relate to a lo'er control ris!; A substanti*e strate y means that the auditor has decided not to rely on the entity$s controls to reduce audit ris!- but rather to reduce audit ris! solely by obtainin sufficient e*idence from substanti*e procedures and procedures. The reliance strate y re0uires a more detailed understandin of internal control than the substanti*e strate y does because the auditor intends to rely on the controls. Further- tests of controls are necessary to implement the reliance strate y. A reliance strate y relates 'ith lo'er control ris! as the auditor 'ould be able to rely more hea*ily on the controls if the control ris! is lo'er.

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Analysis Di iculty: !asy "earning #$%ecti&e: .

,+. 1escribe the limitations of internal control. :hy do limitations on internal control e#ist; The effecti*eness of any internal control system is limited by potential for any of the follo'in ? mana ement o*erride of internal control- personnel errors or mista!es- and collusion. Further- internal control effecti*eness is limited by cost. The cost of the control system must be balanced 'ith the related benefits.

AACSB: Analytic AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Com*re)ension Di iculty: ,oderate "earning #$%ecti&e: 1

6-62

Chapter 06 - Internal Control in a Financial Statement Audit

,,. :hat are four potential tools a*ailable to the auditor for documentin their understandin of a client$s system of internal control; 1. Copies of the entity$s procedures manuals and or ani3ational charts. 2. A narrati*e description of internal control- 'hich is often in the form of a memorandum. ". Internal control 0uestionnaires %. Flo'charts

AACSB: Communications AICPA BB: Critical ()inking AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: 3

100. :hat are some typical types of e*idence that may be collected in testin a client$s internal controls; Applicable procedures include in6uiry of appropriate entity personnel and ins*ection o documents- reports or electronic files indicatin the performance of the control. The auditor mi ht also o$ser&e application of the control- re*er orm the application of the control or perform a walkt)roug). A 'al!throu h in*ol*es tracin a transaction from its ori ination to its inclusion in the financial statements throu h a combination of audit procedures includin in0uiry- obser*ation- and inspection.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: +/

6-6"

Chapter 06 - Internal Control in a Financial Statement Audit

101. :hy mi ht an auditor decide to test controls at an interim date; An auditor mi ht test controls at an interim date because the assertion bein tested may be important- but not crucial to internal control- the control has been effecti*e in prior audits or it may be more efficient to conduct the tests at that time because of less busy staff accountants and less year-end o*ertime. Additionally- if the controls are found not to be operatin effecti*ely- testin them at an interim date i*es the auditor more time to reassess the control ris! and modify the audit plan. It also i*es the auditor time to inform mana ement so that li!ely misstatements can be located and corrected before the rest of the audit is performed.

AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Com*re)ension Di iculty: !asy "earning #$%ecti&e: +0

102. :hile performin an audit on the internal controls o*er financial reportin for Air:a*es Corporation- your audit team finds 'hat it considers to be a si nificant deficiency. Air:a*es is a lar e- pri*ate company. :hat steps 'ould you ta!e to communicate this findin ; Auditin standards re0uire that the auditor communicate a si nificant deficiency to the audit committee or to a similar le*el of authority 'hen the entity does not ha*e an audit committee. The auditor can communicate 'ith the audit committee *ia 'ritin or orally. If the communication is oral- the auditor should document the communication in the 'or!in papers.

AACSB: Communications AICPA BB: "egal AICPA FN: Re*orting Bloom's: A**lication Di iculty: !asy "earning #$%ecti&e: +'

6-6%

Chapter 06 - Internal Control in a Financial Statement Audit

10". 1ata capture occurs throu h source documentation- direct data entry- or a combination of the t'o. 6ist three purposes of data capture controls. 1ata capture controls ensure that <1= all transactions are recorded in the application system<2= transactions are recorded only once and <"= re2ected transactions are identified- controlledcorrected- and reentered into the system.

AACSB: (ec)nology AICPA BB: "e&eraging (ec)nology AICPA FN: "e&eraging (ec)nology Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: +-

10%. :hat are the differences bet'een document flo'charts- system flo'charts- and pro ram flo'charts; A document flo'chart represents the flo' of documents amon departments in the entity. A systems flo'chart e#tends this approach by includin the processin steps- includin computer processin - in the flo'chart. A pro ram flo'chart illustrates the operations performed by the computer in e#ecutin a pro ram.

AACSB: Communications AICPA BB: Industry AICPA FN: Risk Analysis Bloom's: Knowledge Di iculty: ,oderate "earning #$%ecti&e: +.

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