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Chapter 07 - Internal Control

Chapter 07 Internal Control


True / False Questions

1. Internal control is concerned with the reliability of financial information. True False

2. The Foreign Corrupt ractices !ct prohibits bribes to foreign corporate officials to obtain business. True False

". Incompatible duties e#ist when an employee is in a position to perpetrate and conceal errors or fraud. True False

$. Internal auditors should preferably report to the chief accounting officer of the company. True False

%. &ell-designed internal control will pre'ent all fraud by top management. True False

(. C ! firms may use written narrati'es to describe internal control in their audit wor)ing papers. True False

7. The auditors* communication of internal control significant deficiencies should be addressed only to senior management of the company. True False

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Chapter 07 - Internal Control

+. If the auditors* assessment of the design of internal control re'eals that it cannot be relied upon, the auditors are not re-uired to prepare any documentation of internal control for their wor)ing papers. True False

.. The relati'ely low number of types of transactions incurred by small firms ma)es the segregation of duties impossible. True False

10. In a financial statement audit, C !s are re-uired to assess the operating effecti'eness of most significant accounting oriented controls. True False

Multiple Choice Questions

11. &hich of the following matters would an auditor most li)ely consider to be a significant deficiency to be communicated to the audit committee/ !. 0anagement*s failure to renegotiate unfa'orable long-term purchase commitments. 1. 2ecurring operating losses that may indicate going concern problems. C. 3'idence of a lac) of ob4ecti'ity by those responsible for accounting decisions. 5. 0anagement*s current plans to reduce its ownership e-uity in the entity.

12. In assessing the ob4ecti'ity of a client*s internal auditors, the C ! would be most li)ely to consider internal auditor6 !. 3ducation le'els. 1. 3#perience. C. 7rgani8ational status within the company. 5. Training and super'isory s)ills.

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Chapter 07 - Internal Control

1". In a financial statement audit performed following !IC ! rofessional 9tandards, how fre-uently must an auditor test operating effecti'eness of controls that appear to function as they ha'e in past years and on which the auditor wishes to rely upon in the current year/ !. 0onthly. 1. 3ach audit. C. !t least e'ery second audit. 5. !t least e'ery third audit.

1$. !fter obtaining an understanding of internal control and arri'ing at a preliminary assessed le'el of control ris), an auditor decided to perform tests of controls. The auditor most li)ely decided that6 !. !dditional e'idence to support a reduction in the assessed le'el of control ris) is not a'ailable. 1. !n increase in the assessed le'el of control ris) is 4ustified for certain financial statement assertions. C. It would be efficient to perform tests of controls that would result in a reduction in planned substanti'e procedures. 5. There were many internal control deficiencies that would allow misstatements to enter the accounting system.

1%. &hich of the following is least li)ely to be e'idence of operating effecti'eness of controls/ !. Cancelled supporting documents. 1. Confirmations of accounts recei'able. C. 2ecords documenting usage of computer programs. 5. 9ignatures on authori8ation forms.

1(. &hich of the following is not ordinarily a procedure for documenting an auditor*s understanding of internal control for planning purposes/ !. Chec)list. 1. Flowchart. C. :uestionnaire. 5. Confirmation.

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Chapter 07 - Internal Control

17. Tests of controls do not ordinarily address6 !. 1y whom a control was applied. 1. ;ow a control was applied. C. The consistency with which a control was applied. 5. The cost effecti'eness of the way a control was applied.

1+. &hich is most li)ely when the assessed le'el of control ris) increases/ !. Change from performing substanti'e procedures at year-end to an interim date. 1. erform substanti'e procedures directed inside the entity rather than tests directed toward parties outside the entity. C. <se the ma#imum number of dual purpose tests. 5. <se larger sample si8es for substanti'e procedures.

1.. &hich of the following must the auditor communicate to the audit committee/ !. 9ignificant deficiencies and material wea)nesses. 1. 7nly significant deficiencies. C. 7nly material wea)nesses. 5. =either significant deficiencies nor material wea)nesses.

20. ! client*s internal control appears strong, but the C ! has elected not to perform any tests of controls. The planned assessed le'el of control ris) is at what le'el/ !. >ero. 1. ?ow. C. 0oderate. 5. 0a#imum.

21. &hich of the following would be least li)ely to be regarded as a test of a control/ !. Tests of the additions to property by physical inspection. 1. Comparisons of the signatures on cancelled chec)s to the authori8ed chec) signer list. C. Tests of signatures on purchase orders. 5. 2ecalculation of payroll deductions.

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Chapter 07 - Internal Control

22. &hich of the following is not considered one of the fi'e ma4or components of internal control/ !. 2is) assessment. 1. 9egregation of duties. C. Control acti'ities. 5. 0onitoring.

2". &hich of the following statements is correct concerning the understanding of internal control needed by auditors/ !. The auditors must understand the information system, not the accounting system. 1. The auditors must understand monitoring and all preliminary accounting controls. C. The auditors must ha'e a sufficient understanding to assess the ris)s of material misstatement. 5. The auditors must understand the control en'ironment, ris) assessment, and all control acti'ities.

2$. The effecti'eness of controls is not generally tested by6 !. Inspection of documents and reports. 1. erformance of analytical procedures. C. 7bser'ation of the application of accounting policies and procedures. 5. In-uiries of appropriate client personnel.

2%. 7n financial statement audits, it is re-uired that the auditors obtain an understanding of internal control, including6 !. Its operating effecti'eness. 1. &hether it has been implemented @placed in operationA. C. erforming tests of controls for all material controls. 5. Its ability to pro'ide reasonable assurance.

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Chapter 07 - Internal Control

2(. ! significant deficiency6 !. 5iffers from a material wea)ness in that it in'ol'es internal control o'er operations rather than internal control o'er financial reporting. 1. In'ol'es an amount of disco'ered misstatements greater than the amount used as the planning measure of materiality. C. Is identical to a material wea)ness e#cept that it need not be communicated to those responsible for o'ersight of the company*s financial reporting. 5. Is less se'ere than a material wea)ness.

27. This organi8ation de'eloped a set of criteria that pro'ide management with a basis to e'aluate controls not only o'er financial reporting, but also o'er the effecti'eness and efficiency of operations and compliance with laws and regulations6 !. Foreign Corrupt ractices Corporation. 1. Committee of 9ponsoring 7rgani8ations. C. Cohen Commission. 5. Financial !ccounting 9tandards 1oard.

2+. &hich of the following is most li)ely to be considered a ris) assessment procedure relating to internal control/ !. Confirm accounts recei'able. 1. erform a test of a control relating to payroll. C. Ta)e test counts of the year-end in'entory. 5. Trace a transaction through the information system rele'ant to financial reporting.

2.. &hich statement is correct concerning the definition of internal control de'eloped by the Committee of 9ponsoring 7rgani8ations @C797A/ !. Its applicability is largely limited to internal auditing applications. 1. It is recogni8ed in the 9tatements on !uditing 9tandards. C. It emphasi8es the effecti'eness and efficiency of operations o'er the reliability of financial reporting. 5. It suggests that it is important to 'iew internal control as an end product as contrasted to a process or means to obtain an end.

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Chapter 07 - Internal Control

"0. The definition of internal control de'eloped by the Committee of 9ponsoring 7rgani8ations @C797A includes controls related to the reliability of financial reporting, the effecti'eness and efficiency of operations, and6 !. Compliance with applicable laws and regulations. 1. 3ffecti'eness of pre'ention of fraudulent occurrences. C. 9afeguarding of entity e-uity. 5. Incorporation of ethical business practice standards.

"1. &hich statement is correct concerning the rele'ance of 'arious types of controls to a financial statement audit/ !. !n auditor may ordinarily ignore the consideration of controls when a substanti'e audit approach is used. 1. Controls o'er the reliability of financial reporting are ordinarily most directly rele'ant to an audit, but other controls may also be rele'ant. C. Controls o'er safeguarding assets and liabilities are of primary importance, while controls o'er the reliability of financial reporting may also be rele'ant. 5. !ll controls are ordinarily rele'ant to an audit.

"2. &hich of the following is not a component of the control en'ironment/ !. Integrity and ethical 'alues. 1. 2is) assessment. C. Commitment to competence. 5. 7rgani8ational structure.

"". &hich of the following is not ordinarily considered a factor indicati'e of increased financial reporting ris) when an auditor is considering a client*s ris) assessment policies/ !. 9alaried sales personnel. 1. Implementation of a new information system. C. 2apid growth of the organi8ation. 5. Corporate restructuring.

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Chapter 07 - Internal Control

"$. The 9arbanes-7#ley !ct of 2002 re-uires that the audit committee6 !. !nnually reassess control ris) using information from the C ! firm. 1. 1e directly responsible for the appointment, compensation and o'ersight of the wor) of the C ! firm. C. 2e-uire that the company*s C ! firm rotate the partner in charge of the audit. 5. 2e'iew the le'el of management compensation.

"%. &hen tests of controls re'eal that controls are operating as anticipated, it is most li)ely that the assessed le'el of control ris) will6 !. 1e less than the preliminary assessed le'el of control ris). 1. 3-ual the preliminary assessed le'el of control ris). C. 3-ual the actual control ris). 5. 1e less than the actual control ris).

"(. <nder which circumstance is it li)ely that the e#tent of substanti'e procedures will be e#panded beyond that anticipated in the audit plan/ !. The auditors ha'e determined that controls ha'e been implemented @placed in operationA but, in accordance with the audit plan, ha'e performed no tests of controls. 1. Certain controls do not lea'e a trail of documentary e'idence. C. 5e'iation rates were greater than 8ero and approached anticipated le'els. 5. The operating effecti'eness of certain controls was found to be less than e#pected, although no material misstatements were identified.

"7. The pro'isions of the Foreign Corrupt ractices !ct apply to6 !. !ll <.9. corporations. 1. !ll <.9. corporations that engage in foreign operations. C. !ll corporations that must file under the 9ecurities 3#change !ct of 1."$. 5. !ll <.9. partnerships and corporations.

"+. If the auditors do notperform tests of controls for certain assertions6 !. They ha'e performed a substandard audit. 1. They are not re-uired to communicate significant deficiencies relating to those accounts to management and the board of directors. C. They must issue a -ualified opinion. 5. They must assess control ris) at the ma#imum le'el for those assertions.

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Chapter 07 - Internal Control

".. 5uring financial statement audits, the auditors* consideration of their clients* internal control is integral to both assess the ris) of material misstatement and to6 !. !ssess inherent ris). 1. 5esign further audit procedures. C. !ssess compliance with the Foreign Corrupt ractices !ct. 5. ro'ide a reasonable basis for an opinion on compliance with applicable laws.

$0. &hich of the following comes closest to outlining the auditors* responsibility for considering internal control in all financial statement audits/ !. !n understanding of the control en'ironment, information and communication, ris) assessment and monitoring is necessaryB an understanding of control acti'ities is only necessary for areas in which the auditor is performing tests of controls. 1. The auditor must obtain an understanding of each of the fi'e internal control components sufficient to assess the ris)s of material misstatement for the audit. C. &hen tests of controls ha'e been performed, control ris) must be assessed at a le'el less than the ma#imum. 5. !n understanding of the control en'ironment is necessary, but no understanding of the other components is necessary unless control ris) is to be assessed at a le'el less than the ma#imum.

$1. &hich of the following is not a primary procedure auditors use to obtain sufficient )nowledge about the design of the rele'ant controls and to determine whether they ha'e been implemented @placed in operationA/ !. re'ious e#perience with the entity. 1. In-uiries of appropriate management personnel. C. erformance of substanti'e procedures. 5. Inspection of document and records.

$2. ! control deficiency that is less se'ere than a material wea)ness, but important enough to merit attention by those responsible for o'ersight of the company*s financial reporting is referred to as a@nA6 !. Control deficiency. 1. Inherent limitation. C. 2eportable deficiency. 5. 9ignificant deficiency.

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Chapter 07 - Internal Control

$". For effecti'e internal control, which of the following functions should not be assigned to the company*s accounting department/ !. 2econciling accounting records with e#isting assets. 1. 2ecording financial transactions. C. 9igning payroll chec)s. 5. reparing financial reports.

$$. &hich of the following is not a responsibility that should be assigned to a company*s internal audit department/ !. 3'aluating internal control. 1. !ppro'ing disbursements. C. 2eporting on the effecti'eness of operating segments. 5. In'estigating potential merger candidates.

$%. &hich of the following is true about the auditors* consideration of internal control in a financial statement audit/ !. The auditors must assess control ris) at a le'el lower than the ma#imum. 1. The auditors must prepare a flowchart description of internal control for their wor)ing papers. C. The auditors must obtain an understanding of the steps in processing ma4or types of transactions. 5. The auditors must perform tests of controls.

$(. &hich of the following is an ad'antage of describing internal control through the use of a standardi8ed -uestionnaire/ !. :uestionnaires highlight wea)nesses in the system. 1. :uestionnaires are more fle#ible than other methods of describing internal control. C. :uestionnaires usually identify situations in which internal control wea)nesses are compensated for by other strengths in the system. 5. :uestionnaires pro'ide a clearer and more specific portrayal of a client*s system than other methods of describing internal control.

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Chapter 07 - Internal Control

$7. &hich of the following is least li)ely to be considered a ris) assessment procedure relating to internal control/ !. Counting mar)etable securities at year-end. 1. In-uiries of client personnel. C. Inspecting documents and reports. 5. 7bser'ing the application of specific controls.

$+. &hich of the following is least li)ely to be considered a ris) assessment procedure/ !. !nalytical procedures. 1. Inspection of documents. C. 7bser'ation of the counting of in'entory. 5. 7bser'ation of the performance of certain accounting procedures.

$.. &hich of the following is not a factor that is considered a part of the client*s o'erall control en'ironment/ !. The organi8ational structure. 1. The information system. C. 0anagement philosophy and operating style. 5. 1oard of directors.

%0. &hich of the following would be least li)ely to be considered a benefit of effecti'e internal control/ !. 3liminating all employee fraud. 1. 2estricting access to assets. C. 5etecting ineffecti'eness. 5. 3nsuring authori8ation of transactions.

%1. !fter documenting the client*s prescribed internal control, the auditors will often perform a wal)-through of each transaction cycle. !n ob4ecti'e of a wal)-through is to6 !. Cerify that the controls ha'e been implemented @placed in operationA. 1. 2eplace tests of controls. C. 3'aluate the ma4or strengths and wea)nesses in the client*s internal control. 5. Identify wea)nesses to be communicated to management in the management letter.

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Chapter 07 - Internal Control

%2. The ma4or components of internal control include all of the following, e#cept6 !. 2is) assessment. 1. The control en'ironment. C. Internal auditing. 5. Control acti'ities.

%". &hich of the following is correct with respect to control deficiencies disco'ered during an audit/ !. !uditors must communicate and recommend corrections relating to all material wea)nesses in internal control to management. 1. !ll material wea)nesses in internal control should be reported to the audit committee. C. !ll such matters must be communicated to the audit committee and regulatory agencies. 5. !ll control deficiencies are also significant deficiencies.

%$. !fter considering the client*s internal control the auditors ha'e concluded that it is well designed and is functioning as anticipated. <nder these circumstances the auditors would most li)ely6 !. Cease to perform further substanti'e procedures. 1. 2educe substanti'e procedures in areas where the internal control was found to be effecti'e. C. Increase the e#tent of anticipated analytical procedures. 5. erform all tests of controls to the e#tent outlined in the preplanned audit program.

%%. The use of fidelity bonds protects a company from embe88lement loses and also6 !. 0inimi8es the possibility of employing persons with dubious records in positions of trust. 1. 2educes the company*s need to obtain e#pensi'e business interruption insurance. C. !llows the company to substitute the fidelity bonds for 'arious parts of internal control. 5. rotects employees who made unintentional errors from possible monetary damages resulting from such errors.

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Chapter 07 - Internal Control

%(. The independent auditors might consider the procedures performed by the internal auditors because6 !. They are employees whose wor) must be re'iewed during substanti'e testing. 1. They are employees whose wor) might affect the independent auditors* wor). C. Their wor) impacts upon the costDbenefit tradeoff in e'aluating inherent limitations. 5. Their degree of independence may be inferred by the nature of their wor).

%7. In the consideration of internal control, the operating effecti'eness of controls is tested by6 !. Flowcharts 'erification. 1. Tests of controls. C. 9ubstanti'e procedures. 5. 5ecision tables.

%+. The auditors who become aware of an internal control significant deficiency are re-uired to communicate this to the6 !. Client*s legal counsel. 1. Compensation committee. C. !udit committee. 5. Internal auditors.

%.. ! material wea)ness in'ol'es an amount that could result in a misstatement that is !. 9maller than inconse-uential. 1. ?arger than inconse-uential. C. Tolerable. 5. 0aterial.

(0. !t least what le'el of probability of a material misstatement is re-uired for a control deficiency to be considered a material wea)ness/ !. 0ore than remote. 1. robable. C. 2easonable possibility. 5. 9ufficient.

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Chapter 07 - Internal Control

(1. ! situation in which the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to pre'ent or detect material misstatements on a timely basis is referred to as a6 !. Control deficiency. 1. 0aterial wea)ness. C. 2eportable condition. 5. 9ignificant deficiency.

(2. To pro'ide for the greatest degree of independence in performing internal auditing functions, an internal auditor most li)ely should report to the6 !. Financial 'ice-president. 1. Corporate controller. C. !udit committee. 5. Corporate stoc)holders.

(". &ell-designed internal control that is functioning effecti'ely is most li)ely to detect an fraud arising from6 !. The fraudulent action of se'eral employees. 1. The fraudulent action of an indi'idual employee. C. Informal de'iations from the official organi8ation chart. 5. 0anagement fraud.

($. The program flowcharting symbol representing a decision is a6 !. Triangle. 1. Circle. C. 2ectangle. 5. 5iamond.

(%. Controls are not designed to pro'ide assurance that6 !. Transactions are e#ecuted in accordance with management*s authori8ation. 1. Fraud will be eliminated. C. !ccess to assets is permitted only in accordance with management*s authori8ation. 5. The recorded accountability for assets is compared with the e#isting assets at reasonable inter'als.

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Chapter 07 - Internal Control

((. The scope of substanti'e procedures as compared to the scope of tests of controls generally 'ary6 !. In a parallel manner. 1. In'ersely. C. 5irectly. 5. 3-ually.

(7. &hich of the following is least li)ely to be a factor that might indicate to an auditor that an identified ris) of misstatement re-uires special audit consideration/ !. Comple# calculations are in'ol'ed. 1. The rate of technological change is moderate in the industry. C. The potential for fraud seems high. 5. Carious sub4ecti'e methods of application of a )ey accounting policy e#ist.

(+. &hich of the following audit tests would be regarded as a test of a control/ !. Tests of the specific items ma)ing up the balance in a gi'en general ledger account. 1. Tests confirming recei'ables. C. Tests of the signatures on canceled chec)s to board of director*s authori8ations. 5. Tests of the additions to property, plant, and e-uipment by physical inspection.

(.. If the independent auditors decide that the wor) performed by the internal auditors may ha'e a bearing on their own procedures, they should consider the internal auditors*6 !. Competence and ob4ecti'ity. 1. 3fficiency and e#perience. C. Independence and re'iew s)ills. 5. Training and super'isory s)ills.

70. In the consideration of internal control, the auditor is basically concerned that it pro'ides reasonable assurance that6 !. 0anagement can not o'erride the system. 1. 7perational efficiency has been achie'ed in accordance with management plans. C. 0isstatements ha'e been pre'ented or detected. 5. Controls ha'e not been circum'ented by collusion.

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Chapter 07 - Internal Control

71. &hich of the following is least li)ely to be considered an appropriate response relating to ris)s the auditors identify at the financial statement le'el/ !. !ssign more e#perienced staff. 1. Incorporate additional elements of unpredictability in the selection of audit procedures. C. Increase the scope of auditor procedures. 5. 3mphasi8e the need to remain neutral, rather than to e#ercise professional s)epticism.

72. In assessing the competence of a client*s internal auditor, an independent auditor most li)ely would consider the !. Internal auditor*s compliance with professional internal auditing standards. 1. Client*s policies that limit the internal auditor*s access to management salary data. C. 3'idence supporting a further reduction in the assessed le'el of control ris). 5. 2esults of ratio analysis that may identify unusual transactions and e'ents.

7". &hich of the following factors would most li)ely be considered an inherent limitation to an entity*s internal control/ !. The comple#ity of the information processing system. 1. ;uman 4udgment in the decision ma)ing process. C. The ineffecti'eness of the board of directors. 5. The lac) of management incenti'es to impro'e the control en'ironment.

7$. roper segregation of duties reduces the opportunities to allow any employee to be in a position to both !. Eournali8e cash receipts and disbursements and prepare the financial statements. 1. 0onitor internal controls and e'aluate whether the controls are operating as intended. C. !dopt new accounting pronouncements and authori8e the recording of transactions. 5. 2ecord and conceal fraudulent transactions in the normal course of assigned tas)s.

7%. &hich of the following is intended to detect de'iations from prescribed controls/ !. 9ubstanti'e procedures specified by a standardi8ed audit program. 1. Tests of controls designed specifically for the client. C. !nalytical procedures as set forth in an industry audit guide. 5. Computeri8ed analytical procedures tailored for the configuration of the computer e-uipment in use.

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Chapter 07 - Internal Control

7(. !n auditor*s purpose for performing tests of controls is to pro'ide reasonable assurance that6 !. Controls are operating effecti'ely. 1. The ris) that the auditor may un)nowingly fail to modify the opinion on the financial statements is minimi8ed. C. Transactions are e#ecuted in accordance with management*s authori8ation and access to assets is limited by a segregation of functions. 5. Transactions are recorded as necessary to permit the preparation of the financial statements in conformity with generally accepted accounting principles.

77. 7f the following statements about internal control, which one is not 'alid/ !. =o one person should be responsible for the custodial responsibility and the recording responsibility for an asset. 1. Transactions must be properly authori8ed before such transactions are processed. C. 1ecause of the costDbenefit relationship, a client may apply control procedures on a test basis. 5. Control acti'ities reasonably insure that collusion among employees can not occur.

7+. Tests of controls are most li)ely to be performed when6 !. Controls seem wea) and must be properly documented. 1. Inade-uate substanti'e procedures e#ist to restrict audit ris) to an acceptable le'el. C. The auditor wishes to assess control ris) at the ma#imum. 5. The client*s control en'ironment appears wea).

7.. &hich of the following would be least li)ely to be included in an auditor*s tests of controls/ !. Inspection. 1. 7bser'ation. C. In-uiry. 5. !nalytical procedures.

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Chapter 07 - Internal Control

+0. The internal control pro'isions of the Sarbanes-Oxley Act of 2002 apply to which companies in the <nited 9tates6 !. !ll companies. 1. 93C registrants. C. 7nly those companies included in the Fortune %00. 5. !ll nonpublic companies.

+1. !n integrated audit performed under 9ection $0$b of the 9arbanes-7#ley !ct addresses financial statements and6 !. Compliance with laws. 1. Internal control o'er asset safeguarding. C. Internal control o'er financial reporting. 5. 9uitable criteria.

+2. ! report on internal control performed in accordance with C!71 9tandard =o. 2 includes an opinion on internal control for6 !. The entire year. 1. The prior -uarter. C. The Fas of date.F 5. The end of each -uarter.

+". &hen performing an audit of internal control under C!71 re-uirements, auditors

e'aluate control6 !. 7ption ! 1. 7ption 1 C. 7ption C 5. 7ption 5

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Chapter 07 - Internal Control

+$. &hen performing an internal control audit under C!71 re-uirements, one or more material wea)nesses in internal control that e#ist at year-end may result in what type of report@sA6

!. 7ption ! 1. 7ption 1 C. 7ption C 5. 7ption 5

+%. &hen performing an internal control audit under C!71 standards, one or more material wea)nesses in internal control that e#ist at year-end may result in what type of report@sA6

!. 7ption ! 1. 7ption 1 C. 7ption C 5. 7ption 5

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Chapter 07 - Internal Control


Essay Questions

+(. Independent auditors should consider the wor) of internal auditors in their assessment of control ris). a. !re internal auditors independent of management/ 3#plain. b. &hat is the difference between the primary ob4ecti'e of the independent auditors and that of internal auditors/ 3#plain. c. 5iscuss the factors that should be considered by the independent auditors in deciding how much, if any, reliance should be placed on the wor) of the internal auditors.

+7. !uditors are re-uired to consider a client*s internal control. a. 5escribe the two purposes of the auditors* consideration of a client*s internal control. b. 3'en the best internal control has certain limitations. ?ist three of those limitations.

++. &hen considering a client*s internal control, the auditors focus on its 'arious characteristics. For each of the following characteristics indicate the auditors* responsibility under generally accepted auditing standards and the procedures used to meet that responsibility. a. The design of internal control. b. Controls ha'e been implemented @placed in operationA. c. The operating effecti'eness of controls.

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Chapter 07 - Internal Control

+.. !ssume that you ha'e assessed inherent ris) for an audit area at a 'ery high le'el. &hile obtaining an understanding of internal control, you ha'e determined that it appears to be 'ery strong. =onetheless, due to the large number of transactions in'ol'ed, you ha'e chosen not to test controls in the area. a. !t what le'el will the planned assessed le'el of control ris) be established/ b. 5escribe the scope of tests of controls that will be performed. c. !t what le'el will the assessed le'el of control ris) be established/ d. &hat must be documented in the wor)ing papers relating to internal control/ e. !t what le'el will detection ris) be established/ f. 5escribe the re-uired scope of substanti'e procedures, if any. 0a)e certain to discuss details of li)ely nature, timing and e#tent.

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Chapter 07 - Internal Control

Chapter 07 Internal Control !nswer Gey

True / False Questions

1. Internal control is concerned with the reliability of financial information. TRUE

Difficulty: Easy

2. The Foreign Corrupt ractices !ct prohibits bribes to foreign corporate officials to obtain business. FALSE

Difficulty: Hard

". Incompatible duties e#ist when an employee is in a position to perpetrate and conceal errors or fraud. TRUE

Difficulty: Easy

$. Internal auditors should preferably report to the chief accounting officer of the company. FALSE

Difficulty: Medium

%. &ell-designed internal control will pre'ent all fraud by top management. FALSE

Difficulty: Easy

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Chapter 07 - Internal Control

(. C ! firms may use written narrati'es to describe internal control in their audit wor)ing papers. TRUE

Difficulty: Easy

7. The auditors* communication of internal control significant deficiencies should be addressed only to senior management of the company. FALSE

Difficulty: Easy

+. If the auditors* assessment of the design of internal control re'eals that it cannot be relied upon, the auditors are not re-uired to prepare any documentation of internal control for their wor)ing papers. FALSE

Difficulty: Medium

.. The relati'ely low number of types of transactions incurred by small firms ma)es the segregation of duties impossible. FALSE

Difficulty: Easy

10. In a financial statement audit, C !s are re-uired to assess the operating effecti'eness of most significant accounting oriented controls. FALSE

Difficulty: Medium

Multiple Choice Questions

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Chapter 07 - Internal Control

11. &hich of the following matters would an auditor most li)ely consider to be a significant deficiency to be communicated to the audit committee/ !. 0anagement*s failure to renegotiate unfa'orable long-term purchase commitments. 1. 2ecurring operating losses that may indicate going concern problems. C. 3'idence of a lac) of ob4ecti'ity by those responsible for accounting decisions. 5. 0anagement*s current plans to reduce its ownership e-uity in the entity.

Difficulty: Medium Source: AIC A

12. In assessing the ob4ecti'ity of a client*s internal auditors, the C ! would be most li)ely to consider internal auditor6 !. 3ducation le'els. 1. 3#perience. C. 7rgani8ational status within the company. 5. Training and super'isory s)ills.

Difficulty: Medium

1". In a financial statement audit performed following !IC ! rofessional 9tandards, how fre-uently must an auditor test operating effecti'eness of controls that appear to function as they ha'e in past years and on which the auditor wishes to rely upon in the current year/ !. 0onthly. 1. 3ach audit. C. !t least e'ery second audit. . !t least e'ery third audit.

Difficulty: Medium

7-2$

Chapter 07 - Internal Control

1$. !fter obtaining an understanding of internal control and arri'ing at a preliminary assessed le'el of control ris), an auditor decided to perform tests of controls. The auditor most li)ely decided that6 !. !dditional e'idence to support a reduction in the assessed le'el of control ris) is not a'ailable. 1. !n increase in the assessed le'el of control ris) is 4ustified for certain financial statement assertions. C. It would be efficient to perform tests of controls that would result in a reduction in planned substanti'e procedures. 5. There were many internal control deficiencies that would allow misstatements to enter the accounting system.

Difficulty: Hard Source: AIC A

1%. &hich of the following is least li)ely to be e'idence of operating effecti'eness of controls/ !. Cancelled supporting documents. !. Confirmations of accounts recei'able. C. 2ecords documenting usage of computer programs. 5. 9ignatures on authori8ation forms.

Difficulty: Hard

1(. &hich of the following is not ordinarily a procedure for documenting an auditor*s understanding of internal control for planning purposes/ !. Chec)list. 1. Flowchart. C. :uestionnaire. . Confirmation.

Difficulty: Easy

7-2%

Chapter 07 - Internal Control

17. Tests of controls do not ordinarily address6 !. 1y whom a control was applied. 1. ;ow a control was applied. C. The consistency with which a control was applied. . The cost effecti'eness of the way a control was applied.

Difficulty: Hard

1+. &hich is most li)ely when the assessed le'el of control ris) increases/ !. Change from performing substanti'e procedures at year-end to an interim date. 1. erform substanti'e procedures directed inside the entity rather than tests directed toward parties outside the entity. C. <se the ma#imum number of dual purpose tests. . <se larger sample si8es for substanti'e procedures.

Difficulty: Medium

1.. &hich of the following must the auditor communicate to the audit committee/ A. 9ignificant deficiencies and material wea)nesses. 1. 7nly significant deficiencies. C. 7nly material wea)nesses. 5. =either significant deficiencies nor material wea)nesses.

Difficulty: Medium

20. ! client*s internal control appears strong, but the C ! has elected not to perform any tests of controls. The planned assessed le'el of control ris) is at what le'el/ !. >ero. 1. ?ow. C. 0oderate. . 0a#imum.

Difficulty: Hard

7-2(

Chapter 07 - Internal Control

21. &hich of the following would be least li)ely to be regarded as a test of a control/ A. Tests of the additions to property by physical inspection. 1. Comparisons of the signatures on cancelled chec)s to the authori8ed chec) signer list. C. Tests of signatures on purchase orders. 5. 2ecalculation of payroll deductions.

Difficulty: Hard

22. &hich of the following is not considered one of the fi'e ma4or components of internal control/ !. 2is) assessment. !. 9egregation of duties. C. Control acti'ities. 5. 0onitoring.

Difficulty: Medium

2". &hich of the following statements is correct concerning the understanding of internal control needed by auditors/ !. The auditors must understand the information system, not the accounting system. 1. The auditors must understand monitoring and all preliminary accounting controls. C. The auditors must ha'e a sufficient understanding to assess the ris)s of material misstatement. 5. The auditors must understand the control en'ironment, ris) assessment, and all control acti'ities.

Difficulty: Easy

2$. The effecti'eness of controls is not generally tested by6 !. Inspection of documents and reports. !. erformance of analytical procedures. C. 7bser'ation of the application of accounting policies and procedures. 5. In-uiries of appropriate client personnel.

Difficulty: Medium

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Chapter 07 - Internal Control

2%. 7n financial statement audits, it is re-uired that the auditors obtain an understanding of internal control, including6 !. Its operating effecti'eness. !. &hether it has been implemented @placed in operationA. C. erforming tests of controls for all material controls. 5. Its ability to pro'ide reasonable assurance.

Difficulty: Medium

2(. ! significant deficiency6 !. 5iffers from a material wea)ness in that it in'ol'es internal control o'er operations rather than internal control o'er financial reporting. 1. In'ol'es an amount of disco'ered misstatements greater than the amount used as the planning measure of materiality. C. Is identical to a material wea)ness e#cept that it need not be communicated to those responsible for o'ersight of the company*s financial reporting. . Is less se'ere than a material wea)ness.

Difficulty: Medium

27. This organi8ation de'eloped a set of criteria that pro'ide management with a basis to e'aluate controls not only o'er financial reporting, but also o'er the effecti'eness and efficiency of operations and compliance with laws and regulations6 !. Foreign Corrupt ractices Corporation. !. Committee of 9ponsoring 7rgani8ations. C. Cohen Commission. 5. Financial !ccounting 9tandards 1oard.

Difficulty: Medium

7-2+

Chapter 07 - Internal Control

2+. &hich of the following is most li)ely to be considered a ris) assessment procedure relating to internal control/ !. Confirm accounts recei'able. 1. erform a test of a control relating to payroll. C. Ta)e test counts of the year-end in'entory. . Trace a transaction through the information system rele'ant to financial reporting.

Difficulty: Hard

2.. &hich statement is correct concerning the definition of internal control de'eloped by the Committee of 9ponsoring 7rgani8ations @C797A/ !. Its applicability is largely limited to internal auditing applications. !. It is recogni8ed in the 9tatements on !uditing 9tandards. C. It emphasi8es the effecti'eness and efficiency of operations o'er the reliability of financial reporting. 5. It suggests that it is important to 'iew internal control as an end product as contrasted to a process or means to obtain an end.

Difficulty: Hard

"0. The definition of internal control de'eloped by the Committee of 9ponsoring 7rgani8ations @C797A includes controls related to the reliability of financial reporting, the effecti'eness and efficiency of operations, and6 A. Compliance with applicable laws and regulations. 1. 3ffecti'eness of pre'ention of fraudulent occurrences. C. 9afeguarding of entity e-uity. 5. Incorporation of ethical business practice standards.

Difficulty: Medium

7-2.

Chapter 07 - Internal Control

"1. &hich statement is correct concerning the rele'ance of 'arious types of controls to a financial statement audit/ !. !n auditor may ordinarily ignore the consideration of controls when a substanti'e audit approach is used. !. Controls o'er the reliability of financial reporting are ordinarily most directly rele'ant to an audit, but other controls may also be rele'ant. C. Controls o'er safeguarding assets and liabilities are of primary importance, while controls o'er the reliability of financial reporting may also be rele'ant. 5. !ll controls are ordinarily rele'ant to an audit.

Difficulty: Hard

"2. &hich of the following is not a component of the control en'ironment/ !. Integrity and ethical 'alues. !. 2is) assessment. C. Commitment to competence. 5. 7rgani8ational structure.

Difficulty: Medium

"". &hich of the following is not ordinarily considered a factor indicati'e of increased financial reporting ris) when an auditor is considering a client*s ris) assessment policies/ A. 9alaried sales personnel. 1. Implementation of a new information system. C. 2apid growth of the organi8ation. 5. Corporate restructuring.

Difficulty: Medium

"$. The 9arbanes-7#ley !ct of 2002 re-uires that the audit committee6 !. !nnually reassess control ris) using information from the C ! firm. !. 1e directly responsible for the appointment, compensation and o'ersight of the wor) of the C ! firm. C. 2e-uire that the company*s C ! firm rotate the partner in charge of the audit. 5. 2e'iew the le'el of management compensation.

Difficulty: Medium

7-"0

Chapter 07 - Internal Control

"%. &hen tests of controls re'eal that controls are operating as anticipated, it is most li)ely that the assessed le'el of control ris) will6 !. 1e less than the preliminary assessed le'el of control ris). !. 3-ual the preliminary assessed le'el of control ris). C. 3-ual the actual control ris). 5. 1e less than the actual control ris).

Difficulty: Hard

"(. <nder which circumstance is it li)ely that the e#tent of substanti'e procedures will be e#panded beyond that anticipated in the audit plan/ !. The auditors ha'e determined that controls ha'e been implemented @placed in operationA but, in accordance with the audit plan, ha'e performed no tests of controls. 1. Certain controls do not lea'e a trail of documentary e'idence. C. 5e'iation rates were greater than 8ero and approached anticipated le'els. . The operating effecti'eness of certain controls was found to be less than e#pected, although no material misstatements were identified.

Difficulty: Hard

"7. The pro'isions of the Foreign Corrupt ractices !ct apply to6 !. !ll <.9. corporations. 1. !ll <.9. corporations that engage in foreign operations. C. !ll corporations that must file under the 9ecurities 3#change !ct of 1."$. 5. !ll <.9. partnerships and corporations.

Difficulty: Medium

"+. If the auditors do notperform tests of controls for certain assertions6 !. They ha'e performed a substandard audit. 1. They are not re-uired to communicate significant deficiencies relating to those accounts to management and the board of directors. C. They must issue a -ualified opinion. . They must assess control ris) at the ma#imum le'el for those assertions.

Difficulty: Medium

7-"1

Chapter 07 - Internal Control

".. 5uring financial statement audits, the auditors* consideration of their clients* internal control is integral to both assess the ris) of material misstatement and to6 !. !ssess inherent ris). !. 5esign further audit procedures. C. !ssess compliance with the Foreign Corrupt ractices !ct. 5. ro'ide a reasonable basis for an opinion on compliance with applicable laws.

Difficulty: Easy

$0. &hich of the following comes closest to outlining the auditors* responsibility for considering internal control in all financial statement audits/ !. !n understanding of the control en'ironment, information and communication, ris) assessment and monitoring is necessaryB an understanding of control acti'ities is only necessary for areas in which the auditor is performing tests of controls. !. The auditor must obtain an understanding of each of the fi'e internal control components sufficient to assess the ris)s of material misstatement for the audit. C. &hen tests of controls ha'e been performed, control ris) must be assessed at a le'el less than the ma#imum. 5. !n understanding of the control en'ironment is necessary, but no understanding of the other components is necessary unless control ris) is to be assessed at a le'el less than the ma#imum.

Difficulty: Medium

$1. &hich of the following is not a primary procedure auditors use to obtain sufficient )nowledge about the design of the rele'ant controls and to determine whether they ha'e been implemented @placed in operationA/ !. re'ious e#perience with the entity. 1. In-uiries of appropriate management personnel. C. erformance of substanti'e procedures. 5. Inspection of document and records.

Difficulty: Medium

7-"2

Chapter 07 - Internal Control

$2. ! control deficiency that is less se'ere than a material wea)ness, but important enough to merit attention by those responsible for o'ersight of the company*s financial reporting is referred to as a@nA6 !. Control deficiency. 1. Inherent limitation. C. 2eportable deficiency. . 9ignificant deficiency.

Difficulty: Medium

$". For effecti'e internal control, which of the following functions should not be assigned to the company*s accounting department/ !. 2econciling accounting records with e#isting assets. 1. 2ecording financial transactions. C. 9igning payroll chec)s. 5. reparing financial reports.

Difficulty: Medium

$$. &hich of the following is not a responsibility that should be assigned to a company*s internal audit department/ !. 3'aluating internal control. !. !ppro'ing disbursements. C. 2eporting on the effecti'eness of operating segments. 5. In'estigating potential merger candidates.

Difficulty: Hard

7-""

Chapter 07 - Internal Control

$%. &hich of the following is true about the auditors* consideration of internal control in a financial statement audit/ !. The auditors must assess control ris) at a le'el lower than the ma#imum. 1. The auditors must prepare a flowchart description of internal control for their wor)ing papers. C. The auditors must obtain an understanding of the steps in processing ma4or types of transactions. 5. The auditors must perform tests of controls.

Difficulty: Medium

$(. &hich of the following is an ad'antage of describing internal control through the use of a standardi8ed -uestionnaire/ A. :uestionnaires highlight wea)nesses in the system. 1. :uestionnaires are more fle#ible than other methods of describing internal control. C. :uestionnaires usually identify situations in which internal control wea)nesses are compensated for by other strengths in the system. 5. :uestionnaires pro'ide a clearer and more specific portrayal of a client*s system than other methods of describing internal control.

Difficulty: Medium

$7. &hich of the following is least li)ely to be considered a ris) assessment procedure relating to internal control/ A. Counting mar)etable securities at year-end. 1. In-uiries of client personnel. C. Inspecting documents and reports. 5. 7bser'ing the application of specific controls.

Difficulty: Hard

7-"$

Chapter 07 - Internal Control

$+. &hich of the following is least li)ely to be considered a ris) assessment procedure/ !. !nalytical procedures. 1. Inspection of documents. C. 7bser'ation of the counting of in'entory. 5. 7bser'ation of the performance of certain accounting procedures.

Difficulty: Hard

$.. &hich of the following is not a factor that is considered a part of the client*s o'erall control en'ironment/ !. The organi8ational structure. !. The information system. C. 0anagement philosophy and operating style. 5. 1oard of directors.

Difficulty: Medium

%0. &hich of the following would be least li)ely to be considered a benefit of effecti'e internal control/ A. 3liminating all employee fraud. 1. 2estricting access to assets. C. 5etecting ineffecti'eness. 5. 3nsuring authori8ation of transactions.

Difficulty: Medium

%1. !fter documenting the client*s prescribed internal control, the auditors will often perform a wal)-through of each transaction cycle. !n ob4ecti'e of a wal)-through is to6 A. Cerify that the controls ha'e been implemented @placed in operationA. 1. 2eplace tests of controls. C. 3'aluate the ma4or strengths and wea)nesses in the client*s internal control. 5. Identify wea)nesses to be communicated to management in the management letter.

Difficulty: Medium

7-"%

Chapter 07 - Internal Control

%2. The ma4or components of internal control include all of the following, e#cept6 !. 2is) assessment. 1. The control en'ironment. C. Internal auditing. 5. Control acti'ities.

Difficulty: Medium

%". &hich of the following is correct with respect to control deficiencies disco'ered during an audit/ !. !uditors must communicate and recommend corrections relating to all material wea)nesses in internal control to management. !. !ll material wea)nesses in internal control should be reported to the audit committee. C. !ll such matters must be communicated to the audit committee and regulatory agencies. 5. !ll control deficiencies are also significant deficiencies.

Difficulty: Hard

%$. !fter considering the client*s internal control the auditors ha'e concluded that it is well designed and is functioning as anticipated. <nder these circumstances the auditors would most li)ely6 !. Cease to perform further substanti'e procedures. !. 2educe substanti'e procedures in areas where the internal control was found to be effecti'e. C. Increase the e#tent of anticipated analytical procedures. 5. erform all tests of controls to the e#tent outlined in the preplanned audit program.

Difficulty: Easy Source: AIC A

7-"(

Chapter 07 - Internal Control

%%. The use of fidelity bonds protects a company from embe88lement loses and also6 A. 0inimi8es the possibility of employing persons with dubious records in positions of trust. 1. 2educes the company*s need to obtain e#pensi'e business interruption insurance. C. !llows the company to substitute the fidelity bonds for 'arious parts of internal control. 5. rotects employees who made unintentional errors from possible monetary damages resulting from such errors.

Difficulty: Medium Source: AIC A

%(. The independent auditors might consider the procedures performed by the internal auditors because6 !. They are employees whose wor) must be re'iewed during substanti'e testing. !. They are employees whose wor) might affect the independent auditors* wor). C. Their wor) impacts upon the costDbenefit tradeoff in e'aluating inherent limitations. 5. Their degree of independence may be inferred by the nature of their wor).

Difficulty: Medium Source: AIC A

%7. In the consideration of internal control, the operating effecti'eness of controls is tested by6 !. Flowcharts 'erification. !. Tests of controls. C. 9ubstanti'e procedures. 5. 5ecision tables.

Difficulty: Easy Source: AIC A

7-"7

Chapter 07 - Internal Control

%+. The auditors who become aware of an internal control significant deficiency are re-uired to communicate this to the6 !. Client*s legal counsel. 1. Compensation committee. C. !udit committee. 5. Internal auditors.

Difficulty: Medium Source: AIC A

%.. ! material wea)ness in'ol'es an amount that could result in a misstatement that is !. 9maller than inconse-uential. 1. ?arger than inconse-uential. C. Tolerable. . 0aterial.

Difficulty: Medium

(0. !t least what le'el of probability of a material misstatement is re-uired for a control deficiency to be considered a material wea)ness/ !. 0ore than remote. 1. robable. C. 2easonable possibility. 5. 9ufficient.

Difficulty: Medium

(1. ! situation in which the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to pre'ent or detect material misstatements on a timely basis is referred to as a6 A. Control deficiency. 1. 0aterial wea)ness. C. 2eportable condition. 5. 9ignificant deficiency.

Difficulty: Medium

7-"+

Chapter 07 - Internal Control

(2. To pro'ide for the greatest degree of independence in performing internal auditing functions, an internal auditor most li)ely should report to the6 !. Financial 'ice-president. 1. Corporate controller. C. !udit committee. 5. Corporate stoc)holders.

Difficulty: Medium Source: AIC A

(". &ell-designed internal control that is functioning effecti'ely is most li)ely to detect an fraud arising from6 !. The fraudulent action of se'eral employees. !. The fraudulent action of an indi'idual employee. C. Informal de'iations from the official organi8ation chart. 5. 0anagement fraud.

Difficulty: Medium Source: AIC A

($. The program flowcharting symbol representing a decision is a6 !. Triangle. 1. Circle. C. 2ectangle. . 5iamond.

Difficulty: Medium Source: AIC A

(%. Controls are not designed to pro'ide assurance that6 !. Transactions are e#ecuted in accordance with management*s authori8ation. !. Fraud will be eliminated. C. !ccess to assets is permitted only in accordance with management*s authori8ation. 5. The recorded accountability for assets is compared with the e#isting assets at reasonable inter'als.

Difficulty: Medium Source: AIC A

7-".

Chapter 07 - Internal Control

((. The scope of substanti'e procedures as compared to the scope of tests of controls generally 'ary6 !. In a parallel manner. !. In'ersely. C. 5irectly. 5. 3-ually.

Difficulty: Medium Source: AIC A

(7. &hich of the following is least li)ely to be a factor that might indicate to an auditor that an identified ris) of misstatement re-uires special audit consideration/ !. Comple# calculations are in'ol'ed. !. The rate of technological change is moderate in the industry. C. The potential for fraud seems high. 5. Carious sub4ecti'e methods of application of a )ey accounting policy e#ist.

Difficulty: Easy

(+. &hich of the following audit tests would be regarded as a test of a control/ !. Tests of the specific items ma)ing up the balance in a gi'en general ledger account. 1. Tests confirming recei'ables. C. Tests of the signatures on canceled chec)s to board of director*s authori8ations. 5. Tests of the additions to property, plant, and e-uipment by physical inspection.

Difficulty: Medium Source: AIC A

(.. If the independent auditors decide that the wor) performed by the internal auditors may ha'e a bearing on their own procedures, they should consider the internal auditors*6 A. Competence and ob4ecti'ity. 1. 3fficiency and e#perience. C. Independence and re'iew s)ills. 5. Training and super'isory s)ills.

Difficulty: Medium Source: AIC A

7-$0

Chapter 07 - Internal Control

70. In the consideration of internal control, the auditor is basically concerned that it pro'ides reasonable assurance that6 !. 0anagement can not o'erride the system. 1. 7perational efficiency has been achie'ed in accordance with management plans. C. 0isstatements ha'e been pre'ented or detected. 5. Controls ha'e not been circum'ented by collusion.

Difficulty: Medium Source: AIC A

71. &hich of the following is least li)ely to be considered an appropriate response relating to ris)s the auditors identify at the financial statement le'el/ !. !ssign more e#perienced staff. 1. Incorporate additional elements of unpredictability in the selection of audit procedures. C. Increase the scope of auditor procedures. . 3mphasi8e the need to remain neutral, rather than to e#ercise professional s)epticism.

Difficulty: Easy

72. In assessing the competence of a client*s internal auditor, an independent auditor most li)ely would consider the A. Internal auditor*s compliance with professional internal auditing standards. 1. Client*s policies that limit the internal auditor*s access to management salary data. C. 3'idence supporting a further reduction in the assessed le'el of control ris). 5. 2esults of ratio analysis that may identify unusual transactions and e'ents.

Difficulty: Medium Source: AIC A

7". &hich of the following factors would most li)ely be considered an inherent limitation to an entity*s internal control/ !. The comple#ity of the information processing system. !. ;uman 4udgment in the decision ma)ing process. C. The ineffecti'eness of the board of directors. 5. The lac) of management incenti'es to impro'e the control en'ironment.

Difficulty: Medium Source: AIC A

7-$1

Chapter 07 - Internal Control

7$. roper segregation of duties reduces the opportunities to allow any employee to be in a position to both !. Eournali8e cash receipts and disbursements and prepare the financial statements. 1. 0onitor internal controls and e'aluate whether the controls are operating as intended. C. !dopt new accounting pronouncements and authori8e the recording of transactions. . 2ecord and conceal fraudulent transactions in the normal course of assigned tas)s.

Difficulty: Easy Source: AIC A

7%. &hich of the following is intended to detect de'iations from prescribed controls/ !. 9ubstanti'e procedures specified by a standardi8ed audit program. !. Tests of controls designed specifically for the client. C. !nalytical procedures as set forth in an industry audit guide. 5. Computeri8ed analytical procedures tailored for the configuration of the computer e-uipment in use.

Difficulty: Medium Source: AIC A

7(. !n auditor*s purpose for performing tests of controls is to pro'ide reasonable assurance that6 A. Controls are operating effecti'ely. 1. The ris) that the auditor may un)nowingly fail to modify the opinion on the financial statements is minimi8ed. C. Transactions are e#ecuted in accordance with management*s authori8ation and access to assets is limited by a segregation of functions. 5. Transactions are recorded as necessary to permit the preparation of the financial statements in conformity with generally accepted accounting principles.

Difficulty: Medium Source: AIC A

7-$2

Chapter 07 - Internal Control

77. 7f the following statements about internal control, which one is not 'alid/ !. =o one person should be responsible for the custodial responsibility and the recording responsibility for an asset. 1. Transactions must be properly authori8ed before such transactions are processed. C. 1ecause of the costDbenefit relationship, a client may apply control procedures on a test basis. . Control acti'ities reasonably insure that collusion among employees can not occur.

Difficulty: Easy Source: AIC A

7+. Tests of controls are most li)ely to be performed when6 !. Controls seem wea) and must be properly documented. !. Inade-uate substanti'e procedures e#ist to restrict audit ris) to an acceptable le'el. C. The auditor wishes to assess control ris) at the ma#imum. 5. The client*s control en'ironment appears wea).

Difficulty: Hard

7.. &hich of the following would be least li)ely to be included in an auditor*s tests of controls/ !. Inspection. 1. 7bser'ation. C. In-uiry. . !nalytical procedures.

Difficulty: Medium Source: AIC A

+0. The internal control pro'isions of the Sarbanes-Oxley Act of 2002 apply to which companies in the <nited 9tates6 !. !ll companies. !. 93C registrants. C. 7nly those companies included in the Fortune %00. 5. !ll nonpublic companies.

Difficulty: Medium

7-$"

Chapter 07 - Internal Control

+1. !n integrated audit performed under 9ection $0$b of the 9arbanes-7#ley !ct addresses financial statements and6 !. Compliance with laws. 1. Internal control o'er asset safeguarding. C. Internal control o'er financial reporting. 5. 9uitable criteria.

Difficulty: Medium

+2. ! report on internal control performed in accordance with C!71 9tandard =o. 2 includes an opinion on internal control for6 !. The entire year. 1. The prior -uarter. C. The Fas of date.F 5. The end of each -uarter.

Difficulty: Hard

+". &hen performing an audit of internal control under C!71 re-uirements, auditors e'aluate control6

A. 7ption ! 1. 7ption 1 C. 7ption C 5. 7ption 5

Difficulty: Medium

7-$$

Chapter 07 - Internal Control

+$. &hen performing an internal control audit under C!71 re-uirements, one or more material wea)nesses in internal control that e#ist at year-end may result in what type of report@sA6

!. 7ption ! 1. 7ption 1 C. 7ption C 5. 7ption 5

Difficulty: Hard

+%. &hen performing an internal control audit under C!71 standards, one or more material wea)nesses in internal control that e#ist at year-end may result in what type of report@sA6

!. 7ption ! 1. 7ption 1 C. 7ption C . 7ption 5

Difficulty: Medium

7-$%

Chapter 07 - Internal Control

Essay Questions

+(. Independent auditors should consider the wor) of internal auditors in their assessment of control ris). a. !re internal auditors independent of management/ 3#plain. b. &hat is the difference between the primary ob4ecti'e of the independent auditors and that of internal auditors/ 3#plain. c. 5iscuss the factors that should be considered by the independent auditors in deciding how much, if any, reliance should be placed on the wor) of the internal auditors. a. =o. ;owe'er, internal auditors may achie'e independence from departments they e'aluate by reporting to a senior officer or the board of directors. b. The independent auditors* ob4ecti'e is to e#press an opinion on the client*s financial statements. The internal auditors* primary ob4ecti'e is to aid management in achie'ing the most efficient and effecti'e administration of the business. c. In deciding the degree of reliance to be placed on the wor) of the internal auditors, the independent auditors should consider the competence and ob4ecti'ity of the internal auditors, and e'aluate their wor).

Difficulty: Hard

+7. !uditors are re-uired to consider a client*s internal control. a. 5escribe the two purposes of the auditors* consideration of a client*s internal control. b. 3'en the best internal control has certain limitations. ?ist three of those limitations. a. The auditors* consideration of their clients* internal control is integral to both @1A to assess the ris)s of material misstatement in the financial statements and @2A to design the nature, timing and e#tent of further audit procedures. b. The limitations of internal control include @only three re-uiredA6 Carelessness. 0isunderstanding of instructions. Top management may o'erride the system Collusion among employees may circum'ent controls dependent upon segregation of duties. Cost considerations often limit the effecti'eness of the design of the structure.

Difficulty: Medium

7-$(

Chapter 07 - Internal Control

++. &hen considering a client*s internal control, the auditors focus on its 'arious characteristics. For each of the following characteristics indicate the auditors* responsibility under generally accepted auditing standards and the procedures used to meet that responsibility. a. The design of internal control. b. Controls ha'e been implemented @placed in operationA. c. The operating effecti'eness of controls. a. The auditors ha'e a responsibility to obtain an understanding of internal control that is sufficient to plan the audit. !n understanding of the design of the structure is obtained by inspecting control manuals, organi8ation charts, and 4ob descriptions, and by inter'iewing client personnel. b. The auditors ha'e a responsibility to determine whether significant internal control policies and procedures are implemented @placed in operationA in e'ery audit. The auditors may determine whether the controls ha'e been implemented @placed in operationA by obser'ation, inspection, and in-uiry. &al)-through tests may also be used. c. The auditors ha'e a responsibility to determine the operating effecti'eness of controls that pro'ide the basis for the auditors* assessment of control ris) at le'els below the ma#imum. The auditors use obser'ation, inspection, in-uiry, and reperformance to test the operating effecti'eness of controls.

Difficulty: Medium

7-$7

Chapter 07 - Internal Control

+.. !ssume that you ha'e assessed inherent ris) for an audit area at a 'ery high le'el. &hile obtaining an understanding of internal control, you ha'e determined that it appears to be 'ery strong. =onetheless, due to the large number of transactions in'ol'ed, you ha'e chosen not to test controls in the area. a. !t what le'el will the planned assessed le'el of control ris) be established/ b. 5escribe the scope of tests of controls that will be performed. c. !t what le'el will the assessed le'el of control ris) be established/ d. &hat must be documented in the wor)ing papers relating to internal control/ e. !t what le'el will detection ris) be established/ f. 5escribe the re-uired scope of substanti'e procedures, if any. 0a)e certain to discuss details of li)ely nature, timing and e#tent. a. 0a#imum, ;igh or ;ighest. b. =one will be performed @because control ris) is being assessed at the ma#imum le'elA. c. 0a#imum, ;igh or ;ighest d. Control ris) assessed at ma#imum @or high or highestA le'el. The auditor need not document the reason for assessing control ris) at the ma#imum @we delete points from scores of students who state that the auditor needs to document the reasonA. e. 0inimum, low, or lowest f. =ature--3#ternal sources rather than internal Timing--Hear-end testing rather than interim testing. 3#tent--Ireatest e#tent

Difficulty: Hard

7-$+