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Audit Planning (Reviewer in Auditing Theory)
Audit Planning: Assessment of Control Risk
MULTIPLE CHOICE:
1. Which of the following is ordinarily considered a test of internal control
procedures?
a. Send confirmation letters to banks.
b. Count and list cash on hand.
c. Examine signatures on checks.
d. Obtain or prepare reconciliations of bank accounts as of the balance
sheet date.
ANSWER: C
2. When obtaining an understanding of an entity's control environment, an
auditor should concentrate on the substance of management's policies
and procedures rather than their form because
a. The auditor may believe that the policies and procedures are
inappropriate for that particular
entity.
b. The board of directors may not be aware of management's attitude toward
the control environment.
c. Management may establish appropriate policies and procedures but
not act on them.
d. The policies and procedures may be so weak that no
reliance is contemplated by the auditor.
ANSWER: C
3. After the study and evaluation of a client's internal control policies and
procedures has been completed, an auditor might decide to
a. Increase the extent of substantive testing in areas where the
internal control policies and procedures are strong.
b. Reduce the extent of control testing in areas where the internal control
policies and procedures are strong.
c. Reduce the extent of both substantive and control testing in areas where
the internal control policies and procedures are strong.
d. Increase the extent of substantive testing in areas where the
internal controls are weak.
ANSWER: D
4. A conceptually logical approach to the auditor's evaluation of internal
accounting control consists of the following four steps:
I. Determine whether the necessary procedures are prescribed and are
being followed satisfactorily.
II. Consider the types of errors and fraud that could
occur.
III. Determine the internal control policies and procedures
that should prevent or detect errors and fraud.
IV. Evaluate any weakness to determine its effect on the nature, timing, or
extent of auditing procedures to be applied and suggestions to
be made to the client.
What should be the order in which these four steps are performed?
a. III, IV, I, II
b. III, I, II, IV
c. II, III, I, IV
d. II, I, III, IV
ANSWER: C
5. An auditor evaluates the existing internal control in order to
a. Determine the extent of substantive tests which must be performed.
b. Determine the extent of control tests which must be performed.
c. Ascertain whether irregularities are probable.
d. Ascertain whether any employees have incompatible functions.
ANSWER: A
6. The auditor is studying internal control policies and procedures within the
sales, shipping, and billing subset of the revenue cycle. Which of the
following conditions suggests a need for additional testing of controls?
a. Internal control is found to be weak with regard to shipping and
billing.
b. Internal control over sales, billing, and shipping appears strong, but
80% of sales revenue is attributable to three major customers.
c. Internal control over billing and shipping is thought to be strong and
the auditor considers additional testing of selected controls will
result in a major reduction in substantive testing.
d. Internal control over the recording of sales is found to be weak and
the sales are evenly divided among a large number of
customers.
ANSWER: C
7. A secondary objective of the auditor's study and evaluation of internal
control is that the study and evaluation provide
a. A basis for constructive suggestions concerning improvements in internal
control.
b. A basis for reducing the auditor's assessed level of control risk below
the maximum level.
c. An assurance that the records and documents have been maintained
in accordance with existing company policies and procedures.
d. A basis for determination of the resultant extent of the tests to
which auditing procedures are to be restricted.
ANSWER: A
8. In studying the design and implementation of a client's internal controls,
the auditor needs to identify necessary control points. Controls existing
at these points may be classified as "accuracy" controls and
"safeguard" controls. Which of the following controls may be regarded
as a safeguard control?
a. In processing sales orders, the computer is programmed to compare
the customer's credit limit minus the prior balance with the
current sales order amount.
b. Sales prices are stored in computer memory and are automatically
applied as stock numbers are entered from customer orders.
c. Although the payroll is prepared manually, a second employee
recalculates gross pay, withholdings, and net pay.
d. Negotiable securities are kept in a locked vault and are accessible
only by the treasurer accompanied by one of her assistants.
ANSWER: D
9. The auditor's review of the client's internal control is documented in order
to substantiate
a. Conformity of the accounting records with generally accepted
accounting principles.
b. Representation as to adherence to requirements of management.
c. Representation as to compliance with generally accepted auditing
standards.
d. The fairness of the financial statement presentation.
ANSWER: C
10. An internal control questionnaire indicates that an approved receiving
report is required to accompany every check request for payment of
merchandise. Which of the following procedures provides the greatest
assurance that this control is operating effectively?
a. Select and examine canceled checks and ascertain that the related
receiving reports are dated no earlier than the checks.
b. Select and examine canceled checks and ascertain that the related
receiving reports are dated no later than the checks.
c. Select and examine receiving reports and ascertain that the related
canceled checks are dated no earlier than the receiving reports.
d. Select and examine receiving reports and ascertain that the related
canceled checks are dated no later than the receiving reports.
ANSWER: B
11. When considering internal control, an auditor must be aware of the
concept of reasonable assurance which recognizes that
a. The employment of competent personnel provides assurance that
the objectives of internal control will be achieved.
b. The establishment and maintenance of a system of internal control
is an important responsibility of the management and not of the
auditor.
c. The cost of internal control should not exceed the benefits expected to be
derived from internal control.
d. The segregation of incompatible functions is necessary to obtain
assurance that the internal control is effective.
ANSWER: C
12. Statement on Auditing Standards No. 60 requires the auditor to
communicate "reportable conditions" to the audit committee of the
board of directors or, in the absence of an audit committee, to a body
having similar oversight authority. Of the following, which
does not represent a reportable condition?
a. Bank accounts have not been reconciled in the last nine months,
including the last month of the fiscal year.
b. The corporate controller, unknown to the board of directors, has
submitted her resignation effective two months from now.
c. Perpetual inventory records contain numerous errors and can no
longer be relied upon to reflect proper inventory levels.
d. Although documents are prenumbered, they are not safeguarded
and are not being used in numerical sequence.
ANSWER: B
13. In connection with the examination of financial statements by an
independent auditor, the client suggests that members of the internal
audit staff be utilized to minimize audit costs. Which of the following
tasks could most appropriately be delegated to the internal audit staff?
a. Selection of accounts receivable for confirmation, based upon the
internal auditor's judgment as to how many accounts and which
accounts will provide sufficient coverage.
b. Preparation of schedules for negative accounts receivable
responses.
c. Evaluation of the internal control for accounts receivable and sales.
d. Determination of the adequacy of the allowance for doubtful
accounts.
ANSWER: B
14. An auditor uses the knowledge provided by the understanding of internal
control and the final assessed level of control risk primarily to
determine the nature, timing, and extent of the
a. Attribute tests. b. Compliance tests. c. Tests of controls. d. Substantive
tests.
ANSWER: D
15. Flowcharting as a means of internal control evaluation provides the
following advantage over the use of questionnaires and descriptive
narratives:
a. Ease of preparation.
b. Comprehensive coverage of controls.
c. Simplicity.
d. Ease in following information flow.
ANSWER: D
16. Which of the following factors most likely affects the auditor's judgment
about the quantity, type, and content of working papers?
a. The effectiveness of the existing internal control.
b. The content of the client's representation letter.
c. The timing of substantive tests completed prior to the balance sheet
date.
d. The usefulness of the working papers as a reference source for the
client.
ANSWER: A
17. If the independent auditors decide that the work performed by the
internal auditor may have a bearing on their own procedures, they
should consider the internal auditor's
a. Competence and objectivity.
b. Efficiency and experience.
c. Independence and review skills.
d. Training and supervisory skills.
ANSWER: A
18. An auditor's purpose for further testing of internal control procedures is
to
a. Provide a basis for reducing the assessed level of control risk below
that which resulted from the auditor's initial understanding of
internal control.
b. Reduce the risk that errors or fraud which are not prevented or
detected by internal control are not detected by the independent
audit.
c. Provide assurance that transactions are executed in accordance with
management's authorization and accessed to assets is limited by
a segregation of functions.
d. Provide assurance that transactions are recorded as
necessary to permit the preparation of the financial
statements in conformity with GAAP.
ANSWER: A
19. Control testing is performed in order to determine whether or not
a. The assessed level of control risk can be reduced.
b. Necessary controls are absent.
c. Incompatible functions exist.
d. Material dollar errors exist.
ANSWER: A
20. The independent auditor should acquire an understanding of the internal
audit function as it relates to the independent auditor's study and
evaluation of internal control because
a. The audit programs, working papers, and reports of internal auditors
can often be used as a substitute for the work of the independent
auditor's staff.
b. The procedures performed by the internal audit staff may eliminate
the independent auditor's need for an extensive study and
evaluation of internal control.
c. The work performed by internal auditors may be a factor in
determining the nature, timing, and extent of the independent
auditor's procedures.
d. The understanding of the internal audit function is an important
substantive test to be performed by the independent auditor.
ANSWER: C
21. In the assessment of control risk, the auditor is basically concerned that
the client's internal control provides reasonable assurance that
a. Management cannot override the system.
b. Operational efficiency has been achieved in accordance with
management plans.
c. Errors and fraud have been prevented or detected.
d. Controls have not been circumvented by collusion.
ANSWER: C
22. Which of the following may be considered an appropriate means for
further testing controls over vendor payments?
a. Confirm year-end balances with vendors.
b. Search for unrecorded invoices at year-end.
c. Develop a set of hypothetical transactions designed to test existing
controls over vendor payments (e.g., introduce into the system,
a voucher containing an invoice for raw materials but lacking a
purchase order and/or receiving report.)
d. Construct an internal control flowchart covering the payment
processing function.
ANSWER: C
23. Which of the following statements concerning the independent auditor's
required communication of material weaknesses in internal control is
correct?
a. Weaknesses reported at interim dates must be repeated in the final
communication.
b. If the auditor does not become aware of any material weaknesses
during the examination, that fact must be communicated.
c. Weaknesses that had been reported in prior years' communications
and have not been corrected need not be repeated in the current
year's communication.
d. Although written communication is preferable, the auditor may
communicate the findings orally.
ANSWER: D
24. Which of the following would be the best procedure to determine
whether purchases were properly authorized?
a. Discuss authorization procedures with personnel in the controller's
and purchasing functions.
b. Review and evaluate a flowchart of purchasing procedures.
c. Determine whether a sample of entries in the purchase journal is
supported by properly executed purchase orders.
d. Vouch payments for selected purchases to supporting
receiving reports.
ANSWER: C
25. After studying and evaluating a client's existing internal control, an
auditor has concluded that the policies and procedures are well
designed and functioning as intended. Under these circumstances, the
auditor would most likely
a. Perform further control tests to the extent outlined in the audit
program.
b. Determine the control policies and procedures that should prevent
or detect errors and fraud.
c. Set detection risk at a higher level than would be set under
conditions of weak internal control.
d. Set detection risk at a lower level than would be set under
conditions of weak internal control.
ANSWER: C
26. An auditor is required to obtain a basic understanding of the client's
internal control to plan the audit. The auditor may then decide to
perform tests of controls on all internal control procedures
a. That would aid in preventing fraud.
b. Documented in the flowchart.
c. Considered to be weaknesses that might allow errors to enter the
accounting system.
d. Considered to be strengths for which the auditor desires further
reduction in the assessed level of control risk.
ANSWER: D
27. The auditor's understanding of the client's internal control is documented
in order to substantiate
a. Conformity of the accounting records with generally accepted
accounting principles.
b. Compliance with generally accepted auditing standards.
c. Adherence to requirements of management.
d. The fairness of the financial statement presentation.
ANSWER: B
28. To determine whether the client's system of internal control operated
effectively to minimize errors of failure to invoice a shipment, the
auditor would select a sample of transactions from the population
represented by the
a. Customer order file.
b. Bill of lading file.
c. Open invoice file.
d. Sales invoice file.
ANSWER: B
29. When evaluating a client's system of internal control to determine
whether the necessary procedures are prescribed and have been
implemented satisfactorily, an auditor must
a. Develop questionnaires and checklists.
b. Obtain an understanding of internal control.
c. Perform tests of internal control procedures.
d. Evaluate administrative policies.
ANSWER: B
30. Of the following internal control policies or procedures, which would most
likely allow for a reduction in the scope of the auditor's tests of
depreciation expense?
a. Review and approval of the periodic equipment depreciation entry
by a supervisor who does not actively participate in its
preparation.
b. Comparison of equipment account balances for the current year with
the current-year budget and prior-year actual balances.
c. Review of the miscellaneous income account for salvage credits and
scrap sales of partially depreciated equipment.
d. Authorization of payment of vendors' invoices by a designated
employee who is independent of the equipment receiving
function.
ANSWER: A
31. Tracing copies of sales invoices to shipping documents will provide
evidence that all
a. Shipments to customers were recorded as receivables.
b. Billed sales were shipped.
c. Debits to the subsidiary accounts receivable ledger are for sales
shipped.
d. Shipments to customers were billed.
ANSWER: B
32. In assessing control risk, the auditor must, as a minimum
a. Perform tests of all significant controls.
b. Obtain an understanding of the design and
implementation of the client's internal control.
c. Obtain an understanding of the design of the client's internal control.
d. Obtain an understanding of the design, implementation, and
operating effectiveness of the client's internal control.
ANSWER: B
33. An independent auditor has concluded that the client's records,
procedures and representations can be relied upon based on tests
made during the year when internal control was found to be effective.
The auditor should test the records, procedures, and representations
again at year-end if
a. Inquiries and observations lead the auditor to believe that conditions
have changed significantly.
b. Comparisons of year-end balances with like balances at prior dates
revealed significant fluctuations.
c. Unusual transactions occurred subsequent to the completion of the
interim audit work.
d. Client records are in a condition that facilitate effective and efficient
testing.
ANSWER: A
34. An auditor is least likely to further test control procedures by examining
documents with respect to controls relating to
a. Segregation of the functions of recording disbursements and
reconciling the bank account.
b. Comparison of receiving reports and vendors' invoices with purchase
orders.
c. Approval of the purchase and sale of marketable securities.
d. Classification of revenue and expense transactions by product line.
ANSWER: A
35. An auditor usually examines receiving reports to support
entries in the
a. Voucher register and sales returns journal.
b. Sales journal and sales returns journal.
c. Voucher register and sales journal.
d. Check register and sales journal.
ANSWER: A
36. Regardless of whether the auditor decides to test controls for operating
effectiveness, he/she must fully document his or her understanding of
the internal control policies and procedures obtained through whatever
means. Which of the following does notdescribe an appropriate means
for documenting such understanding?
a. Internal control flowchart.
b. Internal control implementation.
c. Internal control memorandum.
d. Internal control questionnaire.
ANSWER: B
37. Which of the following best describes the primary reason for the auditor's
use of flowcharts during an audit engagement?
a. To comply with the requirements of generally accepted auditing
standards.
b. To classify the client's documents and transactions by major
operating functions, e.g., cash receipts, cash disbursements, etc.
c. To record the auditor's understanding of the client's internal control
policies and procedures.
d. To interpret the operational effectiveness of the client's existing
organizational structure.
ANSWER: C
38. An auditor generally tests physical security controls over inventory by
a. Test counts and cutoff procedures.
b. Examination and reconciliation.
c. Inspection and recomputation.
d. Inquiry and observation.
ANSWER: D
39. Which of the following is not an auditing procedure that is commonly
used in performing control tests?
a. Inquiring.
b. Observing.
c. Confirming.
d. Inspecting.
ANSWER: C
40. If the independent auditor decides that the work performed by internal
auditors may have a bearing on the independent auditor's own
procedures, the independent auditor should consider the objectivity of
the internal auditors. One method of judging objectivity is to
a. Review the recommendations made in the reports of the internal
auditor.
b. Examine, on a test basis, documentary evidence of the work
performed by internal auditors.
c. Inquire of management about the qualifications of the internal audit
staff.
d. Consider the client's practices for hiring, training, and supervising
the internal audit staff.
ANSWER: A
41. Tracing bills of lading to sales invoices will provide evidence that
a. Recorded sales were shipped.
b. Invoiced sales were shipped.
c. Shipments to customers were invoiced.
d. Shipments to customers were recorded as sales.
ANSWER: C
42. The development of constructive suggestions to clients for
improvements in internal accounting control is
a. A requirement of the auditor's study and evaluation of internal
accounting control.
b. A desirable byproduct of an audit engagement.
c. Addressed by the auditor only during a special engagement.
d. As important as establishing a basis for reliance upon the internal
accounting control system.
ANSWER: B
43. Which of the following statements with respect to the independent
auditor's evaluation of internal control is correct?
a. The auditor should decrease control testing when weaknesses in
cash receipts are mitigated by strong controls in cash
disbursement procedures.
b. The auditor should increase control testing when weaknesses in
billing procedures are mitigated by strong controls in collection
procedures.
c. The auditor generally should not evaluate the overall effectiveness
of internal control, but should separately evaluate each of the
transaction cycles.
d. The auditor should evaluate all internal control weaknesses before
determining the control procedures that should prevent or detect
errors or irregularities.
ANSWER: C
44. Which of the following statements best describes the auditor's
responsibility regarding the detection of material fraud?
a. Because of the inherent limitations of an audit, the auditor is not
responsible for the failure to detect material fraud.
b. The auditor is responsible for the failure to detect material fraud
when such failure results from nonperformance of audit
procedures specifically described in the engagement letter.
c. The auditor should design audit programs that will provide
reasonable assurance that material errors and fraud will be
detected in the ordinary course of the examination.
d. The auditor is responsible for the failure to detect material fraud
when the auditor's evaluation of internal control procedures
indicates that they are ineffective.
ANSWER: C
45. Which of the following procedures most likely would be included as part
of an auditor's tests of control procedures?
a. Inspection.
b. Reconciliation.
c. Confirmation.
d. Analytical procedures.
ANSWER: A
46. If, after obtaining an initial understanding of a client's internal control,
the auditor wishes to further reduce the assessed level of control risk
relating to plant asset transactions, the auditor should next
a. Make extensive substantive tests of plant asset balances.
b. Establish the physical existence of current year additions.
c. Complete the plant asset section of the internal accounting control
questionnaire.
d. Further test those internal control procedures relating to processing
and recording plant asset transactions.
ANSWER: D
47. The auditor is most likely to presume that a high risk of defalcation exists
if
a. The client is a multinational company that does business in
numerous foreign countries.
b. The client does business with several related parties.
c. Inadequate segregation of duties places an employee in a position to
perpetrate and conceal thefts.
d. Inadequate employee training results in lengthy CBIS exception
reports each month.
ANSWER: C
48. After obtaining an understanding of the client’s internal control, the
auditor should consider whether
a. The projected degree of effectiveness of internal control is justified.
b. The evidential matter obtained from the study of the internal control
system can provide a reasonable basis for an opinion.
c. Further testing of internal control procedures is likely to permit
further reduction of assessed control risk.
d. Sufficient knowledge has been obtained about the entity's entire
system of internal control.
ANSWER: C
49. Which of the following is the correct order of performing the auditing
procedures A through C below?
A = Tests of internal control procedures.
B = Preparation of a flowchart depicting the client's
internal control system.
C = Substantive tests.
a. ABC.
b. ACB.
c. BAC.
d. BCA.
ANSWER: C
50. Auditors frequently use flowcharts in connection with which
of the following
a. Preparation of generalized computer audit programs.
b. Review of the client's internal control procedures.
c. Use of statistical sampling in performing an audit.
d. Performance of analytical review procedures of account balances.
ANSWER: B
51. Which of the following conditions suggest alowering of
the aggregate materiality threshold?
a. Internal controls in the area of payroll processing are found to be
much stronger than the auditor's initial assessment.
b. The application of analytical procedures reveals a favorable sales
budget variance that is material and that remains unexplained.
c. Study of the business and industry reveals a material decline in both
industry and client revenue during the current year.
d. Tests of internal controls in nearly all transaction cycle subsets have
produced numerous and widespread errors.
ANSWER: D
52. If, during the course of an annual audit of a publicly held manufacturing
company, an independent auditor becomes aware of a material
weakness in the company's internal control, the auditor is required to
communicate the weakness to
a. The audit committee of the board of directors, or to a similar body
having financial oversight responsibility.
b. The senior management of the company.
c. The board of directors of the company.
d. The treasurer and controller of the client entity.
ANSWER: A
53. Under which of the following conditions would you consider lowering
individual itemmateriality thresholds.
a. Study of the business and industry, together with the application of
analytical procedures, reveals that the client has enjoyed a surge
in sales and gross profit during an industry downturn.
b. Application of analytical procedures shows that the client's gross
profit rate is significantly below last year and also is materially
lower than the industry average.
c. Study of internal controls within the revenue cycle reveal material
weaknesses.
d. Study of internal controls within the payroll cycle confirm the
auditor's belief that few errors have occurred.
ANSWER: A
54. Which of the following is not a medium that can normally be used by an
auditor to record information concerning a client's internal control
policies and procedures?
a. Narrative memorandum.
b. Procedures manual.
c. Flowchart.
d. Questionnaire.
ANSWER: B
55. With respect to the client's system of internal control, the auditor is
concerned that the existing policies and procedures provide
reasonable assurance that
a. Operational efficiency has been achieved in accordance with
management plans.
b. Errors and fraud have been prevented or detected.
c. Controls have not been circumvented by collusion.
d. Management cannot override the internal controls.
ANSWER: B
56. The auditor observes client employees during the review of the client's
system of internal control in order to
a. Prepare a flowchart.
b. Update information contained in the organization and procedure
manuals.
c. Assist in obtaining an understanding of the client's internal control
policies and procedures.
d. Determine the extent of compliance with quality control standards.
ANSWER: C
57. An auditor's flowchart of a client's accounting system is a diagrammatic
representation that depicts the auditor's
a. Program for tests of controls.
b. Understanding of the system.
c. Understanding of the types of fraud that are probable, given the
present system.
d. Documentation of the study and evaluation of the system.
ANSWER: B
58. An independent auditor might consider the procedures performed by the
internal auditors because
a. They are employees whose work must be reviewed during
substantive testing.
b. They are employees whose work might be relied upon.
c. Their work impacts upon the cost/benefit tradeoff in evaluating
inherent limitations.
d. Their degree of independence may be inferred by the
nature of their work.
ANSWER: B
59. A procedure that would most likely be used by an auditor in performing
tests of control procedures that involve segregation of functions and
that leave no transaction trail is
a. Inspection.
b. Observation.
c. Reprocessing.
d. Reconciliation.
ANSWER: B
60. It is important for the CPA to consider the competence of the audit
client's employees because their competence bears directly and
importantly upon the
a. Cost/benefit relationship of the internal control system.
b. Achievement of the objectives of the internal control system.
c. Comparison of recorded accountability with assets.
d. Timing of the tests to be performed.
ANSWER: B
61. In studying internal control and assessing control risk, the auditor applies
the following steps:
a. Determine the internal control policies and procedures necessary to
prevent or detect errors or fraud that could occur in the absence
of controls.
b. Identify control weaknesses.
c. Determine whether the necessary policies and procedures have
been designed and whether they have been placed in operation.
d. Design substantive audit programs.
e. Consider the types of errors or fraud that could occur in the absence
of necessary controls.
The proper sequence in applying these steps is:
a. CDEAB
b. CBAED
c. EACBD
d. AECBD
ANSWER: C
62. The primary purpose of performing further control tests is to provide
a. A basis for reducing the assessed level of control risk below the maximum
level.
b. A basis for understanding the flow of transactions through the
accounting system.
c. Assurance that transactions are properly recorded.
d. All accounting control procedures leave visible evidence.
ANSWER: A
63. To determine whether refunds granted to customers were properly
approved, the auditor should trace accounts receivable entries to:
a. Sales invoices.
b. Remittance advices.
c. Shipping documents.
d. Credit memos.
ANSWER: D
64. A well-prepared flowchart should make it easier for the auditor to
a. Prepare audit procedure manuals.
b. Prepare detailed job descriptions.
c. Trace the origin and disposition of documents.
d. Assess the degree of accuracy of financial data.
ANSWER: C
COMPLETION:
65. After assessing inherent risk, the auditor needs to assess control risk in
order to complete the phase of the audit.
ANSWER: PLANNING
66. Based on the initial understanding of internal control, the auditor may
decide to assess control risk at the maximum level for some assertions
and below maximum for others. To justify reducing the assessed level
of control risk below maximum, the auditor must obtain an
understanding of the of the controls relating to those assertions.
ANSWER: OPERATING EFFECTIVENESS
67. As an internal control documentation device, the internal control , by
presenting a pictorial overview of the processing steps, has the
advantage of providing a clear and easy review of existing internal
control policies and procedures.
ANSWER: FLOWCHART
68. is an effective means for further testing of selected internal control
policies and procedures where an audit trail in the form of
documentation exists.
ANSWER: DOCUMENT EXAMINATION AND TESTING
69. Whenever control risk is assessed below maximum, the auditor must
document thefor such reduction.
ANSWER: BASIS
70. If, based on the study of the business and application of analytical
procedures, the auditor suspects earnings inflation, individual item
materiality thresholds should be
.
ANSWER: LOWERED (DECREASED, REDUCED)
71. For transaction cycle subsets where internal control is weak and
numerous errors are expected, aggregate materiality thresholds
should be set ____ relative to those applicable to strong internal control
subsets.
ANSWER: LOW
72. The nature and timing of substantive audit procedures requires
a approach to designing audit programs, whereas determining the
extent of testing suggests a approach.
ANSWER: QUALITATIVE, QUANTITATIVE
MATCHING:
73. Indicate by letter how each of the listed controls can be
most effectively tested.
a. Observation
b. Reprocessing
c. Document examination and testing
____1. Computer controls applicable to payroll processing
____2. Correctness of account distribution appearing on vendor
invoices
____3. Whether invoices exist for shipments to customers
____4. Evidence, appearing on the face of receiving reports,
that the goods were transferred from receiving to
stores
____5. Whether computer errors are reprocessed by the “control
group rather than the computer operator
____6. All documents must be attached in order to vouchers to
be approved for payment
SOLUTION:
1. b
2. c
3. c
4. c
5. a
6. c
74. Each of the listed scenarios represents conditions discovered
by the auditor after analyzing inherent risk and completing tests
of financial reporting controls. Indicate by letter the impact on
materiality thresholds set previously by the auditor during the
preliminary planning stages of the audit. More than one answer
may apply to a given scenario.
a. Increase the dollar amount of the individual item threshold
b. Lower the dollar amount of the individual item threshold
c. Increase aggregate threshold as a percent of the individual
item threshold
d. Lower aggregate threshold as a percent of the individual item
threshold
e. No need to change initial thresholds
____1. Although controls over sales processing appear to be
effective, analytical procedures indicate possible
management override of the controls in the form of
premature revenue recognition
____2. Originally considered weak, payroll controls now appear
to be effective, based on auditor testing of selected
controls
____3. Although controls over the processing of vendor invoices
were effective in past years and were thought to be
unchanged for the year under audit, tests of controls
revealed a significant deterioration
____4. Testing of sales processing controls caused the auditor
to increase the assessed level of control risk for the
revenue cycle; and the application of analytical
procedures indicates that sales revenue may be materially
overstated and that discounts and returns may have been
understated
____5. After testing controls related to payroll processing,
the auditor was able to reduce the assessed level of
control risk; but application of analytical procedures
suggests that salaries and wages expense may be materially
overstated
____6. The auditor decided not to test controls in the
expenditure cycle because they were considered ineffective in
past years and, in the auditor’s opinion,
have not improved
____7. In past audits, Sara Lindquest, CPA, lowered the
individual item threshold given the use of “liberal”
accounting practices by Lopez Industries, an audit
client (Proposed audit adjustments typically reduced unaudited
net income by 15% to 20%.) Application of
analytical procedures to the current year’s unaudited income,
however, indicates the use of more conservative accounting
practices
SOLUTION:
1. b
2. c
3. d
4. b,d
5. a,c
6. e
7. e
PROBLEM/ESSAY:
75. In studying her client’s existing internal control over cash
receipts, the auditor determined the following:
1. All sales are made on credit.
2. Customer checks are prelisted and restrictively endorsed upon
receipt.
3. The endorsed checks are then forwarded to data processing
where they are entered into the computer system.
4. The checks are transferred to the cashier who prepares the
daily deposit and delivers it to the bank.
Required:
a. Identify specific errors or fraud that might occur given the
above system for processing cash receipts.
b. The above description of cash receipts processing is unclear
as to whether certain controls that may prevent or detect errors
and fraud are present in the existing system.
1. Identify the controls that are clearly missing;
2. Identify other controls that may or may not be present, but
that are necessary to prevent or detect the errors and fraud that
you listed in part (a).
c. For the controls that are clearly missing, identify
possible compensating controls?
d. Assuming the auditor determines that the controls
which you listed in (b)(2) are present, how might she
test them? Be specific.
SOLUTION:
a.
1. Checks may be misappropriated by one or more persons in data
processing;
2. Recording errors might occur in processing the checks
a. Wrong customer credited;
b. Wrong amount entered;
c. Improper discount taken.
3. Checks may be misappropriated by cashier
b.
1. The checks should not be forwarded to data processing. Rather,
the checks should be transferred directly to the cashier after
being endorsed for deposit only; and a copy of the prelisting,
together with any accompanying remittance advices, should be sent
to data processing for recording.
2. Controls that should be present:
a. Someone not having access to the checks should compare the
total of the prelisting of cash receipts with the receipted
deposit ticket obtained from the bank, and also with the debit to
cash produced by computer processing of the receipts;
b. Computer editing controls should check for proper customer
number and correctness of cash discounts taken
c. A control total for cash receipts should be compared by the
computer with the total of cash receipts processed to verify
correctness of cash receipts entered into the computer.
d. Monthly statements should be mailed to customers and all
exceptions cleared by persons not having access to remittances.
c.
Comparing the prelisting of cash receipts with the
deposit ticket and clearing exceptions to monthly
statements should detect any missing checks.
d.
1. Select a sample of daily cash prelistings and compare with
general ledger debit to cash and to receipted deposit ticket.
2. Select a sample of customer statement copies and check
customer correspondence files for exceptions and how the
exceptions were resolved.
3. Either reprocess or observe reprocessing of customer
remittances to determine effectiveness of computer editing
controls (be particularly alert to errors in entering customer
account numbers and improper discounts)
76. a. What is the auditor’s documentation responsibility with
regard to the client’s system of internal control?
b. Under what conditions might the auditor elect not to test
controls for operating effectiveness?
SOLUTION:
a.
1. Auditors must document their understanding of clients’
internal control;
2. If control risk is assessed below maximum, the auditor must
document the basis for such reduction.
b.
1. The auditor considers the controls to be ineffective;
2. The cost of testing the controls exceeds the cost savings
associated with reduced substantive testing.
