CHAPTER 10

Multiple-Choice Questions

1. Which of the following parties is responsible for establishing an entity’s internal controls?easy a. Management.a c. Auditors.

b. Management and auditors.d. Committee of Sponsoring Organizations.

2. Which of the following is not one of the three primary objectives of effective internal control?easy a. Reliability of financial reportingd b. Efficiency and effectiveness of operations

c. Compliance with laws and regulationsd. Each of the above is a primary objective of effective internal control.

3. (Public) The PCAOB states that reasonable assurance allows for easy a. a nominal likelihood of ineffective internal controls.b b. a remote likelihood that material misstatements will not be prevented or detected by

internal control.c. a likelihood that material misstatements will not be prevented or detected by

internal control.d. a high likelihood that material misstatements will not be prevented or detected by

internal control.

4. Internal controls can never be considered as absolutely effective becauseeasy a. their effectiveness is limited by the competency and dependability of employees.a b. controls always have inherent weaknesses that can be exploited.

c. controls are designed to prevent and detect only material misstatements.d. none of the above.

5. A major control available in a small company, which might not be feasible in a large company, is

easy a. a wider segregation of duties.d b. a voucher system.

c. fewer transactions to process.d. the owner-manager’s personal interest and close relationship with personnel.

6. An act of two or more employees to steal assets or misstate records is frequently referred to aseasy a. collusion.a b. a material weakness.

c. a control deficiency.d. Any of the above.

7.easy

When the auditor attempts to understand the operation of the accounting system by tracing a few transactions through the accounting system, this is referred to as

c a. tracing.b. vouching.c. a walk-through.d. tests of controls.

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8. (SOX)easy

Which section of the Sarbanes-Oxley Act requires management to issue an internal control report?

c a. 202b. 203c. 404d. 408

9. (SOX)easy

Sarbanes-Oxley requires management to issue an internal control report that includes two specific items. Which of the following is one of these two requirements?

a a. A statement that management is responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting.b. A statement that management and the board of directors are responsible for establishing

and maintaining an adequate internal control structure and procedures for financial reporting.

c. A statement that management, the board of directors, and the external auditors for establishing and maintaining an adequate internal control structure and procedures for financial reporting.

d. None of the above is correct.

10. (Public)easy

When management is evaluating the design of internal control, management evaluates whether the control can do all but which of the following?

c a. Prevent material misstatements.b. Detect material misstatements.c. Correct material misstatements.d. None of the above is correct.

11. (Public)easyb

Internal control reports issued by public companies must identify the framework used to evaluate the effectiveness of internal control. Which of the following is the most common framework in the U.S.?a. Effective Internal Control Framework - AICPAb. Internal Control - Integrated Framework - COSOc. Enterprise Internal Control - COSOd. There is no single common framework used in the U.S.

12. (Public)easy

Auditor’s tests of operating effectiveness of internal controls might include which of the following types of procedures?

d a. Inspection of relevant documentationb. Inquiries of personnelc. Reperformance of the application of controlsd. All of the above

13.easy

With which one of management’s concerns with respect to implementing internal controls is the auditor primarily concerned?

b a. Efficiency of operations.b. Reliability of financial reporting.c. Effectiveness of operations.d. Compliance with applicable laws and regulations.

14.easy

Which of the following activities would be least likely to strengthen a company’s internal control?

b a. Separating accounting from other financial operations.b. Maintaining insurance for fire and theft.c. Fixing responsibility for the performance of employee duties.d. Carefully selecting and training employees.

15. (Public) Management must disclose material weaknesses in internal control easy a. whenever the weakness is deemed significant to a single class of transactions.

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c b. whenever the weakness is significant to overall financial reporting objectives.c. even if just one weakness is found.d. only if the auditor identifies the weakness as significant.

16.easy

When auditing a nonpublic company, the auditor should obtain an understanding of internal control sufficient

b a. to provide reasonable protection against client fraud and defalcations by client employees.

b. to assess control risk.c. to provide a basis for constructive suggestions to the client for improving the accounting

system.d. to provide a method for safeguarding assets, checking the accuracy and reliability of

accounting data, promoting operational efficiency, and encouraging adherence to prescribed managerial policies.

17. Which of the following audit tests would be regarded as a test of a control?easy a. Tests of the specific items making up the balance in a given general ledger account.c b. Tests of the inventory pricing to vendors’ invoices.

c. Tests of the signatures on canceled checks to management’s authorizations.d. Tests of the additions to property, plant, and equipment by physical inspections.

18. During which part of an audit examination is the preparation of flowcharts most appropriate?easy a. When performing preliminary analytical procedures.d b. When performing tests of controls.

c. When evaluating the system of administrative control.d. When reviewing the system of internal control.

19.easy

The ______ consists of the actions, policies, and procedures that reflect the overall attitudes of top management.

c a. control activities.b. management philosophy.c. control environment.d. monitoring function.

20. (Public) An auditor’s primary emphasis is internal controls overmedium a. material account balancesb b. classes of transactions

c. account balances and classes of transactionsd. immaterial and material account balances

21. The auditor’s study of a nonpublic client’s internal control ismedium a. required by GAAP.b b. required by GAAS.

c. required by the IRS.d. recommended by the AICPA.

22.medium

Internal controls can never be regarded as completely effective. Even if company personnel could design an ideal system, its effectiveness depends on the

d a. adequacy of the computer system.b. proper implementation by management.c. ability of the internal audit staff to maintain it.d. competency and dependability of the people using it.

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23.medium

Even with the most effectively designed internal control, the auditor must obtain audit evidence, beyond testing the controls, for every

c a. transaction.b. financial statement account.c. material financial statement account.d. financial statement account that will be relied upon by third parties.

24. (Public)medium

To express an opinion on internal controls, an auditor obtains an understanding of and performs tests of controls related to all but which of the following?

a a. Account balances.b. Significant account balances.c. Classes of transactions.d. Disclosures and related assertions in the financial statements.

25. The essence of an effectively controlled organization lies in themedium a. effectiveness of its independent auditor.d b. effectiveness of its internal auditor.

c. attitude of its employees.d. attitude of its management.

26. (Public)medium

To issue a report on internal control over financial reporting for a public company, an auditor must

c a. evaluate management’s assessment process.b. independently assess the design and operating effectiveness of internal control.c. evaluate management’s assessment process and independently assess the design and

operating effectiveness of internal control.d. test controls over significant account balances.

27. (Public)medium

Which of the stock exchanges require listed companies to have an audit committee composed entirely of independent directors?

d a. AMEX and NYSEb. NASDAQ onlyc. AMEX and NASDAQd. AMEX, NASDAQ, and NYSE

28. Which of the following factors may increase risks to an organization?medium a. Geographic dispersion of company operations.d b. Decreasing quality of personnel.

c. Presence of new information technologies.d. All of the above.

29. Which of the following statements is correct with respect to separation of duties?medium a. Employees should not have temporary and permanent custody of assets.b b. It is desirable to prevent employees who authorize transactions from having custody of

related assets.c. It is permissible to allow an employee to open cash receipts and record those receipts.d. None of the above is correct.

30.medium

Authorizations can be either general or specific. Which of the following is not an example of a general authorization?

b a. Automatic reorder points for raw materials inventory.b. A sales manager’s authorization for a sales return.c. Credit limits for various classes of customers.d. A sales price list for merchandise.

31. The most important type of protective measure for safeguarding assets and records ismedium a. adequate separation of duties among personnel.

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c b. proper authorization of transactions.c. the use of physical precautions.d. adequate documentation.

32.medium

Which of the following statements is correct with respect to the design and use of business documents?

d a. Only documents used for internal purposes must be prenumbered.b. Documents should be designed for single purposes only to avoid confusion in their use.c. Documents should be designed to be understandable only to those responsible for their use.d. None of the above statements is correct.

33. (Public) The SEC prohibits U.S. stock exchanges from listing securities if a company’s audit committee is

medium a. not comprised of solely independent directors.d b. inadequately funded.

c. not solely responsible for hiring and firing the company’s auditors.d. All of the above are correct.

34. All of the following are substantive tests exceptmedium a. tests of controls.a b. tests of details of transactions.

c. tests of details of balances.d. analytical procedures.

35.mediumb

Most audits of a company are done annually by the same CPA firm. Except for initial engagements, the auditor begins the audit with a great deal of information about the internal controls developed in prior years. Because systems and controls usually do not change often,a. the auditor can skip the evaluation of this area on repeat engagements.b. this information can be updated and carried forward to the current year’s audit.c. it eases the burden on the auditor’s requirement to do a complete study of the controls

this year.d. it is sufficient for the auditor just to inquire of client whether the controls have been

changed since last year.

36. Narratives, flowcharts, and internal control questionnaires are three common methods ofmedium a. testing the internal controls.b b. documenting the auditor’s understanding of internal controls.

c. designing the audit manual and procedures.d. documenting the auditor’s understanding of a client’s organizational structure.

37.medium

Which of the following is not an element of a proper narrative of an accounting system and related controls?

d a. The origin of every document and record in the system should be stated.b. All processing that takes place should be described.c. The disposition of every document and record in the system should be stated.d. There should be an indication of all controls affecting the applicable process.

38. Which of the following statements about the internal control questionnaire is not correct?mediumc

a. A questionnaire can lead to a piecemeal view of a client’s control without providing an overall view.

b. The questionnaire can be prepared reasonably quickly.c. A questionnaire is usually applicable to a wide variety of companies, especially smaller

ones.d. Each of the above statements is correct.

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39. (Public)medium

Specific assessments must be made to arrive at the preliminary assessment of control risk. Which of the following is not one of these assessments?

c a. Is the entity auditable?b. What is the expectation that internal controls will neither prevent material misstatements

from occurring nor detect and correct them if they have occurred?c. Is management committed to internal control?d. Each of the above is a required assessment.

40. Which of the following is not one of the levels of an absence of internal controls? medium a. Internal control weakness.a b. Material weakness.

c. Significant deficiency.d. None of the above.

41. Which of the following is the correct definition of “control deficiency?”mediuma

a. A control deficiency exists if the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis.

b. A control deficiency exists if one or more deficiencies exist that adversely affect a company’s ability to prepare external financial statements reliably.

c. A control deficiency exists if the design or operation of controls results in a more than remote likelihood that controls will not prevent or detect misstatements.

d. None of the above is a correct definition.

42. The purpose of an entity’s accounting information and communication system is to ______.medium a. initiate transactions.d b. record and process transactions.

c. monitor transactions.d. a and b only.

43.medium

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

b a. inspection.b. observation.c. reperformance.d. reconciliation.

44. Internal controls normally include procedures designed to provide reasonable assurance thatmedium a. employees act with integrity when performing their assigned tasks.b b. transactions are executed in accordance with management’s general or specific

authorization.c. decision processes leading to management’s authorization of transactions are sound.d. collusive activities would be detected by segregation of employee duties.

45. (Public) Which of the following is not a common step used to identify internal control deficiencies?medium a. Decide whether there is a significant deficiency or material weakness.d b. Identify existing controls.

c. Identify the absence of key controls.d. Each of the above is a common step used to identify internal control deficiencies.

46. Which of the following is not a component of an entity’s internal control?medium a. Control risk.a b. Control procedures.

c. The accounting system.d. The control environment.

47. (Public)medium

Before making the final assessment of internal control at the end of an integrated audit, the auditor must

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d a. test controls.b. perform substantive tests of details.c. a only.d. a and b.

48. (Public)medium

Significant deficiencies and material weaknesses in internal control of a public company must be reported to which of the following?

c a. The Public Company Accounting Oversight Board.b. Members of management who are responsible for the related area of the company.c. Audit committee of the company’s board of director.d. None of the above.

49. Of the following statements about internal controls, which one is not valid?mediumd

a. No one person should be responsible for the custodial responsibility and the recording responsibility for an asset.

b. Transactions must be properly authorized before such transactions are processed.c. Because of the cost benefit relationship, a client may apply control procedures on a test

basis.d. Control procedures reasonably ensure that collusion among employees cannot occur.

50.medium

Which of the following best describes the inherent limitations that should be recognized by an auditor when considering the potential effectiveness of internal control?

a a. Procedures whose effectiveness depends on segregation of duties can be circumvented by collusion.

b. The competence and integrity of client personnel provides an environment conducive to accounting control and provides assurance that effective control will be achieved.

c. Procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are effective against irregularities perpetrated by management.

d. The benefits expected to be derived from effective internal accounting control usually do not exceed the costs of such control.

51. Which of the following is not one of the subcomponents of the control environment?medium a. Management’s philosophy and operating style.c b. Organizational structure.

c. Adequate separation of duties.d. Commitment to competence.

52.medium

It is important for the CPA to consider the competence of the audit clients’ employees because their competence bears directly and importantly upon the

b a. cost/benefit relationship of the system of internal control.b. achievement of the objectives of internal control.c. comparison of recorded accountability with assets.d. timing of the tests to be performed.

53.medium

Effective internal control in a small company that has an insufficient number of employees to permit proper division of responsibilities can best be enhanced by

b a. employment of temporary personnel to aid in the separation of duties.b. direct participation by the owner of the business in the record-keeping activities of the

business.c. engaging a CPA to perform monthly “write-up” work.d. delegation of full, clear-cut responsibility to each employee for the functions assigned to

each.

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54. Evidential matter concerning proper segregation of duties ordinarily is best obtained bymedium a. direct personal observation of the employee who applies control procedures.a b. making inquiries of co-workers about the employee who applies control procedures.

c. preparation of a flowchart of duties performed and available personnel.d. inspection of third-party documents containing the initials of who applied control

procedures.

55. Proper segregation of functional responsibilities calls for separation of the functions ofmedium a. authorization, execution, and payment.b b. authorization, recording, and custody.

c. custody, execution, and reporting.d. authorization, payment, and recording.

56. When considering the objectivity of internal auditors, an independent auditor shouldmedium a. evaluate the quality control program in effect for the internal auditors.d b. examine documentary evidence of the work performed by the internal auditors.

c. test a sample of the transactions and balances that the internal auditors examined.d. determine the organizational level to which the internal auditors report.

57. Internal controls are not designed to provide reasonable assurance thatmedium a. all frauds will be eliminated.a b. transactions are executed in accordance with management’s authorization.

c. access to assets is permitted only in accordance with management’s authorization.d. the recorded accountability for assets is compared with the existing assets at reasonable

intervals.

58.medium

Which of the following statements regarding auditor documentation of the client’s internal controls is correct?

d a. Documentation must include flow charts.b. Documentation must include procedural write-ups.c. No documentation is necessary although it is desirable.d. No one particular form of documentation is necessary.

59.medium

Significant deficiencies are matters that come to an auditor’s attention, which should be communicated to an entity’s audit committee because they represent

b a. material frauds perpetrated by high-level management.b. internal control deficiencies that could adversely affect a company’s ability to initiate,

record, process, or report external financial statements reliably.c. flagrant violations of the entity’s documented conflict-of-interest policies.d. intentional attempts by client personnel to limit the scope of the auditor’s field work.

60.challenginga

Which of the following statements, if any, is correct?a. The NASDAQ market requires listed companies to have audit committees that have only

independent directors.b. The NASDAQ market requires listed companies to have audit committees that have a

minority of the positions held by independent directors.c. The NASDAQ market recommends, but does not require, listed companies to have audit

committees.d. The NASDAQ market recommends, but does not require, listed companies to have audit

committees that have a minority of the positions held by independent directors.

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61.challenging

Which of the following is not typically one of management’s concerns in designing effective internal controls?

d a. Reliability of financial reporting.b. Efficiency and effectiveness of operations.c. Compliance with applicable laws and regulations.d. Obtaining the best internal control possible.

62. (SOX) The Sarbanes-Oxley Act requireschallenging a. all public companies to issue an internal control report.a b. all public companies to define adequate internal controls.

c. the auditor of public companies to design effective internal controls over financial reporting.

d. provides for all three of the above.

63.challenging

When considering internal control, an auditor should be aware of the concept of reasonable assurance, which recognizes that the

d a. segregation of incompatible functions is necessary to ascertain that internal control is effective.

b. employment of competent personnel provides assurance that the objectives of internal control will be achieved.

c. establishment and maintenance of internal control is an important responsibility of the management and not of the auditor.

d. costs of internal control should not exceed the benefits expected to be derived from internal control.

64.challenginga

To comply with the second standard of fieldwork, the auditor need not be concerned with all five areas of internal control that apply to management. The auditor’s primary concerns are with the internal control’s ability toa. ensure reliability of financial reporting for external purposes.b. provide reliable data and promote efficiency.c. promote efficiency and encourage adherence to policy.d. provide reliable data, safeguard assets, and comply with the Sarbanes-Oxley Act of

2002.

65.challenging

The financial statements are not likely to correctly reflect generally accepted accounting principles if

a a. the controls affecting the reliability of financial reporting are inadequate.b. the company’s controls do not promote efficiency.c. the company’s controls do not promote effectiveness.d. all three of the above are true.

66. The primary emphasis by auditors is on controls overchallenging a. classes of transactions.a b. account balances.

c. both a and b, because they are equally important.d. both a and b, because they vary from client to client.

67.challenging

The most important difference in a nonpublic company in assessing control risk is the ability to assess control risk at _______ for any or all control-related objectives.

c a. lowb. mediumc. highd. none of the above

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68. Having an audit committee composed of outside directors is a requirement ofchallenging a. all public and private companies.c b. all private companies.

c. all companies that are listed on the NYSE, AMEX, and NASDAQ.d. all companies that are audited by members of the AICPA.

69.challenging

An auditor should consider two key issues when obtaining an understanding of a client’s internal controls. These issues are

c a. the effectiveness and efficiency of the controls.b. the frequency and effectiveness of the controls.c. the design and utilization of the controls.d. none of the above.

70.challenging

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 accounting control because

c 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.

71.challengingd

Taylor Sales Corp. maintains a large full-time internal audit staff that reports directly to the chief accountant. Audit reports prepared by the internal auditors indicate that the system is functioning as it should and that the accounting records are reliable. The independent auditor will probablya. eliminate tests of controls.b. increase the depth of the study and evaluation of administrative controls.c. avoid duplicating the work performed by the internal audit staff.d. place limited reliance on the work performed by the internal audit staff.

72. When planning an audit, the auditor’s assessed level of control risk ischallenging a. determined by using actuarial tables.c b. calculated by using the audit risk model.

c. an economic issue, trading off the costs of testing controls against the cost of testing balances.

d. calculated by using the formulas provided in the AICPA’s auditing standards.

73. When a compensating control exists, the absence of a key control challenginga

a. is no longer a concern because there is no longer a significant deficiency or material weakness.

b. is a slight concern to the auditor.c. could cause a material loss, so it must be tested using substantive procedures.d. is magnified and must be removed from the sampling process and examined in its

entirety.

74.challenginga

An internal control narrative indicates that an approved voucher is required to support 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 vouchers are dated no

later than the checks.b. Select and examine vouchers and ascertain that the related canceled checks are dated no

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earlier than the vouchers.c. Select and examine canceled checks and ascertain that the related vouchers are dated no

earlier than the checks.d. Select and examine vouchers and ascertain that the related canceled checks are dated no

later than the vouchers.

75.challenginga

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 becausea. management may establish appropriate policies and procedures but not act on them.b. the board of directors may not be aware of management’s attitude toward the control

environment.c. the auditor may believe that the policies and procedures are inappropriate for that

particular entity.d. the policies and procedures may be so weak that no reliance is contemplated by the

auditor.

Essay Questions

76.easy

With which aspect of internal control are auditors primarily concerned?

Answer:The aspect of internal control that auditors are primarily concerned with is the reliability of financial reporting.

77.easy

An effective accounting information and communication system must satisfy six transaction-related objectives. One of these objectives is that transactions are recorded on the correct dates (timing). Identify the five remaining objectives.

Answer:The five remaining objectives are: Recorded transactions exist (existence). Existing transactions are recorded (completeness). Recorded transactions are stated at the correct amounts (accuracy). Transactions are properly classified (classification). Recorded transactions are properly included in the master files and correctly

summarized (posting and summarization).

78. (Public)medium

There are four steps in the auditor’s process of understanding internal control and assessing control risk for a public company. Step one is obtain and document an understanding of internal control: design and operation. What are the remaining three steps?

Answer:The remaining three steps are: Assess control risk. Design, perform and evaluate tests of controls. Decide planned detection risk and substantive tests.

79.medium

Management’s identification and analysis of risk is an ongoing process and is a critical component of effective internal control. An important first step is for management to identify factors that may increase risk. Identify at least five factors, observable by management, that may lead to increased risk in a typical business organization.

Answer:

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There are many factors that may lead to increased risk in an organization. Some examples include: failure to meet prior objectives. decreasing quality of personnel. increasing geographic dispersion of company operations. increasing significance and complexity of core business processes. introduction of new information technologies. entrance of new competitors.

80.medium

During a financial statement audit of a non-public company, three steps must be completed by the auditor before he/she can conclude that control risk is low. Discuss these three steps.

Answer:The three steps that must be completed by the auditor before he/she can conclude that control risk is low are:1. obtain an understanding of the control environment, risk assessment procedures,

accounting information and communication system, and monitoring methods at a fairly detailed level;

2. identify specific controls that will reduce control risk and make an assessment of control risk; and

3. test the controls for effectiveness.

81. (Public)medium

In addition to understanding the design of internal control, the auditor must also evaluate whether the designed controls are actually placed in operation. List four common methods auditors use to fulfill this requirement during the audit of a public company.Answer:

There are five common procedures listed below. Students were asked to list four common methods:

Update and evaluate auditors’ previous experience with the entity. Make inquiries of client personnel. Examine documents and records. Observe entity activities and operations. Perform walkthroughs of the accounting system. Read client’s policy and systems manual

82.medium

A proper narrative of an accounting system and related controls should possess several key characteristics. What are three such characteristics?

Answer:The characteristics are: The origin of every document and record in the system. All processing that takes place. The disposition of every document and record in the system. An indication of the controls relevant to the assessment of control risk.

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83. Describe three inherent limitations of internal control.medium Answer:

The effectiveness of internal controls depends on the competency and dependability of the people using it. Inherent limitations of internal control include: employee carelessness, lack of understanding, management override, and collusion.

84.medium

The internal control framework developed by COSO includes five so-called “components” of internal control. Discuss each of these five components.Answer:

Five components of internal control are: The control environment. The control environment consists of the actions, policies,

and procedures that reflect the overall attitudes of top management, directors and owners, about internal control and its importance to the company.

Risk assessment. This is management’s identification and analysis of risks relevant to the preparation of financial statements in accordance with GAAP.

Information and communication. This is the set of manual and/or computerized procedures that identifies, assembles, classifies, analyzes, records, and reports a company’s transactions and maintains accountability for the related assets.

Control activities. These are the policies and procedures that help ensure necessary actions are taken to address risks in the achievement of the company’s objectives.

Monitoring. This is management’s ongoing and periodic assessment of the quality of internal control performance to determine that controls are operating as intended and modified when needed.

85.medium

Discuss what is meant by the term “control environment” and identify four control environment subcomponents that the auditor should consider.Answer:

The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about control and its importance to the entity. Subcomponents include: Integrity and ethical values. Commitment to competence. Board of directors or audit committee participation. Management’s philosophy and operating style. Organizational structure. Assignment of authority and responsibility. Human resource policies and practices.

86.medium

Control activities, one of the five components of internal control, are defined as “the policies and procedures, in addition to those included in the other four components, that help ensure necessary actions are taken to address risks in the achievement of the entity’s objectives.” There are five categories of control activities. Please describe the five categories of control activities.Answer:

The five categories of control activities are: Adequate separation of duties.

a. Custody of assets should be separated from accounting.b. Authorizing transactions should be separated from custody of related assets.c. Operational responsibility should be separated from record-keeping.d. Duties within IT should be separated from user departments.

Proper authorization of transactions and activities.

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a. General authorization is given for transactions meeting established criteria.b. Specific authorization is required for individual transactions that don’t confirm

to the criteria. Adequate document and records.

a. Documents should be prenumbered and simple to understand and use.b. A chart of accounts should be available.c. Systems manuals should be available.

Physical control over assets and records. These should include fireproof safes and limited access storerooms.

Independent checks on performance by internal verification should be used.

87.medium

Adequate documents and records are important for effective internal control. There are five principles that dictate the proper design and use of documents and records. One principle is that documents and records should be prenumbered consecutively to facilitate control over missing documents, and as an aid in locating documents when they are needed at a later date. Please discuss each of the other four principles of adequate documents and records.

Answer:Documents and records should be: Prepared at the time a transaction takes place, or as soon thereafter as possible. Sufficiently simple to ensure that they are clearly understood. Designed for multiple use whenever possible, to minimize the number of different

forms. Constructed in a manner that encourages correct preparation, such as providing a

degree of internal check within the form or record.

88. Describe each of the three broad objectives management typically has for internal control.medium Answer:

The three objectives are: Reliability of financial reporting. Management has both a legal and professional

responsibility to be sure that the information is fairly presented in according with reporting requirements such as GAAP.

Efficiency and effectiveness of operations. Controls within an organization are meant to encourage efficient and effective use of its resources to optimize the company’s goals.

Compliance with laws and regulations. Public and non-public organizations are required to follow many laws and regulations. Some relate to accounting only indirectly, such as environmental protection and civil rights laws. Others are closely related to accounting, such as income tax regulations and fraud.

89. (Public)medium

Auditors of financial statements issued by a public company are required to report on internal control over financial reporting. Briefly describe the auditor’s responsibility.

Answer:The report on internal control over financial reporting must include the auditor’s opinion as to whether management’s assessment of the design and operating effectiveness of internal control over financial reporting is fairly stated in all material respects. This involves an evaluation of management’s assessment process to determine whether internal controls are effective and the auditor’s independent assessment of the internal control’s design and operating effectiveness.

90.medium

What two specific assessments must be made to arrive at the preliminary assessment of control risk during the audit of a public company?

Answer:The two specific assessments are:

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Assessment of whether the entity is auditable Determine assessed control risk supported by the understanding obtained assuming

the controls are being followed

91.challenging

Adequate separation of duties is an important control activity. Please discuss the four general guidelines for separation of duties to prevent both intentional and unintentional misstatements that are of significance to auditors.

Answer:The general guidelines are: Custody of assets should be separated from accounting. Authorizing transactions should be separated from custody of related assets. Operational responsibility should be separated from record-keeping. Duties within IT should be separated from user departments.

Other Objective Answer Format Questions

92. Match seven of the terms (a-i) with the definitions provided below (1-7):medium a. Control environment

b. Control activitiesc. Independent checks on performanced. Internal controle. Monitoringf. Separation of dutiesg. General authorizationh. Specific authorizationi. Risk assessment

E 1. Management’s ongoing and periodic assessment of the quality of internal control performance to determine that controls are operating as intended and modified when needed.

G 2. Company-wide policies for the approval of all transactions within stated limits.

A 3. The actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about internal control and its importance to the entity.

F 4. Segregation of the following activities in an organization: custody of assets, accounting, authorization, and operational responsibility.

I 5. Management’s identification and analysis of risks relevant to the preparation of financial statements in accordance with generally accepted accounting principles.

B 6. Policies and procedures that help ensure necessary actions are taken to address risks in the achievement of the entity’s objectives.

D 7. A process designed to provide reasonable assurance regarding the achievement of management’s objectives in the following categories: (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations.

93.easy

If, when obtaining an understanding of control activities of a relatively small client, the auditor identified no control activities, the auditor would probably set a low assessment of

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b control risk.a. Trueb. False

94.easyb

When internal controls are not effective, then substantive audit tests are less reliable; thus, the extent of substantive tests should be reduced.a. Trueb. False

95.easya

In an audit of a non-public company, the less control risk there is, the smaller the amount of planned substantive evidence required.a. Trueb. False

96.easyb

As a client’s information system becomes more complex, it is likely that an auditor will decrease reliance on controls and increase substantive tests to support a control risk assessment.a. Trueb. False

97.easyb

When a company designs and implements internal controls, cost of the controls is not a valid consideration.a. Trueb. False

98. (Public)easya

PCAOB Standard 2 requires auditors to perform walkthroughs to assist in understanding internal control.a. Trueb. False

99.easyb

Adequate documents and records is a subcomponent of the control environment.a. Trueb. False

100.easya

For proper internal control, there should be adequate separation of duties. However, the extent of separation of duties considered “adequate” depends heavily on the size of the organization.a. Trueb. False

101.easya

In an audit of a non-public company, the auditor’s assessment of control risk and the extent of tests of controls are inversely related; that is, if the auditor’s assessment of control risk decreases, more extensive tests of controls are applied.a. Trueb. False

102.mediumb

Smaller companies usually have more extensive internal controls than larger companies which result in fewer frauds being committed at small companies.a. Trueb. False

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103. (SOX)mediumb

The Sarbanes-Oxley Act of 2002 requires that private and public companies issue an internal control report.a. Trueb. False

104.mediumb

The most important component of internal control is risk assessment.a. Trueb. False

105.mediumb

The primary emphasis by auditors when evaluating and testing internal control is on controls over account balances rather than controls over classes of transactions.a. Trueb. False

106.mediumb

When internal controls over a given financial statement account are assessed by the auditor as highly effective, the auditor need not obtain audit evidence for that account beyond testing the controls.a. Trueb. False

107.mediuma

The chart of accounts is a control and is closely related to the controls related to adequate documents and records.a. Trueb. False

108.mediumb

For proper internal control, the custodianship of cash, including receipts and disbursements, should be the responsibility of the accounting department.a. Trueb. False

109.mediumb

Auditing standards prohibit reliance on the work of internal auditors due to the lack of independence of the internal auditors.a. Trueb. False

110.mediuma

Procedures used to obtain an understanding of internal control are normally performed on fewer transactions than procedures used to test controls.a. Trueb. False

111.mediuma

For most uses, flowcharts are superior to narratives as a method of communicating the characteristics of internal control.a. Trueb. False

112.mediumb

When documenting their understanding of a client’s internal controls, auditors are required to use narratives.a. Trueb. False

113.mediumb

The two primary determinants of an entity’s auditability are the integrity of management and the competency of personnel.a. Trueb. False

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