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Auditing Theory - Internal Control Consideration 1. The independent auditor should acquire an understanding of a client's internal audit function to determine whether the work of internal auditors will be a factor in determining the nature, timing and extent of the independent auditor's procedures. The work performed by internal auditors might be such a factor when the work includes a) Verification of the mathematical accuracy of invoices. b) Review of istrative practices to improve efficiency and achieve management objectives. c) Consideration of the internal control structure. d) Preparation of internal financial reports for management purposes. 2. Effective I/C in a small company that has insufficient employees to permit proper division of responsibilities can be best enhanced by a) Employment of temporary personnel to aid in the separation of duties. b) Direct participation by the owner of the business in the recordkeeping activities of the business. c) Engaging a A to perform monthly "write-up" work. d) Delegation of full, clear-cut responsibility to each employee for the functions assigned to each. 3. An auditor is considering the internal control system for purchasing and disbursement procedures. The auditor will be least influenced by a) The availability of a company manual describing purchasing and disbursement procedures. b) The scope and results of audit work by the company's internal auditor. c) The existence within the purchasing and disbursement area of internal control strengths that offset weaknesses. d) The strength or weakness of internal control in other areas, e.g., sales and s receivable. 4. In general, material irregularities perpetrated by which of the following are most difficult to detect? a) Cashier b) Key-punch operator c) Internal auditor d) Controller 5. If, during the course of an annual audit of a publicly held manufacturing company, an independent auditor becomes aware of a reportable condition in the company's internal control, the auditor is required to communicate the reportable condition to a) The senior management and the board of directors of the company. b) The senior management of the company. c) The board of directors of the company. d) The audit committee of the board of directors. 6. 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 GAAS. b) To interpret the operational effectiveness of the client's existing organizational structure. c) To classify the client's documents and transactions by major operating functions e.g., cash receipts, cash disbursements, etc. d) To record the auditor's understanding of the client's I/C. 7. The independent auditor should acquire an understanding of the internal audit function as it relates to the independent auditor's consideration of the I/C because a) The audit program, 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 consideration of the I/C. 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. 8. The auditor's understanding of the client's I/C is documented in order to substantiate a) Conformity of the ing records with generally accepted ing principles. b) Compliance with generally accepted auditing standards. c) Adherence to requirements of management. d) The fairness of the financial statement presentation. 9. The ICS normally would include procedures that are designed to provide reasonable assurance that a) Employees act with integrity when performing their assigned tasks. 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) Collusion activities would be detected by segregation of employee duties. 10. In general, a reportable condition may be defined as a condition in which material errors or irregularities ordinarily would not be detected within a timely period by a) An auditor during the normal consideration of the internal controls. b) A controller when reconciling s in the general ledger. c) Employees in the normal course of performing their assigned duties. d) The chief financial officer when reviewing interim F/S. 11. Proper segregation of functional responsibilities
calls for separation of the a) Authorization, approval and execution functions. b) Authorization, execution and payment functions. c) Receiving, shipping and custodial functions. d) Authorization, recording and custodial functions. 12. The ultimate risk against which the auditor requires reasonable protection is a combination of two separate risks. The first of these is that material errors will occur in the ing process by which the F/S are developed, and the second is that a) A company's internal control system is not adequate to detect errors and irregularities. b) Those errors that occur will not be detected by the auditor's examination. c) Management may possess an attitude that lacks integrity. d) Evidential matter is not competent enough for the auditor to form an opinion based on reasonable assurance. 13. When an independent auditor decides that the work performed by internal auditors may have a bearing on the nature, extent and timing of the independent auditor's procedures, the independent auditor should evaluate the competence and objectivity of the internal auditors. Relative to objectivity, the independent auditor should a) Consider the organizational level to which internal auditors report the results of their work. b) Review the training program in effect for the internal auditors. c) Examine the quality of the internal audit reports. d) Consider the qualifications of the internal audit staff. 14. To provide the greatest degree of independence in performing internal auditing functions, an internal auditor should probably report to the a) Financial vice-president. b) Corporate controller. c) Board of directors. d) Corporate stockholders. 15. When considering the client's ICS to determine whether the necessary procedures are prescribed and are followed satisfactorily, an auditor must a) Develop questionnaires and checklists. b) Review the ICS and perform tests of controls. c) Perform tests of controls and analytical procedures. d) Evaluate istrative policies. 16. After the auditor has prepared a flowchart of the I/C surrounding sales and evaluated the design of the ICS, the auditor would perform tests of controls on all internal control procedures a) Documented in the flowchart. b) Considered to be weaknesses that might allow errors to enter the ing system. c) Considered to be strengths that the auditor plans to rely on.
d) That would aid in preventing irregularities. 17. A consideration of the ICS made in connection with an annual audit is usually not sufficient to express an opinion on an entity's internal control because a) Weaknesses in the ICS may go unnoticed during the audit period. b) A consideration of the ICS is not necessarily made during an audit engagement. c) Only those controls on which an auditor intends to rely are reviewed, tested and evaluated. d) Internal controls can change each year. 18. Which of the following would be least likely to suggest to an auditor that the client's management may have overridden the ICS? a) There are numerous delays in preparing timely internal financial reports. b) Management does not correct I/C weaknesses that it knows about. c) Differences are always disclosed on a computer exception report. d) There have been two new controllers this year. 19. Which of the following is intended to detect deviation from prescribed ing Department procedures? a) Substantive test specified by a standardized audit program. b) Tests of controls designed specifically for the client. c) Analytical procedures as designed in the industry audit guide. d) Computerized analytical tests tailored for the configuration of EDP equipment in use. 20. The independent auditor selects several transactions in each functional area and traces them through the entire system, paying special attention to evidence about whether or not the control features are in operation. This is an example of a a) Control test. b) Tests of controls c) Substantive test d) Functional test. 21. In the consideration of the ICS, the auditor is basically concerned that the system provides reasonable assurance that a) Management can not override the system. b) Operational efficiency has been achieved i/a/w management plans. c) Errors have been prevented or detected. d) Controls have not been circumvented by collusion. 22. During the audit, the independent auditor identified the existence of a reportable condition in the client's system of internal controls and orally communicated this finding to the client's senior management and audit committee. The auditor should a) Consider the reportable condition a scope limitation
and therefore disclaim an opinion. b) Document the matter in the working papers and consider the effects of the condition on the audit. c) Suspend all audit activities pending directions from the client's audit committee. d) Withdraw from the engagement. 23. Which of the following statements concerning the independent auditor's required communication of reportable conditions is correct? a) Conditions reported at interim dates must be repeated in the final communication. b) If the auditor does not become aware of any reportable conditions during the examination, that fact must be communicated. c) Conditions that had been reported in prior year's 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. 24. Which of the following is least likely to be evidence the auditor examines to determine whether operations are in compliance with the internal control system? a) Records documenting usage of EDP programs. b) Canceled ing documents. c) Confirmations of s receivable. d) Signatures on authorization forms. 25. The auditor's communication of reportable conditions in internal control is a) Required to enable the auditor to state that the examination has been made in accordance with GAAS. b) The principal reason for considering the ICS. c) Incident to the auditor's objective of forming an opinion as to the fair presentation of the financial statements. d) Required to be documented in a written report to the board of directors or the board's audit committee. 26. An auditor may compensate for a condition in the ICS by increasing the a) Level of detection risk. b) Extent of tests of controls. c) Preliminary judgment about audit risk. d) Extent of analytical procedures 27. After considering the client's internal controls, an auditor has concluded that I/C is well designed and is functioning as intended. Under these circumstances, the auditor would most likely a) Perform tests of controls to the extent outlined in the audit program. b) Determine the control procedures that should prevent or detect errors and irregularities. c) Not increase the extent of predetermined substantive tests. d) Determine whether transactions are recorded to permit preparation of F/S in conformity with GAAP.
28. The use of fidelity bonds may indemnify a company from embezzlement losses. The use also a) Reduces the company's need to obtain expensive business interruption insurance. b) Protects employees who make unintentional errors from possible monetary damages resulting from such errors. c) Allows the company to substitute the fidelity bonds for various parts of internal control. d) Reduces the possibility of employing persons with dubious records in positions of trust. 29. Which of the following procedures most likely would be included as part of an auditor's tests of controls? a) Inspection. b) Reconciliation. c) Confirmation. d) Analytical procedures. 30. If the independent auditors decide that the work performed by the internal auditor may have 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. 31. Which statement is correct concerning the definition of internal control developed by the Committee of Sponsoring Organizations (COSO)? a) Its applicability is largely limited to internal auditing applications. b) It is recognized in the Statement on Auditing Standards. c) It emphasizes the effectiveness and efficiency of operations rather than the reliability of financial reporting. d) It suggests that it is important to view internal control as an end product as contrasted to a process or means to obtain an end. 32. Monitoring is considered a) A component of internal control. b) An element of the control environment. c) The primary asset safeguarding technique. d) A portion of information and communication. 33. Which of the following is not a factor included in the control environment? a) Integrity and ethical values. b) Risk assessment. c) Commitment to competence. d) Organizational structure. 34. An entity's ongoing monitoring activities often include a) Periodic audits by the audit committee. b) Reviewing the purchasing function. c) The audit of the annual financial statements. d) Control risk assessment in conjunction with
quarterly reviews.
d) Be less than the actual control risk.
35. The definition of internal control developed by the Committee of Sponsoring Organizations (COSO) and included in the professional standards includes the reliability of financial reporting, the effectiveness and efficiency of operations and a) Compliance with applicable laws and regulations. b) Effectiveness of prevention of fraudulent occurrences. c) Safeguarding of entity assets. d) Incorporation of ethical business practice standards.
41. Which of the following is not a control that is designed to protect investment securities? a) Custody over securities should be limited to individuals who have record keeping responsibility over the securities. b) Securities should be properly controlled physically in order to prevent unauthorized usage. c) Access to securities should be vested in more than one individual. d) Securities should be ed in the name of the owner.
36. Which statement is correct concerning the relevance of various types of controls to a financial audit? a) An auditor may ordinarily ignore a consideration of controls when a substantive audit approach is taken. b) Controls over the reliability of financial reporting are ordinarily most directly relevant to an audit but other controls may also be relevant. c) Controls over safeguarding of assets and liabilities are of primary importance, while controls over the reliability of financial reporting may also be relevant. d) All controls are ordinarily relevant to an audit.
Answers - Internal Controls Questions 1. C 2. B 3. D 4. D 5. D 6. D 7. C 8. B 9. B 10. C 11. D 12. B 13. A 14. C 15. B 16. C 17. C 18. C 19. B 20. B 21. C 22. B 23. D 24. C 25. C 26. D 27. C 28. D 29. A 30. A 31. B 32. A 33. B 34. C 35. A 36. B 37. A 38. B 39. B 40. B 41. A
37. Which of the following is not ordinarily considered a factor indicative of increased financial reporting risk when an auditor is considering a client's risk assessment policies? a) Commissioned sales personnel. b) Implementation of a new information system. c) Rapid growth organization. d) Corporate restructuring. 38. While obtaining an understanding of a client's risk assessment policies, an auditor does not ordinarily include how management a) Identifies risk. b) Eliminates significant risks. c) Assesses the likelihood of occurrence of events due to significant risks. d) Relates risk assessment to financial reporting. 39. When an auditor considers a client's internal control, which of the following is ordinarily a type of control activity that is considered? a) Risk assessment over cash disbursements. b) Segregation of duties over payroll. c) Inclusion of the president as a member of the audit committee. d) Management's monitoring policies over cash receipts. 40. When tests of controls reveal that controls are operating as anticipated, it is most likely that the assessed level of control risk will a) Be less than the planned assessed level of control risk. b) Equal the planned assessed level of control risk. c) Equal the actual control risk.
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 s 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 ing 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 ing records with generally accepted ing 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 s 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 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 s receivable for confirmation, based upon the internal auditor's judgment as to how many s and which s will provide sufficient coverage. b. Preparation of schedules for negative s receivable responses. c. Evaluation of the internal control for s receivable and sales. d. Determination of the adequacy of the allowance for doubtful s. 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 ed by properly executed purchase orders. d. Vouch payments for selected purchases to ing 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 ing 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 ing records with generally accepted ing 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 istrative 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 balances for the current year with the current-year budget and prioryear actual balances. c. Review of the miscellaneous income 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 s 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 . 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 entries in the a. Voucher and sales returns journal. b. Sales journal and sales returns journal. c. Voucher and sales journal. d. Check 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 ing control is a. A requirement of the auditor's study and evaluation of internal ing 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 ing 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 ing 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 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 ing 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 A 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 ability 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 ing system. c. Assurance that transactions are properly recorded. d. All ing control procedures leave visible evidence. ANSWER: A 63. To determine whether refunds granted to customers were properly approved, the auditor should trace s 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
audit engagement? a) To comply with the requirements of GAAS. b) To interpret the operational effectiveness of the client's existing organizational structure. c) To classify the client's documents and transactions by major operating functions e.g., cash receipts, cash disbursements, etc. d) To record the auditor's understanding of the client's I/C. 7. The independent auditor should acquire an understanding of the internal audit function as it relates to the independent auditor's consideration of the I/C because a) The audit program, 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 consideration of the I/C. 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. 8. The auditor's understanding of the client's I/C is documented in order to substantiate a) Conformity of the ing records with generally accepted ing principles. b) Compliance with generally accepted auditing standards. c) Adherence to requirements of management. d) The fairness of the financial statement presentation. 9. The ICS normally would include procedures that are designed to provide reasonable assurance that a) Employees act with integrity when performing their assigned tasks. 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) Collusion activities would be detected by segregation of employee duties. 10. In general, a reportable condition may be defined as a condition in which material errors or irregularities ordinarily would not be detected within a timely period by a) An auditor during the normal consideration of the internal controls. b) A controller when reconciling s in the general ledger. c) Employees in the normal course of performing their assigned duties. d) The chief financial officer when reviewing interim F/S. 11. Proper segregation of functional responsibilities
calls for separation of the a) Authorization, approval and execution functions. b) Authorization, execution and payment functions. c) Receiving, shipping and custodial functions. d) Authorization, recording and custodial functions. 12. The ultimate risk against which the auditor requires reasonable protection is a combination of two separate risks. The first of these is that material errors will occur in the ing process by which the F/S are developed, and the second is that a) A company's internal control system is not adequate to detect errors and irregularities. b) Those errors that occur will not be detected by the auditor's examination. c) Management may possess an attitude that lacks integrity. d) Evidential matter is not competent enough for the auditor to form an opinion based on reasonable assurance. 13. When an independent auditor decides that the work performed by internal auditors may have a bearing on the nature, extent and timing of the independent auditor's procedures, the independent auditor should evaluate the competence and objectivity of the internal auditors. Relative to objectivity, the independent auditor should a) Consider the organizational level to which internal auditors report the results of their work. b) Review the training program in effect for the internal auditors. c) Examine the quality of the internal audit reports. d) Consider the qualifications of the internal audit staff. 14. To provide the greatest degree of independence in performing internal auditing functions, an internal auditor should probably report to the a) Financial vice-president. b) Corporate controller. c) Board of directors. d) Corporate stockholders. 15. When considering the client's ICS to determine whether the necessary procedures are prescribed and are followed satisfactorily, an auditor must a) Develop questionnaires and checklists. b) Review the ICS and perform tests of controls. c) Perform tests of controls and analytical procedures. d) Evaluate istrative policies. 16. After the auditor has prepared a flowchart of the I/C surrounding sales and evaluated the design of the ICS, the auditor would perform tests of controls on all internal control procedures a) Documented in the flowchart. b) Considered to be weaknesses that might allow errors to enter the ing system. c) Considered to be strengths that the auditor plans to rely on.
d) That would aid in preventing irregularities. 17. A consideration of the ICS made in connection with an annual audit is usually not sufficient to express an opinion on an entity's internal control because a) Weaknesses in the ICS may go unnoticed during the audit period. b) A consideration of the ICS is not necessarily made during an audit engagement. c) Only those controls on which an auditor intends to rely are reviewed, tested and evaluated. d) Internal controls can change each year. 18. Which of the following would be least likely to suggest to an auditor that the client's management may have overridden the ICS? a) There are numerous delays in preparing timely internal financial reports. b) Management does not correct I/C weaknesses that it knows about. c) Differences are always disclosed on a computer exception report. d) There have been two new controllers this year. 19. Which of the following is intended to detect deviation from prescribed ing Department procedures? a) Substantive test specified by a standardized audit program. b) Tests of controls designed specifically for the client. c) Analytical procedures as designed in the industry audit guide. d) Computerized analytical tests tailored for the configuration of EDP equipment in use. 20. The independent auditor selects several transactions in each functional area and traces them through the entire system, paying special attention to evidence about whether or not the control features are in operation. This is an example of a a) Control test. b) Tests of controls c) Substantive test d) Functional test. 21. In the consideration of the ICS, the auditor is basically concerned that the system provides reasonable assurance that a) Management can not override the system. b) Operational efficiency has been achieved i/a/w management plans. c) Errors have been prevented or detected. d) Controls have not been circumvented by collusion. 22. During the audit, the independent auditor identified the existence of a reportable condition in the client's system of internal controls and orally communicated this finding to the client's senior management and audit committee. The auditor should a) Consider the reportable condition a scope limitation
and therefore disclaim an opinion. b) Document the matter in the working papers and consider the effects of the condition on the audit. c) Suspend all audit activities pending directions from the client's audit committee. d) Withdraw from the engagement. 23. Which of the following statements concerning the independent auditor's required communication of reportable conditions is correct? a) Conditions reported at interim dates must be repeated in the final communication. b) If the auditor does not become aware of any reportable conditions during the examination, that fact must be communicated. c) Conditions that had been reported in prior year's 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. 24. Which of the following is least likely to be evidence the auditor examines to determine whether operations are in compliance with the internal control system? a) Records documenting usage of EDP programs. b) Canceled ing documents. c) Confirmations of s receivable. d) Signatures on authorization forms. 25. The auditor's communication of reportable conditions in internal control is a) Required to enable the auditor to state that the examination has been made in accordance with GAAS. b) The principal reason for considering the ICS. c) Incident to the auditor's objective of forming an opinion as to the fair presentation of the financial statements. d) Required to be documented in a written report to the board of directors or the board's audit committee. 26. An auditor may compensate for a condition in the ICS by increasing the a) Level of detection risk. b) Extent of tests of controls. c) Preliminary judgment about audit risk. d) Extent of analytical procedures 27. After considering the client's internal controls, an auditor has concluded that I/C is well designed and is functioning as intended. Under these circumstances, the auditor would most likely a) Perform tests of controls to the extent outlined in the audit program. b) Determine the control procedures that should prevent or detect errors and irregularities. c) Not increase the extent of predetermined substantive tests. d) Determine whether transactions are recorded to permit preparation of F/S in conformity with GAAP.
28. The use of fidelity bonds may indemnify a company from embezzlement losses. The use also a) Reduces the company's need to obtain expensive business interruption insurance. b) Protects employees who make unintentional errors from possible monetary damages resulting from such errors. c) Allows the company to substitute the fidelity bonds for various parts of internal control. d) Reduces the possibility of employing persons with dubious records in positions of trust. 29. Which of the following procedures most likely would be included as part of an auditor's tests of controls? a) Inspection. b) Reconciliation. c) Confirmation. d) Analytical procedures. 30. If the independent auditors decide that the work performed by the internal auditor may have 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. 31. Which statement is correct concerning the definition of internal control developed by the Committee of Sponsoring Organizations (COSO)? a) Its applicability is largely limited to internal auditing applications. b) It is recognized in the Statement on Auditing Standards. c) It emphasizes the effectiveness and efficiency of operations rather than the reliability of financial reporting. d) It suggests that it is important to view internal control as an end product as contrasted to a process or means to obtain an end. 32. Monitoring is considered a) A component of internal control. b) An element of the control environment. c) The primary asset safeguarding technique. d) A portion of information and communication. 33. Which of the following is not a factor included in the control environment? a) Integrity and ethical values. b) Risk assessment. c) Commitment to competence. d) Organizational structure. 34. An entity's ongoing monitoring activities often include a) Periodic audits by the audit committee. b) Reviewing the purchasing function. c) The audit of the annual financial statements. d) Control risk assessment in conjunction with
quarterly reviews.
d) Be less than the actual control risk.
35. The definition of internal control developed by the Committee of Sponsoring Organizations (COSO) and included in the professional standards includes the reliability of financial reporting, the effectiveness and efficiency of operations and a) Compliance with applicable laws and regulations. b) Effectiveness of prevention of fraudulent occurrences. c) Safeguarding of entity assets. d) Incorporation of ethical business practice standards.
41. Which of the following is not a control that is designed to protect investment securities? a) Custody over securities should be limited to individuals who have record keeping responsibility over the securities. b) Securities should be properly controlled physically in order to prevent unauthorized usage. c) Access to securities should be vested in more than one individual. d) Securities should be ed in the name of the owner.
36. Which statement is correct concerning the relevance of various types of controls to a financial audit? a) An auditor may ordinarily ignore a consideration of controls when a substantive audit approach is taken. b) Controls over the reliability of financial reporting are ordinarily most directly relevant to an audit but other controls may also be relevant. c) Controls over safeguarding of assets and liabilities are of primary importance, while controls over the reliability of financial reporting may also be relevant. d) All controls are ordinarily relevant to an audit.
Answers - Internal Controls Questions 1. C 2. B 3. D 4. D 5. D 6. D 7. C 8. B 9. B 10. C 11. D 12. B 13. A 14. C 15. B 16. C 17. C 18. C 19. B 20. B 21. C 22. B 23. D 24. C 25. C 26. D 27. C 28. D 29. A 30. A 31. B 32. A 33. B 34. C 35. A 36. B 37. A 38. B 39. B 40. B 41. A
37. Which of the following is not ordinarily considered a factor indicative of increased financial reporting risk when an auditor is considering a client's risk assessment policies? a) Commissioned sales personnel. b) Implementation of a new information system. c) Rapid growth organization. d) Corporate restructuring. 38. While obtaining an understanding of a client's risk assessment policies, an auditor does not ordinarily include how management a) Identifies risk. b) Eliminates significant risks. c) Assesses the likelihood of occurrence of events due to significant risks. d) Relates risk assessment to financial reporting. 39. When an auditor considers a client's internal control, which of the following is ordinarily a type of control activity that is considered? a) Risk assessment over cash disbursements. b) Segregation of duties over payroll. c) Inclusion of the president as a member of the audit committee. d) Management's monitoring policies over cash receipts. 40. When tests of controls reveal that controls are operating as anticipated, it is most likely that the assessed level of control risk will a) Be less than the planned assessed level of control risk. b) Equal the planned assessed level of control risk. c) Equal the actual control risk.
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 s 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 ing 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 ing records with generally accepted ing 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 s 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 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 s receivable for confirmation, based upon the internal auditor's judgment as to how many s and which s will provide sufficient coverage. b. Preparation of schedules for negative s receivable responses. c. Evaluation of the internal control for s receivable and sales. d. Determination of the adequacy of the allowance for doubtful s. 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 ed by properly executed purchase orders. d. Vouch payments for selected purchases to ing 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 ing 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 ing records with generally accepted ing 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 istrative 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 balances for the current year with the current-year budget and prioryear actual balances. c. Review of the miscellaneous income 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 s 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 . 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 entries in the a. Voucher and sales returns journal. b. Sales journal and sales returns journal. c. Voucher and sales journal. d. Check 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 ing control is a. A requirement of the auditor's study and evaluation of internal ing 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 ing 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 ing 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 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 ing 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 A 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 ability 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 ing system. c. Assurance that transactions are properly recorded. d. All ing control procedures leave visible evidence. ANSWER: A 63. To determine whether refunds granted to customers were properly approved, the auditor should trace s 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
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