Internal Control

Well-functioning internal control for the inventory/production functions would provide that finished goods are to be accepted for stock only after presentation of a completed production order and a(n) a. Shipping order. b. Material requisition. c. Bill of lading. d. Inspection report.

Inspection report This answer is correct because finished goods should be inspected to determine their condition before leaving the production department. This answer is incorrect because a material requisition will be used during the production process to requisition materials with which to produce the goods.

Which of the following are correct concerning the likelihood of loss and the potential amount involved with a material weakness? Likelihood of loss Potential amount involved Probable More than inconsequential Probable Material Reasonable possibility More than inconsequential Reasonable possibility Material

Reasonable possibility Material This answer is correct because the professional standards indicate that a material weakness has more than a reasonable possibility of resulting in a material misstatement.

Which of the following factors most likely would assist an independent auditor in assessing the objectivity of the internal auditor? a. The organizational status of the director of internal audit. b. The professional certifications of the internal audit staff. c. The consistency of the internal audit reports with the results of work performed. d. The appropriateness of internal audit conclusions in the circumstances.

The organizational status of the director of internal audit. This answer is correct because the organizational status of the director of internal audit, and who he or she reports to (e.g., top management and the audit committee vs. the controller) impacts likely objectivity of the director.

The company being audited has an internal auditor that is both competent and objective. The independent auditor wants to assign tasks for the internal auditor to perform. Under these circumstances, the independent auditor may a. Allow the internal auditor to perform tests of internal control. b. Allow the internal auditor to audit a major subsidiary of the company. c. Not assign any task to the internal auditor because of the internal auditor's lack of independence. d. Allow the internal auditor to perform analytical procedures, but not be involved with any test of details.

a. Allow the internal auditor to perform tests of internal control. This answer is correct because the independent auditor may allow the internal auditor to perform tests of controls, although the independent auditor must bear in mind that s/he is still ultimately responsible for the opinion and the underlying evidence.

To avoid potential errors and fraud a well-designed internal control in the accounts payable area should include a separation of which of the following functions? a. Cash disbursements and invoice verification. b. Invoice verification and merchandise ordering. c. Physical handling of merchandise received and preparation of receiving reports. d. Check signing and cancellation of payment documentation.

a. Cash disbursements and invoice verification. This answer is correct because the requirements concerning internal control in the accounts payable area and separation of cash disbursements and invoice verification is an effective control. The accounts payable function normally includes invoice verification. The important separation should be between authorization of payment and actual cash disbursements. Thus the accounts payable area (including invoice verification) should be separated from cash custodianship and disbursement.

When assessing internal auditors' objectivity, an independent auditor should a. Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned. b. Review the internal auditors' reports to determine that their conclusions are consistent with the work performed. c. Verify that the internal auditors' assessment of control risk is comparable to the independent auditor's assessment. d. Evaluate the quality of the internal auditors' working paper documentation and their recent audit recommendations.

a. Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned. This answer is correct because internal auditors may lose objectivity when auditing areas where they recently were assigned—they may in essence be performing a self-review of their own work. This answer is incorrect because internal auditors often will not assess control risk, and when they do, the independent auditor is more likely to consider their performance in assessing their competence.

Holding all other factors constant, decreasing the extent of substantive audit procedures for accounts payable ordinarily has what effect on audit risk? a. Increases. b. Decreases. c. No effect. d/ Indeterminate.

a. Increases. This answer is correct because decreasing the extent of substantive audit procedures increases detection risk, and this will increase audit risk when all other factors remain constant.

An independent auditor has concluded that the client's records, procedures, and representation 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 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 facilitates effective and efficient testing.

a. Inquiries and observations lead the auditor to believe that conditions have changed significantly. This answer is correct because auditors should retest records and transactions if year-end inquiries and observations lead the auditor to believe conditions have changed significantly.

Jackson, the purchasing agent of Judd Hardware Wholesalers, has a relative who owns a retail hardware store. Jackson arranged for hardware to be delivered by manufacturers to the retail store on a COD basis thereby enabling his relative to buy at Judd's wholesale prices. Jackson was probably able to accomplish this because of Judd's poor internal control over a. Purchase orders. b. Purchase requisitions. c. Cash receipts. d. Perpetual inventory records.

a. Purchase orders. This answer is correct because proper control over purchases would require that ordered goods only be shipped to authorized locations; proper control would also determine that all ordered goods had been received by the firm. If purchase orders are issued by Judd and the purchases are never received, there is an internal control condition over the purchase orders. All purchase orders should be accounted for (prenumbered) and followed up to assure receipt of orders that are issued. This answer is incorrect because purchase requisitions are internal documents which are prepared by user departments and sent to the purchasing department for action.

In order to safeguard the assets through proper internal control, accounts receivable that are written off are transferred to a(n) a. Separate ledger. b. Attorney for evidence in collection proceedings. c. Tax deductions files. d. Credit manager since customers may seek to reestablish credit by paying.

a. Separate ledger. This answer is correct because when accounts receivable are written off they should be controlled for possible future collection. Accordingly, they should be recorded to maintain accountability in a separate ledger. If they were simply written off and forgotten, there would be no means of maintaining accountability over these contingent assets. This answer is incorrect because credit managers should not have control over accounts that have been written off because there is not sufficient separation of functional responsibilities.

An effective control that protects against the preparation of improper or inaccurate disbursements would be to require that all checks be a. Signed by an officer after necessary supporting evidence has been examined. b. Reviewed by the treasurer before mailing. c. Sequentially numbered and accounted for by internal auditors. d. Perforated or otherwise effectively canceled when they are returned with the bank statement.

a. Signed by an officer after necessary supporting evidence has been examined. This answer is correct because requiring an officer to sign a check only after necessary supporting evidence is provided will be an effective internal control measure. This procedure would allow checks to only be written for disbursements which have accurate, supporting documentation. This answer is incorrect because the treasurer would provide an authorization function in addition to custodianship over cash. These two functions should be segregated for effective internal control.

Which of the following factors would least likely affect the extent of the auditor's consideration of the client's internal control? a. The amount of time budgeted to complete the engagement. b. The size and complexity of the client. c. The nature of specific relevant controls. d. The auditor's prior experience with client operations.

a. The amount of time budgeted to complete the engagement. This answer is correct because it is least likely since an auditor should not decrease (or increase) the consideration of internal control simply due to the overall time budget. This answer is incorrect because the auditor's prior experience with the client will have a large effect on the current consideration of the client's internal control.

Which of the following procedures represents a weakness in internal control for payroll? a. The payroll clerk distributes signed payroll checks. Undistributed checks are returned to the payroll department. b. The accounting department wires transfer funds to the payroll bank account. The transfer is based on totals from the payroll department summary. c. The payroll department prepares checks using a signature plate. The treasurer supervises the process before payroll checks are distributed. d. The payroll department prepares checks. The chief financial officer signs the payroll checks.

a. The payroll clerk distributes signed payroll checks. Undistributed checks are returned to the payroll department. This answer is correct because it is a weakness to have the payroll clerk distribute signed payroll checks and for the payroll department to maintain undistributed checks. Payroll checks should be distributed by a paymaster, and undistributed checks should be deposited in a bank account. This answer is incorrect because the payroll department may often prepare and distribute checks in this manner under good internal control.

In meeting the control objective of safeguarding of assets, which department should be responsible for Distribution of paychecks Custody of unclaimed paychecks a. Treasurer Treasurer b. Payroll Treasurer c. Payroll Payroll d. Treasurer Payroll

a. Treasurer Treasurer This answer is correct because these custody functions should not be performed by the payroll department which is a recordkeeping function. Under proper internal control recordkeeping, custody, and authorization of transactions should be segregated.

Proper authorization procedures in the revenue cycle usually provide for the approval of bad debt write-offs by an employee in which of the following departments? a. Treasurer. b. Sales. c. Billing. d. Accounts receivable.

a. Treasurer. This answer is correct because the department responsible for bad debt write-offs should be independent of the sales authorization and recordkeeping functions.

Concerning current audit use of audit evidence about the operating effectiveness of controls obtained in prior year audits, the auditor generally may a. Use such evidence, but should test related controls at least every third year. b. Not use such evidence in the current audit. c. Use such evidence, but only for immaterial accounts. d. Only use such evidence for controls that have been implemented for a period of at least five years.

a. Use such evidence, but should test related controls at least every third year. This answer is correct because the professional standards allow use of such evidence if the related controls are tested at least every third year.

Which of the following controls will most likely prevent the concealment of a cash shortage resulting from the improper write-off of a trade account receivable? a. Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence. b. Write-offs must be supported by an aging schedule showing that only receivable overdue several months have been written off. c. Write-offs must be approved by the cashier who is in a position to know if the receivables have, in fact, been collected. d. Write-off must be authorized by company field sales employees who are in a position to determine the financial standing of the customers.

a. Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence. This answer is correct because if accounts receivable write-offs must be approved by an officer on the basis of credit department recommendations including supporting evidence, there is very little likelihood of improper write-offs to conceal cash shortages. This answer is incorrect because receivables overdue by several months is not a basis for write-off; uncollectibility is a basis.

Which of the following is a standard control for cash disbursements? a. Checks should be signed by the controller and at least one other employee of the company. b. Checks should be sequentially numbered and the numerical sequence should be accounted for by the person preparing bank reconciliations. c. Checks and supporting documents should be marked "Paid" immediately after the check is returned with the bank statement. d. Checks should be sent directly to the payee by the employee who prepares documents that authorize check preparation.

b. Checks should be sequentially numbered and the numerical sequence should be accounted for by the person preparing bank reconciliations. This answer is correct because checks should be sequentially numbered, and the person preparing bank reconciliations should account for all checks. This provides control over unauthorized and unrecorded checks. This answer is incorrect because supporting documentation should be cancelled (or marked "Paid") as soon as the checks are signed (i.e., to avoid duplicate payment).

A primary objective of procedures performed to obtain an understanding of internal control is to provide an auditor with a. Audit evidence to use in reducing detection risk. b. Knowledge necessary to assess the risks as misstatement. c. A basis from which to modify tests of controls. d. Information necessary to prepare flowcharts.

b. Knowledge necessary to assess the risks as misstatement. This answer is correct because the auditor should obtain a sufficient understanding of an entity's control to assess the risk of material misstatement. This answer is incorrect because while tests of controls may be modified during the consideration of internal control, modification is not a primary objective.

Which of the following factors is most likely to affect the extent of the documentation of the auditor's understanding of a client's system of internal controls? a. The industry and the business and regulatory environments in which the client operates. b. The degree to which information technology is used in the accounting function. c. The relationship between management, the board of directors, and external stakeholders. d. The degree to which the auditor intends to use internal audit personnel to perform substantive tests.

b. The degree to which information technology is used in the accounting function. This answer is correct because differences in information technology use will have a major effect. For example, documentation of the understanding of a complex information system with a large volume of transactions may include flowcharts, questionnaires, and/or decision tables; documentation for an information system with limited or no use of IT and few transactions may be in the form of a memorandum.

Which of the following is not part of the required content of management's report on internal control under the standards of the Public Company Accounting Oversight Board? a. The criteria used for assessment. b. The financial reporting principles used by the company. c. Management's acknowledgement of responsibility for internal control. d. Management's assessment of internal control.

b. The financial reporting principles used by the company. This answer is correct because the financial reporting principles deal with the financial statements not internal control.

One of the auditor's objectives in observing the actual distribution of payroll checks is to determine that every name on the payroll is that of a bona fide employee. The payroll observation is an auditing procedure that is generally performed for which of the following reasons? a. The professional standards that are generally accepted require the auditor to perform the payroll observation. b. The various phases of payroll work are not sufficiently segregated to afford effective internal control. c. The independent auditor uses personal judgement and decides to observe the payroll distribution on a particular audit. d. The standards that are generally accepted by the profession are interpreted to mean that payroll observation is expected on an audit unless circumstances dictate otherwise.

b. The various phases of payroll work are not sufficiently segregated to afford effective internal control. This answer is correct because a typical problem in the payroll area is the apparent existence of fictitious employees which may arise due to inadequate segregation in the payroll area. The observation of a payroll distribution should detect any such irregularity.

Which of the following is the most important internal control activity over acquisitions of property, plant, and equipment? a. Establishing a written company policy distinguishing between capital and revenue expenditures. b. Using a budget to forecast and control acquisitions and retirements. c. Analyzing monthly variances between authorized expenditures and actual costs. d. Requiring acquisitions to be made by user departments.

b. Using a budget to forecast and control acquisitions and retirements. This answer is correct because using budgets to control acquisitions implies a follow-up analysis of budget variances. The use of budgets also permits the level of authorized expenditures to be controlled. Major asset acquisitions are properly approved by the firm's board of directors and properly controlled through capital budgeting techniques. This answer is incorrect because delegation of acquisitions to user departments will weaken controls over property rather than strengthen them.

An examination of the balance in the accounts payable account as a part of a financial statement audit is ordinarily not designed to a. Detect accounts payable which are substantially past due. b. Verify that accounts payable were properly authorized. c. Ascertain the reasonableness of recorded liabilities. d. Determine that all existing liabilities at the balance sheet date have been recorded.

b. Verify that accounts payable were properly authorized. This answer is correct because proper authorization is an internal control principle that an auditor examines by testing controls. Proper authorization only suggests that related account balances are more likely to be correct. Based on this reliance the auditor adjusts his/her substantive tests of account balances accordingly. Additionally, account balances may be correct whether they are properly authorized or not. examining the balance of AP is a substantive test not a control test

Sound internal control dictates that defective merchandise returned by customers should be presented to the a. Purchasing clerk. b. Receiving clerk. c. Inventory control clerk. d. Sales clerk.

b. receiving clerk This answer is correct because the receiving clerk serves a custody function and having defective merchandise returned to receiving centralizes the custody of all goods received by the firm. This answer is incorrect because while the inventory control clerk does serve a custody function, control is best established by having all merchandise enter the system through receiving.

Apex Manufacturing Corporation mass produces eight different products. The controller who is interested in strengthening controls over the accounting for materials used in production would be most likely to implement a. An economic order quantity (EOQ) system. b. A job order cost accounting system. c. A perpetual inventory system. d. A separation of duties among production personnel.

c. A perpetual inventory system. This answer is correct because a perpetual inventory system will show when and where materials are being used.

One important reason why a CPA, during the course of an audit engagement, prepares internal control flowcharts is to a. Reduce the need for inquiries of client personnel concerning the operations of internal control. b. Depict the organizational structure and document flow in a single chart for review and reference purposes. c. Assemble the internal control findings into a comprehensible format suitable for analysis. d. Prepare documentation that would be useful in the event of a future consulting engagement.

c. Assemble the internal control findings into a comprehensible format suitable for analysis. This answer is correct because flowcharts are prepared as part of the consideration of internal control. The use of structure flowcharts assembles the internal control findings into a comprehensible format. This answer is incorrect because the entire organizational structure and document flow of a large company usually cannot be depicted in a single flowchart.

To improve accountability for fixed asset retirements, management most likely would implement control that includes a. Continuous analysis of the repairs and maintenance account. b. Periodic inquiry of plant executives by internal auditors as to whether any plant assets have been retired. c. Continuous utilization of serially numbered retirement work orders. d. Periodic inspection of insurance policies by the internal auditors.

c. Continuous utilization of serially numbered retirement work orders. This answer is correct because the continuous utilization of serially numbered retirement work orders will allow management to account for each retirement. This will help prevent unrecorded or unauthorized retirements. This answer is incorrect because a periodic inquiry of plant executives would be an unsystematic procedure of limited effectiveness.

When an auditor issues an unqualified opinion on an entity's internal control, it is implied that the a. Entity has not violated provisions of the Foreign Corrupt Practices Act. b. Likelihood of management fraud is minimal. c. Financial records are sufficiently reliable to permit the preparation of financial statements. d. Entity's system of internal control is in conformity with criteria established by its audit committee.

c. Financial records are sufficiently reliable to permit the preparation of financial statements. This answer is correct because the broad objectives of internal control are to render reasonable assurance that assets are safeguarded from unauthorized use or disposition and that financial records are sufficiently reliable to permit the preparation of financial statements. This answer is incorrect because typically auditors do not address whether audit committee criteria have been met.

When auditing a public warehouse, which of the following is the most important audit procedure with respect to disclosing unrecorded liabilities? a. Confirmation of negotiable receipts with holders. b. Review of outstanding receipts. c. Inspection of receiving and issuing procedures. d. Observation of inventory.

c. Inspection of receiving and issuing procedures. This answer is correct because inspection of receiving and issuing procedures will permit the auditor to thoroughly evaluate the internal control over the custodial responsibilities of the warehouse employee. If the custodial responsibilities are not properly discharged, there may be significant unrecorded liabilities.

After obtaining an understanding of internal control and assessing control risk of an entity, an auditor decided not to perform tests of controls. The auditor most likely decided that a. The available audit evidence obtained through tests of controls would not support an increased level of control risk. b. A reduction in the assessed level of control risk is justified for certain financial statement assertions. c. It would be inefficient to perform tests of controls that would result in a reduction in planned substantive tests. d. The assessed level of inherent risk exceeded the assessed level of control risk.

c. It would be inefficient to perform tests of controls that would result in a reduction in planned substantive tests. This answer is correct because an auditor may conclude that it is inefficient to obtain additional audit evidence through tests of controls and may use the assessed level of control risk to plan the substantive tests for those assertions.

Each of the following types of controls is considered to be an entity-level control, except those a. Relating to the control environment. b. Pertaining to the company's risk assessment process. c. Regarding the company's annual stockholder meeting. d. Addressing policies over significant risk management practices.

c. Regarding the company's annual stockholder meeting. This answer is correct because controls relating to the annual stockholder meeting are directly related to that function and would not be considered entity-level controls. This answer is incorrect because a company's policies relating to risk management involve entity-level control.

The independent auditor should acquire an understanding of the internal audit function as it relates to the independent auditor's consideration of internal control because a. The audit plans, 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 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.

c. The work performed by internal auditors may be a factor in determining the nature, timing, and extent of the independent auditor's procedures.

In comparison to the external auditor, an internal auditor is more likely to be concerned with a. Internal control. b. Cost accounting procedures. c. Operational auditing. d. Reviewing interim financial statements.

c. operational auditing This answer is correct because operational auditing, a broader concept than included in financial statement audits, is more important to the internal auditor because it includes budgets and other control devices. This answer is incorrect because both external and internal auditors are extremely concerned with internal control.

Which of the following questions would an auditor most likely include on an internal control questionnaire for notes payable? a. Are assets that collateralize notes payable critically needed for the entity's continued existence? b. Are two or more authorized signatures required on checks that repay notes payable? c. Are the proceeds from notes payable used for the purchase of noncurrent assets? d. Are direct borrowings on notes payable authorized by the board of directors?

d. Are direct borrowings on notes payable authorized by the board of directors? This answer is correct because companies frequently require that direct borrowings on notes payable be authorized by the board of directors; accordingly, auditors will determine whether proper policy has been followed. the internal control questionnaire for disbursements is more likely to address the required authorized signatures on checks than will the internal control questionnaire for notes payable.

Of the following statements about internal control, which one is not valid? 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 controls on a test basis. d. Controls reasonably ensure that collusion among employees cannot occur.

d. Controls reasonably ensure that collusion among employees cannot occur. This answer is correct because controls whose effectiveness depends on segregation of duties cannot be relied upon to ensure that collusion among employees will not occur. Segregation of employees may be circumvented by collusion. the concept of reasonable assurance the cost/benefit relationship must be considered.

Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both a. Journalize cash receipts and disbursements and prepare financial statements. b. Monitor internal control and evaluate whether the controls are operating as intended. c. Adopt new accounting pronouncements and authorize the recording of transactions. d. Record and conceal fraudulent transactions in the normal course of assigned tasks.

d. Record and conceal fraudulent transactions in the normal course of assigned tasks. Individual recording transactions may prepare financial statements.

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

d. Select and examine canceled checks and ascertain that the related vouchers are dated no later than the checks. This answer is correct because vouchers should have been prepared and approved prior to issuance of the check (otherwise the voucher was not present when the check was issued). In addition, the auditor should begin his/her test with the canceled checks to determine whether all checks are supported by an approved voucher.

A weakness in internal control over recording retirements of equipment may cause the auditor to a. Inspect certain items of equipment in the plant and trace those items to the accounting records. b. Review the subsidiary ledger to ascertain whether depreciation was taken on each item of equipment during the year. c. Trace additions to the "other assets" account to search for equipment that is still on hand but no longer being used. d. Select certain items of equipment from the accounting records and locate them in the plant.

d. Select certain items of equipment from the accounting records and locate them in the plant. This answer is correct because testing from the population of asset accounting records to certain pieces of equipment in the plant will provide assurance that recorded assets are being used by the company. If the auditor finds that recorded assets are no longer in use, there would appear to be a problem recording retirements of assets.

At which point in an ordinary sales transaction of a wholesaling business would a lack of specific authorization be of least concern to the auditor in the conduct of an audit? a. Granting of credit. b. Shipment of goods. c. Determination of discounts. d. Selling of goods for cash.

d. Selling of goods for cash. This answer is correct because at the point of selling the goods for cash, decisions on matters such as appropriate discounts will have already been made. The fact that cash is being received eliminates any credit problem considerations. Therefore, the lack of specific authorization will not be of great concern to the auditor in this situation. This answer is incorrect because specific authorization will be needed for shipment of goods and, thus, is of concern to the auditor.

Which of the following would not typically be a control relied upon during an audit? a. Use of the double-entry system. b. An internal audit staff. c. Competent personnel. d. A comparison-shopping staff.

d. a comparison-shopping staff This answer is correct because a comparison-shopping staff is not generally relevant to recording, processing, summarizing, and reporting financial data. This answer is incorrect because use of the double-entry system is an internal control which aids in more accurate recording of transactions.

During a financial statement audit an internal auditor may provide direct assistance to the independent CPA in performing both tests of controls and substantive tests t or f

true