Auditing Quiz #4

What are the factors that affect the control environment?

-Communication and enforcement of integrity and ethical values. -A commitment to competence. -Participation of those charged with governance. -Management's philosophy and operating style. -Organizational structure. -Assignment of authority and responsibility. -Human resource policies and practices.

List the tools that can document the understanding of internal control.

-Procedures manuals and organizational charts. -Narrative description. -Internal control questionnaires. -Flowcharts.

What are management's incentives for establishing and maintaining strong internal control? What are the auditor's main concerns with internal control?

-Strong internal controls ensure that assets and records are properly safeguarded. Management also needs a control system that generates reliable information for decision making. If the information system does not generate reliable information, management may be unable to make informed decisions about issues such as product pricing, cost of production, and profit information. -The auditor uses the understanding of the entities internal control to identify the types of potential misstatements, ascertain factors that affect the risk of material misstatement, and design tests of controls and substantive procedures. The auditors understanding of internal control is a major factor in determining the overall audit strategy.

What are the requirements under auditing standards for documenting the assessed level of control risk?

-Structured working paper. -Internal control questionnaire. -A memorandum.

What are the major differences between a substantive strategy and a reliance strategy when the auditor considers internal control in planning an audit?

-Substantive strategy: the auditor has decided not to rely on the entity's controls and instead use substantive procedures as the main source of evidence about the assertions in the financial statements. -Reliance Strategy: the auditor intends to rely on the entity's controls. If a reliance strategy is followed, the auditor may need a more detailed understanding of internal control to develop a preliminary or "planned" assessment of control risk.

Describe the five components of internal control.

1. Control Environment: sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for effective internal control, providing discipline and structure. The control environment includes the attitudes, awareness, policies, and actions of management and the board of directors concerning the entity's internal control and its importance in the entity. 2. Risk Assessment: how management identifies risks relevant to the preparation of financial statements that are fairly presented in conformity with GAAP, estimates their significance, assesses the likelihood of their occurrence, and decides upon actions to manage them. 3. Information & Communication: includes the accounting system, consists of the procedures, whether automated or manual, and records established to initiate, record, process, and report entity transactions and to maintain accountability for the related assets, liabilities, and equity. Communication involves providing an understanding of individual roles and responsibilities pertaining to internal control over financial reporting. 4. Monitoring Activities: a process to assess the quality of internal control performance over time. It involves assessing the design and operation of controls on a timely basis and taking necessary corrective actions. 3. Existing Control Activities: policies and procedures that help ensure that management directives are carried out, for example, that necessary actions are taken to address risks to achievement of the entity's objectives. Control activities, whether automated or manual, have various objectives and are applied at various organizational and functional levels.

Control deficiency:

A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis.

Significant deficiency:

A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance.

Material weakness:

A deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis.

Monitoring of controls:

A process that assesses the quality of internal control performance over time.

Walkthrough:

A transaction being traced by an auditor from origination through the entity's information system until it is reflected in the entity's financial reports. It encompasses the entire process of initiating, authorizing, recording, processing, and reporting individual transactions and controls for each of the significant processes identified.

What are the potential benefits and risks to an entity's internal control from information technology?

Benefits: - Consistent application of predefined business rules and performance of complex calculations in processing large volumes of transactions or data. -Enhancement of the timeliness, availability, and accuracy of information. -Facilitation of additional analysis of information. -Enhancement of the ability to monitor the performance of the entity activities and its policies and procedures. -Reduction in the risk that controls will be circumvented. -Enhancement of the ability to achieve effective segregation of duties by implementing security controls in applications, databases, and operating systems. Risks: -Reliance on systems or programs that inaccurately process data, process inaccurate data, or both. -Unauthorized access to data that may result in destruction of data or improper changes to data, including the recording of unauthorized or nonexistent transactions or inaccurate recording of transactions. -Unauthorized changes to data in master files. -Unauthorized changes to systems or programs. -Failure to make necessary changes to systems or programs. -Inappropriate manual intervention. -Potential loss of data.

Electronic (Internet) commerce:

Business transactions between individuals and organizations that occur without paper documents, using computers and telecommunication networks.

Computer-assisted audit techniques (CAATs):

Computer programs that allow auditors to test computer files and databases.

Application controls:

Controls that apply to the processing of specific computer applications and are part of the computer programs used in the accounting system.

General controls:

Controls that relate to the overall information processing environment and have a pervasive effect on the entity's computer operations.

What factors should the auditor consider when substantive procedures are to be completed at an interim date? If the auditor conducts substantive procedures at an interim date, what audit procedures would normally be completed for the remaining period?

Factors to consider when substantive procedures are to be completed at an interim date: -The control environment and other relevant controls. -The availability of information at a later date that is necessary for the auditor's procedures. -The objective of the substantive procedure. -The assessed risk of material misstatement. -The nature of the class of transactions or account balance and relevant assertions. -The ability of the auditor to reduce the risk that misstatements existing at the periods end are not detected by performing appropriate substantive procedures or substantive procedures combined with tests of controls to cover the remaining period. Substantive procedures conducted in the remaining period include comparing the year-end account balance with the interim account balance. It might also involve conducting analytical procedures or reviewing related journals and ledgers for large or unusual transactions.

What is meant by the concept of reasonable assurance in terms of internal control? What are the inherent limitations of internal control?

Reasonable assurance recognizes that the cost of an entity's internal control system should not exceed the benefits that are expected to be derived.The effectiveness of any internal control system is subject to certain inherent limitations: -Management override of internal control. -Personnel errors or mistakes. -Collusion.

What is the auditor's responsibility for communicating control deficiencies that are severe enough to be considered significant deficiencies or material weaknesses?

The auditor MUST communicate in writing, any discovered significant deficiencies and material weaknesses to management and those charged with governance.

Why must the auditor obtain an understanding of internal control?

The auditor should obtain an understanding of each of the five components of internal control in order to plan the audit. This understanding includes knowledge about the design of relevant controls and whether they have been placed in operation by the entity. The auditor uses this knowledge to: -Identify the types of potential misstatement. -Pinpoint the factors that affect the risk of material misstatement. -Design tests of controls and substantive procedures

Substantive strategy:

The auditor's decision not to rely on the entity's controls and to audit the related financial statement accounts by relying more on substantive procedures.

Reliance strategy:

The auditor's decision to rely on the entity's controls, test those controls, and reduce the direct tests of the financial statement accounts.

Internal control:

The method by which an entity's board of directors, management, and other personnel provide reasonable assurance about the achievement of objectives in the following categories: (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations.

Control activities:

The policies and procedures that help ensure that management's directives are carried out.

Control risk:

The risk that a misstatement that could occur in an assertion about an account or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control.

Control environment:

The tone of an organization, which reflects the overall attitude, awareness, and actions of the board of directors, management, and owners influencing the control consciousness of its people.

Electronic data interchange:

The transmission of business transactions over telecommunications networks.

Audit data analytics:

Using analysis, modeling, and visualization to discover and analyze patterns, anomalies, and other information in data in the context of the audit.

After obtaining an understanding of an entity's internal control system, an auditor may set control risk at high for some assertions because the auditor: a. Believes the internal controls are unlikely to be effective. b. Determines that the pertinent internal control components are not well documented. c. Performs tests of controls to restrict detection risk to an acceptable level. d. Identifies internal controls that are likely to prevent material misstatements.

a. Believes the internal controls are unlikely to be effective.

Which of the following audit techniques would most likely provide an auditor with the least assurance about the effectiveness of the operation of a control? a. Inquiry of entity personnel. b. Reperformance of the control by the auditor. c. Observation of entity personnel. d. Walkthrough.

a. Inquiry of entity personnel.

Assessing control risk below high involves all of the following except: a. Identifying specific controls to rely on. b. Concluding that controls are ineffective. c. Performing tests of controls. b. Analyzing the achieved level of control risk after performing tests of controls.

b. Concluding that controls are ineffective.

The highest-quality and most reliable audit evidence that segregation of duties is properly implemented is obtained by: a. Inspection of documents prepared by a third party but which contain the initials of those applying entity controls. b. Observation by the auditor of the employees performing control activities. c. Inspection of a flowchart of duties performed and available personnel. d. Inquiries of employees who apply control activities.

b. Observation by the auditor of the employees performing control activities.

An auditor's flowchart of an entity's accounting system is a diagrammatic representation that depicts the auditor's: a. Program for tests of controls. b. Understanding of the system. c. Understanding of the types of fraud that are probable, given the present system. d. Documentation of the study and evaluation of the system.

b. Understanding of the system.

Significant deficiencies are matters that come to an auditor's attention that should be communicated to an entity's audit committee because they represent: a. Disclosures of information that significantly contradict the auditor's going concern assumption. b. Material fraud or illegal acts perpetrated by high-level management. c. Significant deficiencies in the design or operation of the internal control. d. Manipulation or falsification of accounting records or documents from which financial statements are prepared.

c. Significant deficiencies in the design or operation of the internal control.

Regardless of the assessed level of control risk, an auditor would perform some: a. Tests of controls to determine the effectiveness of internal controls. b. Analytical procedures to verify the design of internal controls. c. Substantive procedures to restrict detection risk for significant transaction classes. d. Dual-purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk.

c. Substantive procedures to restrict detection risk for significant transaction classes.

An auditor's primary consideration regarding an entity's internal controls is whether they: a. Prevent management override. b. Relate to the control environment. c. Reflect management's philosophy and operating style. d. Affect the financial statement assertions.

d. Affect the financial statement assertions.

Internal control is a process designed to provide reasonable assurance regarding the achievement of which objective? a. Effectiveness and efficiency of operations. b. Reliability of financial reporting. c. Compliance with applicable laws and regulations. d. All of the above are correct.

d. All of the above are correct.

SOC 1, Type 2 reports issued by the service organization's auditor typically: a. Provide reasonable assurance that their financial statements are free of material misstatements. b. Ensure that the entity will not have any misstatements in areas related to the service organization's activities. c. Ensure that the entity is billed correctly. d. Assess whether the service organization's controls are suitably designed and operating effectively.

d. Assess whether the service organization's controls are suitably designed and operating effectively.

An auditor anticipates assessing control risk at a low level in an IT environment. Under these circumstances, on which of the following controls would the auditor initially focus? a. Data capture controls. b. Application controls. c. Output controls. d. General controls.

d. General controls.

Which of the following statements about internal control is correct? a. A properly maintained internal control system reasonably ensures that collusion among employees cannot occur. b. The establishment and maintenance of internal control is an important responsibility of the internal auditor. c. An exceptionally strong internal control system is enough for the auditor to eliminate substantive procedures on a significant account balance. d. The cost-benefit relationship is a primary criterion that should be considered in designing an internal control system.

d. The cost-benefit relationship is a primary criterion that should be considered in designing an internal control system.

Monitoring is a major component of the COSO Internal Control— Integrated Framework. Which of the following is not correct in how the company can implement the monitoring component? a. Monitoring can be an ongoing process. b. Monitoring can be conducted as a separate evaluation. c. Monitoring and other audit work conducted by internal audit staff can reduce external audit costs. d. The independent auditor can serve as part of the entity's control environment and continuous monitoring.

d. The independent auditor can serve as part of the entity's control environment and continuous monitoring.