Chapter 5 Multiple Choice

5.48 The purpose of separating the duties of hiring personnel and distributing payroll checks is to separate the: a. Authorization of transactions from the custody of related assets. b. Operational responsibility from the record-keeping responsibility. c. Human resources function from the controllership function. d. Administrative controls from the internal accounting controls. (AICPA adapted)

a. Authorization of transactions from the custody of related assets. This is an example of effective separation of duties. Separation of duties is designed to help the organization achieve effective internal control. To accomplish separation of duties, the payroll function should be divided into its authorization, recording, and custody functions. Authorization of hiring, wage rates, and deductions is typically completed by the human resources department. Authorization of hours worked is typically completed by the production department (or the department where the work was completed). Based on these authorizations, the accounting department would then calculate and record the payroll in the accounting system. Based on the calculated amounts, the treasurer would then prepare and distribute payroll checks.

5.39 When planning the audit of internal controls for an issuer, the audit team should: a. Identify significant accounts, locations, and assertions. b. Conduct a walkthrough of the internal control process. c. Make inquiries of employees regarding the existence of control activities. d. Reperform control activities performed by client employees to determine their effectiveness.

a. Identify significant accounts, locations, and assertions. The audit team identifies significant accounts, locations, and assertions in the planning stage of an audit of internal controls.

5.50 If the auditor plans to assess control risk at less than the maximum and rely on controls, and the nature, timing, and extent of further audit procedures are based on that lower assessment, the auditor must a. Obtain evidence that the controls selected for testing are designed effectively and operated effectively during the entire period of reliance. b. Assess control risk at less than the maximum for all relevant assertions. c. Perform only substantive procedures. d. Provide additional examples of responses to assessed fraud risks relating to fraudulent financial reporting.

a. Obtain evidence that the controls selected for testing are designed effectively and operated effectively during the entire period of reliance. When an auditor plans to reduce control risk below the maximum and rely on controls to reduce substantive testing, they must make sure that the controls have been designed and are operating effectively in order to feel comfortable relying on such controls. The auditor cannot take the client's word that the controls are operating effectively. Rather, they must test the controls.

5.38 A transaction-level internal control activity is best described as: a. An action taken by auditors to obtain evidence. b. An action taken by client personnel for the purpose of preventing, detecting, and correcting errors and frauds in transactions to eliminate or mitigate risks identified by the company. c. A method for recording, summarizing, and reporting financial information. d. The functioning of the board of directors in support of its audit committee.

b. An action taken by client personnel for the purpose of preventing, detecting, and correcting errors and frauds in transactions to eliminate or mitigate risks identified by the company. This is one way to describe the purpose of a transaction-level control activity.

5.36 Which of the following is a device designed to help the audit team obtain evidence about the accounting and control activities of an audit client? a. A narrative memorandum describing the control system. b. An internal control questionnaire. c. A flowchart of the documents and procedures used by the company. d. All of the above.

b. An internal control questionnaire. The internal control questionnaire is a device for collecting evidence in the form of answers to control questions.

5.35 In most audits of large entities, control risk assessment contributes to audit efficiency, which means that: a. The cost of substantive procedures will exceed the cost of control evaluation work. b. Auditors will be able to reduce the cost of substantive procedures by an amount more than the control evaluation costs. c. The cost of control evaluation work will exceed the cost of substantive procedures. d. Auditors will be able to reduce the cost of substantive procedures by an amount less than the cost of tests of controls.

b. Auditors will be able to reduce the cost of substantive procedures by an amount more than the control evaluation costs. The cost savings of substantive testing exceeds the control evaluation cost.

5.32 According to the PCAOB, during the audit of internal controls for an issuer, the ultimate objective of testing the design effectiveness of internal controls is to a. Determine whether the company' controls are processing company data effectively b. Determine that the company's controls will satisfy the company's control objectives and can effectively prevent or detect errors or fraud that could result in material misstatements, if they operate as prescribed c. Determine that the company's employees are processing the controls according to the policy and procedures manuals at the company d. None of the above

b. Determine that the company's controls will satisfy the company's control objectives and can effectively prevent or detect errors or fraud that could result in material misstatements, if they operate as prescribed The testing of design effectiveness relates primarily to whether the control has been properly put in place to prevent or detect errors or fraud. In AS5, this is exactly the objective of testing the design effectiveness of a control as per paragraph 42 of the standard.

5.30 The primary purpose for obtaining an understanding of a nonpublic audit client's internal control is to a. Provide a basis for making constructive suggestions in a management letter b. Determine the nature, timing, and extent of tests to be performed in the audit. c. Provide the rationale for the inherent risk assessment at the financial statement assertion level. d. Provide information for a communication of internal control-related matters to management.

b. Determine the nature, timing, and extent of tests to be performed in the audit. These are the auditors' responsibilities under GAAS.

5.54 Once the auditor detects a control deficiency, which of the following steps must he or she take first? a. Perform tests of other controls related to the same assertion as the control deemed ineffective. b. Evaluate the severity of the deficiency on the auditor's control risk assessment for that assertion. c. Modify the planned substantive procedures as a result of the deficiency. d. Test the deficient control, assuming a maximum level of risk.

b. Evaluate the severity of the deficiency on the auditor's control risk assessment for that assertion. The first step an auditor is likely to take after detecting a control deficiency is to determine the impact of the severity of the deficiency on the auditor's control risk assessment for that assertion. The additional steps to be taken will depend in large part on this determination.

5.29 The most important fundamental component of an entity's internal control is a. Effectiveness and efficiency of operations. b. The control environment. c. Reliability of financial reporting. d. Compliance with applicable laws and regulations.

b. The control environment. The control environment is is the most important foundational component of the internal control system. All other components are dependent, in part, on the effectiveness of the control environment.

5.45 When completing the audit of internal controls for a public company, AS 2201 requires auditors to test: a. Operating effectiveness only. b. Design effectiveness only. c. Both operating and design effectiveness. d. Neither operating nor design effectiveness

c. Both operating and design effectiveness. AS 2201 requires testing for design effectiveness and operating effectiveness.

5.33 To test the operating effectiveness of a control, an audit team might use a combination of each of the following tests except for: a. Inquiry of client personnel. b. Observation of company operations. c. Confirmation of balances d. Inspection of documentation

c. Confirmation of balances This is a substantive test, not a test of a control's operating effectiveness.

5.47 Which report would not be appropriate for a public accounting firm to provide on financial reporting controls? a. Unqualified—no material weaknesses found. b. Disclaimer of opinion—unable to perform all necessary procedures. c. Disclaimer of opinion—significant deficiencies exist. d. Adverse—material weaknesses exist.

c. Disclaimer of opinion—significant deficiencies exist. A disclaimer is used when the auditor's scope is limited but not when significant deficiencies exist, so it is not an appropriate report.

5.43 When completing the audit of internal controls for a public company, the PCAOB requires auditors to audit internal controls over a. Operations b. Compliance with Regulations c. Financial reporting d. All of the above

c. Financial reporting AS 2201 applies to financial reporting controls only.

5.40 A material weakness is a situation in which: a. It is probable that an immaterial financial statement misstatement would not be detected on a timely basis. b. There is a remote likelihood that a material misstatement would be detected on a timely basis. c. It is probable that a material financial statement misstatement would not be detected on a timely basis. d. It is probable that an immaterial financial statement misstatement would not be detected on a timely basis.

c. It is probable that a material financial statement misstatement would not be detected on a timely basis. By definition, a material weakness in internal control is defined as a deficiency, or combination of deficiencies that results in a reasonable possibility that a material misstatement would not be prevented or detected on a timely basis.

5.44 When completing the audit of internal controls for an issuer, AS 2201 requires auditors report on (Management's Report on Internal Control; An audit of Internal Control) a. No; No b. Yes; No c. No; Yes d. Yes; Yes

c. No; Yes AS 2201 requires auditors to issue a report on the audit of internal controls.

5.34 Which of the following is a preventive control? a. Reconciliation of a bank account. b. Recalculation of a sample of payroll entries by internal auditors. c. Separation of duties between the payroll and personnel departments. d. Detailed fluctuation analysis completed by the CFO for revenue

c. Separation of duties between the payroll and personnel departments.

5.53 The auditor should assess control risk for each relevant assertion by evaluating the evidence obtained from all sources, including: a. The auditor's testing of controls for the audit of internal control on a public company. b. Misstatements detected during the financial statement audit. c. Any control deficiencies identified during the audit. d. All of the above.

d. All of the above. Evidence obtained during the test of controls would be relevant to the assessment of control risk (response a); misstatements detected during the audit (response b); and control deficiencies detected during the audit (response c) would all be relevant. As a result, the correct answer is all of the above.

5.51 When testing a control activity's operating effectiveness, procedures the auditor performs to test operating effectiveness would likely include a. Inquiry of appropriate personnel b. Reading over the company's code of conduct c. Reperformance of the control activity d. Both A and C are correct

d. Both A and C are correct When testing the operating effectiveness of a control, the auditor should use a combination of inquiry, observation, inspection, and reperformance. Thus, response (a) and response (c) are appropriate responses. Thus, this is the correct answer.

5.49 If the auditors encounter a significant scope limitation in evaluating a public company's internal control over financial reporting, which of the following types of opinions on the effectiveness of the company's internal control over financial reporting would be appropriate? a. Unqualified opinion or adverse opinion. b. Qualified opinion or adverse opinion. c. Unqualified opinion or disclaimer of opinion. d. Disclaimer of opinion.

d. Disclaimer of opinion. The reporting option when a scope limitation exists is a disclaimer of opinion.

5.37 Tests of controls in a GAAS audit are required for: a. Obtaining evidence about the financial statement assertions. b. Accomplishing control over the occurrence of recorded transactions. c. Applying analytical procedures to financial statement balances. d. Obtaining evidence about the operating effectiveness of client control activities.

d. Obtaining evidence about the operating effectiveness of client control activities. Tests of controls produce the evidence about actual operation of company control activities.

5.46 Which of the following would probably not be considered an indication of a material weakness? a. Evidence of a material misstatement. b. Ineffective oversight by the audit committee. c. Immaterial fraud committed by senior management. d. Overproduction by the manufacturing plant.

d. Overproduction by the manufacturing plant. This does not directly relate to a material misstatement of the financial statements but is an operational issue.

5.31 Effectiveness of audit procedures would be reduced by a. Selecting larger sample sizes for audit. b. Performing audit procedures at the fiscal year-end date as opposed to the interim period c. Deciding to obtain external evidence instead of internal evidence. d. Performing procedures during the interim period as opposed to at the fiscal year-end date.

d. Performing procedures during the interim period as opposed to at the fiscal year-end date. Performing procedures at an interim date is less effective.

5.42 Which of the following does not accurately summarize auditor's requirements regarding internal control? (issuers; non-issuers) Yes, Yes a. Understanding b. Documenting c. Evaluating Control Risk d. Test Controls

d. Test Controls Testing controls is required only for audits of issuers under AS 2201

5.52 Matters that could affect the necessary extent of testing for a control activity as it related to the degree of auditor reliance on a control activity would not include the following: a. The frequency of the performance of the control by the company during the period being audited. b. The length of time that the auditor is planning to rely on the operating efficiency of the control activity. c. The expected rate of deviation for a control activity. d. The relevance and reliability of the audit evidence to be obtained to test the operating effectiveness of a control activity

d. The relevance and reliability of the audit evidence to be obtained to test the operating effectiveness of a control activity The relevance and reliability of the evidence to be obtained would not have an impact on the extent of testing to be completed. The extent of testing required should be determined and then the necessary evidence should be gathered.