ACCT 4631 - Internal Auditing: HW 11
[ 16 ] The internal auditor is responsible for evaluating internal control to determine whether it allows undetected fraud. Based on the information presented, the most likely undetected fraud, if any, is that the A. Purchasing agent is purchasing the majority of products from a favorite vendor because rotation among purchasing agents is not mandatory. B. Purchasing agent is sending fake purchase orders to a dummy vendor, inserting a receiving slip, and having payments made to the dummy vendor. C. Receiving department is diverting receipts to different locations and failing to create receiving reports. D. Production department is deflating the price of products purchased and thereby increasing the reported gross margin of sales.
B. *Correct Answer* Internal control is unlikely to detect the purchasing agent's fraud because this individual is in a position to perpetrate and conceal irregularities. Receiving documents and vendors' invoices should be sent to accounts payable, not to the purchasing agent.
[ 21 ] The extent of loans made to fictitious borrowers by the loan officer could best be determined by A. Reviewing a representative sample of the loan officer's transactions for compliance with bank policies and procedures. B. Reviewing a representative sample of loan files for properly completed documents, such as loan agreements, credit approvals, and approval of secured collateral. C. Comparing current loan approval balances with those of prior years. D. Requesting positive confirmations for all outstanding loans made by the loan officer.
B. *Correct Answer* Reviewing a representative sample of loan files for properly completed documents, such as loan agreements, credit approvals, and approval of secured collateral, could uncover fictitious borrowers (secured collateral would be difficult to obtain for a fraudulent loan).
[ 7 ] Number 1, "John was trusted completely . . .," is an example of a(n) A. Document symptom. B. Situational pressure. C. Opportunity to commit. D. Physical symptom.
C. *Correct Answer* Complete trust in an individual is an opportunity to commit fraud. John's actions went unscrutinized because of the absence of an appropriate segregation of functions and his ability to override whatever control procedures were in place.
[ 3 ] Auditors must always be alert for the possibility of fraud. Assume the controls over each risk listed below are marginal. Which of the following possible frauds or misuses of organization assets should be considered the area of greatest risk? A. The president is using company travel and entertainment funds for activities that might be considered questionable. B. Purchases of supplies are made from fictitious vendors. C. Grants are made to organizations that might be associated with the president or are not for purposes dictated in the organization's charter. D. The payroll clerk has added ghost employees.
C. *Correct Answer* Grants represent 83.6% (US $418 ÷ $500) of current revenue. Consequently, fraudulent grants constitute a much greater risk exposure than any of the other items listed.
[ 1 ] Internal auditing is responsible for assisting in the prevention of fraud by A. Informing the appropriate authorities within the organization and recommending whatever investigation is considered necessary in the circumstances when wrongdoing is suspected. B. Establishing the organization's governance, operations, and information systems concerning compliance with laws, regulations, and contracts. C. Examining and evaluating the adequacy and the effectiveness of control, commensurate with the extent of the potential exposure or risk in the various segments of the organization's operations. D. Determining whether operating standards are acceptable and are being met.
C. *Correct Answer* Internal auditors are responsible for assisting in the prevention of fraud by examining and evaluating the adequacy and the effectiveness of controls.
[ 2 ] After noting some red flags, an internal auditor has an increased awareness that fraud may be present. Which of the following best describes the internal auditor's responsibility? A. Expand activities to determine whether an investigation is warranted. B. Report the possibility of fraud to senior management and the board and ask them how they would like to proceed. C. Consult with external legal counsel to determine the course of action to be taken, including the approval of the proposed engagement work program to make sure it is acceptable on legal grounds. D. Report the matter to the audit committee and request funding for outside service providers to help investigate the possible fraud.
A. *Correct Answer* An internal auditor's responsibilities for detecting fraud include evaluating fraud indicators and deciding whether any additional action is necessary or whether an investigation should be recommended.
[ 22 ] One remote unit's petty cash custodian, because of the small staff, also had responsibility for the imprest fund checking account reconciliation. The cashier concealed a diversion of funds by altering the beginning balance on the monthly reconciliations sent to the group office. A possible engagement procedure to detect this fraud is to A. Compare monthly balances and use change and trend analysis. B. Require additional monitoring by headquarters whenever improper segregation of duties exists at remote units. C. Determine whether any employees have high personal debt. D. Determine whether any employees are leading expensive lifestyles.
A. *Correct Answer* Comparing the beginning balance one month with the ending balance of the prior month is a means of uncovering this fraud. Applying analytical procedures is also a way to detect the diversion of funds. It will isolate unexpected and unexplained fluctuations.
[ 9 ] Red flags are conditions that indicate a higher likelihood of fraud. Which of the following is not considered a red flag? A. Management has delegated the authority to make purchases under a certain value to subordinates. B. An individual has held the same cash-handling job for an extended period without any rotation of duties. C. An individual handling marketable securities is responsible for making the purchases, recording the purchases, and reporting any discrepancies and gains/losses to senior management. D. The assignment of responsibility and accountability in the accounts receivable department is not clear.
A. *Correct Answer* Delegating the authority to make purchases under a certain value to subordinates is an acceptable and common practice intended to limit risk while promoting efficiency. It is not, by itself, considered a red flag.
[ 17 ] During an engagement relating to purchasing, the internal auditor finds that the largest blanket purchase order is for tires, which are expensed as vehicle maintenance items. The fleet manager requisitions tires against the blanket order for the company's 400vehicle service fleet based on a visual inspection of the cars and trucks in the parking lot each week. Sometimes the fleet manager picks up the tires but always signs the receiving report for payment. Vehicle service data are entered into a maintenance database by the mechanic after the tires are installed. What is the best course of action for the internal auditor in these circumstances? A. Determine whether the number of tires purchased can be reconciled to maintenance records. B. Count the number of tires on hand and trace them to the related receiving reports. C. Select a judgmental sample of requisitions and verify that each one is signed by the fleet manager. D. Compare the number of tires purchased under the blanket purchase order with the number of tires purchased in the prior year for reasonableness.
A. *Correct Answer* That the fleet manager both requisitions and receives the tires provides an opportunity for fraud. The internal auditor should determine whether tires purchased have been used on company vehicles rather than diverted to another purpose.
[ 14 ] The internal auditor reviewed documentation showing that a customer had recently returned three expensive products to the regional service center for warranty replacement. The documentation also showed that the warranty clerk had rejected the claim and sent it to the customer's local distributor. The claim was rejected because the serial numbers listed in the warranty claim were not found in the computer's sales history file. Subsequently, the distributor supplied three different serial numbers, all of which were validated by the computer system, and the clerk completed the warranty claim for replacements. What is the best course of action for the internal auditor under the circumstances? A. Determine if the original serial numbers provided by the customer can be traced to other records, such as production and inventory records. B. Notify the appropriate authorities within the organization that there are sufficient indicators that a fraud has been committed. C. Verify with the appropriate supervisor that the warranty clerk had followed relevant procedures in the processing and disposition of this claim. D. Summarize this item along with other valid transactions in the internal auditor's test of warranty transactions.
A. *Correct Answer* The best course of action for the internal auditor is to determine whether the related equipment had actually been reported in a sales transaction. This will allow the auditor to draw preliminary conclusions as to whether this is a case of error or of fraud.
[ 24 ] After completing an investigation, internal auditing has concluded that an employee has stolen a significant amount of cash receipts. A draft of the proposed communication on this observation should be submitted for review to A. Legal counsel. B. The board. C. The chief executive officer of the organization. D. The organization's outside auditors.
A. *Correct Answer* The internal auditor must be concerned about the possibility of inclusion (and dissemination) of a statement for which the accused employee could sue the organization. Thus, a draft of the proposed final communications on fraud should be submitted to legal counsel for review. If the internal auditor wants to invoke client privilege, consideration should be given to addressing the report to legal counsel.
[ 15 ] During a postcompletion engagement related to a warehouse expansion, the internal auditor noted several invoices for redecorating services from a local merchant that were accountcoded and signed for payment only by the cost engineer. The internal auditor should A. Compare the cost and description of the services with the account code used in the construction project and with related estimates in the constructionproject budget. B. Consult with the cost engineer for assurance that these purchases were authorized for this construction project. C. Obtain a facsimile of the cost engineer's signature from the accounts payable group and compare it with the signature on the invoices. D. Recommend reclassifying the expenditure to the appropriate account code for redecorating services.
A. *Correct Answer* The internal auditor needs to determine the validity of the transaction because the engineer is performing incompatible tasks. Comparing the cost and description of the services with the account code and the budget will verify the transaction. However, normal controls over disbursements need to be established.
[ 18 ] An investment portfolio manager has the authority to use financial derivatives to hedge transactions but is not supposed to take speculative positions. However, the manager launches a scheme that includes (1) taking a position larger than required by the hedge, (2) putting the speculative gains in a suspense account, and (3) transferring the funds to a nonexistent broker and from there to a personal account. Which of the following engagement procedures is least effective in detecting this fraud? A. Examine individual trades to determine whether the trades violate the authorization limit for the manager. B. Sample individual trades and determine the exact matching of a hedge. Schedule and investigate all differences. C. Sample all debits to the suspense account and examine their disposition. D. Sample fund transfers to brokers and determine if the brokers are on the organization's authorized list for transactions.
A. *Correct Answer* The monetary amount involved would not reveal whether the transaction was speculative.
Fact Pattern: An internal auditor is performing an operational engagement at a division and observes that an unusually large quantity of goods is on hand in the shipping and materials rework areas. The items are labeled as reship items. Upon inquiry the internal auditor is told that these are goods that have been returned by customers and have either been repaired and shipped back to the original customer or repaired and shipped out as new products because they are fully warranted. [ 23 ] The internal auditor has not yet performed any detailed engagement work. Based on the information given, the most appropriate action for the internal auditor to take is to A. Report the items to divisional management and ask for management's explanation before determining whether to include the observations in an engagement communication. B. Take a sample of the items on hand and compare the sample items with the underlying documents, such as receiving reports and sales orders, to determine how the goods were handled. C. Report the observations but do not perform any additional work without the approval of the chief audit executive because such work is clearly a scope expansion. D. Take an inventory of the goods on hand so the monetary amount can be included in the engagement communications along with the explanation of the problem.
B. *Correct Answer* Sampling items on hand and reviewing the related documents assist the internal auditor in understanding the details of the transactions. This procedure should be performed before taking any further action.
[ 25 ] During a review of contracts, a chief audit executive (CAE) suspects that a supplier was given an unfair advantage in bidding on a contract. After learning that the chief executive officer (CEO) of the company is a member of the supplier's board of directors, how should the CAE proceed? A. Submit a draft report to senior management, excluding the CEO. B. Contact the organization's external auditors for assistance. C. Obtain supporting documentation and present the finding to the chair of the audit committee. D. Immediately notify the board of directors.
C. *Correct Answer* A conflict of interest is an undisclosed, personal economic interest in a transaction that adversely affects the organization. After ascertaining the existence of such a conflict on the part of a senior manager, the CAE should obtain supporting documentation and present the finding to the chair of the audit committee.
[ 4 ] When an internal auditor identifies multiple factors that have been linked with possible fraudulent conditions and suspects that fraud has taken place, the auditor should A. Immediately report to senior management and the board. B. Immediately report to the board. C. Recommend an investigation. D. Extend tests to determine the extent of the fraud.
C. *Correct Answer* An internal auditor's responsibilities for detecting fraud include evaluating fraud indicators and deciding whether any additional action is necessary or whether an investigation should be recommended.
[ 5 ] An internal auditor suspects that a mailroom clerk is embezzling funds. In exercising due professional care, the internal auditor should A. Reassign the clerk to another department. B. Institute stricter controls over mailroom operations. C. Evaluate fraud indicators and decide whether further action is necessary. D. Confront the clerk with the auditor's suspicions.
C. *Correct Answer* An internal auditor's responsibilities for detecting fraud include evaluating fraud indicators and deciding whether any additional action is necessary or whether an investigation should be recommended.
[ 12 ] A means of ensuring that payroll checks are drawn for properly authorized amounts is to A. Conduct periodic floor verification of employees on the payroll. B. Require that undelivered checks be returned to the cashier. C. Require supervisory approval of employee time cards. D. Witness the distribution of payroll checks.
C. *Correct Answer* Review and approval of time cards by line supervisors is appropriate because they should know whether work has been performed. Also, because they do not distribute paychecks, they are not in a position to divert falsely authorized checks.
[ 19 ] Two merging retail enterprises agree to share data on store operations. The data reveal that three stores in Organization A are characterized by: Significantly lower gross margins, Higher-than-average sales volume, and Higher levels of employee bonuses. Assume the internal auditor for the merged enterprise concludes that inventory fraud is the most reasonable explanation of the observed data. Which of the following engagement procedures will provide the most persuasive information that fraud is taking place? A. Use an integrated test facility (ITF) to compare individual sales transactions with test transactions submitted through the ITF. Investigate all differences. B. Interview the three individual store managers to determine if their explanations about the observed differences are the same. Compare their explanations with those of the section manager. C. Schedule a surprise physical inventory. Investigate areas of inventory shrinkage. D. Take a sample of individual store prices and compare them with the sales entered on the cash register for the same items.
C. *Correct Answer* Taking a surprise physical inventory is a highly effective way to uncover inventory fraud. This procedure prevents the suspected wrongdoers from concealing irregularities. Variances between amounts on hand and recorded quantities should be investigated.
[ 10 ] If an internal auditor is interviewing three individuals, one of whom is suspected of committing a fraud, which of the following is the least effective approach? A. Ask each individual to prepare a written statement explaining the individual's actions. B. Take the role of one seeking the truth. C. Listen carefully to what each interviewee has to say. D. Attempt to get the suspected individual to confess.
D. *Correct Answer* Because of the legal hazards and their lack of expertise in criminal interrogation, internal auditors should often defer to security specialists. An attempt to obtain a confession is threatening, contrary to the presumption of innocence, and not likely to gain the confidence of the interviewee.
[ 8 ] Which of the following is an indicator of increased risk of fraud? The controller A. Takes all vacations and has just accepted a promotion to vice president of finance. B. Takes no vacations and has just accepted a promotion to vice president of finance. C. Takes all vacations and has refused promotion to vice president of finance. D. Takes no vacations and has refused promotion to vice president of finance.
D. *Correct Answer* Sawyer, in Sawyer's Internal Auditing (p. 1018), states that "refusing to take vacations and shunning promotions" may indicate a fear of detection. The apparent lack of ambition is inconsistent with the controller's diligence.
[ 13 ] A production manager for a moderate-sized manufacturer began ordering excessive raw materials and had them delivered to a wholesale business that the manager was running on the side. The manager falsified receiving documents and approved the invoices for payment. Which of the following procedures is most likely to detect this fraud? A. Take a sample of cash disbursements; compare purchase orders, receiving reports, invoices, and check copies. B. Take a sample of cash disbursements; confirm the amount purchased, purchase price, and date of shipment with the vendors. C. Observe the receiving dock and count materials received; compare the counts with receiving reports completed by receiving personnel. D. Perform analytical tests, comparing production, materials purchased, and raw materials inventory levels; investigate differences.
D. *Correct Answer* The application of analytical procedures is based on the premise that, in the absence of known conditions to the contrary, relationships among information may reasonably be expected to exist and continue. Hence, the analytical procedures should identify an unexplained increase in materials used.
[ 6 ] The following are facts about a subsidiary: 1. The subsidiary has been in business for several years and enjoyed good profit margins although the general economy was in a recession, which affected competitors. 2. The working capital ratio has declined from a healthy 3:1 to 0.9:1. 3. Turnover for the last several years has included three controllers, two supervisors of accounts receivable, four payables supervisors, and numerous staff in other financial positions. 4. Purchasing policy requires three bids. However, the supervisor of purchasing at the subsidiary has instituted a policy of sole-source procurement to reduce the number of suppliers. When conducting a financial audit of the subsidiary, the internal auditor should A. Most likely not detect 1, 2, or 3. B. Ignore 2 since the economy had a downturn during this period. C. Consider 3 to be normal turnover, but be concerned about 2 and 4 as warning signals of fraud. D. Consider 1, 2, 3, and 4 as warning signals of fraud.
D. *Correct Answer* The fact that the organization has reported high profits when competitors have not may indicate a material misstatement in the financial statements. Insufficient working capital may indicate such problems as over-expansion, decreases in revenues, transfers of funds to other organizations, insufficient credit, and excessive expenditures. The internal auditor should be alert for the diversion of funds for personal use through such methods as unrecorded sales and falsified expenditures. Rapid turnover in financial positions may signify existing problems with which the individuals feel uncomfortable but that they do not want to disclose. Accountability for funds and other resources should be determined upon termination of employment. Use of sole-source procurement does not encourage competition to ensure that the organization is obtaining the required materials or equipment at the best price. Sole-source procurement, if not adequately justified, indicates potential favoritism or kickbacks.
[ 20 ] An internal auditor becomes concerned that fraud, in the form of payments to bogus entities, may exist. Buyers, who are responsible for all purchases for specific product lines, are able to approve expenditures up to US $50,000 without any other approval. Which of the following procedures would be most effective in addressing the internal auditor's concerns? A. Use generalized audit software to list all purchases over US $50,000 to determine whether the expenditures were properly approved. B. Develop a "snapshot" technique to trace all transactions by suspected buyers. C. Use generalized audit software to take a random sample of all expenditures under US $50,000 to determine whether the expenditures were properly approved. D. Use generalized audit software to list all major vendors by product line; select a sample of paid invoices to new vendors and examine information indicating that services or goods were received.
D. *Correct Answer* The primary use of generalized audit software (GAS) is to select, sort, and summarize a client's records for additional testing. These packages allow the internal auditor to exploit the computer to examine many more records than otherwise possible with far greater speed and accuracy. Examining a sample of paid invoices to new vendors and searching for indications that goods or services were actually received could reveal fraudulent invoices.
[ 11 ] Fraudulent use of the organization's credit cards is minimized by which of the following internal control procedures? A. Establishing an organizational policy on the issuance of credit cards to authorized employees. B. Reviewing the validity of credit card need at executive and operating levels on a periodic basis. C. Reconciling the monthly statement from the credit card issuer with the submitted copies of the cardholder's charge slips. D. Subjecting credit card charges to the same expense controls as those used on regular organizational expense forms.
D. *Correct Answer* The problem of charging the organization for unauthorized expenditures is the same for any type of expense account, whether credit card or cash. Thus, normal expense controls should preclude credit card fraud by employees.