Auditing Chapter 5

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. Correct

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.

a. Correct

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

b. Correct "People" is the most important fundamental component.

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

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. Correct This is a preventive control.

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

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. Correct The cost savings of substantive testing exceeds the control evaluation cost.

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. Correct A disclaimer is used when the auditor's scope is limited but not when significant deficiencies exist, so it is not an appropriate report.

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. Correct AS 5 applies to financial reporting controls only.

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

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.

Correct 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.

Which of the following statements is not true with respect to the auditors' report on internal control over financial reporting? a. The report will be dated as of the date of the financial statements. b. The report will express an opinion on the effectiveness of internal control over financial reporting. c. The auditor will issue an adverse opinion if one or more material weaknesses exist. d. The report may be presented with the report on the entity's financial statements as a combined report.

a. Correct The report would be dated as of the day that enough evidence has been gathered to support the auditors' opinion on the effectiveness of the entity's internal control.

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. Correct 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.

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's 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. Correct 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.

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 further audit tests to be performed. 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. Correct These are the auditors' responsibilities under GAAS.

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. Correct This is one way to describe the purpose of a transaction-level control activity.

When completing the audit of internal controls for a public company, AS 5 requires auditors to 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. Correct AS 5 requires auditors to issue a report on the audit of internal controls.

When completing the audit of internal controls for a public company, AS 5 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. Correct AS 5 requires testing for both design effectiveness and operating effectiveness.

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 reasonably possible that a material misstatement would not be detected on a timely basis. d. It is reasonably possible that an immaterial misstatement would not be detected on a timely basis.

c. Correct 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.

Which of the following information would be included in the introductory paragraph of the auditors' report on internal control over financial reporting if the report is presented separately from the auditors' report on the entity's financial statements? a. The fact that the auditors conducted an audit of the entity's financial statements. b. The definition of a material weakness in internal control over financial reporting. c. Statements identifying the responsibility of the auditors and management for internal control over financial reporting. d. A reference to the auditors' report and opinion on the entity's financial statements.

c. Correct Statements identifying the responsibility of the auditor and management for internal control over financial reporting would be included in the introductory paragraph.

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. Correct This is a substantive test, not a test of a control's operating effectiveness.

When completing the audit of internal controls for an issuer, the severity of an internal control deficiency depends on: a. Whether there is a reasonable possibility that the company's controls will fail to prevent or detect a misstatement of an account balance or disclosure. b. Whether the account has a history of errors. c. The magnitude of the potential misstatement resulting from the deficiency or the deficiencies. d. Both a and c are correct. e. All of the above are correct.

d. Correct Both (a) and (c) are factors.

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. Correct Performing procedures at an interim date is less effective.

Which of the following does not accurately summarize auditors' requirements regarding internal control? Public Entity Nonpublic Entity a. Understanding Yes Yes b. Documenting Yes Yes c. Evaluating control risk Yes Yes d. Test Controls Yes Yes

d. Correct Testing controls is required only for audits of public companies under AS 5.

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. Correct Tests of controls produce the evidence about actual operation of company control activities.

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. Correct 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.

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. Correct This does not directly relate to a material misstatement of the financial statements but is an operational issue.

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. 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.