CHAPTER 10
1) Which of the following is responsible for establishing a private company's internal control? A) Senior Management B) Internal Auditors C) FASB D) Audit committee
A
10) Before making the final assessment of internal control at the end of an integrated audit, the auditor must: A) Test controls Perform substantive tests of details Yes Yes B) Test controls Perform substantive tests of details No No C) Test controls Perform substantive tests of details Yes No D) Test controls Perform substantive tests of details No Yes
A
11) In performing the audit of internal control over financial reporting the auditor emphasizes internal control over class of transactions because: A) the accuracy of accounting system outputs depends heavily on the accuracy of inputs and processing. B) the class of transaction is where most fraud schemes occur. C) account balances are less important to the auditor then the changes in the account balances. D) classes of transactions tests are the most efficient manner to compensate for inherent risk.
A
15) The Sarbanes-Oxley Act requires: A) all public companies to issue reports on internal controls. B) all public companies to define adequate internal controls. C) the auditor of public companies to design effective internal controls. D) the auditor of public companies to withdraw from an engagement if internal controls are weak.
A
16) The financial statements may not correctly reflect accounting frameworks such as GAAP or IFRS if the: A) controls affecting the reliability of financial reporting are inadequate. B) company's controls do not promote efficiency. C) company's controls do not promote effectiveness. D) company's controls do not promote compliance with applicable rules and regulations.
A
16) When a compensating control exists, the absence of a key control: A) is no longer a concern because there is no longer a significant deficiency or material weakness. B) is still a major concern to the auditor. C) could cause a material loss, so it must be tested using substantive procedures. D) is magnified and must be removed from the sampling process and examined in its entirety.
A
17) The primary emphasis by auditors is on controls over: A) classes of transactions. B) account balances. C) both A and B, because they are equally important. D) both A and B, because they vary from client to client.
A
2) The purpose of phase 3 in the "process for understanding internal control and assessing control risk" is to: A) design, perform and evaluate tests of controls. B) obtain and document an understanding of internal control design an operation. C) assess control risk. D) decide planned detection risk and substantive tests.
A
2) Which of the following components of the control environment define the existing lines of responsibility and authority? A) Organizational structure B) Management philosophy and operating style C) Human resource policies and practices D) Management integrity and ethical values
A
20) Reasonable assurance allows for: A) low likelihood that material misstatements will not be prevented or detected by internal controls. B) no likelihood that material misstatements will not be prevented or detected by internal control. C) moderate likelihood that material misstatements will not be prevented or detected by internal control. D) high likelihood that material misstatements will not be prevented or detected by internal control.
A
21) To obtain an understanding of an entity's control environment, an auditor should concentrate on the substance of management's policies and procedures rather than their form because: A) management may establish appropriate policies and procedures but not act on them. B) the board of directors may not be aware of management's attitude toward the control environment. C) the auditor may believe that the policies and procedures are inappropriate for that particular entity. D) the policies and procedures may be so weak that no reliance is contemplated by the auditor.
A
21) Which of the following is most correct regarding the requirements under Section 404 of the Sarbanes Oxley Act? A) The audits of internal control and the financial statements provide reasonable assurance as to misstatements. B) The audit of internal control provides absolute assurance of misstatement. C) The audit of financial statements provides absolute assurance of misstatement. D) The audits of internal control and the financial statements provide absolute assurance as to misstatements.
A
3) The employee in charge of authorizing credit to the company's customers does not fully understand the concept of credit risk. This lack of knowledge would constitute: A) a deficiency in operation of internal controls. B) a deficiency in design of internal controls. C) a deficiency of management. D) not constitute a deficiency.
A
3) Which of the following factors may increase risks to an organization? A) Geographic dispersion of company operations Presence of new information technologies Yes Yes B) Geographic dispersion of company operations Presence of new information technologies No No C) Geographic dispersion of company operations Presence of new information technologies Yes No D) Geographic dispersion of company operations Presence of new information technologies No Yes
A
4) Internal controls are not designed to provide reasonable assurance that: A) all frauds will be detected. B) transactions are executed in accordance with management's authorization. C) the company's resources are used efficiently and effectively. D) company personnel comply with applicable rules and regulations.
A
4) When assessing whether the financial statements are auditable, the auditor must consider: A) that the integrity of management and the adequacy of accounting records are the two primary factors determining auditability. B) that the integrity of management and the adequacy of risk management are the two primary factors determining auditability. C) that if all of the transaction information is available only in electronic form without a visible audit trail, the company cannot be audited. D) the control risk before determining if the entity is auditable.
A
4) Which of the following parties provides an assessment of the effectiveness of internal control over financial reporting for public companies? A) Management Financial statement auditors Yes Yes B) Management Financial statement auditors No No C) Management Financial statement auditors Yes No D) Management Financial statement auditors No Yes
A
5) An act of two or more employees to steal assets and cover their theft by misstating the accounting records would be referred to as: A) collusion. B) a material weakness. C) a control deficiency. D) a significant deficiency.
A
5) Once auditors determine that entity level controls are designed and placed in the operation they: A) make a preliminary assessment for each transaction-related audit objective for each major type of transaction. B) make a preliminary assessment of control risk. C) obtain an understanding of the design and implementation of internal control. D) prepare audit documentation in order to opine on the company's internal control system.
A
6) Sarbanes-Oxley requires management to issue an internal control report that includes two specific items. Which of the following is one of these two requirements? A) A statement that management is responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting B) A statement that management and the board of directors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting C) A statement that management, the board of directors, and the external auditors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting D) A statement that the external auditors are solely responsible
A
6) Section 404 of the Sarbanes-Oxley Act requires that public companies issue an internal control report. A) True B) False
A
6) Which of the following is the correct definition of "control deficiency"? A) A control deficiency exists if the design or operation of controls does not permit company personnel to prevent or detect misstatements on a timely basis. B) A control deficiency exists if one or more deficiencies exist that adversely affect a company's ability to prepare external financial statements reliably. C) A control deficiency exists if the design or operation of controls results in a more than remote likelihood that controls will not prevent or detect misstatements. D) A control deficiency exists if the design or operation of controls results in a more than probable likelihood that controls will prevent or detect misstatements.
A
7) Management has a legal and professional responsibility to be sure that the financial statements are prepared in accordance with reporting requirements of applicable accounting frameworks. A) True B) False
A
8) To determine if significant internal control deficiencies are material weaknesses, they must be evaluated on their: A) Likelihood Significance Yes Yes B) Likelihood Significance No No C) Likelihood Significance Yes No D) Likelihood Significance No Yes
A
1) If the results of tests of controls support the design and operations of controls as expected, the auditor uses ________ control risk as the preliminary assessment. A) a lower B) the same C) a higher D) either a lower or higher
B
1) The person responsible for reconciling sales invoices to customer orders does not access to the company's master price list in order to correctly compute sales. This is an example of a(n): A) operating deficiency. B) design deficiency. C) training deficiency. D) management deficiency.
B
1) Which of the following activities would be least likely to strengthen a company's internal control? A) Separating accounting from other financial operations B) Maintaining insurance for fire and theft C) Fixing responsibility for the performance of employee duties D) Carefully selecting and training employees
B
10) An audit procedure that would most likely be used by an auditor in performing tests of control procedures in which the segregation of functions and that leaves no "audit" trail is: A) inspection. B) observation. C) reperformance. D) reconciliation.
B
11) Internal controls normally include procedures designed to provide reasonable assurance that: A) employees act with integrity when performing their assigned tasks. B) transactions are executed in accordance with management's authorization. C) decision processes leading to management's authorization of transactions are sound. D) collusive activities would be detected by segregation of employee duties.
B
12) Significant deficiencies are matters that come to an auditor's attention and should be communicated to an entity's audit committee because they represent: A) material frauds perpetrated by high-level management. B) internal control deficiencies that could adversely affect a company's ability to initiate, record, process, or report external financial statements reliably. C) flagrant violations of the entity's documented conflict-of-interest policies. D) intentional attempts by client personnel to limit the scope of the auditor's field work.
B
13) How must significant deficiencies and material weaknesses be communicated to those charged with governance? A) Either oral or written communication is acceptable. B) Oral communication is required. C) Written communication is required. D) Written communication is required for material weaknesses, but oral communication is allowed for significant deficiencies.
B
13) It is important for the CPA to consider the competence of the clients' personnel because their competence has a direct impact upon the: A) cost/benefit relationship of the system of internal control. B) achievement of the objectives of internal control. C) comparison of recorded accountability with assets. D) timing of the tests to be performed.
B
13) When considering internal controls, an important point to consider is that: A) auditors can ignore controls affecting internal management information. B) auditors are concerned with the client's internal controls over the safeguarding of assets if they affect the financial statements. C) management is responsible for understanding and testing internal control over financial reporting. D) companies must use the COSO framework to establish internal controls.
B
14) Proper segregation of functional responsibilities calls for separation of: A) authorization, execution, and payment. B) authorization, recording, and custody. C) custody, execution, and reporting. D) authorization, payment, and recording.
B
19) When a company designs and implements internal controls, cost of the controls is not a valid consideration. A) True B) False
B
2) When auditing a private company, the auditor should obtain an understanding of internal control sufficient to: A) provide reasonable protection against client fraud and defalcations by client employees. B) assess control risk. C) provide a basis for suggestions to the client for improving the accounting system. D) provide a method for safeguarding assets, checking the accuracy and reliability of accounting data, promoting operational efficiency, and encouraging adherence to prescribed managerial policies.
B
2) Which of management's assertions with respect to implementing internal controls is the auditor primarily concerned? A) Efficiency of operations B) Reliability of financial reporting C) Effectiveness of operations D) Compliance with applicable laws and regulations
B
2) You are performing the audit of internal control for Clifton Company. Which of the following would represent a material weakness in internal control? A) The company's audit committee has experienced unusual turnover of members. B) The company's CFO was indicted for embezzling from the company. C) Bank reconciliations are done monthly. D) The CEO retired after twenty years of service to the company.
B
3) Internal controls: A) are implemented by and are the responsibility of the auditors. B) consist of policies and procedures designed to provide reasonable assurance that the company achieves its objectives and goals. C) guarantee that the company complies with all laws and regulations. D) only apply to SEC companies.
B
3) Narratives, flowcharts, and internal control questionnaires are three common methods of: A) testing the internal controls. B) documenting the auditor's understanding of internal controls. C) designing the audit manual and procedures. D) documenting the auditor's understanding of a client's organizational structure.
B
4) The auditor's consideration of a private company's internal control is: A) required by GAAP. B) required by GAAS. C) required by the IRS. D) recommended by the SEC.
B
4) When dealing with the documentation of internal control: A) in a narrative, most questions simply require a "yes" or "no" response. B) questionnaires offer useful checklists to remind the auditor of the many different types of internal controls that should exist. C) questionnaires and flowcharts should not be used together. D) flowcharts fail to show the segregation of duties in the company.
B
4) Which of the following statements is most correct with respect to separation of duties? A) A person who has temporary or permanent custody of an asset should account for that asset. B) Employees who authorize transactions should not have custody of related assets. C) Employees who open cash receipts should record the amounts in the subsidiary ledgers. D) Employees who authorize transactions should have recording responsibility for these transactions.
B
5) Authorizations can be either general or specific. Which of the following is not an example of a general authorization? A) Automatic reorder points for raw materials inventory B) A sales manager's authorization for a sales return C) Credit limits for various classes of customers D) A sales price list for merchandise
B
6) Which of the following is most correct for audits of non-public companies? A) An audit of internal control is required. B) An audit of internal control is not required. C) An audit of the design of internal controls is required. D) An audit of the operational effectiveness of internal controls is required.
B
8) Which of the following deal with ongoing or periodic assessment of the quality of internal control by management? A) Quality monitoring activities B) Monitoring activities C) Oversight activities D) Management activities
B
9) The auditor must communicate: A) only material weaknesses in internal control to those charged with governance. B) both significant deficiencies and material weaknesses in internal control to those charged with governance. C) any significant deficiencies in internal control to those charged with governance using a management letter. D) issues regarding internal control to those charged with governance in writing within 90 days following the audit report release.
B
9) The auditors primary purpose in auditing the client's system of internal control over financial reporting is: A) to prevent fraudulent financial statements from being issued to the public. B) to evaluate the effectiveness of the company's internal controls over all relevant assertions in the financial statements. C) to report to management that the internal controls are effective in preventing misstatements from appearing on the financial statements. D) to efficiently conduct the Audit of Financial Statements.
B
1) When the auditor attempts to understand the operation of the accounting system by tracing a few transactions through the accounting system, the auditor is said to be: A) tracing. B) vouching. C) performing a walk-through. D) testing controls.
C
10) Management must disclose material weaknesses in internal control in its audit report: A) whenever the weakness is deemed significant to a single class of transactions. B) whenever the weakness is significant to overall financial reporting objectives. C) if the weakness exists at the end of the year. D) only if the auditor identifies the weakness as significant.
C
11) Significant deficiencies and material weaknesses in internal control of a public company must be reported in writing to which of the following? A) Public Company Accounting Oversight Board B) Members of management who are responsible for the related area of the company C) Audit committee of the company's board of directors and to management D) AICPA
C
12) Which of the following is not one of the subcomponents of the control environment? A) Management's philosophy and operating style B) Organizational structure C) Adequate separation of duties D) Commitment to competence
C
15) When assessing control risk: A) many auditors use actuarial tables to assist in the control risk assessment process. B) each control can be used to satisfy only one audit objective. C) many auditors use a control risk matrix to assist in the control risk assessment process. D) all controls, including key controls, should be considered.
C
15) Without an effective ________, the other components of the COSO framework are unlikely to result in effective internal control, regardless of their quality. A) risk assessment policy B) monitoring policy C) control environment D) system of control activities
C
16) Which of the following groups establishes and maintains the company's internal controls? A) Internal auditors B) Board of Directors C) Management D) Audit committee
C
17) If a company has an effective internal audit department: A) the internal auditors can express an opinion on the fairness of the financial statements. B) their work cannot be used by the external auditors per PCAOB Standard 5. C) it can reduce external audit costs by providing direct assistance to the external auditors. D) the internal auditors must be CPAs in order for the external auditors to rely on their work.
C
18) An auditor should consider two key issues when obtaining an understanding of a client's internal controls. These issues are: A) the effectiveness and efficiency of the controls. B) the frequency and effectiveness of the controls. C) the design and operating effectiveness of the controls. D) the implementation and operating effectiveness of the controls.
C
2) Two key concepts that underlie management's design and implementation of internal control are: A) costs and materiality. B) absolute assurance and costs. C) inherent limitations and reasonable assurance. D) collusion and materiality.
C
22) To issue a report on internal control over financial reporting for a public company, an auditor must: A) evaluate management's assessment process. B) independently assess the design and operating effectiveness of internal control. C) evaluate management's assessment process and independently assess the design and operating effectiveness of internal control. D) test controls over significant account balances.
C
3) In the audit of a private company, the auditor will test internal controls when control risk is initially assessed at: A) Low Moderate High Yes No Yes B) Low Moderate High No No Yes C) Low Moderate High Yes Yes No D) Low Moderate High No Yes No
C
3) The PCAOB places responsibility for the reliability of internal controls over the financial reporting process on: A) the company's board of directors. B) the audit committee of the board of directors. C) management. D) the CFO and the independent auditors.
C
3) Which of the following represents a correct statement regarding internal control testing? A) When auditors plan to use evidence about the operating effectiveness of internal control contained in prior audits, auditing standards require tests of the controls' effectiveness at least every other year. B) The greater the risk, the less audit evidence the auditor should obtain that controls are operating effectively. C) The auditor uses control risk assessment and results of tests of controls to determine planned detection risk and the related substantive tests for the financial statement audit. D) Testing of internal controls can only be performed by the auditor at the end of the fiscal year.
C
5) Audit evidence regarding the separation of duties is normally best obtained by: A) preparing flowcharts of operational processes. B) preparing narratives of operational processes. C) observation of employees applying control activities. D) inquiries of employees applying control activities.
C
5) Which of the following may represent the biggest challenge smaller public companies face in implementing effective internal control? A) A lack of expertise B) Reduced importance C) Limited resources D) Limited available guidance
C
7) When management is evaluating the design of internal control, management evaluates whether the control can do which of the following? A) Detect material misstatements Correct material misstatements Yes Yes B) Detect material misstatements Correct material misstatements No No C) Detect material misstatements Correct material misstatements Yes No D) Detect material misstatements Correct material misstatements No Yes
C
7) Which of the following best describes the purpose of control activities? A) The actions, policies and procedures that reflect the overall attitudes of management B) The identification and analysis of risks relevant to the preparation of financial statements C) The policies and procedures that help ensure that necessary actions are taken to address risks to the achievement of the entity's objectives D) Activities that deal with the ongoing assessment of the quality of internal control by management
C
7) Which of the following deficiency exists if a necessary control is missing or not properly formulated? A) Control B) Significant C) Design D) Operating
C
8) When one material weakness is present at the end of the year, management of a public company must conclude that internal control over financial reporting is: A) insufficient. B) inadequate. C) ineffective. D) inefficient.
C
1) A control available in a small company, which may be necessitated because of lack of competent personnel, is: A) a wider segregation of duties. B) a voucher system. C) fewer transactions to process. D) the owner-manager's direct involvement in the control process.
D
1) When determining what type of report to issue on internal control under Section 404: A) an adverse opinion on internal control must be given if any weaknesses in a key internal control is discovered. B) a scope limitation requires the auditor to disclaim an opinion on internal controls. C) if the auditor gives a qualified opinion on the financial statements, they must give a qualified opinion on internal controls. D) a scope limitation requires the auditor to express a qualified opinion or a disclaimer of opinion on internal controls.
D
1) Which of the following is not one of the three primary objectives of effective internal control? A) Reliability of financial reporting B) Efficiency and effectiveness of operations C) Compliance with laws and regulations D) Assurance of elimination of business risk
D
12) Internal controls can never be regarded as completely effective. Even if company personnel could design an ideal system, its effectiveness depends on the: A) adequacy of the computer system. B) proper implementation by management. C) ability of the internal audit staff to maintain it. D) competency and dependability of the people using it.
D
14) A five-step approach can be used to identify deficiencies, significant deficiencies, and material weaknesses. The first step in this approach is: A) identify the absence of key controls. B) consider the possibility of compensating controls. C) determine potential misstatements that could result. D) identify existing controls.
D
14) Of the following statements about internal controls, which one is least likely to be correct? 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) Control procedures reasonably ensure that collusion among employees cannot occur.
D
18) To promote operational efficiency, the internal audit department would ideally report to: A) line management. B) PCAOB. C) Chief Accounting Officer. D) audit committee.
D
19) Hanlon Corp. maintains a large internal audit staff that reports directly to the accounting department. Audit reports prepared by the internal auditors indicate that the system is functioning as it should and that the accounting records are reliable. An independent auditor will probably: A) eliminate tests of controls. B) increase the depth of the study and evaluation of administrative controls. C) avoid duplicating the work performed by the internal audit staff. D) place limited reliance on the work performed by the internal audit staff.
D
2) An auditor is likely to use four types of procedures to support the operating effectiveness of internal controls. Which of the following would generally not be used? A) Make inquiries of appropriate client personnel B) Examine documents, records, and reports C) Reperform client procedures D) Inspect design documents
D
20) External financial statement auditors must obtain evidence regarding what attributes of an internal audit (IA) department if the external auditors intend to rely on IA's work? A) Integrity B) Objectivity C) Competence D) All of the above
D
6) Which of the following is correct with respect to the design and use of business documents? A) The documents should be in paper format. B) Documents should be designed for a single purposes to avoid confusion in their use. C) Documents should be designed to be understandable only by those who use them. D) Documents should be prenumbered consecutively to facilitate control over missing documents.
D
9) Which of the following best describes an entity's accounting information and communication system? A) Monitor transactions Record and process transactions Initiate transactions Yes Yes Yes B) Monitor transactions Record and process transactions Initiate transactions No No No C) Monitor transactions Record and process transactions Initiate transactions Yes No No D) Monitor transactions Record and process transactions Initiate transactions No Yes Yes
D