Deck 8: Internal Control and Control Risk

Question 1

Effective internal control in a small company that has an insufficient number of employees to permit proper division of responsibilities can BEST be enhanced by:

A) employment of temporary personnel to aid in the separation of duties.
B) engaging a public accountant to perform monthly 'write- up' work.
C) direct participation by the owner of the business in the record- keeping activities of the business.
D) delegation of full, clear- cut responsibility to each employee for the functions assigned to each.

Answer 1

C

Question 2

Which one of the following is NOT a component of an entity's internal control?

A) Control risk
B) The control environment
C) The accounting system
D) Control procedures

Answer 2

A

Question 3

An auditor will use an internal control questionnaire as a means to:

A) assess control risk.
B) evaluate internal controls in place in an accounting system.
C) understand the internal controls procedures for an accounting system.
D) highlight inadequate aspects of internal control.

Answer 3

D

Question 4

Once an understanding of the client's internal control is obtained that is sufficient for audit planning, then the auditor must first assess:

A) whether the financial statements are auditable.
B) the level of control risk supported by the understanding obtained.
C) the level of control risk.
D) whether a lower level of control risk could be supported.

Question 5

The documents of a client company must be adequate to provide assurance that all assets are properly controlled and all transactions are correctly recorded.

A) qualitative
B) sufficient appropriate
C) absolute
D) reasonable

Question 6

The procedures for proper record- keeping should be spelled out in:

A) run manuals.
B) minutes of the board of directors.
C) the corporate bylaws.
D) systems manuals.

Question 7

Which of the following is not an inherent limitation of internal controls?

A) Management overriding a control
B) Misunderstanding of instructions
C) Collusion by employees
D) Inappropriate assessment of the effectiveness of internal controls

Question 8

An internal control dictates that prices on sales invoices are verified with a standard price list by client personnel. Which of the following procedures provides the greatest assurance that this control is operating effectively?

A) Examining the invoices for signatures
B) Inquiry
C) Reperformance
D) Observation

Question 9

If evidence was obtained in the prior year's audit that indicates a key control was operating effectively:

A) the tests of that control will be reduced this year.
B) the auditor would not test this area again this year.
C) it will be unnecessary to test that control this year.
D) the extent of tests of that control may be reduced this year if the auditor determines that it is still in place.

Question 10

Tests of controls are conducted when:

A) control risk may be higher than the initial assessment.
B) the auditor determines that substantive testing is not effective.
C) controls are expected to be operating effectively.
D) controls are not operating as effectively as initially assessed.

Question 11

The auditor need NOT be concerned with all three areas of internal control that apply to management. The auditor's primary concerns are with the system's ability to:

A) ensure reliability of financial reporting.
B) provide reliable data and promote efficiency.
C) promote efficiency and encourage adherence to policy.
D) provide reliable data, safeguard assets and comply with the Corporations Act.

Question 12

Which of the following is NOT typically one of management's concerns in designing effective internal controls?

A) Efficiency and effectiveness of operations
B) Obtaining the best internal control system possible
C) Compliance with applicable laws and regulations
D) Reliability of financial reporting

Question 13

Proper segregation of functional responsibilities calls for separation of the functions of:

A) authorisation, payment and recording.
B) authorisation, recording and custody.
C) custody, execution and reporting.
D) authorisation, execution and payment.

Question 14

A system of internal accounting control normally would include procedures that are designed to provide reasonable assurance that:

A) transactions are executed in accordance with management's general or specific authorisation.
B) employees act with integrity when performing their assigned tasks.
C) unusual transactions are accurately recorded.
D) collusive activities would be detected by segregation of employee duties.

Question 15

Often, for efficiency, the auditor will ignore internal controls. This can occur because:

A) detection risk is low.
B) it is a small entity.
C) control risk is assumed to be maximum.
D) all of the above

Question 16

Monitoring activities in an internal control structure determines that:

A) auditing procedures are to be restricted.
B) external audit assurance is no longer necessary.
C) improvements in internal control are overdue.
D) controls are operating as intended.

Question 17

The auditor considers internal control by 4 steps. What is the order for these steps? 1. Obtain an understanding of internal control.
2) Assess control risk.
3) Perform tests of controls.
4) Decide on planned detection risk and substantive testing.

A) 4, 1, 2, 3
B) 1, 2, 3, 4
C) 1, 3, 2, 4
D) 2, 1, 3, 4

Question 18

A transaction walk- through involves:

A) reviewing the process of recording transactions.
B) reviewing and evaluating the client's accounting processes.
C) tracing a sample of documents through the accounting process.
D) touring the client's plant and operations.

Question 19

The primary emphasis by auditors is on controls over:

A) account balances.
B) classes of transactions.
C) both A and B, because they are equally weighted.
D) both A and B, because they vary from client to client.

Question 20

Which of the following is NOT an objective of management in designing internal control systems?

A) Compliance with applicable laws and regulations
B) Efficient and effective use of resources
C) Reliable financial reporting
D) Reducing control risk

Question 21

Significant deficiencies in internal control are first communicated by auditors to the:

A) Australian Securities Industry Commission (ASIC).
B) board of directors.
C) chief executive officer.
D) audit committee.

Question 22

When the auditor's assessment of control risk is below maximum:

A) detection risk is set as high.
B) the auditor reevaluates control risk.
C) the auditor predominately performs substantive tests.
D) the auditor performs tests of controls.

Question 23

The study of the client's internal control by the auditor is:

A) recommended by the Corporations Act.
B) required by auditing standards.
C) required by accounting standards.
D) required by the ASX for listed companies.

Question 24

Reportable conditions are matters that come to an auditor's attention, which should be communicated to an entity's audit committee because they represent:

A) significant deficiencies in the design or operation of the internal controls.
B) intentional attempts by client personnel to limit the scope of the auditor's field work.
C) flagrant violations of the entity's documented conflict- of- interest policies.
D) material irregularities or illegal acts perpetrated by high- level management.

Question 25

The reason to prevent those who authorise transactions from having control over the related asset is to protect the company primarily against:

A) defalcation.
B) error.
C) non- compliance with accounting standards.
D) unbiased information.

Question 26

A major control available in a small company, which might not be feasible in a large company, is:

A) fewer transactions to process.
B) a voucher system.
C) a wider segregation of duties.
D) the owner- manager's personal interest and close relationship with the personnel.

Question 27

A well- designed system of management risk assessment is likely to help management identify the:

A) risks of ineffective audit procedures.
B) risks of making a loss for the year.
C) risks of being over- audited.
D) risks relevant to the preparation of appropriate financial statements.

Question 28

The most important aspect of any system of controls is:

A) regular review by top management.
B) competent trustworthy personnel.
C) proper authorisation procedures.
D) separation of duties.

Question 29

When a compensating control exists, a deficiency in the system:

A) is reduced but not removed; therefore, it is still of concern to the auditor.
B) is no longer a concern because the potential for misstatement has been sufficiently reduced.
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.

Question 30

It is important for the auditor to consider the competence of the audit client's employees because their competence bears directly and importantly upon the:

A) cost/benefit relationship of the system of internal control.
B) timing of the tests to be performed.
C) achievement of the objectives of the system of internal control.
D) comparison of recorded accountability with assets.

Question 31

Each key control that the auditor intends to rely on must be supported by sufficient:

A) analytical review procedures.
B) tests of transactions.
C) tests of controls.
D) reperformance procedures.

Question 32

Internal control comprises the plan of the organisation and the procedures and records that are concerned with:

A) authorisation of transactions.
B) reliability of statistical data.
C) decision processes of management.
D) achievement of the company's objectives and goals.

Question 33

Management's integrity and ethical values include:

A) codes of conduct.
B) communication of entity values and behavioural standards to personnel through policy statements.
C) management's actions to reduce incentives for dishonest acts.
D) all of the above

Question 34

Certain relevant principles dictate the proper design and use of documents and records. Which one is NOT correct? Documents and records should be:

A) sufficiently simple to ensure they are clearly understood.
B) prenumbered consecutively.
C) designed for multiple use.
D) prepared at some time after a transaction takes place.

Question 35

Authorisations can be either general or specific. Which one of the following is NOT an example of a general authorisation?

A) Automatic reorder points for raw materials inventory
B) A sales price list for merchandise
C) Credit limits for various classes of customers
D) A sales manager's authorisation for a sales return

Question 36

The financial statements are NOT likely to correctly reflect applicable accounting standards if:

A) the company's controls do not promote effectiveness.
B) the company's controls do not promote efficiency.
C) the controls affecting the reliability of financial reporting are inadequate.
D) all of the above

Question 37

When two or more employees act together to misstate accounting records, they have committed what is referred to as:

A) a felony.
B) collusion.
C) defalcation.
D) malfeasance.

Question 38

Which one of the following is NOT a control related to safeguarding IT equipment, programs and data files?

A) Backup and recovery procedures
B) Automated internal verification procedures
C) Physical controls
D) Access controls

Question 39

A procedure that would most likely be used by an auditor in performing tests of control procedures that involve segregation of functions and that leave no transaction trail is:

A) observation.
B) reconciliation.
C) inspection.
D) reperformance.

Question 40

When controls leave no documentary evidence or trail:

A) it is impossible to verify them, so the auditor will have to rely on substantive tests.
B) it is impossible to audit that area of client's system.
C) the only thing available as verification of their effectiveness is inquiry of management.
D) the auditor generally observes them being applied.

Question 41

The control environment consists of the actions, policies and procedures that reflect the overall attitudes towards internal control of:

A) owners.
B) directors.
C) top management.
D) all of the above

Question 42

Which one of the following BEST describes the inherent limitations that should be recognised by an auditor when considering the potential effectiveness of a system of internal accounting control?

A) Procedures whose effectiveness depends on segregation of duties can be circumvented by collusion.
B) The competence and integrity of client personnel provides an environment conducive to accounting control and provides assurance that effective control will be achieved.
C) The benefits expected to be derived from effective internal accounting control usually do not exceed the costs of such control.
D) Procedures designed to assure the execution and recording of transactions in accordance with proper authorisations are effective against irregularities perpetrated by management.

Question 43

Which one of the following statements regarding auditor documentation of the client's internal controls is correct?

A) Documentation must include procedural write- ups.
B) Documentation must include flowcharts.
C) No documentation is necessary, although it is desirable.
D) No one particular form of documentation is necessary, and the extent of documentation may vary.

Question 44

Most audits of a company are done annually by the same audit firm. Except for initial engagements, the auditor begins the audit with a great deal of information about the client's internal controls developed in prior years. Because systems and controls usually don't change frequently:

A) it eases the burden on the auditor's requirement to do a complete study of the controls this year.
B) it is sufficient for the auditor just to inquire of the client whether the controls have been changed since last year.
C) the auditor can skip the evaluation of this area on repeat engagements.
D) this information can be updated and carried forward to the current year's audit.

Question 45

The procedures to test effectiveness of control policies and procedures in support of a lower assessment of control risk are called:

A) analytical tests.
B) tests of controls.
C) a walk- through.
D) tests of transactions.

Question 46

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 the client's organisational structure.

Question 47

The essence of an effectively controlled organisation lies in the:

A) attitude of its management.
B) effectiveness of its independent auditor.
C) effectiveness of its internal auditor.
D) attitude of its employees.

Question 48

The auditor's primary objective to obtain an understanding of internal control is that it must provide:

A) a basis for constructive suggestions to the client for improving the accounting system.
B) a method for safeguarding assets, checking the accuracy and reliability of accounting data, promoting operational efficiency and encouraging adherence to prescribed managerial policies.
C) reasonable protection against client fraud and defalcations by client employees.
D) an understanding that is sufficient for the auditor to plan the audit adequately.

Question 49

Which one of the following is NOT typically a type of audit evidence the auditor would use in obtaining and understanding of internal controls?

A) Inquiry
B) Reperformance
C) Observation
D) Documentation

Question 50

An essential characteristic of the persons performing internal verification procedures is:

A) a thorough knowledge of accounting.
B) independence from the original data preparer.
C) an analytical and inquisitive mind.
D) all of the above

Question 51

The reason for NOT permitting a person who has temporary or permanent custody of an asset to account for that asset is to protect the company primarily against:

A) defalcation.
B) error.
C) non- compliance with accounting standards.
D) unbiased information.

Question 52

Auditors assess internal controls for the purpose of planned audit evidence.

A) increasing
B) reducing
C) requiring
D) estimating

Question 53

Is reperformance a type of audit evidence typically used in assessing control risk?

A) Yes, in testing controls only.
B) Yes, in both obtaining an understanding of controls and testing controls.
C) Yes, in obtaining an understanding of controls only.
D) No.

Question 54

Which one of the following audit tests would be regarded as a test of a control?

A) Tests of the specific items making up the balance in a given general ledger account
B) Tests of matching batch totals of quantities shipped to quantities billed
C) Tests of the additions to property, plant and equipment by physical inspections
D) Tests of the inventory pricing to vendors' invoices

Question 55

Which one of the following statements about the internal control questionnaire is NOT correct?

A) The primary disadvantage of the questionnaire approach is that individual parts of the system are examined without providing an overall view.
B) The questionnaire can cover each audit area reasonably quickly, and it can be accomplished at the beginning of the audit engagement.
C) The primary advantage of the questionnaire approach is the relative completeness of coverage of each audit area that a good instrument affords.
D) It is unacceptable for the auditor to rely on an internal control questionnaire that has been filled out by client's personnel.

Question 56

Management typically has the following three concerns, or broad objectives, in designing an effective control system: 1. Reliability of financial reporting
2) Efficient and effective operations
3) Compliance with applicable laws and regulations
4) Maximise profit for stakeholders

A) 2, 3, 4
B) 1, 2, 4
C) 1, 2, 3
D) 1, 3, 4

Question 57

Which one of the following statements is NOT correct?

A) When reliable and understandable narratives, flowcharts and questionnaires are available from the client, it is desirable to use them rather than have the auditor prepare his or her own documents.
B) It would be unusual to use both a narrative and a flowchart to describe the same system.
C) The advantage of the narrative description is the ease of describing the details of the internal controls.
D) The use of both questionnaires and flowcharts on the same engagement is highly desirable for understanding the client's system.

Question 58

If the auditor wants a lower assessed control risk:

A) larger sample sizes for the tests of control would be appropriate.
B) a greater number of controls must be tested.
C) more tests must be conducted on each control.
D) all of the above would apply.

Question 59

Internal controls can NEVER be regarded as completely effective. Even if systems personnel could design an ideal system, its effectiveness depends on the:

A) adequacy of the computer system.
B) competency and dependability of the people using it.
C) ability of the internal audit staff to maintain it.
D) proper implementation by management.

Question 60

Record keeping is typically included in a separate department under the financial controller to protect the company primarily against:

A) defalcation.
B) error.
C) non- compliance with accounting standards.
D) unbiased information.

Question 61

The primary emphasis of auditors is on internal controls over classes of transactions because:

A) financial statements may not accurately reflect accounting standards correctly.
B) the accuracy of the output of accounting systems is based on the accuracy of the input and processing.
C) the accuracy of the output of accounting systems is based on the accuracy of the input.
D) all of the above.

Question 62

After considering a client's internal controls, an auditor has concluded that it is well designed and is functioning as intended. Under these circumstances the auditor would most likely:

A) determine whether transactions are recorded to permit preparation of financial statements in conformity with generally accepted accounting principles.
B) perform reduced tests of controls to the extent outlined in the audit program.
C) not increase the extent of predetermined substantive tests.
D) determine the control procedures that should prevent or detect errors and irregularities.

Question 63

Which of the following is NOT a type of audit evidence used in assessing internal control?

A) Checking approval of customer sales orders
B) Matching prices on sales invoices against a standard price list
C) Observation of staff performing their duties
D) Observation of the inventory count

Question 64

Evidential matter concerning proper segregation of duties ordinarily is BEST obtained by:

A) direct personal observation of the employee who applies control procedures.
B) making inquiries of coworkers about the employee who applies control procedures.
C) inspection of third- party documents containing the initials of who applied control procedures.
D) preparation of a flowchart of duties performed and available personnel.

Question 65

The auditor can conclude that control risk is low:

A) after identifying specific controls that will reduce control risk and making an assessment of control risk.
B) after testing the controls for effectiveness.
C) after obtaining an understanding of the control environment and the accounting system at a fairly detailed level.
D) only after all three steps above are completed.

Question 66

ASA 315 states: The auditor shall obtain an understanding of internal control to the audit.

A) relevant
B) realistic
C) required
D) relative

Question 67

Control risk is a measure of the auditor's expectation that the internal controls:

A) will prevent material misstatements from occurring.
B) will either prevent material misstatements or detect and correct them.
C) will detect and correct material misstatements.
D) will neither prevent material misstatements nor detect and correct them.

Question 68

All of the following are characteristics of an accounting information system EXCEPT:

A) risk assessment.
B) data preparation.
C) document and report generation.
D) data entry.

Question 69

The most important type of protective measure for safeguarding assets and records is:

A) proper authorisation of transactions.
B) adequate separation of duties among personnel.
C) the use of physical precautions.
D) adequate documentation.

Question 70

An important part of effectiveness and efficiency of controls is safeguarding assets and records. This refers to:

A) confidential documents.
B) general ledger and journals.
C) physical assets of a company.
D) all of the above

Question 71

When the auditor identifies significant deficiencies in the design or operation of internal controls, it will be communicated to client's audit committee in the:

A) audit report.
B) management letter.
C) reportable conditions letter.
D) engagement letter.

Question 72

List, in order, the steps in the auditor's process of understanding internal control and assessing control risk.

Question 73

During which part of an audit examination is the preparation of flowcharts most appropriate?

A) When documenting the auditor's understanding of internal control
B) When evaluating the system of internal administrative control
C) When performing preliminary analytical procedures
D) When performing tests of controls

Question 74

Management of public listed entities have to issue a report on the effectiveness of their organisation's internal control system:

A) in the United States.
B) in neither Australia nor the United States.
C) in Australia.
D) in both Australia and the United States.

Question 75

Understanding components of internal control and assessing the level of control risk are primarily used by the auditor to:

A) determine the nature, timing and extent of substantive tests for financial statement assertions.
B) modify the initial assessments of inherent risk and preliminary judgements about materiality levels.
C) ascertain whether the opportunities to allow any person to both perpetrate and conceal irregularities are minimised.
D) determine whether procedures and records concerning the safeguarding of assets are reliable.

Question 76

An effective accounting information and communication system must satisfy six transaction- related objectives. Identify the six objectives.

Question 77

If employees are competent and trustworthy, how does this affect controls?

A) All employees become bored or dissatisfied.
B) All employees can reduce the system to a shambles.
C) Other controls can be absent.
D) All employees need numerous controls.

Question 78

When planning an audit, the auditor's assessed level of control risk is:

A) calculated by using the formulas provided in ASA 315.
B) calculated by using the audit risk model.
C) an economic issue, trading off the costs of testing controls against the cost of testing balances.
D) determined by using actuarial tables.

Question 79

Which one of the following activities would be LEAST likely to strengthen a company's internal control?

A) Maintaining insurance for fire and theft
B) Carefully selecting and training employees
C) Fixing responsibility for the performance of employee duties
D) Management demonstrating by policy and example that it values accuracy and integrity

Question 80

Tests of controls are conducted when:

A) controls are not operating as effectively as initially assessed.
B) control risk may be higher than the initial assessment.
C) the auditor determines that substantive testing is not effective.
D) controls are expected to be operating effectively.