Deck 8: Internal control and control risk

Question 1

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

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

Answer 1

B

Question 2

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

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

Answer 2

C

Question 3

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

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

Answer 3

A

Question 4

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

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

Question 5

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

A) the United States.
B) Australia.
C) both Australia and the United States.
D) none of the above

Question 6

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 7

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

Question 8

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, safeguard assets, and comply with the Corporations Act.
C) promote efficiency and encourage adherence to policy.
D) provide reliable data and promote efficiency.

Question 9

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

A) inappropriate assessment of the effectiveness of internal controls
B) collusion by employees
C) management overriding a control
D) misunderstanding of instructions

Question 10

ASA 315 states that the auditor shall obtain an understanding of internal control ________ to the audit.

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

Question 11

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

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

Question 12

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

A) reliability of financial reporting
B) compliance with applicable laws and regulations
C) obtaining the best internal control system possible
D) efficiency and effectiveness of operations

Question 13

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

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

Question 14

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

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

Question 15

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

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

Question 16

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

Question 17

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

Question 18

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

A) reducing control risk
B) compliance with applicable laws and regulations
C) efficient and effective use of resources
D) reliable financial reporting

Question 19

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

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

Question 20

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

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

Question 21

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

A) the accounting system
B) the control environment
C) control risk
D) control procedures

Question 22

Management's integrity and ethical values include:

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

Question 23

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

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

Question 24

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 25

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

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

Question 26

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

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

Question 27

Monitoring activities in an internal control structure determines that:

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

Question 28

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

A) access controls
B) physical controls
C) automated internal verification procedures
D) backup and recovery procedures

Question 29

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) achievement of the objectives of the system of internal control.
C) timing of the tests to be performed.
D) comparison of recorded accountability with assets.

Question 30

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) collusive activities would be detected by segregation of employee duties.
D) unusual transactions are accurately recorded.

Question 31

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

A) management demonstrating by policy and example that it values accuracy and integrity
B) fixing responsibility for the performance of employee duties
C) maintaining insurance for fire and theft
D) carefully selecting and training employees

Question 32

The essence of an effectively controlled organisation lies in the:

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

Question 33

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

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

Question 34

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

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

Question 35

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 36

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 37

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 38

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

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

Question 39

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

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

Question 40

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

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

Question 41

Tests of controls are conducted when:

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

Question 42

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

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

Question 43

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

Question 44

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

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

Question 45

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

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

Question 46

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

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

Question 47

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

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

Question 48

Which one of the following statements is NOT correct?

A) It would be unusual to use both a narrative and a flowchart to describe the same system.
B) The advantage of the narrative description is the ease of describing the details of the internal controls.
C) The use of both questionnaires and flowcharts on the same engagement is highly desirable for understanding the client's system.
D) 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.

Question 49

The auditor considers internal control by four 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) 2, 1, 3, 4
D) 1, 3, 2, 4

Question 50

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 51

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

Question 52

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

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

Question 53

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

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

Question 54

Narratives, flowcharts, and internal control questionnaires are three common methods of:

A) designing the audit manual and procedures.
B) documenting the auditor's understanding of internal controls.
C) documenting the auditor's understanding of the client's organisational structure.
D) testing the internal controls.

Question 55

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

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

Question 56

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) engaging a public accountant to perform monthly 'write-up' work.
B) employment of temporary personnel to aid in the separation of duties.
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.

Question 57

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

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

Question 58

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 59

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

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

Question 60

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) reportable conditions letter.
C) management letter.
D) engagement letter.

Question 61

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 62

A transaction walk-through involves:

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

Question 63

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

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

Question 64

When controls leave no documentary evidence or trail:

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

Question 65

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

A) documentation
B) inquiry
C) observation
D) reperformance

Question 66

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

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

Question 67

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) observing staff performing their duties
D) observing the inventory count

Question 68

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

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

Question 69

Management, with the help of the auditor, must establish and maintain the entity's controls.

Question 70

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) reperformance
B) inquiry
C) examining the invoices for signatures
D) observation

Question 71

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

A) is magnified and must be removed from the sampling process and examined in its entirety.
B) could cause a material loss, so it must be tested using substantive procedures.
C) is reduced but not removed; therefore, it is still of concern to the auditor.
D) is no longer a concern because the potential for misstatement has been sufficiently reduced.

Question 72

If the auditor wants a lower assessed control risk:

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

Question 73

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

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

Question 74

A company should develop internal controls that provide reasonable, but not absolute, assurance that the financial statements are fairly stated.

Question 75

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

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

Question 76

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

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

Question 77

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

Question 78

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

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

Question 79

Tests of controls are conducted when:

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

Question 80

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

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