Deck 10: Internal Control, Control Risk, and Section 404 Audits

Question 1

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.

Answer 1

A

Question 2

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.

Answer 2

C

Question 3

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.

Answer 3

C

Question 4

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

Question 5

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.

Question 6

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.

Question 7

Describe each of the three broad objectives management typically has for internal control.With which of these objectives is the auditor primarily concerned?

Question 8

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

Question 9

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.

Question 10

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.

Question 11

Which of the following parties provides an assessment of the effectiveness of internal control over financial reporting for public companies?

A)
B)
C)
D)

Question 12

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.

Question 13

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

Question 14

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

Question 15

When management is evaluating the design of internal control, management evaluates whether the control can do which of the following?

A)
B)
C)
D)

Question 16

Section 404 of the Sarbanes-Oxley Act requires that public companies issue an internal control report.

Question 17

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.

Question 18

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.

Question 19

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.

Question 20

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.

Question 21

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.

Question 22

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

Question 23

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.

Question 24

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.

Question 25

Which of the following best describes an entity's accounting information and communication system?

A)
B)
C)
D)

Question 26

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

Question 27

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

Question 28

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.

Question 29

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.

Question 30

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.

Question 31

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.

Question 32

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

Question 33

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.

Question 34

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

Question 35

When a company designs and implements internal controls, cost of the controls is not a valid consideration.

Question 36

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.

Question 37

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.

Question 38

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.

Question 39

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.

Question 40

Which of the following factors may increase risks to an organization?

A)
B)
C)
D)

Question 41

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.

Question 42

Separation of duties is essential in preventing errors and intentional misstatements on the financial statements.List below the four general guidelines.

Question 43

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

Question 44

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

Question 45

The internal control framework developed by COSO includes five so-called "components" of internal control.Discuss each of these five components.

Question 46

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.

Question 47

Control activities are a subcomponent of the information and communication component of internal control.

Question 48

In developing an understanding of the client's accounting information system the auditor follows a sequential process.Describe the process below:

Question 49

To promote operational efficiency, the internal audit department would ideally report to:

A)line management.
B)PCAOB.
C)Chief Accounting Officer.
D)audit committee.

Question 50

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

Question 51

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

Question 52

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.

Question 53

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.

Question 54

Control activities help assure that the necessary actions are taken to address risks to the achievement of the company's objectives.List the five types of control activities.

Question 55

Discuss what is meant by the term "control environment" and identify four control environment subcomponents that the auditor should consider.

Question 56

Management's identification and analysis of risk is an ongoing process and is a critical component of effective internal control.An important first step is for management to identify factors that may increase risk.Identify at least five factors, observable by management, which may lead to increased risk in a typical business organization.

Question 57

Adequate documents and records is a subcomponent of the control environment.

Question 58

List the three steps in management's assessment of risk and then list two of the categories of management assertions that must be satisfied during the risk assessment process.

Question 59

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.

Question 60

Certain principles dictate the proper design and use of documents and records.Briefly describe several of these principles.

Question 61

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.

Question 62

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.

Question 63

For most uses, flowcharts are superior to narratives as a method of communicating the characteristics of internal control.

Question 64

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.

Question 65

The chart of accounts is helpful in preventing classification errors if it accurately describes which type of transaction should be in each account.

Question 66

When documenting their understanding of a client's internal controls, auditors are required to use narratives.

Question 67

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.

Question 68

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.

Question 69

Which of the following deficiency exists if a necessary control is missing or not properly formulated?

A)Control
B)Significant
C)Design
D)Operating

Question 70

If an auditor wishes to rely on the work of internal auditors (IA), the auditor must obtain satisfactory evidence related to the IA's competence, integrity, and objectivity.

Question 71

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.

Question 72

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.

Question 73

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.

Question 74

Walkthroughs combine observation, inspection, and inquiry to assure that the controls designed by management have been implemented.

Question 75

To determine if significant internal control deficiencies are material weaknesses, they must be evaluated on their:

A)
B)
C)
D)

Question 76

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.

Question 77

A narrative should describe the disposition of every document and record in the system.

Question 78

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.

Question 79

Auditing standards prohibit reliance on the work of internal auditors due to the lack of independence of the internal auditors.

Question 80

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.