Deck 7: Gaining an Understanding of the Clients System of Internal Controls

Question 1

Internal controls in large and medium sized entities can only provide an entity with reasonable assurance in achieving its financial reporting objectives. Which of the following is
Not an inherent limitation of internal control?

A) human error that results in a breakdown in internal control
B) collusion by two or more individuals to circumvent a control
C) a control within a software program being overridden or disabled
D) changing audit risk parameters

Answer 1

D

Question 2

One of the elements of an entity's control environment is management's philosophy and
operating style.

Answer 2

True

Question 3

Checklists and preformatted questionnaires are particularly helpful in industries that the
auditor may not personally be familiar with auditing.

Answer 3

True

Question 4

Control risk refers to the risk that the auditor's testing procedures will not be effective in
detecting a material misstatement.

Question 5

Narratives involve the auditor describing in words each step of the flow of transactions from
start to finish.

Question 6

In larger entities, there are often limitations surrounding the entity's ability to put effective
internal controls in place.

Question 7

An internal control exception is an observed condition that provides evidence that the control
being tested did not operate as intended.

Question 8

Internal control is intended to provide reasonable assurance about the achievement of an
entity's objectives.

Question 9

The internal control objective of 'valued' refers to controls in place to ensure that transactions
are recorded in the correct accounting period.

Question 10

The purpose of an auditor's management letter is to inform the client of the auditor's
recommendations for improving its internal controls.

Question 11

The internal control objective of 'real' refers to controls in place to ensure that fictitious or
duplicate transactions are not included in the books and records of the organization.

Question 12

Stanley Morgan has learned that it is important to be aware of the attitude and actions of management and those charged with governance concerning the entity's internal control and its
Importance in the entity. This best describes dealing with

A) a key control objective.
B) the control environment.
C) mitigation of audit risk.
D) financial statement assertions.

Question 13

The concept that no one employee should be in a position both to perpetrate and hide errors
or fraud in the normal course of their duties is known as segregation of incompatible duties.

Question 14

Audit risk is the risk that an entity's internal control system will not prevent or detect material
misstatements.

Question 15

Thea Lisowski decided to list several questions for herself about factors that influence management's attitudes towards internal control so as to assure herself that she could have
More confidence in management's abilities and integrity. When she was finished, which control
Environment element did she tick off on her working papers?

A) management's philosophy and operating style
B) communication and enforcement of integrity and ethical values
C) commitment to competence
D) participation by those charged with governance

Question 16

As part of her annual review Roma Lazor reviews her client's draft financial statements for proper disclosures and compliance to accounting standards. This best describes which control
Objective(s)?

A) posting
B) classification and understandability
C) valuation
D) timeliness

Question 17

The inherent limitations of internal control include the possibility of collusion by two or more
individuals to circumvent a control.

Question 18

Internal control weaknesses decrease the risk of material misstatements being undetected
by management's processes and controls.

Question 19

A partner and his team performed an audit and issued an unqualified audit report. A year later his firm was sued when a shareholder found out the financial statements were misstated.
This situation best describes:

A) poor internal controls.
B) human error.
C) unethical behaviour.
D) audit risk.

Question 20

Significant professional judgment is never required to decide whether an identified internal
control weakness is significant enough to warrant communicating to management.

Question 21

Which of the following statements about internal control is incorrect?

A) Internal control is a very broad concept.
B) Internal control eliminates the possibility of fraud and error.
C) Internal control encompasses all of the elements of an organization.
D) Internal control provides reasonable assurance about the achievement of the entity's objectives.

Question 22

Which of the following is an element of the control environment?

A) participation by those charged with governance
B) commitment to competence
C) segregation of duties
D) both a and b

Question 23

Maxime Talbot is concerned that his client's control system has a risk of the wrong price being charged on the purchase invoice by the supplier. At which transaction stage would this
Risk be reviewed?

A) purchase requisition transaction
B) receiving transaction
C) purchasing transaction
D) none of the above

Question 24

All of the following are components of internal control, except for:

A) monitoring of controls.
B) the control environment.
C) audit committees.
D) the information system.

Question 25

Which of the following is an inherent limitation of internal control?

A) a control within a software program being overridden or disabled
B) human error that results in a breakdown in internal control
C) collusion by two or more individuals to circumvent a control
D) all of the above

Question 26

Mona Kew is reviewing the purchasing and payments process. At which stage would she determine that purchases that are being made are properly authorized?

A) purchase requisition transaction
B) recording purchases and related items transaction
C) invoicing transaction
D) purchasing transaction

Question 27

Marcia Salinger reviewed the following activities in the Sales cycle: She ensured that once the invoice had been created it was posted to the appropriate accounts in the sales journal and
The accounts receivable sub ledger in the appropriate accounting period and that the sales
Journal was reconciled to the general ledger accounts. These activities are part of which of the
Following sales process activities?

A) invoicing customers
B) cash receipts
C) recording sales and trade receivables
D) none of the above

Question 28

Harry Karas was involved in getting a big picture of his client's entity controls. He went about finding out whether periodic evaluations of internal control are made and determining
The extent to which personnel, in carrying out their regular duties, obtain evidence as to
Whether the system of internal controls continues to function. These activities are part of:

A) internal control activities.
B) documentation controls.
C) monitoring of controls.
D) none of the above.

Question 29

The internal control objective of 'classified' means there are controls in place to ensure that:

A) fictitious or duplicate transactions are not included in the books of an organization.
B) correct amounts are assigned to transactions.
C) transactions are recorded in the correct accounting period.
D) transactions are charged and allocated to the correct general ledger account.

Question 30

When Vanessa Lanthier reviewed the different key activities in the marketing department of a wholesaler of jewellery, she was performing an entity level review of:

A) monitoring controls.
B) the control environment.
C) internal controls.
D) the risk assessment process.

Question 31

If controls are in place to ensure that transactions are recorded in the correct accounting period, this satisfies which internal control objective?

A) timely
B) real
C) valued
D) posted

Question 32

Rina Glickstein is unsure about the best way to evaluate her audit staff. She decides to look at their professional characteristics such as their expertise, experience, knowledge and training.
What best describes what she is looking for?

A) their independence
B) their professional judgment
C) their due care
D) none of the above

Question 33

Anwar Maris is considering whether to use a checklist or narrative approach to describing the purchasing system of an environmental engineering company. What part of the audit
Process is he involved in?

A) documenting internal controls
B) risk assessment of company
C) review of control environment
D) none of the above

Question 34

When Melissa Lee, a senior auditor, performed an audit of an electronics firm, she reviewed the control environment, performed a risk assessment, and reviewed the key business
Processes and control activities. These activities are part of:

A) a review of entity-level controls.
B) a review of the internal control system.
C) establishing audit risk.
D) none of the above.

Question 35

The generally accepted objectives of internal control do not include:

A) efficiency.
B) classified.
C) recorded.
D) timely.

Question 36

When internal controls are effective:

A) there will be an increased reliance on substantive tests of transactions and account balances.
B) control risk will also be high.
C) the organization is more likely to achieve its strategic and operating objectives.
D) the organization is less likely to achieve its strategic and operating objectives.

Question 37

Internal control encompasses which of the following elements of an organization?

A) processes
B) culture
C) systems
D) all of the above

Question 38

As part of her yearly audit plan activities, Krystyne Sliz reviews audit working papers of previous years to determine the risk that a client's system of internal controls will not prevent or
Detect a material misstatement. This review refers to:

A) audit risk.
B) inherent risk.
C) control risk.
D) detection risk.

Question 39

Which assertion is not specifically addressed by internal control objectives?

A) cut-off
B) presentation and disclosure
C) completeness
D) existence

Question 40

Claudia Andreou was concerned when she reviewed the operations of her client and noticed that many of the employees had incompatible duties over the recording of transactions and
Custody of assets. This best refers to which desired control?

A) information processing controls
B) physical controls
C) authorization controls
D) segregation of incompatible duties

Question 41

An internal control exception is:

A) only expected to exist when internal controls are effective.
B) an observed condition that provides evidence that the control being tested did not operate as indicated.
C) both a and b.
D) an observed condition that provides evidence that the control being tested did operate as indicated.

Question 42

The purpose of the management letter is to inform:

A) the auditor with concerns held by the client's management about the audit fee.
B) the client's management of the auditor's opinion on the company's financial statements.
C) the client's audit committee's disagreements with management.
D) the client of the auditor's recommendations for improving its internal controls.

Question 43

Which of the following statements is correct?

A) Significant professional judgment is not necessary in deciding whether a weakness identified is significant enough to warrant communicating to management.
B) A management letter is prepared by management.
C) Significant professional judgment is necessary in deciding whether a weakness identified is significant enough to warrant communicating to management.
D) All of the above.
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Question 44

Explain the seven generally accepted objectives of internal control activities and identify the relevant assertions.

Question 45

For purchasing inventory transactions, an example of a risk that arises is:

A) goods that have been sold and invoiced are included in the inventory on hand.
B) the wrong quantities are recorded during the inventory count.
C) the wrong labour costs are added to the cost of individual inventory items.
D) the wrong amount is paid against an invoice.

Question 46

Performance reviews are control activities that include:

A) authorization for access to computer programs.
B) segregating incompatible duties.
C) reviews of actual performance versus budgets.
D) periodic counting and comparison with amounts shown on control records.

Question 47

Flowcharts involve:

A) the auditor summarizing in boxes each step of a transaction from start to finish.
B) the auditor describing in words each step of the flow of transactions from start to finish.
C) both a and b.
D) none of the above.

Question 48

What are the most common forms of documentation used by auditors to document their understanding of internal controls?

Question 49

Explain the key elements of the control environment.

Question 50

In understanding the client's control activities at the entity level, consideration is given to factors such as:

A) the extent to which performance of control activities relies on IT.
B) the extent to which controls included in the organization's policies are being applied.
C) whether adequate safeguards are in place to prevent unauthorized access to or destruction of documents, records and assets.
D) all of the above.

Question 51

Which of the following is not an example of an internal control for the sales process?

A) credit committee review of credit limits on a quarterly basis
B) approved purchase order is reconciled to invoice
C) application control that only allows orders to be processed against existing approved customers with enough unused credit limit
D) invoices automatically generated from order documents

Question 52

When gaining an understanding of the client's monitoring processes at the entity level, factors ordinarily considered include:

A) evaluations or observations made by the external auditors.
B) management's approach to correcting known significant deficiencies on a timely basis.
C) both a and b.
D) none of the above.

Question 53

Checklists and preformatted questionnaires are particularly helpful:

A) in industries that the auditor may not personally be familiar with auditing.
B) when control risk is high.
C) when less experienced auditors find it difficult to identify which are the critical controls.
D) both a and c.

Question 54

The control environment does not:

A) set the tone of an entity.
B) set the foundation for all other components of internal control.
C) refer to the policies and procedures that help make sure management's directives are carried out.
D) influence the control consciousness of employees.

Question 55

The most common ways of auditors documenting their understanding of internal controls include:

A) flowcharts.
B) narratives.
C) preformatted questionnaires.
D) all of the above.

Question 56

What are control activities and explain the major categories of them?

Question 57

Which of the following statements relating to control activities is incorrect?

A) They include management's philosophy and operating style.
B) They are policies and procedures that help make sure management's directives are carried out.
C) They help guarantee that necessary actions are taken to address risks impacting the achievement of the organization's objectives.
D) They have various objectives and are applied at various organizational and functional levels.

Question 58

Detection risk refers to:

A) the susceptibility of an assertion to a material misstatement, assuming there are no related controls.
B) the risk that the auditor's testing procedures will not be effective in detecting a material misstatement.
C) the risk that a client's system of internal controls will not prevent or detect a material misstatement.
D) none of the above.

Question 59

Indicate whether you agree or disagree with the following statements and explain your reasoning.
a) During her career as a public accountant, Carolina Doukas has performed audits of large and medium sized clients. When she visited a small business client, a food wholesaler that has had a history of poor controls, she gave a lot of thought to performing her planned audit approach. She decided to use the combined audit approach.
b) Tanya Konczynski was discussing with her audit manager how she could assess whether controls are being monitored. Her audit manager mentioned that the internal audit function is a primary source of assessing and monitoring control activities.
c) The audit senior has been reviewing the key controls in the purchasing and payables process. She has been asked by a junior auditor: "When should the client set up the payable?" She answers: "The company can set up the payable when the goods are received in good order, and then the client can make the payment when the invoice is received."
d) The auditor decided to review transaction-level controls at year-end.

Question 60

For identified risks, management:

A) assesses the likelihood of their occurrence.
B) decides upon actions to manage them.
C) estimates their significance.
D) all of the above.