Question 1

Proper separation of duties reduces the opportunities to allow persons to be in positions to both:

Accepted Answer

Proper separation of duties is a key internal control that helps prevent fraud by ensuring no single individual has control over all aspects of a financial transaction. This makes it harder for someone to commit and then conceal fraudulent activities, as it would require collusion between multiple parties. Options A, B, and C describe functions that can be separated to enhance controls, but they do not directly address the dual aspects of committing and concealing fraud as effectively as option D does.

Question 2

Which of the following most likely would not be considered an inherent limitation of the potential effectiveness of an entity's internal controls?

Accepted Answer

Incompatible duties refer to a situation where an employee is given responsibilities that conflict with each other, which is a design flaw in the internal control system rather than an inherent limitation. Inherent limitations, such as management override, mistakes in judgment, and collusion among employees, acknowledge that even well-designed internal controls can fail due to human actions or errors that are difficult to completely prevent or predict.

Question 3

Which of the following areas can external auditors rely on internal auditors' work in auditing internal controls?

Accepted Answer

External auditors can rely on internal auditors' work in testing low risk internal control activities, but they cannot rely on internal auditors' work as the sole evidence for their opinion. The external auditor must still perform their own testing and evaluation of internal controls. The other options are either incorrect or too broad.

Question 4

Management's report on internal controls must include each of the following except:

Accepted Answer

Each of the other options listed (A, B, and C) are required components of management's report on internal controls under the Sarbanes-Oxley Act. However, there is no requirement to explicitly evaluate the control environment. That being said, a discussion of the control environment can be helpful and informative in providing context for the overall assessment of internal controls.

Question 5

If a control total were to be computed on each of the following data items, which would best be identified as a hash total for a payroll IT application?

Accepted Answer

A hash total is a control total that does not have a direct financial meaning but is used to ensure data integrity. Department numbers work well for this purpose as they can be added together to create a non-financial total that can be used to check that all data has been processed correctly, unlike hours worked, total debits and credits, or net pay, which are financial figures.

Question 6

Generally accepted auditing standards (GAAS) give auditors considerable discretion to decide the amount of work required to satisfy auditing standards guiding internal control evaluation and related audit planning. Which of the descriptions below best expresses the minimum amount of work permitted by GAAS for nonpublic companies?

Accepted Answer

GAAS requires auditors to obtain an understanding of the client's environment, accounting, and control activities. This understanding is crucial for assessing control risk and planning the audit. While auditors can decide to assess control risk at the maximum and still comply with GAAS, they must document this decision. This approach allows for a more extensive substantive audit, though not necessarily 100%, to ensure financial statement transactions and balances are accurately stated.

Question 7

After obtaining an understanding of internal controls and assessing control risk on the audit of a non-public company, an auditor decided to perform tests of controls. The auditor most likely decided that:

Accepted Answer

After assessing control risk, the auditor has determined that performing tests of controls would be efficient and effective in reducing planned substantive tests. This means that the auditor wants to rely on the effectiveness of internal controls to reduce the amount of substantive testing required, which saves time and resources.

Question 8

As part of understanding the internal control, an auditor is not required to:

Accepted Answer

Understanding the internal control system as part of an audit involves considering factors that affect the risk of material misstatement, ascertaining whether internal control policies and activities have been implemented, and identifying the types of potential misstatements. However, obtaining knowledge about the operating effectiveness of the client's internal control activities goes beyond understanding the system and involves testing the controls, which is not required for all audits.

Question 9

A report on internal control effectiveness by the management team of public companies is required by:

Accepted Answer

The Sarbanes-Oxley Act of 2002 requires management of public companies to report on the effectiveness of their internal control over financial reporting. This requirement is intended to provide greater transparency and accountability to investors and the public. The PCAOB and the AICPA are entities involved in auditing and accounting standards, but they do not mandate the management report on internal control effectiveness. Auditors may rely on management's report, but they are not required to prepare it.

Question 10

The primary objective of procedures performed to obtain an understanding of the entity's internal control is to provide an auditor with:

Accepted Answer

The primary objective of procedures performed to obtain an understanding of the entity's internal control is to provide an auditor with knowledge necessary for audit planning. This includes identifying the risks of material misstatement, assessing the design and implementation of internal controls, and determining the nature, timing, and extent of further audit procedures. The information gathered during these procedures is critical to the development of an effective audit plan, which is the foundation for the entire audit engagement. Evidential matter, a basis for modifying tests of controls, or an evaluation of the consistency of application of management's policies are all possible outcomes of understanding internal control, but they are not the primary objective.

Question 11

List several elements of a company's control environment.

Accepted Answer

The answer of List several elements of a company's control...

Question 12

Assessing control risk at below the maximum level most likely would involve:

Accepted Answer

Assessing control risk below the maximum level involves identifying specific internal control activities that are relevant to specific financial statement assertions. This allows auditors to rely on those controls and perform fewer substantive tests with smaller sample sizes. Reducing inherent risk or changing the timing of substantive tests are not necessarily related to assessing control risk at a lower level.

Question 13

Which of the following would most likely be classified as a material weakness?

Accepted Answer

Ineffective oversight of the financial reporting process by the company's audit committee is a material weakness because it can lead to significant misstatements in financial reports, impacting the reliability of financial information.

Question 14

Which of the following is not an objective of internal controls over financial reporting as defined by the Sarbanes-Oxley Act?

Accepted Answer

Explanation: The Sarbanes-Oxley Act focuses on the accuracy and reliability of financial reporting and the prevention of fraudulent activities within corporations. While it does emphasize compliance with laws and regulations as part of its broader objectives, the specific objective of ensuring compliance with all applicable laws and regulations is not directly stated as an objective of internal controls over financial reporting. The primary focus is on the accuracy of financial records, authorization of transactions, and safeguarding of assets.

Question 15

The overall attitude and awareness of an entity's board of directors concerning the importance of the client's internal control usually is reflected in its:

Accepted Answer

The overall attitude and awareness of an entity's board of directors concerning the importance of the client's internal control is reflected in its control environment, which sets the tone for the organization's internal control system. The control environment includes factors such as the board's oversight, management's philosophy and operating style, organizational structure, and the company's ethical values and culture. Computer-based control activities, system of separation of duties, and safeguards over access to assets are specific aspects of internal control that are influenced by the control environment. However, the control environment encompasses the overall attitude and awareness of the board of directors, making it the best choice.

Question 16

In an audit of financial statements of a non-public company in accordance with generally accepted auditing standards, an auditor is required to:

Accepted Answer

Documenting the auditor's understanding of the entity's internal control is a requirement in an audit of financial statements according to generally accepted auditing standards. This helps the auditor plan the audit and assess risks of material misstatement.

Question 17

Which of the following is a step in an auditor's decision to assess control risk at below the maximum?

Accepted Answer

To assess control risk at below the maximum, the auditor must identify specific internal control policies and activities that are likely to detect or prevent material misstatements. This step is crucial in understanding the effectiveness of the internal controls and to determine if they can be relied on to reduce the risk of material misstatements. The other choices are related to the audit process but do not specifically address the decision to assess control risk at below the maximum.

Question 18

In an audit of financial statements, an auditor's primary consideration regarding an internal control policy or activity is whether the policy or activity:

Accepted Answer

The primary consideration of an auditor regarding internal control policy or activity is whether it affects management's financial statement assertions, as it directly impacts the accuracy and reliability of the financial statements. While management's philosophy and operating style, safeguards over asset access, and decision-making processes are also important factors, they are secondary considerations.

Question 19

In testing control activities, an auditor ordinarily selects from a variety of techniques, including:

Accepted Answer

While all the techniques listed may be used in testing control activities, reperformance and observation are the most effective as they involve the auditor physically testing the control activity and observing it in action. Inquiry and analytical procedures may not provide sufficient evidence of the effectiveness of the control activity, while comparison and confirmation may not be applicable to all control activities. Inspection and verification may be useful in some cases, but do not provide the same level of direct evidence as reperformance and observation.

Question 20

When auditing financial statements of a private company, the minimum work an auditor must perform in connection with a company's internal control is best described by which of the following statements?

Accepted Answer

When auditing financial statements of a private company, the minimum work an auditor must perform in connection with a company's internal control is to prepare auditing working papers that document the auditor's understanding of the company's internal control. This is known as documenting the understanding of internal controls and is a required step in every audit. While the other options (A, B, and D) are important components of an internal control audit, they are not the minimum requirements for a private company audit.

Quiz 5: Risk Assessment: Internal Control Evaluation