Question 1

When an auditor is to conduct an audit of a service organization, what considerations should the auditor make in the planning stages regarding internal controls of the organization?

Accepted Answer

Choice "C" is correct. In some situations, the controls at a service organization are designed under the assumption that there will be certain complementary controls implemented by user organizations. These complementary controls should be included in the description of controls. The service auditor should obtain an understanding of such situations, in order to evaluate whether the complementary controls are necessary to achieve stated control objectives. Choice "A" is incorrect. The auditor would need to understand controls before assessing their operating effectiveness. Choice "B" is incorrect. Substantive procedures are not performed by a service auditor, who is either reporting on controls placed in operation, or on controls placed in operation and their operating effectiveness. Remember that a service auditor's engagement is not the same as an audit of financial statements. Choice "D" is incorrect. Although a service auditor's engagement differs from an audit of financial statements, it is performed in accordance with the general standards as well as the relevant fieldwork and reporting standards. It is not considered to be an agreed-upon procedures engagement, as the auditor has not been engaged by the service organization to issue a report of findings based on specific, agreed on procedures.

Question 2

The responsibility to establish, maintain and monitor internal controls is that of the entity's:

Accepted Answer

Choice "C" is correct. The entity's management is responsible for establishing, maintaining, and monitoring the entity's internal controls, considering whether those controls are operating as intended, and modifying controls as conditions change. Choice "A" is incorrect. The accounting department is not responsible for establishing, maintaining, and monitoring internal controls. Choice "B" is incorrect. The internal auditors contribute to the monitoring of the entity's activities, but are not responsible for establishing or maintaining them. Choice "D" is incorrect. The (external) auditor is required to obtain sufficient knowledge of internal control, but is not responsible for establishing, maintaining, and/or monitoring internal control.

Question 3

Which of the following statements about internal control is correct?

Accepted Answer

Choice "B" is correct. Internal control is relevant to the entire entity, or to any of its operating units or business functions. Choice "A" is incorrect. There is a direct relationship between: 1. An entity's objectives, which are what the entity strives to achieve, and 2. The components of internal control, which represent what is needed to achieve the objectives. Choice "C" is incorrect. Not all of the entity's objectives and related controls are relevant to an audit of the entity's financial statements. Choice "D" is incorrect. Although internal control is relevant to each of the entity's operating units and business functions, an understanding of internal control relevant to each operating unit and business function may not be necessary to plan and perform an efficient audit.

Question 4

In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:

Accepted Answer

Choice "C" is correct. This question asks about internal control. Review of descriptions of controls would typically be performed while gaining an understanding of an entity's internal control (for any system or cycle, not just inventory). Choice "A" is incorrect. Analysis of inventory ratios is an analytical procedure, which is not used to gain an understanding of internal control. Choice "B" is incorrect. Analytical procedures are used in planning the audit, as a substantive test, or for final overall review; they are not used to gain an understanding of internal control. Choice "D" is incorrect. Observation of physical inventory counts is a substantive test, not a procedure used to gain an understanding of internal control.

Question 5

Which of the following factors would most likely be considered an inherent limitation to an entity's internal control?

Accepted Answer

Choice "B" is correct. Human error is an inherent limitation in internal control, because even a properly designed and operating internal control system cannot prevent errors in the use of information provided by the system. Choice "A" is incorrect. The complexity of the information processing system is not an inherent limitation of internal control, because controls can be adequately designed to take such complexity into account. Choice "C" is incorrect. An ineffective board of directors is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control. Choice "D" is incorrect. Lack of appropriate incentives to improve the control environment is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control.

Question 6

Internal control is relevant to:

Accepted Answer

Choice "D" is correct. Internal control is relevant to the entity, its operating units, and its business functions. Choices "A", "B", and "C" are incorrect. Internal control is relevant to all parts of the entity, although not all controls may be relevant to a financial statement audit.

Question 7

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the:

Accepted Answer

Choice "C" is correct. The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that material misstatements exist in the financial statements. Choice "A" is incorrect. Sometimes risk assessment procedures may raise doubts about the auditability of the financial statements, but this is not the ultimate purpose of assessing control risk. Choice "B" is incorrect. The auditor is required to obtain knowledge about the operating effectiveness of internal controls, if his or her risk assessment is based on the effective operation of controls. Obtaining such knowledge, however, is not the ultimate purpose of assessing control risk. Choice "D" is incorrect. Although the nature and extent of substantive tests may be reduced based on the results of the control risk assessment, this is not the ultimate purpose of assessing control risk.

Question 8

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that:

Accepted Answer

Choice "B" is correct. The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that material misstatements exist in the financial statements. Choice "A" is incorrect. Tests of controls are used to assess control risk, not to identify procedures relevant to assertions. Choice "C" is incorrect. Collusion represents an inherent limitation in the effectiveness of internal control. The auditor does not assess control risk to evaluate such limitations. Choice "D" is incorrect. Management override of policies represents an inherent limitation in the effectiveness of internal control. The auditor does not assess control risk to evaluate such limitations.

Question 9

Quick Service Center processes the payroll for a variety of clients, including James Industries. Adams, CPA, is Quick's auditor, while Robinson, CPA, is the auditor for James Industries. Which of the following is not required of Adams?

Accepted Answer

Choice "B" is correct. The user auditor (Robinson) would make inquiries regarding the professional reputation of the service auditor (Adams), not vice versa. Choice "A" is incorrect. The service auditor is required to describe the scope and nature of the procedures performed. Choice "C" is incorrect. The service auditor is required to inquire of management regarding subsequent events that would have a significant effect on user organizations. Choice "D" is incorrect. The service auditor is required to obtain a management representation letter.

Question 10

When obtaining an understanding of an entity's internal controls, an auditor should concentrate on the substance of the controls rather than their form because:

Accepted Answer

Choice "B" is correct. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. When obtaining an understanding of a client's internal controls, an auditor should concentrate on the substance of controls rather than the form because even when appropriate procedures are established, management may not enforce compliance. Choice "A" is incorrect. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. Procedures that are operating effectively, even if they are not documented, do not illustrate this situation. Choice "C" is incorrect. The auditor should first obtain an understanding of the controls in order to determine whether the controls are appropriate or inappropriate. The auditor would not focus at all on controls deemed to be inappropriate. Choice "D" is incorrect. While the cost-benefit of internal control is of concern to management in the design of the system, it plays no role in the auditor's attempt to gain an understanding of internal controls.

Question 11

An advantage of using systems flowcharts to document information about internal control instead of using internal control questionnaires is that systems flowcharts:

Accepted Answer

Choice "B" is correct. An advantage of using systems flowcharts to document internal information is that flowcharts provide a visual depiction of clients' activities. Choice "A" is incorrect. Identification of internal control weaknesses requires the understanding, testing, and evaluation of controls. Either flowcharts or questionnaires can be used to obtain an understanding of internal control for this purpose. Choice "C" is incorrect. Determining whether control activities are operating effectively requires tests of controls, and generally cannot be determined based on a flowchart or a questionnaire. Choice "D" is incorrect. Observing tasks being performed (routine or otherwise) are tests of controls. The need to perform tests of controls is not affected by the form of audit documentation selected.

Question 12

If a budgetary reporting system provides adequate reports, but the reports are not analyzed and acted upon:

Accepted Answer

Choice "B" is correct. The fact that budgetary reports are being generated indicates that the control has been implemented. The control, however, does not provide any assurance regarding achievement of the entity's objectives, since the report is not being analyzed or acted upon. Accordingly, the control is not operating effectively. Choices "A", "C", and "D" are incorrect. The control has been implemented but is not operating effectively per the explanation above.

Question 13

An auditor's primary consideration regarding an entity's internal control is whether the controls:

Accepted Answer

Choice "A" is correct. An auditor's primary consideration regarding an entity's internal control is whether the controls affect the financial statement assertions (to evaluate the risk that a material misstatement may exist in the financial statements). Choice "B" is incorrect. An inherent limitation of an entity's internal control is that its effectiveness can be reduced by management override, but whether this occurs or not is not the auditor's primary consideration. Choice "C" is incorrect. The control environment is a component of internal control, and the auditor needs to understand it, but it is not the auditor's primary consideration. Choice "D" is incorrect. An auditor needs to determine how management's philosophy and operating style affect internal control, but it is not the auditor's primary consideration.

Question 14

In obtaining an understanding of an entity's internal control, an auditor is required to obtain knowledge about the:

Accepted Answer

Choice "B" is correct. No - Yes. In obtaining an understanding of an entity's internal control, an auditor is required to obtain knowledge about the design of controls and whether they have been implemented. The auditor is not required to obtain knowledge about the "operating effectiveness of controls" as part of obtaining an understanding of internal control. Choices "A", "C", and "D" are incorrect, per the above explanation.

Question 15

Which of the following services performed by another entity would not be considered to be part of the client's information system?

Accepted Answer

Choice "D" is correct. Services performed by another organization are not considered to be part of the client's information system if the services provided are limited to executing transactions that are specifically authorized by the client. Choice "A" is incorrect. A service organization's services are part of an entity's information system if they affect any of the following: How the entity's transactions are initiated; the accounting records, supporting information, and specific accounts in the financial statements involved in the processing and reporting of the entity's transactions; the accounting processing involved from the initiation of transactions to their inclusion in the financial statements, including electronic means used to transmit, process, maintain, and access information; and the financial reporting process used to prepare the entity's financial statements, including significant accounting estimates and disclosures. Choice "" is incorrect. As described more fully above, a service organization's services are part of an entity's information system if they affect the initiation, processing, or reporting of the entity's transactions. Choice "C" is incorrect. As described more fully above, a service organization's services are part of an entity's information system if they affect the initiation, processing, or reporting of the entity's transactions.

Question 16

Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both:

Accepted Answer

Choice "D" is correct. Proper segregation of duties reduces the opportunities for any individual to both perpetrate and conceal errors or fraud. Choice "A" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since journalizing cash receipts and disbursements and preparing the financial statements are both recordkeeping functions, this would not be a violation of proper segregation of duties. Choice "B" is incorrect. Monitoring internal controls and evaluating whether those controls are operating as intended would properly be performed by one person. Combining these functions does not violate the concept of proper segregation of duties, since it does not encompass an inappropriate combination of authorization, recordkeeping, and custodial functions. Choice "C" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since adopting new accounting pronouncements and authorizing the recording of transactions are both authorization functions, this would not be a violation of proper segregation of duties.

Question 17

In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:

Accepted Answer

Choice "A" is correct. In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor would most likely review the entity's descriptions of inventory controls. Choice "B" is incorrect. Performing test counts of inventory during the entity's physical count is a substantive procedure performed after obtaining an understanding of internal control. Choice "C" is incorrect. Analyzing inventory turnover statistics to identify slow-moving and obsolete items is a substantive procedure performed after obtaining an understanding of internal control. Choice "D" is incorrect. Analyzing monthly production reports to identify variances and unusual transactions is a substantive procedure performed after obtaining an understanding of internal control.

Question 18

Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when:

Accepted Answer

Choice "C" is correct. When management is dominated by one individual who is also a shareholder, there may not be any factors to moderate management's aggressive style. In such situations, management's style is likely to have a strong impact on the control environment. Choice "A" is incorrect. An active audit committee tends to moderate management's aggressive reporting style. Choice "B" is incorrect. External policies established by outside parties would tend to moderate management's aggressive reporting style. Choice "D" is incorrect. An effective internal audit function would tend to moderate management's aggressive reporting style.

Question 19

An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the:

Accepted Answer

Choice "D" is correct. An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the substantive tests to be performed. Choices "A", "B", and "C" are incorrect. Attribute tests, compliance tests, and tests of controls are all tests that assist the auditor in assessing control risk and determining the final assessed risk of material misstatement, not the other way around.

Question 20

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

Accepted Answer

Choice "B" is correct. Assessing control risk is the process of evaluating the effectiveness of an entity's internal control in preventing or detecting material misstatements in the financial statements. Choice "A" is incorrect. Management's philosophy and operating style are considered a part of the control environment. They are not the primary consideration in evaluating internal control. Choice "C" is incorrect. Providing adequate safeguards over access to assets is a type of control activity, but it is not the auditor's primary consideration regarding internal control. Choice "D" is incorrect. Policies and procedures concerning the effectiveness, economy, and efficiency of certain management decision-making processes are not relevant to the auditor's consideration of internal control.

Exam 1: CPA Auditing and Attestation Exam

When an auditor is to conduct an audit of a service organization, what considerations should the auditor make in the planning stages regarding internal controls of the organization?

The responsibility to establish, maintain and monitor internal controls is that of the entity's:

Which of the following statements about internal control is correct?

In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:

Which of the following factors would most likely be considered an inherent limitation to an entity's internal control?

Internal control is relevant to:

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the:

The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that:

Quick Service Center processes the payroll for a variety of clients, including James Industries. Adams, CPA, is Quick's auditor, while Robinson, CPA, is the auditor for James Industries. Which of the following is not required of Adams?

When obtaining an understanding of an entity's internal controls, an auditor should concentrate on the substance of the controls rather than their form because:

An advantage of using systems flowcharts to document information about internal control instead of using internal control questionnaires is that systems flowcharts:

If a budgetary reporting system provides adequate reports, but the reports are not analyzed and acted upon:

An auditor's primary consideration regarding an entity's internal control is whether the controls:

In obtaining an understanding of an entity's internal control, an auditor is required to obtain knowledge about the:

Which of the following services performed by another entity would not be considered to be part of the client's information system?

Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both:

In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:

Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when:

An auditor uses the knowledge provided by the understanding of internal control and the final assessed risk of material misstatement primarily to determine the nature, timing, and extent of the:

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