Chapter 10 Audits of Internal Control and Control Risk PDF

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Chapter 10-Audits of Internal Control and Control Risk 1. Which of the following is responsible for establishing a private company’s internal control? a a. Management. b. Auditors. c. Management and auditors. d. Committee of Sponsoring Organizations. 2. Which of the following is not one of the three primary objectives of effective internal d 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. 3. The Public Company Accounting Oversight Board states that reasonable assurance allows b a: a. small likelihood of ineffective internal controls. b. remote likelihood that material misstatements will not be prevented or detected by internal control. c. 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. 4. Two key concepts that underlie management’s design and implementation of internal c control are: a. costs and materiality. b. absolute assurance and costs. c. inherent limitations and reasonable assurance. d. collusion and materiality. 5. Internal controls can never be considered as absolutely effective because: a a. their effectiveness is limited by the competency and dependability of employees. b. not all organizations have internal audit departments. c. controls are designed to prevent and detect only material misstatements. d. internal controls prevent separation of duties. 6. A major control available in a small company, which might not be feasible in a big d company, is: a. a wider segregation of duties. b. a voucher system. c. fewer transactions to process. d. the owner-manager’s personal interest and close relationship with personnel. Johannah Therese V. Veluz

7. aWhich of the following is responsible for establishing internal controls for a public company? a. Management. c. Management and auditors. b. The PCAOB. d. Committee of Sponsoring Organizations. 8. Which of the following parties provides an assessment of the effectiveness of internal a control over financial reporting for public companies?

a. b. c. d.

Management Yes No Yes No

Financial statement auditors Yes No Yes No

9. An act of two or more employees to steal assets or misstate records is frequently referred to a as: a. collusion. c. a control deficiency. b. a material weakness. d. a significant deficiency. 10. When the auditor attempts to understand the operation of the accounting system by tracing c a few transactions through the accounting system, the auditor is said to be: a. tracing. c. performing a walk-through. b. vouching. d. testing controls. 11. Which section of the Sarbanes-Oxley Act requires management to issue an internal control c report? a. 202 c. 404 b. 203 d. 408 12. Sarbanes-Oxley requires management to issue an internal control report that includes two a 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. 13. When management is evaluating the design of internal control, management evaluates c whether the control can do which of the following? Detect material misstatements Correct material misstatements a. Yes Yes

b. c. d.

No Yes No

No No Yes

14. Internal control reports issued by public companies must identify the framework used to b evaluate the effectiveness of internal control. Which of the following is the most common framework in the U.S.? a. Effective Internal Control Framework - AICPA b. Internal Control - Integrated Framework - COSO c. Enterprise Internal Control - COSO d. Enterprise Internal Control - AICPA 15. When one material weakness is present at the end of the year, management of a public c company must conclude that internal control over financial reporting is: a. insufficient. c. ineffective. b. inadequate. d. inefficient. 16. The auditor’s tests to understand the client’s internal controls might include which of the a following types of procedures? a. b. c. d.

Observation of employees Yes No Yes No

Inquiries of personnel Yes No No Yes

17. Which of management’s concerns with respect to implementing internal controls is the b auditor primarily concerned? a. Efficiency of operations. b. Reliability of financial reporting. c. Effectiveness of operations. d. Compliance with applicable laws and regulations. 18. Which of the following activities would be least likely to strengthen a company’s internal b 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. 19.Management must disclose material weaknesses in internal control: c 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. Johannah Therese V. Veluz

20. When auditing a private company, the auditor should obtain an understanding of internal b control sufficient to: a. provide reasonable protection against client fraud and defalcations by client employees. b. assess control risk. c. provide a basis for suggestions to the client for improving the accounting system. d. provide a method for safeguarding assets, checking the accuracy and reliability of accounting data, promoting operational efficiency, and encouraging adherence to prescribed managerial policies. 21.The initial presumption in the audit of a public company is that control risk is: a a. low. c. high. b. moderate. d. low or moderate, but not high. 22. In the audit of a private company, the auditor will test controls when control risk is initially c assessed at: Low Moderate High a. Yes No Yes b. No No Yes c. Yes Yes No d. No Yes No 23.The auditor’s study of a public company’s internal control is: c a. required by GAAS. c. required by the Sarbanes-Oxley Act. b. required by the AICPA. d. recommended by the AICPA. 24.The auditor’s consideration of a private company’s internal control is: b a. required by GAAP. c. required by the IRS. b. required by GAAS. d. recommended by the SEC. 25. Internal controls can never be regarded as completely effective. Even if company personnel d 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. 26. Even with the most effectively designed internal control, the auditor must obtain audit c evidence, beyond testing the controls, for every: a. transaction. b. financial statement account. c. material financial statement account. d. financial statement account that will be relied upon by third parties.

27.The essence of an effectively controlled organization lies in the: d a. effectiveness of its independent auditor. c. attitude of its employees. b. effectiveness of its internal auditor. d. attitude of its management. 28. To issue a report on internal control over financial reporting for a public company, an c 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. 29. Which of the stock exchanges require listed companies to have an audit committee a composed entirely of independent directors?

c a. b. c. d.

adequate separation of duties among personnel. proper authorization of transactions. the use of physical precautions. adequate documentation.

34.Which of the following is correct with respect to the design and use of business documents? a a. Not all documents used for internal purposes need to be prenumbered. b. Documents should be designed for single purposes only to avoid confusion in their use. c. Documents should be designed to be understandable only by those who use them. d. Documents designed for external use must be prenumbered. 35. PCAOB Standard 2 requires auditors to evaluate the effectiveness of the audit committee’s a oversight of the company’s: External financial reporting

a. b. c. d.

NYSE Yes No Yes No

NASDAQ Yes No No Yes

30.Which of the following factors may increase risks to an organization? a Geographic dispersion of company Presence of new information operations technologies a. Yes Yes b. No No c. Yes No d. No Yes 31.Which of the following statements is correct with respect to separation of duties? b a. Employees should not have temporary and permanent custody of assets. b. Employees who authorize transactions should not have custody of related assets. c. It is permissible to allow an employee to open cash receipts and record those receipts. d. Employees who authorize transactions should have recording responsibility for these transactions. 32. Authorizations can be either general or specific. Which of the following is not an example b 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. 33.The most important type of protective measure for safeguarding assets is: Johannah Therese V. Veluz

a. b. c. d.

Yes No Yes No

Efficiency of operations Internal control over financial reporting No Yes No Yes Yes No Yes No

36.Which of the following is correct? c a. Approval is a policy decision implemented by employees. b. Approval occurs as a matter of general policy and includes significant transactions only. c. Authorization is a policy decision for either a general class of transactions or specific transactions. d. Approval should be given by the employee responsible for recording the transaction. 37. Which of the following principles is not necessary for the proper design and use of a documents and records? a. Designed for a single use to increase efficiency of operations. b. Constructed in a manner that encourages correct preparation. c. Prepared at the time a transaction takes place. d. Designed for multiple uses to increase efficiency of operations. 38.Narratives, flowcharts, and internal control questionnaires are three common methods of: b 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. 39. _____ deal with ongoing or periodic assessment of the quality of internal control by b management. a. Quality monitoring activities c. Oversight activities b. Monitoring activities d. Management activities

40. Smaller public companies face challenges implementing effective internal control due to c ______. a. a lack of expertise c. limited resources b. reduced importance d. limited available guidance 41.Which of the following is not one of the levels of an absence of internal controls? a a. Major deficiency. c. Significant deficiency. b. Material weakness. d. Control deficiency. 42.Which of the following is the correct definition of “control deficiency?” a 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. 43.A(n) _______ deficiency exists if a necessary control is missing or not properly formulated. c a. control c. design b. significant d. operating 44. To determine if significant internal control deficiencies are material weaknesses, they must a be evaluated on their: a. b. c. d.

Likelihood Yes No Yes No

Significance Yes No No Yes

47. If the results of tests of controls support the design and operations of controls as expected, b the auditor uses ____ control risk as the preliminary assessment. a. a lower c. a higher b. the same d. either a lower or higher 48. Internal controls normally include procedures designed to provide reasonable assurance b 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. 49.Which of the following is correct? d a. A significant deficiency is always a material weakness. b. A control deficiency is always a material weakness. c. A material weakness is less significant that a control deficiency. d. A material weakness is always a significant deficiency. 50. Which of the following is not a likely procedure to support the operating effectiveness of d internal controls? a. Inquiry of client personnel. b. Observation of control-related activities. c. Reperformance of client procedures. d. Completing an internal control questionnaire. 51. Before making the final assessment of internal control at the end of an integrated audit, the a auditor must: Test controls Perform substantive tests of details a. Yes Yes b. No No c. Yes No d. No Yes

45.The purpose of an entity’s accounting information and communication system is to ______. d Monitor transactions Record and process transactions Initiate transactions a. Yes Yes Yes b. No No No c. Yes No No d. No Yes Yes

52. Significant deficiencies and material weaknesses in internal control of a public company c must be reported to which of the following? a. The Public Company Accounting Oversight Board. b. Members of management who are responsible for the related area of the company. c. Audit committee of the company’s board of directors. d. The AICPA.

46. A procedure that would most likely be used by an auditor in performing tests of control b procedures that involve segregation of functions and that leave no transaction trail is: a. inspection. c. reperformance. b. observation. d. reconciliation.

53.Of the following statements about internal controls, which one is not valid? d 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.

Johannah Therese V. Veluz

d.

Control procedures reasonably ensure that collusion among employees cannot occur.

54. Which of the following best describes the inherent limitations that should be recognized by a an auditor when considering the potential effectiveness of internal control? a. Procedures that depend on segregation of duties can be circumvented by collusion. b. Competent and honest client personnel provide an environment conducive to accounting control and provide absolute assurance that effective control will be achieved. c. Procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are effective against irregularities perpetrated by management. d. The benefits expected to be derived from effective internal accounting control usually do not exceed the costs of such control. 55.Which of the following is not one of the subcomponents of the control environment? c a. Management’s philosophy and operating style. c. Adequate separation of duties. b. Organizational structure. d. Commitment to competence. 56. It is important for the CPA to consider the competence of the clients’ personnel because b their competence bears directly and importantly 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. 57.Audit evidence concerning proper segregation of duties normally is best obtained by: a a. direct personal observation of the employee who applies 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. inspection of third-party documents containing the initials of who applied control procedures. 58.Proper segregation of functional responsibilities calls for separation of: b a. authorization, execution, and payment. c. custody, execution, and reporting. b. authorization, recording, and custody. d. authorization, payment, and recording. 59.Internal controls are not designed to provide reasonable assurance that: a a. all frauds will be eliminated. b. transactions are executed in accordance with management’s authorization. c. access to assets is permitted only in accordance with management’s authorization. d. company personnel comply with applicable rules and regulations. 60. Which of the following statements about auditor documentation of the client’s internal d controls is correct? a. Documentation must include flow charts. Johannah Therese V. Veluz

b. c. d.

Documentation must include procedural write-ups. No documentation is necessary although it is desirable. No one particular form of documentation is necessary.

61. Significant deficiencies are matters that come to an auditor’s attention and should be b communicated to an entity’s audit committee because they represent: a. material frauds perpetrated by high-level management. b. internal control deficiencies that could adversely affect a company’s ability to initiate, record, process, or report external financial statements reliably. c. flagrant violations of the entity’s documented conflict-of-interest policies. d. intentional attempts by client personnel to limit the scope of the auditor’s field work. 62. How must significant deficiencies and material weaknesses be communicated to those c charged with governance? a. Either oral or written communication is acceptable. b. Oral communication is required. c. Written communication is required. d. Written communication is required for material weaknesses, but oral communication is allowed for significant deficiencies. 63. Which of the following statements, if any, is correct? a a. The NASDAQ market requires listed companies to have audit committees that have only independent directors. b. The NASDAQ market requires listed companies to have audit committees that have a minority of the positions held by independent directors. c. The NASDAQ market recommends, but does not require, listed companies to have audit committees. d. The NASDAQ market recommends, but does not require, listed companies to have audit committees that have a minority of the positions held by independent directors. 64.The Sarbanes-Oxley Act requires: a a. all public com...