Auditing Theory - Internal Control Consideration audit engagement?

a) To comply with the requirements of GAAS.

1. The independent auditor should acquire an b) To interpret the operational effectiveness of the
understanding of a client's internal audit function to client's existing organizational structure.
determine whether the work of internal auditors will be c) To classify the client's documents and transactions
a factor in determining the nature, timing and extent of by major operating functions e.g., cash receipts, cash
the independent auditor's procedures. The work disbursements, etc.
performed by internal auditors might be such a factor d) To record the auditor's understanding of the client's
when the work includes I/C.
a) Verification of the mathematical accuracy of
invoices. 7. The independent auditor should acquire an
b) Review of administrative practices to improve understanding of the internal audit function as it
efficiency and achieve management objectives. relates to the independent auditor's consideration of
c) Consideration of the internal control structure. the I/C because
d) Preparation of internal financial reports for a) The audit program, working papers and reports of
management purposes. internal auditors can often be used as a substitute for
the work of the independent auditor's staff.
2. Effective I/C in a small company that has b) The procedures performed by the internal audit
insufficient employees to permit proper division of staff may eliminate the independent auditor's need for
responsibilities can be best enhanced by an extensive consideration of the I/C.
a) Employment of temporary personnel to aid in the c) The work performed by internal auditors may be a
separation of duties. factor in determining the nature, timing and extent of
b) Direct participation by the owner of the business in the independent auditor's procedures.
the recordkeeping activities of the business. d) The understanding of the internal audit function is
c) Engaging a CPA to perform monthly "write-up" an important substantive test to be performed by the
work. independent auditor.
d) Delegation of full, clear-cut responsibility to each
employee for the functions assigned to each. 8. The auditor's understanding of the client's I/C is
documented in order to substantiate
3. An auditor is considering the internal control a) Conformity of the accounting records with generally
system for purchasing and disbursement procedures. accepted accounting principles.
The auditor will be least influenced by b) Compliance with generally accepted auditing
a) The availability of a company manual describing standards.
purchasing and disbursement procedures. c) Adherence to requirements of management.
b) The scope and results of audit work by the d) The fairness of the financial statement
company's internal auditor. presentation.
c) The existence within the purchasing and
disbursement area of internal control strengths that 9. The ICS normally would include procedures that
offset weaknesses. are designed to provide reasonable assurance that
d) The strength or weakness of internal control in a) Employees act with integrity when performing their
other areas, e.g., sales and accounts receivable. assigned tasks.
b) Transactions are executed in accordance with
4. In general, material irregularities perpetrated by management's general or specific authorization.
which of the following are most difficult to detect? c) Decision processes leading to management's
a) Cashier authorization of transactions are sound.
b) Key-punch operator d) Collusion activities would be detected by
c) Internal auditor segregation of employee duties.
d) Controller
10. In general, a reportable condition may be defined
5. If, during the course of an annual audit of a publicly as a condition in which material errors or irregularities
held manufacturing company, an independent auditor ordinarily would not be detected within a timely period
becomes aware of a reportable condition in the by
company's internal control, the auditor is required to a) An auditor during the normal consideration of the
communicate the reportable condition to internal controls.
a) The senior management and the board of directors b) A controller when reconciling accounts in the
of the company. general ledger.
b) The senior management of the company. c) Employees in the normal course of performing their
c) The board of directors of the company. assigned duties.
d) The audit committee of the board of directors. d) The chief financial officer when reviewing interim
F/S.
6. Which of the following best describes the primary
reason for the auditor's use of flowcharts during an 11. Proper segregation of functional responsibilities
calls for separation of the d) That would aid in preventing irregularities.
a) Authorization, approval and execution functions.
b) Authorization, execution and payment functions. 17. A consideration of the ICS made in connection
c) Receiving, shipping and custodial functions. with an annual audit is usually not sufficient to
d) Authorization, recording and custodial functions. express an opinion on an entity's internal control
because
12. The ultimate risk against which the auditor a) Weaknesses in the ICS may go unnoticed during
requires reasonable protection is a combination of two the audit period.
separate risks. The first of these is that material errors b) A consideration of the ICS is not necessarily made
will occur in the accounting process by which the F/S during an audit engagement.
are developed, and the second is that c) Only those controls on which an auditor intends to
a) A company's internal control system is not rely are reviewed, tested and evaluated.
adequate to detect errors and irregularities. d) Internal controls can change each year.
b) Those errors that occur will not be detected by the
auditor's examination. 18. Which of the following would be least likely to
c) Management may possess an attitude that lacks suggest to an auditor that the client's management
integrity. may have overridden the ICS?
d) Evidential matter is not competent enough for the a) There are numerous delays in preparing timely
auditor to form an opinion based on reasonable internal financial reports.
assurance. b) Management does not correct I/C weaknesses that
it knows about.
13. When an independent auditor decides that the c) Differences are always disclosed on a computer
work performed by internal auditors may have a exception report.
bearing on the nature, extent and timing of the d) There have been two new controllers this year.
independent auditor's procedures, the independent
auditor should evaluate the competence and 19. Which of the following is intended to detect
objectivity of the internal auditors. Relative to deviation from prescribed Accounting Department
objectivity, the independent auditor should procedures?
a) Consider the organizational level to which internal a) Substantive test specified by a standardized audit
auditors report the results of their work. program.
b) Review the training program in effect for the b) Tests of controls designed specifically for the
internal auditors. client.
c) Examine the quality of the internal audit reports. c) Analytical procedures as designed in the industry
d) Consider the qualifications of the internal audit audit guide.
staff. d) Computerized analytical tests tailored for the
configuration of EDP equipment in use.
14. To provide the greatest degree of independence
in performing internal auditing functions, an internal 20. The independent auditor selects several
auditor should probably report to the transactions in each functional area and traces them
a) Financial vice-president. through the entire system, paying special attention to
b) Corporate controller. evidence about whether or not the control features
c) Board of directors. are in operation. This is an example of a
d) Corporate stockholders. a) Control test.
b) Tests of controls
15. When considering the client's ICS to determine c) Substantive test
whether the necessary procedures are prescribed and d) Functional test.
are followed satisfactorily, an auditor must
a) Develop questionnaires and checklists. 21. In the consideration of the ICS, the auditor is
b) Review the ICS and perform tests of controls. basically concerned that the system provides
c) Perform tests of controls and analytical reasonable assurance that
procedures. a) Management can not override the system.
d) Evaluate administrative policies. b) Operational efficiency has been achieved i/a/w
management plans.
16. After the auditor has prepared a flowchart of the c) Errors have been prevented or detected.
I/C surrounding sales and evaluated the design of the d) Controls have not been circumvented by collusion.
ICS, the auditor would perform tests of controls on all
internal control procedures 22. During the audit, the independent auditor
a) Documented in the flowchart. identified the existence of a reportable condition in the
b) Considered to be weaknesses that might allow client's system of internal controls and orally
errors to enter the accounting system. communicated this finding to the client's senior
c) Considered to be strengths that the auditor plans to management and audit committee. The auditor should
rely on. a) Consider the reportable condition a scope limitation
and therefore disclaim an opinion. 28. The use of fidelity bonds may indemnify a
b) Document the matter in the working papers and company from embezzlement losses. The use also
consider the effects of the condition on the audit. a) Reduces the company's need to obtain expensive
c) Suspend all audit activities pending directions from business interruption insurance.
the client's audit committee. b) Protects employees who make unintentional errors
d) Withdraw from the engagement. from possible monetary damages resulting from such
errors.
23. Which of the following statements concerning the c) Allows the company to substitute the fidelity bonds
independent auditor's required communication of for various parts of internal control.
reportable conditions is correct? d) Reduces the possibility of employing persons with
a) Conditions reported at interim dates must be dubious records in positions of trust.
repeated in the final communication.
b) If the auditor does not become aware of any 29. Which of the following procedures most likely
reportable conditions during the examination, that fact would be included as part of an auditor's tests of
must be communicated. controls?
c) Conditions that had been reported in prior year's a) Inspection.
communications and have not been corrected need b) Reconciliation.
not be repeated in the current year's communication. c) Confirmation.
d) Although written communication is preferable, the d) Analytical procedures.
auditor may communicate the findings orally.
30. If the independent auditors decide that the work
24. Which of the following is least likely to be performed by the internal auditor may have bearing
evidence the auditor examines to determine whether on their own procedures, they should consider the
operations are in compliance with the internal control internal auditor's
system? a) Competence and objectivity.
a) Records documenting usage of EDP programs. b) Efficiency and experience.
b) Canceled supporting documents. c) Independence and review skills.
c) Confirmations of accounts receivable. d) Training and supervisory skills.
d) Signatures on authorization forms.
31. Which statement is correct concerning the
25. The auditor's communication of reportable definition of internal control developed by the
conditions in internal control is Committee of Sponsoring Organizations (COSO)?
a) Required to enable the auditor to state that the a) Its applicability is largely limited to internal auditing
examination has been made in accordance with applications.
GAAS. b) It is recognized in the Statement on Auditing
b) The principal reason for considering the ICS. Standards.
c) Incident to the auditor's objective of forming an c) It emphasizes the effectiveness and efficiency of
opinion as to the fair presentation of the financial operations rather than the reliability of financial
statements. reporting.
d) Required to be documented in a written report to d) It suggests that it is important to view internal
the board of directors or the board's audit committee. control as an end product as contrasted to a process
or means to obtain an end.
26. An auditor may compensate for a condition in the
ICS by increasing the 32. Monitoring is considered
a) Level of detection risk. a) A component of internal control.
b) Extent of tests of controls. b) An element of the control environment.
c) Preliminary judgment about audit risk. c) The primary asset safeguarding technique.
d) Extent of analytical procedures d) A portion of information and communication.

27. After considering the client's internal controls, an 33. Which of the following is not a factor included in
auditor has concluded that I/C is well designed and is the control environment?
functioning as intended. Under these circumstances, a) Integrity and ethical values.
the auditor would most likely b) Risk assessment.
a) Perform tests of controls to the extent outlined in c) Commitment to competence.
the audit program. d) Organizational structure.
b) Determine the control procedures that should
prevent or detect errors and irregularities. 34. An entity's ongoing monitoring activities often
c) Not increase the extent of predetermined include
substantive tests. a) Periodic audits by the audit committee.
d) Determine whether transactions are recorded to b) Reviewing the purchasing function.
permit preparation of F/S in conformity with GAAP. c) The audit of the annual financial statements.
d) Control risk assessment in conjunction with
quarterly reviews. d) Be less than the actual control risk.

35. The definition of internal control developed by the 41. Which of the following is not a control that is
Committee of Sponsoring Organizations (COSO) and designed to protect investment securities?
included in the professional standards includes the a) Custody over securities should be limited to
reliability of financial reporting, the effectiveness and individuals who have record keeping responsibility
efficiency of operations and over the securities.
a) Compliance with applicable laws and regulations. b) Securities should be properly controlled physically
b) Effectiveness of prevention of fraudulent in order to prevent unauthorized usage.
occurrences. c) Access to securities should be vested in more than
c) Safeguarding of entity assets. one individual.
d) Incorporation of ethical business practice d) Securities should be registered in the name of the
standards. owner.

36. Which statement is correct concerning the Answers - Internal Controls Questions
relevance of various types of controls to a financial 1. C
audit? 2. B
a) An auditor may ordinarily ignore a consideration of 3. D
controls when a substantive audit approach is taken. 4. D
b) Controls over the reliability of financial reporting are 5. D
ordinarily most directly relevant to an audit but other 6. D
controls may also be relevant. 7. C
c) Controls over safeguarding of assets and liabilities 8. B
are of primary importance, while controls over the 9. B
reliability of financial reporting may also be relevant. 10. C
d) All controls are ordinarily relevant to an audit. 11. D
12. B
37. Which of the following is not ordinarily considered 13. A
a factor indicative of increased financial reporting risk 14. C
when an auditor is considering a client's risk 15. B
assessment policies? 16. C
a) Commissioned sales personnel. 17. C
b) Implementation of a new information system. 18. C
c) Rapid growth organization. 19. B
d) Corporate restructuring. 20. B
21. C
38. While obtaining an understanding of a client's risk 22. B
assessment policies, an auditor does not ordinarily 23. D
include how management 24. C
a) Identifies risk. 25. C
b) Eliminates significant risks. 26. D
c) Assesses the likelihood of occurrence of events 27. C
due to significant risks. 28. D
d) Relates risk assessment to financial reporting. 29. A
30. A
39. When an auditor considers a client's internal 31. B
control, which of the following is ordinarily a type of 32. A
control activity that is considered? 33. B
a) Risk assessment over cash disbursements. 34. C
b) Segregation of duties over payroll. 35. A
c) Inclusion of the president as a member of the audit 36. B
committee. 37. A
d) Management's monitoring policies over cash 38. B
receipts. 39. B
40. B
40. When tests of controls reveal that controls are 41. A
operating as anticipated, it is most likely that the
assessed level of control risk will
a) Be less than the planned assessed level of control
risk.
b) Equal the planned assessed level of control risk.
c) Equal the actual control risk.
Audit Planning: Assessment of Control Risk 5. An auditor evaluates the existing internal control in
MULTIPLE CHOICE: order to
1. Which of the following is ordinarily considered a a. Determine the extent of substantive tests which
test of internal control procedures? must be performed.
a. Send confirmation letters to banks. b. Determine the extent of control tests which must be
b. Count and list cash on hand. performed.
c. Examine signatures on checks. c. Ascertain whether irregularities are probable.
d. Obtain or prepare reconciliations of bank accounts d. Ascertain whether any employees have
as of the balance sheet date. incompatible functions.
ANSWER: C ANSWER: A
2. When obtaining an understanding of an entity's 6. The auditor is studying internal control policies and
control environment, an auditor should concentrate on procedures within the sales, shipping, and billing
the substance of management's policies and subset of the revenue cycle. Which of the following
procedures rather than their form because conditions suggests a need for additional testing of
a. The auditor may believe that the policies and controls?
procedures are inappropriate for that particular a. Internal control is found to be weak with regard to
entity. shipping and billing.
b. The board of directors may not be aware of b. Internal control over sales, billing, and shipping
management's attitude toward the control appears strong, but 80% of sales revenue is
environment. attributable to three major customers.
c. Management may establish appropriate policies c. Internal control over billing and shipping is thought
and procedures but not act on them. to be strong and the auditor considers additional
d. The policies and procedures may be so weak that testing of selected controls will result in a major
no reduction in substantive testing.
reliance is contemplated by the auditor. d. Internal control over the recording of sales is found
ANSWER: C to be weak and the sales are evenly divided among a
3. After the study and evaluation of a client's internal large number of customers.
control policies and procedures has been completed, ANSWER: C
an auditor might decide to 7. A secondary objective of the auditor's study and
a. Increase the extent of substantive testing in areas evaluation of internal control is that the study and
where the internal control policies and procedures are evaluation provide
strong. a. A basis for constructive suggestions concerning
b. Reduce the extent of control testing in areas where improvements in internal control.
the internal control policies and procedures are b. A basis for reducing the auditor's assessed level of
strong. control risk below the maximum level.
c. Reduce the extent of both substantive and control c. An assurance that the records and documents have
testing in areas where the internal control policies and been maintained in accordance with existing company
procedures are strong. policies and procedures.
d. Increase the extent of substantive testing in areas d. A basis for determination of the resultant extent of
where the internal controls are weak. the tests to which auditing procedures are to be
ANSWER: D restricted.
4. A conceptually logical approach to the auditor's ANSWER: A
evaluation of internal accounting control consists of 8. In studying the design and implementation of a
the following four steps: client's internal controls, the auditor needs to identify
I. Determine whether the necessary procedures are necessary control points. Controls existing at these
prescribed and are being followed satisfactorily. points may be classified as "accuracy" controls and
II. Consider the types of errors and fraud that could "safeguard" controls. Which of the following controls
occur. may be regarded as a safeguard control?
III. Determine the internal control policies and a. In processing sales orders, the computer is
procedures programmed to compare the customer's credit limit
that should prevent or detect errors and fraud. minus the prior balance with the current sales order
IV. Evaluate any weakness to determine its effect on amount.
the nature, timing, or extent of auditing procedures to b. Sales prices are stored in computer memory and
be applied and suggestions to be made to the client. are automatically applied as stock numbers are
What should be the order in which these four steps entered from customer orders.
are performed? c. Although the payroll is prepared manually, a
a. III, IV, I, II second employee recalculates gross pay,
b. III, I, II, IV withholdings, and net pay.
c. II, III, I, IV d. Negotiable securities are kept in a locked vault and
d. II, I, III, IV are accessible only by the treasurer accompanied by
ANSWER: C one of her assistants.
ANSWER: D
9. The auditor's review of the client's internal control is d. Although documents are prenumbered, they are
documented in order to substantiate not safeguarded and are not being used in numerical
a. Conformity of the accounting records with generally sequence.
accepted accounting principles. ANSWER: B
b. Representation as to adherence to requirements of 13. In connection with the examination of financial
management. statements by an independent auditor, the client
c. Representation as to compliance with generally suggests that members of the internal audit staff be
accepted auditing standards. utilized to minimize audit costs. Which of the following
d. The fairness of the financial statement tasks could most appropriately be delegated to the
presentation. internal audit staff?
ANSWER: C a. Selection of accounts receivable for confirmation,
10. An internal control questionnaire indicates that an based upon the internal auditor's judgment as to how
approved receiving report is required to accompany many accounts and which accounts will provide
every check request for payment of merchandise. sufficient coverage.
Which of the following procedures provides the b. Preparation of schedules for negative accounts
greatest assurance that this control is operating receivable responses.
effectively? c. Evaluation of the internal control for accounts
a. Select and examine canceled checks and ascertain receivable and sales.
that the related receiving reports are dated no earlier d. Determination of the adequacy of the allowance for
than the checks. doubtful accounts.
b. Select and examine canceled checks and ascertain ANSWER: B
that the related receiving reports are dated no later 14. An auditor uses the knowledge provided by the
than the checks. understanding of internal control and the final
c. Select and examine receiving reports and ascertain assessed level of control risk primarily to determine
that the related canceled checks are dated no earlier the nature, timing, and extent of the
than the receiving reports. a. Attribute tests. b. Compliance tests. c. Tests of
d. Select and examine receiving reports and ascertain controls. d. Substantive tests.
that the related canceled checks are dated no later ANSWER: D
than the receiving reports. 15. Flowcharting as a means of internal control
ANSWER: B evaluation provides the following advantage over the
11. When considering internal control, an auditor must use of questionnaires and descriptive narratives:
be aware of the concept of reasonable assurance a. Ease of preparation.
which recognizes that b. Comprehensive coverage of controls.
a. The employment of competent personnel provides c. Simplicity.
assurance that the objectives of internal control will be d. Ease in following information flow.
achieved. ANSWER: D
b. The establishment and maintenance of a system of 16. Which of the following factors most likely affects
internal control is an important responsibility of the the auditor's judgment about the quantity, type, and
management and not of the auditor. content of working papers?
c. The cost of internal control should not exceed the a. The effectiveness of the existing internal control.
benefits expected to be derived from internal control. b. The content of the client's representation letter.
d. The segregation of incompatible functions is c. The timing of substantive tests completed prior to
necessary to obtain assurance that the internal the balance sheet date.
control is effective. d. The usefulness of the working papers as a
ANSWER: C reference source for the client.
12. Statement on Auditing Standards No. 60 requires ANSWER: A
the auditor to communicate "reportable conditions" to 17. If the independent auditors decide that the work
the audit committee of the board of directors or, in the performed by the internal auditor may have a bearing
absence of an audit committee, to a body having on their own procedures, they should consider the
similar oversight authority. Of the following, which internal auditor's
does not represent a reportable condition? a. Competence and objectivity.
a. Bank accounts have not been reconciled in the last b. Efficiency and experience.
nine months, including the last month of the fiscal c. Independence and review skills.
year. d. Training and supervisory skills.
b. The corporate controller, unknown to the board of ANSWER: A
directors, has submitted her resignation effective two 18. An auditor's purpose for further testing of internal
months from now. control procedures is to
c. Perpetual inventory records contain numerous a. Provide a basis for reducing the assessed level of
errors and can no longer be relied upon to reflect control risk below that which resulted from the
proper inventory levels. auditor's initial understanding of internal control.
b. Reduce the risk that errors or fraud which are not a. Weaknesses reported at interim dates must be
prevented or detected by internal control are not repeated in the final communication.
detected by the independent audit. b. If the auditor does not become aware of any
c. Provide assurance that transactions are executed material weaknesses during the examination, that fact
in accordance with management's authorization and must be communicated.
accessed to assets is limited by a segregation of c. Weaknesses that had been reported in prior years'
functions. communications and have not been corrected need
d. Provide assurance that transactions are recorded not be repeated in the current year's communication.
as d. Although written communication is preferable, the
necessary to permit the preparation of the financial auditor may communicate the findings orally.
statements in conformity with GAAP. ANSWER: D
ANSWER: A 24. Which of the following would be the best
19. Control testing is performed in order to determine procedure to determine whether purchases were
whether or not properly authorized?
a. The assessed level of control risk can be reduced. a. Discuss authorization procedures with personnel in
b. Necessary controls are absent. the controller's and purchasing functions.
c. Incompatible functions exist. b. Review and evaluate a flowchart of purchasing
d. Material dollar errors exist. procedures.
ANSWER: A c. Determine whether a sample of entries in the
20. The independent auditor should acquire an purchase journal is supported by properly executed
understanding of the internal audit function as it purchase orders.
relates to the independent auditor's study and d. Vouch payments for selected purchases to
evaluation of internal control because supporting
a. The audit programs, working papers, and reports of receiving reports.
internal auditors can often be used as a substitute for ANSWER: C
the work of the independent auditor's staff. 25. After studying and evaluating a client's existing
b. The procedures performed by the internal audit internal control, an auditor has concluded that the
staff may eliminate the independent auditor's need for policies and procedures are well designed and
an extensive study and evaluation of internal control. functioning as intended. Under these circumstances,
c. The work performed by internal auditors may be a the auditor would most likely
factor in determining the nature, timing, and extent of a. Perform further control tests to the extent outlined
the independent auditor's procedures. in the audit program.
d. The understanding of the internal audit function is b. Determine the control policies and procedures that
an important substantive test to be performed by the should prevent or detect errors and fraud.
independent auditor. c. Set detection risk at a higher level than would be
ANSWER: C set under conditions of weak internal control.
21. In the assessment of control risk, the auditor is d. Set detection risk at a lower level than would be set
basically concerned that the client's internal control under conditions of weak internal control.
provides reasonable assurance that ANSWER: C
a. Management cannot override the system. 26. An auditor is required to obtain a basic
b. Operational efficiency has been achieved in understanding of the client's internal control to plan
accordance with management plans. the audit. The auditor may then decide to perform
c. Errors and fraud have been prevented or detected. tests of controls on all internal control procedures
d. Controls have not been circumvented by collusion. a. That would aid in preventing fraud.
ANSWER: C b. Documented in the flowchart.
22. Which of the following may be considered an c. Considered to be weaknesses that might allow
appropriate means for further testing controls over errors to enter the accounting system.
vendor payments? d. Considered to be strengths for which the auditor
a. Confirm year-end balances with vendors. desires further reduction in the assessed level of
b. Search for unrecorded invoices at year-end. control risk.
c. Develop a set of hypothetical transactions designed ANSWER: D
to test existing controls over vendor payments (e.g., 27. The auditor's understanding of the client's internal
introduce into the system, a voucher containing an control is documented in order to substantiate
invoice for raw materials but lacking a purchase order a. Conformity of the accounting records with generally
and/or receiving report.) accepted accounting principles.
d. Construct an internal control flowchart covering the b. Compliance with generally accepted auditing
payment processing function. standards.
ANSWER: C c. Adherence to requirements of management.
23. Which of the following statements concerning the d. The fairness of the financial statement
independent auditor's required communication of presentation.
material weaknesses in internal control is correct? ANSWER: B
28. To determine whether the client's system of a. Inquiries and observations lead the auditor to
internal control operated effectively to minimize errors believe that conditions have changed significantly.
of failure to invoice a shipment, the auditor would b. Comparisons of year-end balances with like
select a sample of transactions from the population balances at prior dates revealed significant
represented by the fluctuations.
a. Customer order file. c. Unusual transactions occurred subsequent to the
b. Bill of lading file. completion of the interim audit work.
c. Open invoice file. d. Client records are in a condition that facilitate
d. Sales invoice file. effective and efficient testing.
ANSWER: B ANSWER: A
29. When evaluating a client's system of internal 34. An auditor is least likely to further test control
control to determine whether the necessary procedures by examining documents with respect to
procedures are prescribed and have been controls relating to
implemented satisfactorily, an auditor must a. Segregation of the functions of recording
a. Develop questionnaires and checklists. disbursements and reconciling the bank account.
b. Obtain an understanding of internal control. b. Comparison of receiving reports and vendors'
c. Perform tests of internal control procedures. invoices with purchase orders.
d. Evaluate administrative policies. c. Approval of the purchase and sale of marketable
ANSWER: B securities.
30. Of the following internal control policies or d. Classification of revenue and expense transactions
procedures, which would most likely allow for a by product line.
reduction in the scope of the auditor's tests of ANSWER: A
depreciation expense? 35. An auditor usually examines receiving reports to
a. Review and approval of the periodic equipment support
depreciation entry by a supervisor who does not entries in the
actively participate in its preparation. a. Voucher register and sales returns journal.
b. Comparison of equipment account balances for the b. Sales journal and sales returns journal.
current year with the current-year budget and prior- c. Voucher register and sales journal.
year actual balances. d. Check register and sales journal.
c. Review of the miscellaneous income account for ANSWER: A
salvage credits and scrap sales of partially 36. Regardless of whether the auditor decides to test
depreciated equipment. controls for operating effectiveness, he/she must fully
d. Authorization of payment of vendors' invoices by a document his or her understanding of the internal
designated employee who is independent of the control policies and procedures obtained through
equipment receiving function. whatever means. Which of the following
ANSWER: A does notdescribe an appropriate means for
31. Tracing copies of sales invoices to shipping documenting such understanding?
documents will provide evidence that all a. Internal control flowchart.
a. Shipments to customers were recorded as b. Internal control implementation.
receivables. c. Internal control memorandum.
b. Billed sales were shipped. d. Internal control questionnaire.
c. Debits to the subsidiary accounts receivable ledger ANSWER: B
are for sales shipped. 37. Which of the following best describes the primary
d. Shipments to customers were billed. reason for the auditor's use of flowcharts during an
ANSWER: B audit engagement?
32. In assessing control risk, the auditor must, as a a. To comply with the requirements of generally
minimum accepted auditing standards.
a. Perform tests of all significant controls. b. To classify the client's documents and transactions
b. Obtain an understanding of the design and by major operating functions, e.g., cash receipts, cash
implementation of the client's internal control. disbursements, etc.
c. Obtain an understanding of the design of the c. To record the auditor's understanding of the client's
client's internal control. internal control policies and procedures.
d. Obtain an understanding of the design, d. To interpret the operational effectiveness of the
implementation, and operating effectiveness of the client's existing organizational structure.
client's internal control. ANSWER: C
ANSWER: B 38. An auditor generally tests physical security
33. An independent auditor has concluded that the controls over inventory by
client's records, procedures and representations can a. Test counts and cutoff procedures.
be relied upon based on tests made during the year b. Examination and reconciliation.
when internal control was found to be effective. The c. Inspection and recomputation.
auditor should test the records, procedures, and d. Inquiry and observation.
representations again at year-end if ANSWER: D
39. Which of the following is not an auditing a. Because of the inherent limitations of an audit, the
procedure that is commonly used in performing auditor is not responsible for the failure to detect
control tests? material fraud.
a. Inquiring. b. The auditor is responsible for the failure to detect
b. Observing. material fraud when such failure results from
c. Confirming. nonperformance of audit procedures specifically
d. Inspecting. described in the engagement letter.
ANSWER: C c. The auditor should design audit programs that will
40. If the independent auditor decides that the work provide reasonable assurance that material errors
performed by internal auditors may have a bearing on and fraud will be detected in the ordinary course of
the independent auditor's own procedures, the the examination.
independent auditor should consider the objectivity of d. The auditor is responsible for the failure to detect
the internal auditors. One method of judging material fraud when the auditor's evaluation of internal
objectivity is to control procedures indicates that they are ineffective.
a. Review the recommendations made in the reports ANSWER: C
of the internal auditor. 45. Which of the following procedures most likely
b. Examine, on a test basis, documentary evidence of would be included as part of an auditor's tests of
the work performed by internal auditors. control procedures?
c. Inquire of management about the qualifications of a. Inspection.
the internal audit staff. b. Reconciliation.
d. Consider the client's practices for hiring, training, c. Confirmation.
and supervising the internal audit staff. d. Analytical procedures.
ANSWER: A ANSWER: A
41. Tracing bills of lading to sales invoices will provide 46. If, after obtaining an initial understanding of a
evidence that client's internal control, the auditor wishes to further
a. Recorded sales were shipped. reduce the assessed level of control risk relating to
b. Invoiced sales were shipped. plant asset transactions, the auditor should next
c. Shipments to customers were invoiced. a. Make extensive substantive tests of plant asset
d. Shipments to customers were recorded as sales. balances.
ANSWER: C b. Establish the physical existence of current year
42. The development of constructive suggestions to additions.
clients for c. Complete the plant asset section of the internal
improvements in internal accounting control is accounting control questionnaire.
a. A requirement of the auditor's study and evaluation d. Further test those internal control procedures
of internal accounting control. relating to processing and recording plant asset
b. A desirable byproduct of an audit engagement. transactions.
c. Addressed by the auditor only during a special ANSWER: D
engagement. 47. The auditor is most likely to presume that a high
d. As important as establishing a basis for reliance risk of defalcation exists if
upon the internal accounting control system. a. The client is a multinational company that does
ANSWER: B business in numerous foreign countries.
43. Which of the following statements with respect to b. The client does business with several related
the independent auditor's evaluation of internal control parties.
is correct? c. Inadequate segregation of duties places an
a. The auditor should decrease control testing when employee in a position to perpetrate and conceal
weaknesses in cash receipts are mitigated by strong thefts.
controls in cash disbursement procedures. d. Inadequate employee training results in lengthy
b. The auditor should increase control testing when CBIS exception reports each month.
weaknesses in billing procedures are mitigated by ANSWER: C
strong controls in collection procedures. 48. After obtaining an understanding of the client’s
c. The auditor generally should not evaluate the internal control, the auditor should consider whether
overall effectiveness of internal control, but should a. The projected degree of effectiveness of internal
separately evaluate each of the transaction cycles. control is justified.
d. The auditor should evaluate all internal control b. The evidential matter obtained from the study of the
weaknesses before determining the control internal control system can provide a reasonable
procedures that should prevent or detect errors or basis for an opinion.
irregularities. c. Further testing of internal control procedures is
ANSWER: C likely to permit further reduction of assessed control
44. Which of the following statements best describes risk.
the auditor's responsibility regarding the detection of d. Sufficient knowledge has been obtained about the
material fraud? entity's entire system of internal control.
ANSWER: C
49. Which of the following is the correct order of d. Study of internal controls within the payroll cycle
performing the auditing procedures A through C confirm the auditor's belief that few errors have
below? occurred.
A = Tests of internal control procedures. ANSWER: A
B = Preparation of a flowchart depicting the client's 54. Which of the following is not a medium that can
internal control system. normally be used by an auditor to record information
C = Substantive tests. concerning a client's internal control policies and
a. ABC. procedures?
b. ACB. a. Narrative memorandum.
c. BAC. b. Procedures manual.
d. BCA. c. Flowchart.
ANSWER: C d. Questionnaire.
50. Auditors frequently use flowcharts in connection ANSWER: B
with which 55. With respect to the client's system of internal
of the following control, the auditor is concerned that the existing
a. Preparation of generalized computer audit policies and procedures provide reasonable
programs. assurance that
b. Review of the client's internal control procedures. a. Operational efficiency has been achieved in
c. Use of statistical sampling in performing an audit. accordance with management plans.
d. Performance of analytical review procedures of b. Errors and fraud have been prevented or detected.
account balances. c. Controls have not been circumvented by collusion.
ANSWER: B d. Management cannot override the internal controls.
51. Which of the following conditions suggest ANSWER: B
alowering of the aggregate materiality threshold? 56. The auditor observes client employees during the
a. Internal controls in the area of payroll processing review of the client's system of internal control in
are found to be much stronger than the auditor's initial order to
assessment. a. Prepare a flowchart.
b. The application of analytical procedures reveals a b. Update information contained in the organization
favorable sales budget variance that is material and and procedure manuals.
that remains unexplained. c. Assist in obtaining an understanding of the client's
c. Study of the business and industry reveals a internal control policies and procedures.
material decline in both industry and client revenue d. Determine the extent of compliance with quality
during the current year. control standards.
d. Tests of internal controls in nearly all transaction ANSWER: C
cycle subsets have produced numerous and 57. An auditor's flowchart of a client's accounting
widespread errors. system is a diagrammatic representation that depicts
ANSWER: D the auditor's
52. If, during the course of an annual audit of a a. Program for tests of controls.
publicly held manufacturing company, an independent b. Understanding of the system.
auditor becomes aware of a material weakness in the c. Understanding of the types of fraud that are
company's internal control, the auditor is required to probable, given the present system.
communicate the weakness to d. Documentation of the study and evaluation of the
a. The audit committee of the board of directors, or to system.
a similar body having financial oversight ANSWER: B
responsibility. 58. An independent auditor might consider the
b. The senior management of the company. procedures performed by the internal auditors
c. The board of directors of the company. because
d. The treasurer and controller of the client entity. a. They are employees whose work must be reviewed
ANSWER: A during substantive testing.
53. Under which of the following conditions would you b. They are employees whose work might be relied
consider lowering individual itemmateriality upon.
thresholds. c. Their work impacts upon the cost/benefit tradeoff in
a. Study of the business and industry, together with evaluating inherent limitations.
the application of analytical procedures, reveals that d. Their degree of independence may be inferred by
the client has enjoyed a surge in sales and gross the
profit during an industry downturn. nature of their work.
b. Application of analytical procedures shows that the ANSWER: B
client's gross profit rate is significantly below last year 59. A procedure that would most likely be used by an
and also is materially lower than the industry average. auditor in performing tests of control procedures that
c. Study of internal controls within the revenue cycle involve segregation of functions and that leave no
reveal material weaknesses. transaction trail is
a. Inspection.
b. Observation.
c. Reprocessing.
d. Reconciliation.
ANSWER: B
60. It is important for the CPA to consider the
competence of the audit client's employees because
their competence bears directly and importantly upon
the
a. Cost/benefit relationship of the internal control
system.
b. Achievement of the objectives of the internal
control system.
c. Comparison of recorded accountability with assets.
d. Timing of the tests to be performed.
ANSWER: B
61. In studying internal control and assessing control
risk, the auditor applies the following steps:
a. Determine the internal control policies and
procedures necessary to prevent or detect errors or
fraud that could occur in the absence of controls.
b. Identify control weaknesses.
c. Determine whether the necessary policies and
procedures have been designed and whether they
have been placed in operation.
d. Design substantive audit programs.
e. Consider the types of errors or fraud that could
occur in the absence of necessary controls.
The proper sequence in applying these steps is:
a. CDEAB
b. CBAED
c. EACBD
d. AECBD
ANSWER: C
62. The primary purpose of performing further control
tests is to provide
a. A basis for reducing the assessed level of control
risk below the maximum level.
b. A basis for understanding the flow of transactions
through the accounting system.
c. Assurance that transactions are properly recorded.
d. All accounting control procedures leave visible
evidence.
ANSWER: A
63. To determine whether refunds granted to
customers were properly approved, the auditor should
trace accounts receivable entries to:
a. Sales invoices.
b. Remittance advices.
c. Shipping documents.
d. Credit memos.
ANSWER: D
64. A well-prepared flowchart should make it easier
for the auditor to
a. Prepare audit procedure manuals.
b. Prepare detailed job descriptions.
c. Trace the origin and disposition of documents.
d. Assess the degree of accuracy of financial data.
ANSWER: C