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Chapter 10 Test bank

audit (‫)سمش نيع ةعماج‬

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Chapter 10 Internal Control and COSO Framework

Multiple choices

1) Which of the following is not one of the three primary objectives of effective internal
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
Answer: D

2) With which of management's assertions with respect to implementing internal controls is

the auditor primarily concerned?
A) efficiency of operations
B) reliability of financial reporting
C) effectiveness of operations
D) compliance with applicable laws and regulations
Answer: B

3) Internal controls
A) are implemented by and are the responsibility of the auditors.
B) consist of policies and procedures designed to provide reasonable assurance that the company
achieves its objectives and goals.
C) guarantee that the company complies with all laws and regulations.
D) only apply to SEC companies.
Answer: B

4) Internal controls are not designed to provide reasonable assurance that

A) all frauds will be detected.
B) transactions are executed in accordance with management's authorization.
C) the company's resources are used efficiently and effectively.
D) company personnel comply with applicable rules and regulations.
Answer: A

5) Who is responsible for establishing a private company's internal control?

A) senior management
B) internal auditors
C) FASB
D) audit committee
Answer: A
6) Two key concepts that underlie management's design and implementation of internal
control are
A) costs and materiality.
B) absolute assurance and costs.
C) inherent limitations and reasonable assurance.
D) collusion and materiality.
Answer: C
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7) The PCAOB places responsibility for the reliability of internal controls over the
financial reporting process on
A) the company's board of directors.
B) the audit committee of the board of directors.
C) management.
D) the CFO and the independent auditors.
Answer: C

8) Which of the following parties provides an assessment of the effectiveness of internal

control over financial reporting for public companies?
A)
Management Financial statement auditors
Yes Yes

B)
Management Financial statement auditors
No No

C)
Management Financial statement auditors
Yes No

D)
Management Financial statement auditors
No Yes

Answer: A

9) An act of two or more employees to steal assets and cover their theft by misstating the
accounting records would be referred to as
A) collusion.
B) a material weakness.
C) a control deficiency.
D) a significant deficiency.
Answer: A
10) Sarbanes-Oxley requires management to issue an internal control report that includes
two 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 for establishing and maintaining
an adequate system of internal control
Answer: A
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11) When management is evaluating the design of internal control, management evaluates
whether the control can do which of the following?
A)
Detect material Correct material
misstatements misstatements
Yes Yes

B)
Detect material Correct material
misstatements misstatements
No No

C)
Detect material Correct material
misstatements misstatements
Yes No

D)
Detect material Correct material
misstatements misstatements
No Yes

Answer: C

12) When one material weakness is present at the end of the year, management of a public
company must conclude that internal control over financial reporting is
A) insufficient.
B) inadequate.
C) ineffective.
D) inefficient.
Answer: C

13) The auditor's primary purpose in auditing the client's system of internal control over
financial reporting is
A) to prevent fraudulent financial statements from being issued to the public.
B) to evaluate the effectiveness of the company's internal controls over all relevant assertions in
the financial statements.
C) to report to management that the internal controls are effective in preventing misstatements
from appearing on the financial statements.
D) to efficiently conduct the Audit of Financial Statements.
Answer: B

14) The internal control framework used by most U.S. companies is the ________
framework.
A) FASB
B) PCAOB
C) COSO
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D) SEC
Answer: C

15) In performing the audit of internal control over financial reporting, the auditor
emphasizes internal control over classes of transactions because
A) the accuracy of accounting system outputs depends heavily on the accuracy of inputs and
processing.
B) the class of transaction is where most fraud schemes occur.
C) account balances are less important to the auditor then the changes in the account balances.
D) classes of transactions tests are the most efficient manner to compensate for inherent risk.
Answer: A

16) Internal controls can never be regarded as completely effective. Even if company
personnel 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.
Answer: D

17) When considering internal controls,

A) auditors can ignore controls affecting internal management information.
B) auditors are concerned with the client's internal controls over the safeguarding of assets if
they affect the financial statements.
C) management is responsible for understanding and testing internal control over financial
reporting.
D) companies must use the COSO framework to establish internal controls.
Answer: B

18) Of the following statements about internal controls, which one is least likely to be
correct?
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.
D) Control procedures reasonably ensure that collusion among employees cannot occur.
Answer: D

19) The Sarbanes-Oxley Act requires

A) all public companies to issue reports on internal controls.
B) all public companies to define adequate internal controls.
C) the auditor of public companies to design effective internal controls.
D) the auditor of public companies to withdraw from an engagement if internal controls are
weak.
Answer: A

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20) Which of the following is an accurate statement regarding the auditor's responsibility
for understanding internal control?
A) Transaction-related audit objectives typically have no impact on the rights and obligations
objectives.
B) Transaction-related audit objectives typically have a significant impact on the balance-related
audit objective of realizable value.
C) Auditors generally emphasize internal control over account balances rather than classes of
transactions.
D) Auditors and management are both equally concerned about controls that affect the efficiency
and effectiveness of company operations.
Answer: A

21) The primary emphasis by auditors is on controls over

A) classes of transactions.
B) account balances.
C) both A and B, because they are equally important.
D) both A and B, because they vary from client to client.
Answer: A

22) An auditor should consider two key issues when obtaining an understanding of a
client's internal controls. These issues are
A) the effectiveness and efficiency of the controls.
B) the frequency and effectiveness of the controls.
C) the design and operating effectiveness of the controls.
D) the implementation and operating effectiveness of the controls.
Answer: C

23) Reasonable assurance allows for

A) low likelihood that material misstatements will not be prevented or detected by internal
controls.
B) no likelihood that material misstatements will not be prevented or detected by internal
control.
C) moderate 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.
Answer: A

24) Which of the following is most correct regarding the requirements under Section 404 of
the Sarbanes-Oxley Act?
A) The audits of internal control and the financial statements provide reasonable assurance as to
misstatements.
B) The audit of internal control provides absolute assurance of misstatement.
C) The audit of financial statements provides absolute assurance of misstatement.
D) The audits of internal control and the financial statements provide absolute assurance as to
misstatements.
Answer: A

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25) Which of the following activities would be least likely to strengthen a company's
internal 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
Answer: B

26) Which of the following components of the control environment define the existing lines
of responsibility and authority?
A) organizational structure
B) management philosophy and operating style
C) human resource policies and practices
D) management integrity and ethical values
Answer: A

27) Which of the following factors may increase risks to an organization?

A)
Geographic dispersion of Presence of new information
company operations technologies
Yes Yes

B)
Geographic dispersion of Presence of new information
company operations technologies
No No

C)
Geographic dispersion of Presence of new information
company operations technologies
Yes No

D)
Geographic dispersion of Presence of new information
company operations technologies
No Yes

Answer: A

28) Which of the following statements is most correct with respect to separation of duties?
A) A person who has temporary or permanent custody of an asset should account for that asset.
B) Employees who authorize transactions should not have custody of the related assets.
C) Employees who open cash receipts should record the amounts in the subsidiary ledgers.
D) Employees who authorize transactions should have recording responsibility for these
transactions.
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Answer: B

29) Authorizations can be either general or specific. Which of the following is not an
example 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
Answer: B

30) Which of the following is correct with respect to the design and use of business
documents?
A) The documents should be in paper format.
B) Documents should be designed for a single purpose to avoid confusion in their use.
C) Documents should be designed to be understandable only by those who use them.
D) Documents should be prenumbered consecutively to facilitate control over missing
documents.
Answer: D

31) Which of the following best describes the purpose of control activities?
A) the actions, policies and procedures that reflect the overall attitudes of management
B) the identification and analysis of risks relevant to the preparation of financial statements
C) the policies and procedures that help ensure that necessary actions are taken to address risks
to the achievement of the entity's objectives
D) activities that deal with the ongoing assessment of the quality of internal control by
management
Answer: C

32) Which of the following deals with ongoing or periodic assessment of the quality of
internal control by management?
A) verifying activities
B) monitoring activities
C) oversight activities
D) management activities
Answer: B

33) Which of the following best describes an entity's accounting information and
communication system?
A)
Monitor Record and Initiate transactions
Transactions process
transactions
Yes Yes Yes

B)
Monitor Record and Initiate transactions
Transactions process
transactions
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No No No

C)
Monitor Record and Initiate transactions
Transactions process
transactions
Yes No No

D)
Monitor Record and Initiate transactions
Transactions process
transactions
No Yes Yes

Answer: D

34) Which of the following is a risk assessment principle?

A) accountability
B) use relevant, quality information to support the functioning of internal controls
C) consider the potential for fraud
D) develop general controls over technology
Answer: C

35) Which of the following is not an underlying principle related to risk assessment?
A) The organization should have clear objectives in order to be able to identify and assess the
risks relating to the objectives.
B) The auditors should determine how the company's risks should be managed.
C) The organization should consider the potential for fraudulent behavior.
D) The organization should monitor changes that could impact internal controls.
Answer: B

36 management's philosophy and operating style

B) organizational structure
C) adequate separation of duties
D) commitment to competence
Answer: C

37) It is important for the CPA to consider the competence of the clients' personnel because
their competence has a direct impact 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.
Answer: B

38) Proper segregation of functional responsibilities calls for separation of

A) authorization, execution, and payment.
B) authorization, recording, and custody.
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C) custody, execution, and reporting.

D) authorization, payment, and recording.
Answer: B

39) Without an effective ________, the other components of the COSO framework are
unlikely to result in effective internal control, regardless of their quality.
A) risk assessment policy
B) monitoring policy
C) control environment
D) system of control activities
Answer: C

40) Which of the following is an accurate statement regarding control activities?

A) As the level of complexity of IT systems increases, the separation of duties often becomes
blurred.
B) Segregation of duties would be violated if the same person authorizes the payment of a
vendor's invoice and also approves the disbursement of funds to pay the bill.
C) The most important type of protective measure for safeguarding assets and records is the use
of physical precautions.
D) All of the above.
Answer: D

41) If a company has an effective internal audit department,

A) the internal auditors can express an opinion on the fairness of the financial statements.
B) their work cannot be used by the external auditors per PCAOB Standard 5.
C) it can reduce external audit costs by providing direct assistance to the external auditors.
D) the internal auditors must be CPAs in order for the external auditors to rely on their work.
Answer: C

42) To promote operational efficiency, the internal audit department would ideally report
to
A) line management.
B) the PCAOB.
C) the Chief Accounting Officer.
D) the audit committee.
Answer: D

43) Hanlon Corp. maintains a large internal audit staff that reports directly to the
accounting department. Audit reports prepared by the internal auditors indicate that the
system is functioning as it should and that the accounting records are reliable. An
independent auditor will probably
A) eliminate tests of controls.
B) increase the depth of the study and evaluation of administrative controls.
C) avoid duplicating the work performed by the internal audit staff.
D) place limited reliance on the work performed by the internal audit staff.
Answer: D

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44) External financial statement auditors must obtain evidence regarding what attributes
of an internal audit (IA) department if the external auditors intend to rely on IA's work?
A) integrity
B) objectivity
C) competence
D) all of the above
Answer: D

45) To obtain an understanding of an entity's control environment, an auditor should

concentrate on the substance of management's policies and procedures rather than their
form because
A) management may establish appropriate policies and procedures but not act on them.
B) the board of directors may not be aware of management's attitude toward the control
environment.
C) the auditor may believe that the policies and procedures are inappropriate for that particular
entity.
D) the policies and procedures may be so weak that no reliance is contemplated by the auditor.
Answer: A

46) The ________ is helpful in preventing classification errors if it accurately describes

which type of transaction should be in each account.
A) general ledger
B) general journal
C) trial balance
D) chart of accounts
Answer: D

47) Old and new systems operating simultaneously in all locations is a test approach known
as
A) pilot testing.
B) horizontal testing.
C) integrative testing.
D) parallel testing.
Answer: D

48) Which of the following is a component of general controls?

A) processing controls
B) output controls
C) back-up and contingency planning
D) input controls
Answer: C

49) Which of the following statements related to application controls is correct?

A) Application controls relate to various aspects of the IT function including software
acquisition and the processing of transactions.
B) Application controls relate to various aspects of the IT function including physical security
and the processing of transactions in various cycles.
C) Application controls relate to all aspects of the IT function.
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D) Application controls relate to the processing of individual transactions.

Answer: D

50) General controls include all of the following except

A) systems development.
B) online security.
C) processing controls.
D) hardware controls.
Answer: C

51) Which of the following describes the process of implementing a new system in one part
of the organization, while other locations continue to use the current system?
A) parallel testing
B) online testing
C) pilot testing
D) control testing
Answer: C

52) A ________ is responsible for controlling the use of computer programs, transaction
files and other computer records and documentation and releases them to the operators
only when authorized.
A) software engineer
B) chief computer operator
C) librarian
D) data control operator
Answer: C

53) Security controls should require that users enter a(n) ________ before being allowed
access to software and other related data files.
A) echo check
B) parity check
C) self-diagnosis test
D) authorized password
Answer: D

54) Typical controls developed for manual systems which are still important in IT systems
include
A) management's authorization of transactions.
B) competent personnel.
C) adequate preparation of input source documents.
D) all of the above.
Answer: D

55) Which of the following controls prevent and detect errors while transaction data are
processed?
A) software
B) application
C) processing
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D) transaction
Answer: C

56) When purchasing software or developing in-house software,

A) cost should be the only factor.
B) extensive testing of the software is generally not required.
C) a team of both IT and non-IT personnel should be involved in the decision process.
D) the librarian and the IT manager should be the only ones involved in the decision process.
Answer: C

57) Output controls need to be designed for which of the following data integrity
objectives?
A) detecting errors after the processing is completed
B) preventing errors before the processing is completed
C) detecting errors in the general ledger adjustment process
D) preventing errors in separation of duties for IT personnel
Answer: A

58) A control that relates to all parts of the IT system is called a(n)
A) general control.
B) systems control.
C) universal control.
D) applications control.
Answer: A

59) Controls that are designed for each software application and are intended to help a
company satisfy the transaction-related audit objectives are
A) user controls.
B) general controls.
C) audit controls.
D) application controls.
Answer: D

60) Which of the following is not an example of an applications control?

A) Back-up of data is made to a remote site for data security.
B) There is a preprocessing authorization of the sales transactions.
C) There are reasonableness tests for the unit selling price of a sale.
D) After processing, all sales transactions are reviewed by the sales department.
Answer: A

61) Which of the following is not a general control?

A) Computer performed validation tests of input accuracy.
B) Equipment failure causes error messages on monitor.
C) There is a separation of duties between programmer and operators.
D) There are adequate program run instructions for operating the computer.
Answer: A

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62) Controls which are built in by the manufacturer to detect equipment failure are called
A) input controls.
B) data integrity controls.
C) hardware controls.
D) manufacturer's controls.
Answer: C

63) Controls which are designed to assure that the information entered into the computer is
authorized, complete, and accurate are called
A) input controls.
B) processing controls.
C) output controls.
D) general controls.
Answer: A

64) When dealing with the administration of the IT function and the segregation of IT
duties
A) in large organizations, management should assign technology issues to outside consultants.
B) programmers should investigate all security breaches.
C) the board of directors should not get involved in IT decisions since it is a routine function
handled by middle management.
D) in complex environments, management may establish IT steering committees.
Answer: D

65) Which of the following tests determines that every field in a record has been
completed?
A) validation
B) sequence
C) completeness
D) programming
Answer: C

66) An example of a physical control is

A) a hash total.
B) a parallel test.
C) the matching of employee fingerprints to a database before access to the system is allowed.
D) the use of backup generators to prevent data loss during power outages.
Answer: C

67) Controls specific to IT include all of the following except for

A) adequately designed input screens.
B) pull-down menu lists.
C) validation tests of input accuracy.
D) separation of duties.
Answer: D

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68) An internal control deficiency occurs when computer personnel

A) participate in computer software acquisition decisions.
B) design flowcharts and narratives for computerized systems.
C) originate changes in customer master files.
D) provide physical security over program files.
Answer: C

69) Which of the following best explains the relationship between general controls and
application controls?
A) Application controls are effective even if general controls are extremely weak.
B) Application controls are likely to be effective only when general controls are effective.
C) General controls have no impact on application controls.
D) None of the above.
Answer: B

70) A(n) ________ total represents the summary total of codes from all records in a batch
that do not represent a meaningful total.
A) record
B) hash
C) output
D) financial
Answer: B

71) In an IT system, automated equipment controls or hardware controls are designed to

A) correct errors in the computer programs.
B) monitor and detect errors in source documents.
C) detect and control errors arising from the use of equipment.
D) arrange data in a logical sequential manner for processing purposes.
Answer: C

72) 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?
A) gross wages earned
B) employee numbers
C) total hours worked
D) total debit amounts and total credit amounts
Answer: B

73) Which of the following is not an application control?

A) reprocessing authorization of sales transactions
B) reasonableness test for unit selling price of sale
C) post-processing review of sales transactions by the sales department
D) logging in to the company's information systems via a password
Answer: D

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74) Which of the following is not a general control?

A) separation of IT duties
B) systems development
C) processing controls
D) hardware controls
Answer: C

75) ________ is the information technology and internal control processes an organization
has in place to protect computers, networks, programs, and data from unauthorized access.
A) Encryption
B) A firewall
C) Cyber security
D) A processing control
Answer: C

76) The most important output control is

A) distribution control, which assures that only authorized personnel receive the reports
generated by the system.
B) review of data for reasonableness by someone who knows what the output should look like.
C) control totals, which are used to verify that the computer's results are correct.
D) logic tests, which verify that no mistakes were made in processing.
Answer: B

77) A database management system

A) allows clients to create databases that include information that can be shared across multiple
applications.
B) stores data on different files for different purposes, but always knows where they are and how
to retrieve them.
C) allows quick retrieval of data, but at a cost of inefficient use of file space.
D) allows quick retrieval of data, but it needs to update files continually.
Answer: A

78) When auditing a client who uses a database management system, the auditor is
principally aware of elevated risk due to the fact that
A) multiple users can access and update data files.
B) the accounting information is only in one place.
C) the database administrator may lack appropriate accounting knowledge.
D) multiple users could all access the data simultaneously causing a system shutdown.
Answer: A

79) Firewalls are used to protect from

A) erroneous internal handling of data.
B) insufficient documentation of transactions.
C) illogical programming commands.
D) unauthorized external users.
Answer: D

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80) What tools do companies use to limit access to sensitive company data?
A)
Encryption Digital signatures Firewall
techniques
Yes Yes Yes

B)
Encryption Digital signatures Firewall
techniques
Yes No No

C)
Encryption Digital signatures Firewall
techniques
No Yes Yes

D)
Encryption Digital signatures Firewall
techniques
Yes Yes No

Answer: A

81) Rather than maintain an internal IT center, many companies outsource their basic IT
functions such as payroll to an
A) external general service provider.
B) independent computer service center.
C) internal control service provider.
D) internal auditor.
Answer: B

82) When the auditor is obtaining an understanding of the independent computer service
center's internal controls, the auditor should
A) use the same criteria used to evaluate the client's internal controls.
B) use different criteria because the service center resides outside the company.
C) use the same criteria used to evaluate the client's internal controls but omit tests of
transactions.
D) use different criteria for the service center by including substantive tests of balances.
Answer: A

83) ________ protect(s) the security of electronic communication when information is

transmitted and when it is stored.
A) Firewalls
B) Digital signatures
C) Encryption
D) A database
Answer: C

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84) A(n) ________ is a computer resource deployment and procurement model that enables
an organization to obtain IT resources and applications from any location via an Internet
connection.
A) application service provider
B) firewall
C) cloud computing environment
D) local area network
Answer: C

TRUE OR FALSE

1) Section 404 of the Sarbanes-Oxley Act requires that both private and public companies
issue an internal control report.
Answer: FALSE

2) Management has a legal and professional responsibility to be sure that the financial
statements are prepared in accordance with reporting requirements of applicable
accounting frameworks.
Answer: TRUE

3) Deficiencies in internal controls may cause significant losses, delay financial reporting,
but cannot result in material misstatements in the financial statements.
Answer: FALSE

4) The Sarbanes-Oxley Act requires either management of U.S. public companies or their
auditors to report on the effectiveness of internal controls over financial reporting.
Answer: FALSE

5) Other countries around the world have passed similar legislation to the Sarbanes-Oxley
Act regarding mandating management and auditor reporting on internal controls over
financial reporting.
Answer: TRUE

10) A system of internal controls consisting of policies and procedures are designed to
provide management with reasonable assurance that the company can achieve its goals and
objectives.
Answer: TRUE

11) Management has a legal and a professional responsibility to be sure external financial
information, and the information contained therein, are fairly presented in accordance
with generally accepted accounting principles and International Financial Reporting
Standards, when required.
Answer: TRUE

12) One of management's broad objectives in designing an effective internal control system
is to help ensure that the organization follows laws and regulations impacting the
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organization.
Answer: TRUE

13) Under the Dodd-Frank federal financial reform legislation, all public companies are
required to obtain an audit report on internal control over financial reporting.
Answer: FALSE

14) When a company designs and implements internal controls, the cost of the controls is
not a valid consideration.
Answer: FALSE

15) The auditor's responsibilities for internal control include understanding and testing the
audit client's internal controls over financial reporting.
Answer: TRUE

16) If required under special circumstances, an auditor must step in at an audit client and
establish and maintain the audit client's system of internal controls to ensure reliable
financial reporting.
Answer: FALSE

17) Two key concepts underlie management's design and implementation of internal
controls are absolute assurance and inherent limitations.
Answer: FALSE

18) It is possible for management to design an ideal and effective system of internal
controls for example over the counting of the physical inventory.
Answer: FALSE

19) Management's report on internal controls must identify the framework used to
evaluate the effectiveness of internal controls, and this framework may include other
internal control frameworks which exist around the world.
Answer: TRUE

20) It is possible, under certain circumstances, for financial statements to correctly reflect
GAAP or IFRS even if internal controls over financial reporting are inadequate.
Answer: FALSE

30) The auditor is always concerned with their audit client's controls that affect the
efficiency and the effectiveness of company operations, as these controls will always
influence the fair presentation of the financial statements.
Answer: FALSE

31) Once the auditor is satisfied with the transaction-related controls in the revenue and
accounts receivable area, it is not important for the auditor to gain an understanding of the
controls that exist over the ending account balances and the related disclosures made in the
financial statements.
Answer: FALSE
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32) As a result of the Dodd-Frank federal financial reform legislation passed by Congress
in 2010, only larger public companies (accelerated filers) are now required to obtain an
audit report from their auditors on internal control over financial reporting.
Answer: TRUE

33) Control activities are a subcomponent of the information and communication

component of internal control.
Answer: FALSE

34) Adequate documents and records are a subcomponent of the control environment.
Answer: FALSE

35) The chart of accounts is helpful in preventing classification errors if it accurately

describes which type of transaction should be in each account.
Answer: TRUE

36) Auditing standards prohibit reliance on the work of internal auditors due to the lack of
independence of the internal auditors.
Answer: FALSE

37) If an auditor wishes to rely on the work of internal auditors (IA), the auditor must
obtain satisfactory evidence related to the IA's competence, integrity, and objectivity.
Answer: TRUE

38) An example of a specific authorization is management setting a policy authorizing the

ordering of inventory when less than a one-week supply is on hand.
Answer: FALSE

39) Personnel responsible for performing internal verification procedures must be

independent of those originally responsible for preparing the data.
Answer: TRUE

40) The COSO framework, updated in 2013, provides a rules-based approach that provides
additional guidance on designing and implementing an effective system of internal controls.
Answer: FALSE

41) Even without an effective control environment, it is likely that the other four
components of the COSO framework can result in effective internal controls.
Answer: TRUE

42) The audit committee of the board of directors must exercise oversight over the design
and the performance of internal controls over financial reporting, as well as not delegating
the responsibilities for these internal controls to management.
Answer: FALSE

43) The company forms a committee to identify specific risks inside of the company related
to information technology. As shown in the COSO cube, this action is related to
organizational structure.
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Answer: FALSE

44) Parallel testing is used when old and new systems are operated simultaneously in all
locations.
Answer: TRUE

45) Programmers should only be allowed to work with test copies of programs and data.
Answer: TRUE

46) In IT systems, if general controls are effective, it increases the auditor's ability to rely
on application controls to reduce control risk.
Answer: TRUE

47) Parallel testing can be used in combination with pilot testing to test new systems.
Answer: TRUE

48) The effectiveness of automated controls depends solely on the competence of the
personnel performing the controls.
Answer: FALSE

49) Backup and contingency plans should also identify alternative hardware that can be
used to process company data.
Answer: TRUE

50) A large portion of errors in IT systems result from data entry errors.
Answer: TRUE

51) Output controls focus on preventing errors during processing.

Answer: FALSE

52) Processing controls are a category of application controls.

Answer: TRUE

53) Controls that relate to a specific use of the IT system, such as the processing of sales or
cash receipts, are called application controls.
Answer: TRUE

54) IT controls are classified as either input controls or output controls.

Answer: FALSE

55) Firewalls can protect company data and software programs.

Answer: TRUE

56) LANs link equipment within a single or small cluster of buildings and are used within a
company.
Answer: TRUE

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57) Companies using e-commerce systems to transact business electronically do not need to
be concerned about how their e-commerce partners manage IT systems risks.
Answer: FALSE

58) Digital signatures are used by individuals and companies engaged in e-commerce to
guarantee the integrity and the authenticity of transactions or agreements executed
between parties.
Answer: TRUE

59) Enterprise resource planning (ERP) systems integrate limited aspects of an

organization's business activities and transactions into one accounting information system.
Answer: FALSE

60) Management is not as concerned about internal controls when they decide to outsource
some or all of their IT needs to cloud computing environments and suppliers.
Answer: FALSE

61) Cost-benefit considerations should always be part of the consideration of most types of
outsourcing-related decisions made by management.
Answer: TRUE

62) A small business has four employees, including the owner of the business, working for
the business on a daily basis processing cash receipts, making cash disbursements,
processing payroll, and invoicing customers. In this situation, separation of duties is
impossible.
Answer: FALSE
Essay questions

1) Describe each of the three broad objectives management typically has for internal
control. With which of these objectives is the auditor primarily concerned?
Answer: The three objectives are:
• Reliability of financial reporting. Management has both a legal and professional responsibility
to be sure that the information is fairly presented in accordance with reporting requirements such
as U.S. GAAP and IFRS.
• Efficiency and effectiveness of operations. Controls within an organization are meant to
encourage efficient and effective use of its resources to optimize the company's goals.
• Compliance with laws and regulations. Public, non-public, and not-for-profit organizations
are required to follow many laws and regulations. Some relate to accounting only indirectly, such
as environmental protection and civil rights laws. Others are closely related to accounting, such
as income tax regulations and anti-fraud legal provisions.

The auditor's focus in both the audit of financial statements and the audit of internal controls is
on the controls over the reliability of financial reporting plus those controls over operations and
compliance with laws and regulations that could materially affect financial reporting.

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2) Control activities help assure that the necessary actions are taken to address risks to the
achievement of the company's objectives. List the five types of control activities.
Answer:
1. adequate separation of duties
2. proper authorization of transactions and activities
3. adequate documents and records
4. physical control over assets and records
5. independent checks on performance

3) Certain principles dictate the proper design and use of documents and records. Briefly
describe several of these principles.
Answer:
• Documents should be prenumbered consecutively to facilitate control over missing documents
and as an aid in locating documents when they are needed at a later date.
• Documents and records should be prepared at the time a transaction takes place, or as soon as
possible thereafter, to minimize timing errors.
• Documents and records should be designed for multiple uses, when possible, to minimize the
number of different forms.
• Documents and records should be constructed in a manner that encourages correct
preparation. This can be done by providing internal checks within the form or record.

4) Management's identification and analysis of risk is an ongoing process and is a critical

component of effective internal control. An important first step is for management to
identify factors that may increase risk. Identify at least five factors, observable by
management, which may lead to increased risk in a typical business organization.
Answer: There are many factors that may lead to increased risk in an organization. Some
examples include:
• failure to meet prior objectives
• quality of personnel
• geographic dispersion of company operations
• significance and complexity of core business processes
• introduction of new information technologies
• entrance of new competitors
• economic downturns
• rapid technology changes

5) Separation of duties is essential in preventing errors and intentional misstatements on

the financial statements. List below the four general guidelines.
Answer:
1. separation of custody of the assets from accounting
2. separation of the authorization of transactions from custody of related assets
3. separation of operational responsibility from record keeping responsibility
4. separation of IT duties from user departments

6) The internal control framework developed by COSO includes five so-called

"components" of internal control. Discuss each of these five components.
Answer: Five components of internal control are:
• The control environment. The control environment consists of the actions, policies, and
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procedures that reflect the overall attitudes of top management, directors, and owners of an entity
about internal control and its importance to the company.
• Risk assessment. This is management's identification and analysis of risks relevant to the
preparation of financial statements in accordance with appropriate accounting frameworks such
as GAAP or IFRS.
• Information and communication. These are the methods used to initiate, record, process, and
report the entity's transactions and to maintain accountability for the related assets.
• Control activities. These are the policies and procedures that management has established to
meet its objectives for financial reporting.
• Monitoring. This is management's ongoing and periodic assessment of the quality of internal
control performance to determine whether controls are operating as intended and are modified
when needed.

7) Discuss what is meant by the term "control environment" and identify four control
environment subcomponents that the auditor should consider.
Answer: The control environment consists of the actions, policies, and procedures that reflect
the overall attitudes of top management, directors, and owners of an entity about control and its
importance to the entity. Subcomponents include:
• integrity and ethical values
• commitment to competence
• board of director or audit committee participation
• accountability
• organizational structure

8) List the four underlying principles of risk assessment per the COSO framework.
Answer: The underlying principles of risk assessment per the COSO framework are
• have clear objectives in order to identify risks related to those objectives
• determine how risks should be managed
• consider the potential for fraud
• monitor changes

9) Name five of the specific responsibilities specifically directed by the SEC under the
Sarbanes-Oxley Act requiring companies listed on the national stock exchanges to
strengthen their audit committee requirements.
Answer:
1. The audit committee must not be comprised solely of independent directors
2. The audit committee must not be solely responsible for hiring and firing the
company's auditors
3. The audit committee must establish policies and procedures for complaints regarding
accounting, internal controls, or other auditing matters
4. The audit committee must have the ability to engage its own legal counsel and advisors
5. The audit committee must be adequately funded

10) What are the four underlying principles related to risk assessment every organization
should consider?
Answer:
1. The organization should have clear objectives in order to be able to identify and
assess the risks relating to those objectives
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2. The organization should determine how the risks should be managed

3. The organization should consider the potential for fraudulent behavior
4. The organization should monitor changes that could impact internal controls

11) Define control for general controls and application controls. Also list the categories of
controls included under general controls and application controls.
Answer: General controls are those that relate to all aspects of the IT function. They include
controls related to administration, separation of IT duties, systems development, physical and on-
line security, backup and contingency planning, and hardware controls.

Application controls relate to the processing of individual transactions. Application controls are
specific to certain software applications and typically do not affect all IT functions. They include
input controls, processing controls, and output controls.

12) Identify the three categories of application controls, and give one example of each.
Answer: Application controls fall into three categories:
• Input controls — reformatted screens which prompt the data input personnel for the
information to be entered
• Processing controls — a reasonableness test for the unit selling price of a sale
• Output controls — postprocessing review of sales transactions by the sales department

13) One category of general controls is physical and online access controls. Describe the
control and give at two examples of implementation of the control.
Answer: Physical controls over computer equipment restrict access to hardware, software, and
backup data files on magnetic tapes or disks, hard drives, CDs, and external disks. Examples of
physical controls include:
• keypad entrances
• badge-entry systems
• security cameras and security personnel
• employee fingerprints or retina scanning and matching to database before access is allowed
• monitoring of cooling and humidity
• installing fire-extinguishing equipment

Online access controls restrict access to software and related data files, reducing the likelihood
that unauthorized changes are made to software applications and data files. Examples include:
• proper user IDs and passwords
• separate add-on security software packages
• firewalls
• encryption programs

14) Match six of the terms (a-j) with the definitions provided below (1-6).
a. Application controls
b. Error listing
c. General controls
d. Hardware controls
e. Input controls
f. Output controls
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g. Parallel simulation
h. Parallel testing
i. Pilot testing
j. Processing controls

________ 1. The new and old systems operate simultaneously in all locations.

________ 2. Controls that relate to all aspects of the IT system.

________ 3. Controls such as review of data for reasonableness, designed to assure that data
generated by the computer is valid, accurate, complete, and distributed only to authorized people.

________ 4. Controls that apply to processing of transactions.

________ 5. A new system is implemented in one part of the organization while other locations
continue to rely on the old system.

________ 6. Controls such as proper authorization of documents, check digits, and adequate
documentation, designed to assure that the information to be entered into the computer is
authorized, complete, and accurate.

Answer:
1. h
2. c
3. f
4. a
5. i
6. e

15) Processing controls include the following tests:

Validation
Sequence
Data Reasonableness
Completeness

16) Describe what each control is designed to do.

Answer: Validation: ensures that a particular type of transaction is appropriate for processing
Sequence: determines that the data submitted for processing are in the correct order
Data Reasonableness: determines whether the data exceeds prespecified amounts
Completeness: determines that every field in a record has been completed

17) What are the two software testing strategies that companies typically use? Which
strategy is more expensive?
Answer: Companies may use pilot testing and parallel testing to test new software. Pilot testing
involves operating the new software at a limited number of facilities, while continuing to operate
the old software at all other locations. Parallel testing involves operating the new and old
software simultaneously.

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18) Discuss the four areas of responsibility under the IT function that should be segregated
in large companies.
Answer: The responsibilities for IT management, systems development, operations, and data
control should be separated:
• IT management. Oversight of the IT function should be segregated from the systems
development, operations, and data control functions. Oversight of IT should be the responsibility
of the Chief Information Officer or IT manager. The CIO or IT manager should be responsible
for oversight of the IT function to ensure that activities are carried out consistent with the IT
strategic plan. A security administrator should monitor both physical and online access to
hardware, software, and data files and investigate all security breaches.
• Systems development. Systems analysts are responsible for the overall design of each
application system. They also coordinate the development, acquisition, and changes to IT
systems by the IT personnel and the primary system users outside of IT. Programmers develop
flowcharts for each new application, prepare computer instructions, test the programs, and
document the results. Programmers and analysts should not have access to input data or
computer operations to avoid using their knowledge of the system for personal benefit.
• Operations. Computer operators are responsible for the day-to-day operations of the
computer. They also monitor computer consoles for messages about computer efficiency and
malfunction.
• Data control. Data control personnel independently verify the quality of input and the
reasonableness of output. Database administrators are responsible for the operation and access
security of shared databases.

19) Identify the six categories of general controls and give one example of each.
Answer: General controls fall into the following six categories:
• Administration of the IT function. The chief information officer (CIO) should report to senior
management and board of directors.
• Separation of IT duties. There should be separation of duties between the computer
programmers, operators, and the data control group.
• Systems development. Users, analysts, and programmers develop and test software.
• Physical and online security. Access to hardware is restricted, passwords and user IDs limit
access to software and data files, and encryption and firewalls protect data and programs from
external parties.
• Backup and contingency planning. Written backup plans should be prepared and tested on a
regular basis throughout the year.
• Hardware controls. Uninterruptible power supplies should be used to avoid loss of data in the
event of a power blackout.

20) From an internal control perspective, what challenges arise when a company
outsources computer functions?
Answer: Management is responsible for the design and operating effectiveness of internal
controls, and this includes controls that are outsourced to a service provider. The ethics and
integrity of service providers, as well as the design and functioning of their internal controls,
need to be considered by management when selecting a service provider, and evaluated
regularly.

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