17.1 Corporate Governance and Regulations Relating to Internal Control

Question 1

The Foreign Corrupt Practices Act imposes which of the following requirements on companies whose securities are publicly traded in the US?

A. Devising and maintaining a system of internal accounting controls sufficient to provide reasonable assurance that transactions are executed in accordance with management’s authorization
B. Disclosure of information needed for informed investment decisions to potential investors of an initial public offering of the company’s securities
C. Periodic filing of SEC For 8K whenever a significant event takes place affecting the company’s internal controls
D. Issuance of an assertion as to whether the company’s system of internal controls over financial reporting is effective as of the end of the fiscal year

Answer 1

A. Devising and maintaining a system of internal accounting controls sufficient to provide reasonable assurance that transactions are executed in accordance with management’s authorization

Question 2

Who is responsible for the overall direction and oversight of a corporation?

Answer 2

The board of directors is the source of overall direction to, and the authority of, management.

Question 3

Conclusion that the financial statements are presented fairly, in all material respects, in accordance with the framework.

Answer 3

Unmodified opinion

Question 4

Except for the matter(s) described in the basis for qualified opinion paragraph, the financial statements are presented fairly, in all material respects, in accordance with the framework

Answer 4

Qualified opinion

Question 5

Because of the significance of the matter(s) described in the basis for adverse opinion paragraph, the financial statements are not presented fairly

Answer 5

Adverse opinion

Question 6

Because of the significance of the matter(s) described in the basis for disclaimer of opinion paragraph, the auditor has not been able to obtain sufficient appropriate audit evidence. Accordingly, the auditor does not express an opinion on the financial statements

Answer 6

Disclaimer opinion

Question 7

The Foreign Corrupt Practices Act of 1977 prohibits bribery of foreign officials. Which of the following statements correctly describes the act’s application to corporations engaging in such practices?

A. It applies only to multinational corporations
B. It applies only to corporations whose securities are registered under the Securities Exchange Act of 1934.
C. It applies to all domestic corporations engaged in interstate commerce
D. It applies only to corporations engaged in foreign commerce

Answer 7

C. It applies to all domestic corporations engaged in interstate commerce.

Question 8

Which of the following corporations are subject to the accounting requirements of the Foreign Corrupt Practices Act (FCPA)?

A. All corporations engaged in interstate commerce
B. All corporations that have made a public offering under the Securities Act of 1933.
C. All corporations whose securities are registered pursuant to the Securities Exchange Act of 1934
D. All domestic corporations engaged in international trade

Answer 8

C. All corporations whose securities are registered pursuant to the Securities Exchange Act of 1934.

The accounting requirements of the FCPA apply to all companies required to register and report under the Securities Exchange Act of 1934. These companies must maintain books, records, and accounts in reasonable detail that accurately and fairly reflect transactions. The FCPA also requires these companies to maintain a system of internal accounting control that provides certain reasonable assurances, including that corporate assets are not used for bribes.

Question 9

Internal control can provide only reasonable assurance of achieving entity control objectives because

A. The cost of internal control should not exceed its benefits
B. Management monitors internal control
C. The board of directors is active and independent
D. The auditor’s primary responsibility is the detection of fraud

Answer 9

A. The cost of internal control should not exceed its benefits

Internal controls can provide only reasonable assurance of achieving control objectives because the cost of an internal control should not exceed its benefits. Thus, in some cases, such as with petty cash and office supplies, the cost of the control is not worth what the savings would be if there was perfect control.

Question 10

Section 404 of the Sarbanes-Oxley Act of 2002 requires management of publicly traded corporations to do all of the following except

A. Establish and document internal control procedures and to include in their annual reports a report on the company’s internal control over financial reporting
B. Provide an identification of the framework used to evaluate the effectiveness of internal control and a statement that the external auditor has issued an attestation report on management’s assessment
C. Provide a report to include a statement of management’s responsibility for internal control and of management’s assessment of the effectiveness of internal control as of the end of the company’s most recent fiscal year
D. Provide a statement that the audit committee approves the choice of accounting policies and practices

Answer 10

D. Provide a statement that the audit committee approves the choice of accounting policies and practices

The Sarbanes-Oxley Act of 2002 imposes many requirements on management, boards of directors, and auditors. Section 404 deals with internal controls and reports thereon. It requires management to establish and document internal control procedures and to include in their annual reports a report on the company’s internal control over financial reporting. The report is to include a statement of management’s responsibility for internal control, management’s assessment of the effectiveness of internal control as of the end of the most recent fiscal year, identification of the framework used to evaluate the effectiveness of internal control (such as the COSO report), and a statement that the external auditor has issued an attestation report on management’s assessment. Because of this requirement, there are two audit options: one on internal control and one on the financial statements. Section 301 does address activities of the audit committee, but it contains no requirement that the audit committee approve the choice of accounting policies and practices. Section 204 states that the auditor must report to the audit committee all critical accounting policies and practices, alternative treatments of information discussed with management, implications of the alternatives, and the treatment preferred by the auditor.

Question 11

The requirement of the Foreign Corrupt Practices Act of 1977 to devise and maintain adequate internal control is assigned in the act to the

A. Chief financial officer
B. Board of directors
C. Company as a whole with no designation of specific persons or positions
D. Director of internal auditing

Answer 11

C. Company as a whole with no designation of specific persons or positions

The accounting requirements apply to all public companies that must register under the Securities Exchange Act of 1934. The responsibility is thus placed on companies, not individuals.

Question 12

Role of management in the establishment, maintenance, and evaluation of internal control system

Answer 12

• Management has the overall responsibility for protecting company assets and, therefore, for establishing, maintaining, and evaluating the internal control system.
• Has overall responsibility for internal control

Question 13

Role of audit committee in the establishment, maintenance, and evaluation of internal control system

Answer 13

• The audit committee’s primary responsibility involves assisting the board of directors in carrying out their responsibilities as they relate to the organization’s accounting policies, internal control, and financial reporting practices. The audit committee assists management and the board in fulfilling their fiduciary and accountability responsibilities, and helps maintain a direct line of communication between the board and the external and internal auditors.
• Assists the board in carrying out responsibilities

Question 14

Role of external auditor in the establishment, maintenance, and evaluation of internal control system

Answer 14

• The external auditor reviews the organization’s control structure, including the control environment, accounting systems, and control procedures, in order to assess the control risks for financial statement assertions. In addition, the external auditor would inform the company of any material weaknesses found during the interview.
• Reviews the organization’s control structure

Question 15

Role of internal audit department in the establishment, maintenance, and evaluation of internal control system

Answer 15

• The Internal Audit Department performs both operational and financial audits to determine compliance with established policies and procedures, and reports its findings and recommendations to management or the audit committee for evaluation and corrective action. The Internal Audit Department may also assist the external auditors with their review of the internal control system.
• Determines compliance with policies and procedures and provide recommendations for corrective action

Question 16

Characteristics of an audit committee in terms of the following:
a. Composition, size, and term of membership
b. Relationship with management, the external auditor, and the internal auditor

Answer 16

a. The audit committee should consist of at least three independent, outside directors. The maximum size may vary, but normally three to five members would be sufficient to allow each member to play an active role. The term is set by the board or directors and may vary but should include an arrangement to allow continuity to be maintained while rotating the membership.

b. The audit committee is selected by the board of directors and assists the board of directors in carrying out their responsibilities concerning the organization’s accounting policies, internal control, and financial reporting practices. The audit committee’s oversight responsibilities that relate to the activities of management, the external auditor, and the internal auditor provide assurance to management and the public regarding the reliability and integrity of financial information. The audit committee also has the responsibility of selecting the external auditors, helping to resolve problems arising during the audit, and discussing the audit results with management and the external auditor.

Question 17

Which of the following provisions are covered in the U.S Foreign Corrupt Practices Act?

I. Illegal payments to foreign officials to assist in obtaining business.
II. Transparency of accounting records reflecting all transactions.
III. Payments to agents for the purpose of influencing foreign officials.
IV. Maintenance of an adequate system of internal controls.

A. II, III, and IV only
B. I, II, III, and IV
C. I only
D. I and III only

Answer 17

B. I, II, III, and IV

The U.S. Foreign Corrupt Practices Act covers illegal payments to foreign officials to assist in obtaining business, transparency of accounting records reflecting all transactions, payments to agents for the purpose of influencing foreign officials, and maintenance of an adequate system of internal controls.

Question 18

Which of the following is not an aspect of the Foreign Corrupt Practices Act of 1977?

A. It requires the establishment of independent audit committees
B. It prohibits bribes to foreign officials
C. It requires an internal control system to be developed and maintained
D. It subjects management to fines and imprisonment

Answer 18

A. It requires the establishment of independent audit committees.

The Foreign Corrupt Practices Act of 1977 prohibits bribes to foreign officials and requires firms to have adequate systems of internal control. Violation of the act subjects individual managers to fines and/or imprisonment. The act does not specifically require the establishment of audit committees, but many firms have established audit committees as one means of dealing with the internal control provisions of the act.

Question 19

Which of the following features of a large manufacturer’s organizational structure is a control weakness?

A. The controller and treasurer report to the chief financial officer
B. The audit committee of the board consists of the chief executive officer, the chief financial officer, and a major shareholder
C. The chief financial officer is a vice president who reports to the chief executive officer
D. The information systems department is headed by a vice president who reports directly to the president

Answer 19

B. The audit committee of the board consists of the chief executive officer, the chief financial officer, and a major shareholder

The audit committee has a control function because of its oversight of internal as well as external auditing. It should be made up of directors who are independent of management. The authority and independence of the audit committee strengthen the position of the internal audit activity. The board should concur in the appointment or removal of the chief executive, who should have direct, regular communication with the board.

Question 20

The Sarbanes-Oxley Act has strengthened auditor independence by requiring that management

A. Report the nature of disagreements with former auditors
B. Hire a different CPA firm from the one that performs the audit to perform the company’s tax work
C. Select auditors through audit committees
D. Encourage auditors to report in accordance with the Foreign Corrupt Practices Act

Answer 20

C. Select auditors through audit committees

The Sarbanes-Oxley Act requires that the audit committee of a public company hire and pay the external auditors. Such affiliation inhibits management from changing auditors to gain acceptance of a questionable accounting method. Also, a potential successor auditor must inquire of the predecessor auditor before accepting an engagement.

Question 21

Under the Foreign Corrupt Practices Act (FCPA), an action may be brought that seeks

A. Damages and injunctive relief by the Securities and Exchange Commission
B. Treble damages by a private party
C. Criminal sanctions against both corporation and its officers by the Department of Justice
D. Injunctive relief by a private party

Answer 21

C. Criminal sanctions against both the corporation and its officers by the Department of Justice

The SEC may investigate violations of the FCPA, bring civil actions for its enforcement, and recommend that the Justice Department prosecute criminal violations.

Question 22

Section 201 of the Sarbanes-Oxley Act of 2002 prohibits audit firms from performing certain engagements for audit clients. Which of the following services is permitted under Section 201?

A. Bookkeeping services
B. Actual services
C. Internal auditing outsourcing
D. Preparation of tax returns

Answer 22

D. Preparation of tax returns

Tax services are not prohibited by Section 201.