18.1 Control Procedures

Question 1

A company’s accounts payable supervisor assigned a vendor code to a storage facility owned by the supervisor, then instructed the company’s accounting system to pay monthly rent for a storage unit allegedly leased from the storage facility. This situation is an example of a failure of controls due to the lack of

A. Commitment to competence in job skills and knowledge
B. An effective internal audit function
C. Appropriate segregation of duties
D. Appropriate physical controls

Answer 1

C. Appropriate segregation of duties

Question 2

Internal controls may be preventive, detective, corrective, or directive. Which of the following is preventive?

A. Requiring two persons to open mail
B. Reconciling the accounts receivable subsidiary file with the control account
C. Using batch totals
D. Preparing reconciliation

Answer 2

A. Requiring two persons to open mail

Preventive controls are designed to prevent an error or an irregularity. Detective and corrective controls attempt to identify and correct errors or irregularities that have already occurred. Preventive controls are usually more cost beneficial than detective or corrective controls. Assigning two individuals to open mail is an attempt to prevent misstatement of cash receipts.

Question 3

The procedure requiring preparation of a prelisting of incoming cash receipts, with copies of the prelist going to the cashier and to accounting, is an example of which type of control?

A. Preventive
B. Corrective
C. Detective
D. Directive

Answer 3

A. Preventive

A prelisting of cash receipts in the form of checks is a preventive control. It is intended to deter undesirable events from occurring. Because fraud involving cash is most likely to occur before receipts are recorded, either remittance advices or a prelisting of checks should be prepared in the mail room so as to establish recorded accountability for cash as soon as possible. A cash register tape is a form of prelisting for cash received over the counter. One copy of a prelisting will go to accounting for posting to the cash receipts journal, and another is sent to the cashier for reconciliation with checks and currency received.

Question 4

In a well-designed internal control structure in which the cashier receives remittances from the mail room, the cashier should not

A. Endorse the checks
B. Prepare the bank deposit slips
C. Deposit remittances daily at a local bank
D. Post the receipts to the accounts receivable subsidiary ledger cards

Answer 4

D. Post the receipts to the accounts receivable subsidiary ledger cards

The cashier is an assistant to the treasurer and thus performs an asset custody function. Individuals with custodial functions should not have access to the accounting records. If the cashier were allowed to post the receipts to the accounts receivable subsidiary ledger, an opportunity for embezzlement would arise that could be concealed by falsifying the books.

Question 5

Accounting controls are concerned with the safeguarding of assets and the reliability of financial records. Consequently, these controls are designed to provide reasonable assurance that all of the following take place except

A. Permitting access to assets in accordance with management’s authorization.
B. Executing transactions in accordance with management’s general or specific authorization.
C. Compliance with methods and procedures ensuring operational efficiency and adherence to managerial policies.
D. Comparing recorded assets with existing assets at periodic intervals and taking appropriate action with respect to differences.

Answer 5

C. Compliance with methods and procedures ensuring operational efficiency and adherence to managerial policies.

An accounting control is concerned with the safeguarding of assets and the reliability of financial records, whereas an operational or administrative control is concerned with operational efficiency and effectiveness. Thus, compliance with methods and procedures ensuring operational efficiency and adherence to managerial policies is an objective of an operational control.

Question 6

Which one of the following situations represents an internal control weakness in the payroll department?

A. Payroll department personnel are rotated in their duties.
B. Paychecks are distributed by the employees’ immediate supervisor.
C. Payroll records are reconciled with quarterly tax reports.
D. The timekeeping function is independent of the payroll department.

Answer 6

B. Paychecks are distributed by the employees’ immediate supervisor.

Paychecks should not be distributed by supervisors because an unscrupulous person could terminate an employee and fail to report the termination. The supervisor could then clock in and out for the employee and keep the paycheck. A person unrelated to either payroll recordkeeping or the operating department should distribute checks.

Question 7

Auditors document their understanding of internal control with questionnaires, flowcharts, and narrative descriptions. A questionnaire consists of a series of questions concerning controls that auditors consider necessary to prevent or detect errors and fraud. The most appropriate question designed to contribute to the auditors’ understanding of the completeness of the expenditure (purchases-payables) cycle concerns the

A. Internal verification of quantities, prices, and mathematical accuracy of sales invoices
B. Use and accountability of prenumbered checks
C. Disposition of cash receipts
D. Qualifications of accounting personnel

Answer 7

B. Use and accountability of prenumbered checks

A completeness assertion concerns whether all transactions and accounts that should be presented in the financial statements are so presented. The exclusive use of sequentially numbered documents facilitates control over expenditures. An unexplained gap in the sequence alerts the auditor to the possibility that not all transactions have been recorded. A failure to use prenumbered checks would therefore suggest a higher assessment of control risk. If a company uses prenumbered checks, it should be easy to determine exactly which checks were used during a period.

Question 8

Which one of the following situations represents a strength of internal control for purchasing and accounts payable?

A. Prenumbered receiving reports are issued randomly.
B. Invoices are approved for payment by the purchasing department.
C. Unmatched receiving reports are reviewed on an annual basis.
D. Vendors’ invoices are matched against purchase orders and receiving reports before a liability is recorded.

Answer 8

D. Vendors’ invoices are matched against purchase orders and receiving reports before a liability is recorded.

A voucher should not be prepared for payment until the vendor’s invoice has been matched against the corresponding purchase order and receiving report. This procedure provides assurance that a valid transaction has occurred and that the parties have agreed on the terms, such as price and quantity.

Question 9

________ controls alert the proper people after an unwanted event.

Answer 9

Detective controls. They are effective when detection occurs before material harm occurs.

Question 10

The internal auditor recognizes that certain limitations are inherent in any internal control system. Which one of the following scenarios is the result of an inherent limitation of internal control?

A. A security guard allows one of the warehouse employees to remove company assets from the premises without authorization
B. The firm sells to customers on account, without credit approval
C. The comptroller both makes and records cash deposits
D. An employee, who is unable to read, is assigned custody of the firm’s computer tape library and run manuals that are used during the third shift.

Answer 10

A. A security guard allows one of the warehouse employees to remove company assets from the premises without authorization

Inherent limitations of internal control arise from faulty judgement in decision making, simple error or mistake, and the possibility of collusion and management override. Thus, a control (use of security guards) based on segregation of functions may be overcome by collusion among two or more employees.

Question 11

Which one of the following duties assigned to the cashier exposes the organization to a control risk in terms of segregation of duties?

A. Signing the deposit slips
B. Comparing the check register with the bank statement
C. Depositing cash at the bank
D. Entering information in the accounts receivable subsidiary ledger

Answer 11

D. Entering information in the accounts receivable subsidiary ledger

Segregation of duties involves the separation of the functions of authorization, recordkeeping, and asset custody to minimize the opportunities for a person to be able to perpetrate and conceal errors or fraud in the normal course of his or her duties. A cashier who records information in the accounts receivable subsidiary ledger has both custody and recordkeeping duties, which violates segregation of duties.

Question 12

Appropriate control over obsolete materials requires that they be

A. Carried at cost in the accounting records until the actual disposition takes place
B. Determined by an approved authority to be lacking in regular usability
C. Sorted, treated, and packaged before disposition takes place, in order to obtain the best selling price
D. Retained within the regular storage area

Answer 12

B. Determined by an approved authority to be lacking in regular usability

Since auditors, storekeepers, etc., may not have the requisite expertise to determine whether materials are usable, that decision must often be made by a designated independent authority. To provide effective control of materials, this determination, asset custody, and authorization for disposal are functions that should be segregated.

Question 13

Internal control cannot be designed to provide reasonable assurance regarding the achievement of objectives related to

A. Elimination of all fraud
B. Reliability of financial reporting
C. Compliance with applicable laws and regulations
D. Effectiveness and efficiency of operations

Answer 13

A. Elimination of all fraud

Internal control is a process designed to provide reasonable assurance regarding the achievement of organizational objectives. Because of inherent limitations, however, no system can be designed to eliminate all fraud.

Question 14

To test the adequacy of controls, a variety of methods may be used, including

A. Inspection and verification
B. Reperformance and observation
C. Comparison and confirmation
D. Inquiry and analytical procedures

Answer 14

B. Reperformance and observation

Inquiry should be done but is not sufficient by itself to test the adequacy of controls. A system of controls is only effective when properly designed and followed. Other testing methods performed in combination with inquiry may include inspection, recalculation, and reperformance of a relevant control.

Question 15

Which of the following is most likely considered to determine whether internal controls are operating effectively?

A. Attorney’s responses to an auditor’s inquiries
B. A questionnaire completed by an employee in the receiving department about her duties and responsibilities
C. A management representation letter corroborating inventory pricing
D. Confirmations of receivables verifying account balances

Answer 15

B. A questionnaire completed by an employee in the receiving department about her duties and responsibilities

Test of controls are directed toward operating effectiveness. They include (1) inquiries of entity personnel (e.g., a questionnaire completed by an employee in the receiving department); (2) inspection of documents, reports, and electronic files indicating performance of the controls; (3) observation of the application of the controls; and (4) reperformance of the controls.

Question 16

Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle?

A. Merchandise received is not promptly reconciled to the outstanding purchase order file
B. Obsolete items included in inventory balances are rarely reduced to the lower of cost or market value
C. Fictitious transactions are recorded that cause an understatement of revenue and overstatement of receivables
D. The write-off of receivables by personnel who receive cash permits the misappropriation of cash

Answer 16

D. The write-off of receivables by personnel who receive cash permits the misappropriation of cash

Authorization of transactions (write-offs of receivables) and custody of assets (cash) are incompatible duties.

Question 17

Which of the following tests of accounts receivable is most likely to determine the effectiveness of related controls?

A. Inspecting an entity’s analysis of accounts receivable for unusual balances
B. Comparing an entity’s uncollectible accounts expense with actual uncollectible accounts receivable
C. Observing an entity’s employee prepare the schedule of past due accounts receivable
D. Sending requests to an entity’s principal customers to confirm the existence of accounts receivable

Answer 17

C. Observing an entity’s employee prepare the schedule of past due accounts receivable

To test the effectiveness of controls, common methods are inquiry, observation, inspection, recalculation, and reperformance of a control. Thus, observing an entity’s employee prepare the schedule of past due accounts receivable provides evidence of the effectiveness of certain controls over accounts receivable.

Question 18

Which of the following controls most likely would help ensure that all credit sales transactions of an entity are recorded?

A. The accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences they report
B. The accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account monthly
C. The billing department supervisor matches prenumbered shipping documents with entries in the sales journal
D. The billing department supervisor sends copies of approved sales orders to the credit department for comparison to authorized credit limits and current customer account balances

Answer 18

C. The billing department supervisor matches prenumbered shipping documents with entries in the sales journal

The sequential numbering of documents provides a standard control over transactions. The numerical sequence should be accounted for by an independent party. A major objective is to detect unrecorded and unauthorized transactions. Moreover, comparing shipments with the sales journal also will detect unrecorded transactions.

Question 19

Which control is not appropriate for property, plant, and equipment?

A. Proper authority for acquisition and retirement of assets
B. Written policies for capitalization and expenditure and review of application of depreciation methods
C. Disposal of fully depreciated assets
D. Detailed property records and physical controls over assets

Answer 19

C. Disposal of fully depreciated assets

No control should require disposal of fully depreciated assets. They may still be productive and used in the business and should remain on the books until disposal.

Question 20

An entity’s internal control structure (ICS) consists of the policies and procedures established to provide reasonable assurance that specific entity objectives will be achieved. Only some of these objectives, policies, and procedures are relevant to a financial statement audit. Which one of the following would most likely be considered in such an audit?

A. Timely reporting and review of quality control results
B. Marketing analysis of sales generated by advertising projects
C. Maintenance of statistical production analyses
D. Maintenance of control over unused checks

Answer 20

D. Maintenance of control over unused checks

The policies and procedures most likely to be relevant to a financial statement audit pertain to the entity’s ability to record, process, summarize, and report financial data consistent with the assertions embodied in the financial statements. Maintenance of control over unused checks is an example of a relevant procedure because the objective is to safeguard cash. The auditor must understand the ICS policies and procedures relevant to the assertions about cash in the financial statements. (S)he must then assess control risk for those assertions; that is, (s)he must evaluate the effectiveness of the ICS in preventing or detecting material misstatements in the assertions.

Question 21

A proper segregation of duties requires that an individual

A. Authorizing a transaction records it
B. Recording a transaction not compare the accounting record of the asset with the asset itself
C. Maintaining custody of an asset be entitled to access the accounting records for the asset
D. Authorizing a transaction maintain custody of the asset that resulted from the transaction

Answer 21

B. Recording a transaction not compare the accounting record of the asset with the asset itself

One person should not be responsible for all phases of a transaction, i.e., for authorization, recording, and custodianship of the related assets. These duties should be performed by separate individuals to reduce the opportunities for any person to be in a position of both perpetrating and concealing errors or fraud in the normal course of his or her duties. For instance, an employee who receives and lists cash receipts should not be responsible for comparing the recorded accountability for cash with existing amounts

Question 22

Which of the following is the best way to compensate for the lack of adequate segregation of duties in a small organization?

A. Allowing for greater management oversight of incompatible activities
B. Requiring accountants to pass a yearly background check
C. Disclosing lack of segregation of duties to the external auditors during the annual review
D. Replacing personnel every 3 or 4 years

Answer 22

A. Allowing for greater management oversight of incompatible activities

Complete segregation may not be feasible due to cost-benefit restraints. Compensating controls most likely are established when segregation of duties is not feasible. Typical compensating controls may include more management oversight.

Question 23

Auditors regularly evaluate controls. Which of the following best describes the concept of control as recognized by internal auditors?

A. Management takes action to enhance the likelihood that established goals and objectives will be achieved
B. Control procedures should be designed from the “bottom up” to ensure attention to detail
C. Control represents specific procedures that accountants and auditors design to ensure the correctness of processing
D. Management regularly discharges personnel who do not perform up to expectations

Answer 23

A. Management takes action to enhance the likelihood that established goals and objectives will be achieved.

A control is any action taken by management to enhance the likelihood that established goals and objectives will be achieved. Management plans, organizes, and directs the performance of sufficient actions to provide reasonable assurance that objectives and goals will be achieved. Thus, control is the result of proper planning, organizing, and directing by management.

Question 24

An entity wishes to evaluate the design and perform tests of controls over its cash disbursements procedures. If the controls leave no trail of documentary evidence, the most likely testing methods are

A. Inquiry and analytical procedures
B. Observation and inquiry
C. Analytical procedures and confirmation
D. Confirmation and observation

Answer 24

B. Observation and inquiry

When documentary evidence does not exist, tests of the effectiveness of the operation of controls may involve such methods as observation, inquiry, or computer-assisted techniques. Inquiry alone, however, does not ordinarily provide sufficient appropriate evidence to support the conclusion that the control is operating effectively.

Question 25

Which one of the following situations represents an internal control weakness in accounts receivable?

A. Customers’ statements are mailed monthly by the accounts receivable department
B. Internal auditors confirm customer accounts periodically
C. Delinquent accounts are reviewed only by the sales manager
D. The cashier is denied access to customers’ records and monthly statements

Answer 25

C. Delinquent accounts are reviewed only by the sales manager

Internal control over accounts receivable begins with a proper separation of duties. Hence, the cashier, who performs an asset custody function, should not be involved in recordkeeping.

Accounts should be periodically confirmed by an auditor, and delinquent accounts should be reviewed by the head of accounts receivable and the credit manager. Customer statements should be mailed monthly by the accounts receivable department without allowing access to the statements by employees of the cashier’s department. The sales manager should not be the only person to review delinquent accounts because (s)he may have an interest in not declaring an account uncollectible.

Question 26

Which of the following ordinarily provides the least assurance about the operating effectiveness of an internal control activity?

A. Inspection of documents and reports
B. Observation of client personnel
C. Inquiry of client personnel
D. Preparation of system flowcharts

Answer 26

D. Preparation of system flowcharts

System flowcharts provide an overall view of the inputs, processes, and outputs of a system. If internal control is complex, the auditor may use flowcharts, questionnaires, or decision tables to document the understanding of internal control. However, tests of controls (tests of operating effectiveness) are concerned with (1) the manner in which controls were applied, (2) the consistency of application, (3) by whom or by what means they were applied, (4) whether the controls depend on other controls (indirect controls), and (5) the time or period for which the auditor intends to rely on the controls.

Question 27

The cash receipts function should be separated from the related recordkeeping in an organization to

A. Minimize undetected misappropriations of cash receipts
B. Prevent paying cash disbursements from cash receipts
C. Physically safeguard the cash receipts
D. Establish accountability when the cash is first received

Answer 27

a. Minimize undetected misappropriations of cash receipts

Separating cash receipts and recordkeeping prevents an employee from misappropriating cash and altering the records to conceal the irregularity.

Question 28

A multinational corporation has an office in a foreign branch with a monetary transfer facility. Effective internal control requires that

A. Foreign currency translation rates be computed separately by two branch employees in the same department
B. The person making wire transfers not reconcile the bank statement
C. The branch manager not deliver payroll checks to employees
D. The hiring of individual branch employees be approved by the headquarters office

Answer 28

B. The person making wire transfers not reconcile the bank statement

Independent reconciliation of bank accounts is necessary for effective internal control. Persons involved in making disbursements or receiving payments should not reconcile the bank statement with the accounting records. Segregating these functions reduces the opportunity for perpetrating and concealing fraud.

Question 29

A utility company with a large investment in repair vehicles would most likely implement which internal control to reduce the risk of vehicle theft or loss?

A. Physically inventory vehicles and reconcile the results with the accounting records
B. Review insurance coverage for adequacy
C. Systematically account for all repair work orders
D. Maintain vehicles in a secured location with release and return subject to approval by a custodian

Answer 29

D. Maintain vehicles in a secured location with release and return subject to approval by a custodian

Physical control of assets is a preventive control that reduces the likelihood of theft or other loss. Keeping the vehicles at a secure location and restricting access establishes accountability by the custodian and allows for proper authorization of their use.

Question 30

An organization relied heavily on e-commerce for its transactions. Evidence of the organization’s security awareness manual would be an example of which of the following types of controls?

A. Preventive
B. Compliance
C. Corrective
D. Detective

Answer 30

A. Preventive

Preventive controls are measures taken in advance so that anticipated problems associated with performance of an activity will not occur. Creating a security awareness manual involves anticipating problems.

Question 31

Which of the following credit approval procedures would be the basis for developing a deficiency finding for a wholesaler?

A. Salespeople are responsible for evaluating and monitoring the financial condition of prospective and continuing customers
B. Customers not meeting trade-credit standards are shipped merchandise on a cash-on-delivery (COD) basis only
C. Trade-credit standards are reviewed and approved by the finance committee of the board of directors
D. An authorized signature from the credit department, denoting approval of the customer’s credit, is to appear on all credit-sales orders

Answer 31

A. Salespeople are responsible for evaluating and monitoring the financial condition of prospective and continuing customers

Salespeople should be responsible for generating sales and providing service to customers. For effective control purposes, the finance department should be responsible for monitoring the financial condition of prospective and continuing customers in the credit approval process.

Question 32

Which one of the following is a method of testing the adequacy of internal controls?

A. Documentation
B. Exploratory data analysis
C. Robotic processing automation
D. Re-performance

Answer 32

D. Re-performance

Four common methods of testing are inquiry, observation, inspection, and re-performance. Re-performance involves performing the internal control again to assess its accuracy and effectiveness.

Question 33

Describe a possible cause of the condition and recommend actions to be taken and/or controls to be implemented that would correct the condition:

Daily bank deposits do not always correspond with cash receipts

Answer 33

Cause:
Cash received after bank deposits

Action:
Have a separate individual reconcile incoming cash receipts to bank deposits

Question 34

Describe a possible cause of the condition and recommend actions to be taken and/or controls to be implemented that would correct the condition:

Physical inventory counts sometimes differ from perpetual inventory records, and there have been alterations to physical counts and perpetual records.

Answer 34

Cause:
Timing differences

Actions:
Limit access to physical inventory; require and document specific approvals for adjustments to records

Question 35

Describe a possible cause of the condition and recommend actions to be taken and/or controls to be implemented that would correct the condition:

An unexplained and unexpected decrease in gross profit percentage has occurred.

Answer 35

Cause:
Unauthorized discounts or credits provided to customers

Actions:
Establish policies for discounts and credits; document approvals

Question 36

An adequate system of internal controls is most likely to detect a fraud perpetrated by a

A. Group of managers in collusion
B. Group of employees in collusion
C. Single manager
D. Single employee

Answer 36

D. Single employee

Segregation of duties and other control procedures serve to prevent or detect a fraud committed by an employee acting alone. One employee may not have the ability to engage in wrongdoing or may be subject to detection by other employees in the course of performing their assigned duties. However, collusion may circumvent controls. For example, comparison of recorded accountability with assets may fail to detect fraud if persons having custody of assets collude with record keepers.

Question 37

Control procedures include physical controls over access to and use of assets and records. A departure from the purpose of such procedures is that

A. The mail clerk compiles a list of the checks received in the incoming mail.
B. Access to the safe-deposit box requires two officers.
C. Only salespersons and sales supervisors use sales department vehicles.
D. Only storeroom personnel and line supervisors have access to the raw materials storeroom.

Answer 37

D. Only storeroom personnel and line supervisors have access to the raw materials storeroom.

Storeroom personnel have custody of assets, while supervisors are in charge of execution functions. To give supervisors access to the raw materials storeroom is a violation of the essential internal control principle of segregation of duties.

Question 38

Organizational independence in the processing of payroll is achieved by functional separations that are built into the system. Which one of the following functional separations is not required for internal control purposes?

A. Separation of payroll preparation and paycheck distribution.
B. Separation of personnel function from payroll preparation.
C. Separation of payroll preparation and maintenance of year-to-date records.
D. Separation of timekeeping from payroll preparation.

Answer 38

C. Separation of payroll preparation and maintenance of year-to-date records.

Most companies have their payrolls prepared by the same individuals who maintain the year-to-date records. There is no need for this functional separation because both duties involve recordkeeping.

Question 39

If employee paychecks are distributed by hand to employees, which one of the following departments should be responsible for the safekeeping of unclaimed paychecks?

A. Production Department in which the employee works or worked.
B. Cashier or Treasurer’s Department
C. Timekeeping Department
D. Payroll Department

Answer 39

B. Cashier or Treasurer’s Department

The responsibility for unclaimed paychecks should be given to a department that has no opportunity to authorize or write those checks. Because the treasury function serves only an asset custody function and thus has had no input into the paycheck process, it is the logical repository of unclaimed checks.