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AUD > 9 - II: Internal control > Flashcards

9 - II: Internal control Flashcards

1
Q

How should the auditor obtain an initial understanding of internal control?

A

Through inquiry of appropriate personnel, observation, review of audit documentation.

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2
Q

What is transaction cycle? Examples?

A

A group of essentially same type of transactions.

Revenue/receipts, expenditures/disbursement, payroll..

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3
Q

How is the transaction cycle related to audits?

A

Control risk is constant within the transaction cycle. It’s the highest level of aggregation about which meaningful generalizations of control risk can be made.

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4
Q

What are 3 basic ways to document the understanding of internal control?

A
  1. Flowcharts.
  2. Internal control questionnaires (ICQs).
  3. Narrative write-up (written memo).
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5
Q

What are advantages and disadvantages of flowcharts? Meaning of specific symbols?

A

A systematic approach that prevents overlook important considerations, fairly easy to review/understand/update. Tailored to client specific.

Tedious/time consuming. Might miss deficiencies by too much details.

Square: computer operation/process. Square w/wave bottom: document. Square with narrowed bottom: manual operation (off-line). Diamond: decision point. Triangle point down: Off-line storage (filing).

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6
Q

What are advantages and disadvantages of ICQs?

A

Can be prepared in advance - prevent missing important questions. No answer indicates deficiency - easy.

Generic questionnaires not tailored to client - irrelevant questions can be included. Client could inaccurately answer intentionally/unintentionally.

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7
Q

What are advantages and disadvantages of narrative write-ups?

A

can be tailored to client. can be as detailed or general. easy to prepare.

Relatively easy to overlook important considerations because analysis is fairly unstructured.

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8
Q

What is walkthrough?

A

The auditor takes a few transactions to trace them through the client’s accounting system to get some feedback as to whether the auditor has accurately understood/documented the way the client is processing transactions.

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9
Q

Is walkthrough evidence or test of controls?

A

No.

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10
Q

What is a type of control: compensating?

A

Supplements a basic underlying control.

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11
Q

What is a type of control: preventive?

A

Prevents erros or fraud from occurring.

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12
Q

What is batch processing?

A

Transactions that are processed by type.

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13
Q

What is the purpose of obtaining sufficient knowledge of an entity’s information system?

A

To understand the financial reporting process used to prepare the entity’s F/S, including significant accounting estimates/disclosures.

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14
Q

What are 4 steps of evaluating internal control?

A
  1. Preliminary evaluation of internal control.
  2. Perform test of controls.
  3. Reevaluate planned reliance based on the results of test of controls.
  4. Develop a detailed audit plan.
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15
Q

What is the first stage of preliminary evaluation?

A

Consider whether reliance on certain specific internal control strength is appropriate. Consider the apparent adequacy of controls regarding design effectiveness.

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16
Q

What should the auditor do if internal control is perceived to be ineffective?

A

Assess the control risk at the maximum level (no reliance) and perform a wholly substantive audit approach by;

  • considering the possible types of errors/problems that could occur.
  • considering the kinds of procedures that would prevent/detect those.
  • determine whether such control is in place.
  • evaluate implications of any identified weaknesses.
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17
Q

If internal control is perceived effective?

A

Perform tests of control to evaluate the operating effectiveness of control. Consider cost-benefit issues.

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18
Q

What is the purpose of test of controls?

A

To verify the controls that looked good on paper (design effectiveness) were actually working as intended through the period (operating effectiveness).

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19
Q

What is the purpose of considering internal control?

A

To design an audit plan to achieve an appropriate level of detection risk.

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20
Q

Who is responsible for internal control?

A

Management.

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21
Q

What are 3 basic inherent limitations of internal control?

A
  1. Cost-benefit considerations.
  2. Mistakes due to misunderstanding, misjudgments, carelessness, fatigue, etc.
  3. Segregation of duty may break down due to collusion (a conspiracy among employees/management to circumvent internal controls) or management override.
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22
Q

At the very beginning stage of initial review of I/C, if I/C is not adequate to audit, what must the auditor do?

A

Disclaim an opinion or withdraw from the audit.

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23
Q

When the auditor determines that I/C effective, but cost > benefit, what should he do?

A

No reliance. Perform a wholly substantive audit approach.

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24
Q

When is test of control required?

A

When the auditor relies on the control or substantive tests alone are not sufficient to audit particular assertions.

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25
Q

What must the auditor obtain knowledge about when understanding an entity’s I/C?

A

Design controls.

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26
Q

How is test of control performed?

A

Select a sample of transactions and verify that the control procedures of interest were performed.

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27
Q

Control risk should be assessed in terms of what?

A

F/S assertions.

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28
Q

AICPA: what are 2 responsibilities of the auditor?

A
  1. Understanding the entity and its environment and assessing the risks of material misstatement.
  2. Performing Audit Procedures in response to assessed risks and evaluating the audit evidence obtained.
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29
Q

AICPA: What are 3 key objectives of I/C?

A
  1. Reliability of financial reporting.
  2. Effectiveness and efficiency of operations.
  3. Compliance with applicable laws and regulations.
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30
Q

AICPA: What are 5 interrelated components of I/C?

A
  1. Control environment.
  2. Risk assessment.
  3. Information and communication systems.
  4. Control activities.
  5. Monitoring.
31
Q

What is control environment?

A

Policies/procedures to establish the overall control consciousness of the organization (the tone at the top).

32
Q

What are the 7 elements of control environment?

A
  1. Communication/enforcement of ethical values.
  2. Commitment to competence.
  3. Participation by those charged w/ governance.
  4. Management’s philosophy/operating style.
  5. Organizational structure.
  6. Assignment of authority/responsibility.
  7. HR policies/practices.
33
Q

What is risk assessment?

A

Policies/procedures to identify/analyze relevant risks/prioritize them so they can be effectively managed.

34
Q

What is control activities?

A

Policies/procedures to provide reasonable assurance that management’s specific objectives will be achieved.

35
Q

What are 5 control activities? (SCARE).

A 
Segregation of duties.
Controls (physical controls).
Authorization.
Review of performance.
EDP/IT (information processing).
36
Q

What are 3 functions of segregation of duties (CAR)? What is 4th duty?

A

Authorization (execution).
Access (custody).
Accounting (record-keeping).

Reconciliation.

37
Q

What is information/communication?

A

Policies/procedures to identify, capture, exchange relevant information in a form and time frame that enables personnel to meet their responsibilities.

38
Q

What is monitoring?

A

Policies/procedures to assess the effectiveness of I/C over time.

39
Q

AICPA: What are 5 risk assessment procedures?

A
  1. Inquiries of management/others.
  2. Observation/inspection of document etc.
  3. Analytical procedure performed in planning.
  4. Review of info obtained in prior period.
  5. Discussion among audit team members about the RMM.(key members should be involved to understand the potential for material misstatement in areas, discuss areas of sig audit risk, potential for management override, susceptibility of fraud).
40
Q

AICPA: what is significant risks?

A

In the auditor’s judgment, requires special audit consideration.

41
Q

What are situations that are fraud risk?

A

Complexity of transactions, pertain to related parties, involve subjective measurements, unusual transactions.

42
Q

What must the auditor do when identifying sig risks?

A

Obtain an understanding of relevant controls and evaluate whether controls mitigate the risks.

43
Q

What are 5 elements of understanding the entity and its environment?

A
  1. Industry, regulatory, and other external factors.
  2. Nature of the entity (operations, ownerships, etc).
  3. Objectives, strategies, and related business risks that may cause material misstatements.
  4. Measurement and review of the entity’s financial performance measures (these may increase the risks of material misstatement).
  5. I/C relevant to the audit.
44
Q

Can segregation of duties prevent fraud?

A

No. collusion, management override.

45
Q

Is the auditor obligated to search for significant deficiencies?

A

No.

46
Q

What is the concept of reasonable assurance related to I/C structure?

A

Cost benefit concept.

47
Q

When “overall response” (substantive) at F/S level is required, what kind of procedures are needed to perform an audit?

A 
Assign more experienced staff. 
Provide closer supervision.
Use specialists.
Use more unpredictable audit procedures.
Determine whether to use "substantive approach" or "a combined approach" (both test of controls/substantive procedures).
48
Q

When response to the risks of material misstatement is at the relevant assertion level, what response is needed?

A

Make decisions about the nature, timing, and extent of further procedures (test of control, substantive procedures.

49
Q

What does test of controls determine? When is it appropriate to use test of controls?

A

The operating effectiveness of controls.
When the risk assessment includes an “expectation of the operating effectiveness” of controls (relying on certain specific controls: accept somewhat higher risk - assessment must be accurate).
When wholly substantive approach is not sufficient.

50
Q

An audit is an interactive process. What should the auditor do to maintain this?

A

Evaluate whether the assessments of RMM at the relevant assertion level remain appropriate.
Consider all relevant audit evidence (whether it corroborates or contradicts the F/S assertions).

51
Q

What must be documented regarding procedures? (4)

A
  1. The auditor’s over all response to address RMM at the F/S level and nature, timing, extent of further audit procedures performed.
  2. The linkage of those procedures w/ the assessed RMM at the relevant assertion level.
  3. The result of audit procedures.
  4. That the F/S agree or reconcile with the underlying accounting records.
52
Q

How frequently must an auditor test controls which was effective in past years?

A

At least every third audit.

53
Q

How can an auditor compensate for a weakness in internal control?

A

By increasing the extent of analytical procedures.

54
Q

When evidence is available only in electronic form, what may be the best and most effective course of action?

A

Use generalized audit software to extract evidence.

55
Q

What is the auditor’s fundamental responsibility to communicate?

A

Any identified material weaknesses and significant deficiencies either in the design or operation of internal control.

56
Q

What are keys to the definition of significant deficiencies?

A

Less severe than a material weakness.

Important enough to merit attention by those charged with governance.

57
Q

What are keys to the definition of material weakness?

A

A reasonable possibility that a material misstatement of the entity’s F/S will not be prevented or detected and corrected on a timely basis.

58
Q

When the auditor identifies significant deficiencies and material weaknesses, what must he/her do?

A

Must communicate in writing to management/those charged w/ governance.

59
Q

How should an auditor communicate lesser matters?

A

Either verbally or in writing.

60
Q

When must the auditor communicate significant deficiencies and material weaknesses?

A

No later than 60 days following the report release date - - the report is permitted to use (sooner is preferred).

61
Q

Should the byproducts of audit be restricted?

A

Yes, restricted distribution.

62
Q

How is material weakness determined?

A

by whether there is more than a remote likelihood of a material loss occurring due to the control deficiency

63
Q

Must the auditor communicate sig deficiencies and material weakness separately?

A

Yes.

64
Q

A control deficiency that is more than a significant deficiency is most likely to result in what form of audit opinion relating to internal control?

A

Adverse.

65
Q

What are factors must be considered when evaluating deficiencies?

A

The entity’s size, complexity, nature and diversity of business activities.

66
Q

Internal audit function: what is its performance? What is the objective?

A

Assurance and consulting activities.
To evaluate and improve the effectiveness of the entity’s governance, risk management, and internal control processes (GRC functions).

67
Q

What are 2 ways for the auditor to use internal audit function (I/A)?

A
  1. To obtain audit evidence by substituting I/A’s work.

2. To provide direct assistance.

68
Q

What are 3 requirements must the auditor verify when using I/A’s evidence?

A
  1. Objectivity of I/A - organizational status, policies, procedures.
  2. Competence - education, experience, certification.
  3. Systematic/disciplined approach - formal structured approach, including quality control.
69
Q

What are verification procedures the auditor should perform when using I/A’s evidence? (3)

A
  1. Read I/A function’s report related to planned use.
  2. Perform procedures to evaluate I/A’s planning, performance, review, documentation, validity/appropriateness of the conclusion.
  3. Reperform some of the I/A’s work that is to be used.
70
Q

Who must make all the sig judgments about the audit?

A

The external auditor.

71
Q

What are 2 requirements when using I/A as direct assistance?

A
  1. Objectivity.

2. Competence.

72
Q

What are 3 audit procedures when using I/A as direct assistance?

A
  1. Obtain written acknowledgment from management that I/A is free to follow the external auditor without interference.
  2. Appropriately direct, supervise, and review I/A’s work.
  3. Test some of the work performed by the I/A’s accuracy.
73
Q

When using I/A or its work, is there any division of responsibility? Should the auditor mention the use of I/A?

A

No to both.

AUD (24 decks)

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