AUD 4 Flashcards
Tests of Internal Contorls
Substantive tests are performed to identify material misstatements at the assertion level. In case of assertions whose ROMM has been assessed as significant and no tests of control are planned to be performed, the substantive procedures should include tests of detail (i.e. substantive analytical procedures alone cannot be considered as sufficient and appropriate audit evidence for assertions with a significant risk of material misstatement.
Tests of control (TOCs) are performed to assess the operating effectiveness of controls at the financial statement and assertion level. TOCs are necessary to validate the auditor’s expectation of the operating effectiveness of controls (as acquired from the risk assessment procedures performed at the planning stage) and also in case where the performance of substantive procedures alone cannot provide sufficient and appropriate audit evidence in respect of a specific assertion.
In obtaining an understanding of an entity’s internal control structure in a financial statement audit, an auditor is not obligated to
A. Determine whether the control procedures have been placed in operation.
B. Perform procedures to understand the design of the internal control structure policies.
C. Document the understanding of the entity’s internal control structure elements.
D. Search for significant deficiencies in the operation of the internal control structure.
D. Search for significant deficiencies in the operation of the internal control structure.
Explanation - An auditor is not required to search for significant deficiencies in the operation of internal control. However, if such deficiencies come to the auditor’s attention, the auditor must report them to the audit committee.
A letter issued regarding significant deficiencies relating to an entity’s internal control observed during an audit of financial statements should include a
A. Restriction on the distribution of the report.
B. Description of tests performed to search for material weaknesses.
C. Statement of compliance with applicable laws and regulations.
D. Paragraph describing management’s evaluation of the effectiveness of the control structure.
A. Restriction on the distribution of the report.
Explanation - Letters on significant deficiencies are restricted as to distribution. The letters are intended solely for the use of the audit committee (or those charged with governance), management, and others within the organization.
Which of the following matters would an auditor most likely consider to be a significant deficiency to be communicated to the audit committee (or otherwise those charged with governance)?
A. Management’s failure to renegotiate unfavorable long-term purchase commitments.
B. Recurring operating losses that may indicate going concern problems.
C. Evidence of a lack of objectivity by those responsible for accounting decisions.
D. Management’s current plans to reduce its ownership equity in the entity.
C. Evidence of a lack of objectivity by those responsible for accounting decisions.
Explanation - A significant deficiency is a control deficiency in the design or operation of internal control that can adversely affect the financial statements.
If those responsible for accounting decisions appear to lack objectivity, the resultant accounting decisions may result in material misstatements of the financial statements.
For example, revenue recognition decisions might be made to increase current period net income (and managerial bonuses).
In assessing the objectivity of internal auditors, the independent CPA who is auditing the entity’s financial statements would most likely consider the
A. Internal auditing standards developed by The Institute of Internal Auditors.
B. Tests of internal control activities that could detect errors and fraud.
C. Materiality of the accounts recently inspected by the internal auditors.
D. Results of the tests of transactions recently performed by the internal auditors.
A. Internal auditing standards developed by The Institute of Internal Auditors.
Explanation - Internal auditing standards developed by The Institute of Internal Auditors address independence and objectivity and thus might be considered by an independent CPA in assessing the objectivity of internal auditors.
In addition, the independent CPA would consider whether the internal auditor reports to an officer of sufficient status, whether the internal auditor has direct access to the board of directors and the audit committee, whether internal audit employment decisions are overseen by the board of directors and/or the audit committee, and whether policies exist to prohibit the audit of areas in which conflicts of interest exist.
Miller Retailing, Inc. maintains a staff of three full-time internal auditors who report directly to the controller. In planning to use the internal auditors to provide assistance in performing the audit, the independent auditor will most likely
A. Place limited reliance on the work performed by the internal auditors.
B. Decrease the extent of the tests of controls needed to support the assessed level of detection risk.
C. Increase the extent of the procedures needed to reduce control risk to an acceptable level.
D. Avoid using the work performed by the internal auditors.
A. Place limited reliance on the work performed by the internal auditors.
Explanation - The independent auditor will place only limited reliance on the work performed by the internal auditors because of their lack of independence. While internal auditors can never be fully independent, a greater level of relative independence is obtained when they report to the board of directors or the audit committee.
An internal auditor’s work would most likely affect the nature, timing, and extent of an independent CPA’s auditing procedures when the internal auditor’s work relates to assertions about the
A. Existence of contingencies.
B. Valuation of intangible assets.
C. Existence of fixed asset additions.
D. Valuation of related party transactions.
C. Existence of fixed asset additions.
Explanation - Some of the work performed by internal auditors may provide direct evidence about material misstatements in assertions. As a result, the auditor may be able to rely upon such work and reduce the nature, timing, or extent of the auditing procedures to be performed related to those assertions. Internal audit work pertaining to the existence of fixed asset additions would provide direct evidence which could be used to restrict other audit work to be performed.
In assessing the competence and objectivity of an entity’s internal auditor, an independent auditor would be least likely to consider information obtained from
A. Discussions with management personnel.
B. External quality reviews of the internal auditor’s activities.
C. Previous experience with the internal auditor.
D. The results of analytical procedures.
D. The results of analytical procedures.
Explanation - Analytical procedures are performed to aid in the detection of unusual transactions, as substantive procedures, and to aid in the overall review of the financial statements. The results of such procedures would not provide evidence which would aid the independent auditor in assessing the competence and objectivity of the internal auditors.
Which of the following could be difficult to determine because electronic evidence may not be retrievable after a specific period?
A. The acceptance level of detection risk.
B. The timing of control and substantive tests.
C. Whether to adopt substantive or reliance test strategies.
D. The assessed level of inherent risk.
B. The timing of control and substantive tests.
Explanation - When it might be best (or even possible) to perform tests of control and substantive tests could be affected by the availability of underlying evidence.
Proper authorization of write-offs of uncollectible accounts should be approved in which of the following departments? A. Accounts receivable. B. Credit. C. Accounts payable. D. Treasurer.
D. Treasurer.
Explanation - Authorization of write-offs should be made by a department independent of recording or authorization duties pertaining to accounts receivable. The accounts receivable department maintains the accounts receivable records; the credit department approves credit for customers. Neither, therefore, is a good candidate for authorizing write-offs. Assigning the accounts payable department doesn’t make sense. This leaves the treasurer as the best candidate for authorization of write-offs.
Sound internal control procedures dictate that defective merchandise returned by customers should be presented initially to the A. Accounts receivable supervisor. B. Receiving clerk. C. Shipping department supervisor. D. Sales clerk.
B. Receiving clerk.
Explanation - Defective merchandise returned by customers should be presented initially to the receiving clerk. The function of the receiving department is to receive and inspect goods and to document the receipt in the form of a receiving report.
Tracing bills of lading to sales invoices provides evidence that
A. Shipments to customers were invoiced.
B. Shipments to customers were recorded as sales.
C. Recorded sales were shipped.
D. Invoiced sales were shipped.
A. Shipments to customers were invoiced.
Explanation - Tracing bills of lading to sales invoices provides evidence that shipments to customers were invoiced. It is a test of the completeness assertion.
Immediately upon receipt of cash, a responsible employee should
A. Record the amount in the cash receipts journal.
B. Prepare a remittance listing.
C. Update the subsidiary accounts receivable records.
D. Prepare a deposit slip in triplicate.
B. Prepare a remittance listing.
Explanation - The immediate preparation of a remittance listing upon receipt of cash ensures that a control over cash received is established.
An auditor would be most likely to limit substantive audit tests of sales transactions when control risk is assessed as low for the existence or occurrence assertion concerning sales transactions and the auditor has already gathered evidence supporting
A. Opening and closing inventory balances.
B. Cash receipts and accounts receivable.
C. Shipping and receiving activities.
D. Cutoffs of sales and purchases.
B. Cash receipts and accounts receivable.
Explanation - Substantive tests of sales transactions would be limited when control risk is assessed as low for existence/occurrence and evidence has been gathered supporting cash receipts and accounts receivable. Consider the accounts which are impacted by sales transactions, DR Cash or Accounts Receivable and CR Sales. The combination of low control risk in this area plus evidence supporting cash receipts and accounts receivable provides the auditor with assurance that sales transactions have actually occurred.
An auditor would consider a cashier's job description to contain compatible duties if the cashier receives remittances from the mailroom and also prepares the A. Prelist of individual checks. B. Monthly bank reconciliation. C. Daily deposit slip. D. Remittance advices.
C. Daily deposit slip.
Explanation - Adequate segregation of duties provides for the separation of authorizing, recording, and custodial duties. Receiving remittances from the mailroom is a custodial duty. It may properly be combined with preparation of the daily deposit slip which would also require custody of the asset.
