Chapter 5.1 Q Flashcards
Internal control cannot be designed to provide reasonable assurance that
A. The recorded accountability for assets is compared with the existing assets at reasonable intervals.
B. Transactions are executed in accordance with management’s authorization.
C. Access to assets is permitted only in accordance with management’s authorization.
D. Fraud will be eliminated.
Answer (D) is correct.
Internal control is a process designed to provide reasonable assurance regarding the achievement of the entity’s objectives. It can provide reasonable assurance regarding (1) reliability of financial reporting, (2) compliance with applicable laws and regulations, and (3) effectiveness and efficiency of operations. Because of inherent limitations, however, no system can be designed to eliminate all fraud (AU-C 315).
Which of the following most likely would not be considered an inherent limitation of the potential effectiveness of an entity’s internal control? A. Collusion among employees. B. Management override. C. Incompatible duties. D. Faulty judgment.
Answer (C) is correct.
Internal control has inherent limitations. The performance of incompatible duties, however, is a failure to assign different people the functions of authorization, recording, and asset custody, not an inevitable limitation of internal control. Segregation of duties is a category of control activities.
Internal controls are designed to provide reasonable assurance that
A. Management’s planning, organizing, and directing processes are properly evaluated.
B. The internal auditing department’s guidance and oversight of management’s performance is accomplished economically and efficiently.
C. Management’s plans have not been circumvented by worker collusion.
D. Material errors or fraud will be prevented, or detected and corrected, within a timely period by employees in the course of performing their assigned duties.
Answer (D) is correct.
Cost-effective controls should restrict deviations to a tolerable rate. Thus, material errors and improper or illegal acts should be prevented, or detected and corrected, within a timely period by employees in the normal course of performing their assigned duties. Accordingly, the cost-benefit relationship is considered by management during the design of systems, and the potential loss associated with any exposure or risk is weighed against the cost to control it.
Which of the following items is an example of an inherent limitation in an internal control system?
A. Segregation of employee duties.
B. Ineffective board of directors.
C. Understaffed internal audit functions.
D. Human error in decision making.
Answer (D) is correct.
Because of its inherent limitations, internal control can be designed and operated to provide only reasonable assurance that the entity’s objectives are met. Thus, (1) human judgment is faulty, (2) controls may fail because of human error, (3) manual or automated controls can be circumvented by collusion, and (4) management may inappropriately override internal control. Moreover, custom, culture, the corporate governance system, and an effective control environment are not absolute deterrents to fraud. For example, if the nature of management incentives increases the RMMs, the effectiveness of controls may be reduced. A factor that is an inherent limitation of an audit as well as internal control is the need to balance benefit and cost. Although the ability to provide only reasonable assurance is a primary design criterion for internal control, the precise measurement of costs and benefits is not feasible. However, costs should not exceed the benefits of control. Thus, the cost constraint limits internal control.
Which of the following is a component part of the COSO’s internal control framework? A. Event identification. B. Information systems. C. Audit strategy and planning. D. Audit risk.
Answer (B) is correct.
According to the COSO, an entity’s internal control has five components: (1) the control environment, (2) risk assessment process, (3) control activities, (4) information systems, and (5) monitoring. The control environment sets the tone of an organization, influences control consciousness, and provides a foundation for the other components. Risk assessment is the identification, analysis, and management of risks relevant to achievement of objectives. Control activities help ensure that management directives are executed. The information system consists of (1) physical and hardware components, (2) software, (3) people, (4) procedures, and (5) data. Monitoring assesses the performance of internal control over time.
The objective of the auditor is to identify and assess the risks of material misstatement (RMMs). The auditor therefore identifies and assesses RMMs
A. At the financial statement and relevant assertion levels.
B. During initial audit planning only at the financial statement level.
C. For each assertion after considering the effects of internal control.
D. For assertions that are probable of being materially misstated.
Answer (A) is correct.
The objective of the auditor is to identify and assess the RMMs, whether due to fraud or error, at the financial statement and relevant assertion levels. This objective is achieved through understanding the entity and its environment, including the entity’s internal control, to provide a basis for designing and implementing responses to the assessed RMMs. A relevant assertion has a reasonable possibility of containing a misstatement that could cause material misstatement(s) of the financial statements. Thus, a relevant assertion has a meaningful bearing on whether the account is fairly stated.
An auditor is evaluating a client’s internal controls. Which of the following situations would be the most difficult internal control issue for an auditor to detect?
A. The technology department writes a program that does not properly implement the control due to a lack of understanding.
B. Two employees, who work in different departments, are circumventing an internal control.
C. The accounting staff neglects the control due to increased transactions to be processed.
D. Someone erroneously disables edit checks in a software program designed to identify control exceptions.
Answer (B) is correct.
Because of its inherent limitations, internal control can provide only reasonable assurance that the entity’s objectives are met. Thus, manual or automated controls can be circumvented by collusion of two or more people or by management override (AU-C 315). Fraud perpetrated by collusion may be difficult to detect because of schemes designed to conceal it.
Which of the following is an inherent limitation of internal control? A. Collusion. B. Employee peer review. C. Segregation of duties. D. Judgmental sampling.
Answer (A) is correct.
Two or more people may collude, or management may override internal control.
Which of the following situations represents a limitation, rather than a failure, of internal control?
A. A purchasing employee and an outside vendor participate in a kickback scheme.
B. A jewelry store employee steals a small necklace from a display cabinet.
C. A movie theater cashier sells reduced-price tickets to full-paying customers and pockets the difference.
D. A bank teller embezzles several hundred dollars from the cash drawer.
Answer (A) is correct.
Because of the inherent limitations of internal control, it can be designed to provide only reasonable assurance that the entity’s objectives are met. For example, (1) controls may fail because of human error, (2) management may override controls inappropriately, or (3) manual or automated controls may be circumvented by collusion (e.g., a kickback scheme involving a purchasing employee and an outside vendor).
An auditor uses the knowledge provided by the understanding of internal control and the assessed risks of material misstatement primarily to
A. Modify the initial assessments of inherent risk and judgments about materiality levels for planning purposes.
B. Determine the nature, timing, and extent of substantive procedures for financial statement assertions.
C. Determine whether the opportunities to allow any person to both perpetrate and conceal fraud are minimized.
D. Determine whether procedures and records concerning the safeguarding of assets are reliable.
Answer (B) is correct.
The auditor is required to obtain an understanding of the entity and its environment, including its internal control, to assess the risks of material misstatement of the financial statements, whether due to fraud or error, to provide a basis for responding to the assessed RMMs. Regardless of the assessed RMMs, the auditor performs substantive procedures for all relevant assertions for material classes of transactions, account balances, and disclosures. Moreover, the auditor designs and performs further audit procedures whose nature, timing, and extent respond to the assessed RMMs at the relevant assertion level.
An entity should consider the cost of a control in relationship to the risk. Which of the following controls best reflects this philosophy for a large dollar investment in heavy machine tools?
A. Placing security guards at every entrance 24 hours a day.
B. Having all dispositions approved by the vice president of sales.
C. Imprinting a controlled identification number on each tool.
D. Conducting a weekly physical inventory.
Answer (C) is correct.
A controlled identification number on each tool and periodic checking allow for an effective control at reasonable cost.
Although substantive tests may support the accuracy of underlying information used in monitoring, these tests may provide no affirmative evidence of the effectiveness of monitoring controls because
A. Substantive tests rarely guarantee the accuracy of information used in monitoring if only a sample has been tested.
B. When procedures are computerized and leave no audit trail to indicate who performed them, substantive tests may necessarily be limited to inquiries and observation.
C. The information used in monitoring may be accurate even though it is subject to ineffective control.
D. Substantive tests relate to the entire period under audit, but tests of controls ordinarily are confined to the period during which the auditor is on the client’s premises.
Answer (C) is correct.
When obtaining an understanding of each of the five components of internal control (including monitoring), the auditor must perform procedures to understand the design of relevant controls and must determine whether controls have been implemented. If (s)he intends to rely on the controls, (s)he must also determine their effectiveness. However, when controls based on monitoring leave no audit trail, for example, documentation of design or operation, evidence about effectiveness of design or operation may be obtained only by inquiries, observations, and computer-assisted audit methods. Moreover, substantive procedures likewise may provide no affirmative evidence of the effectiveness of monitoring controls because the information may be accurate even though controls over its creation are ineffective. Thus, the ineffectiveness of monitoring would not be revealed by substantive procedures unless the detection of material misstatements resulted in performance of additional audit procedures directed at the controls.
Manual controls would most likely be more suitable than automated controls for which of the following?
A. Large, unusual, or nonrecurring transactions.
B. Situations with routine errors that can be predicted and corrected.
C. High-volume transactions that require additional calculations.
D. Circumstances that require a high degree of accuracy.
Answer (A) is correct.
Manual controls may be more suitable where judgment and discretion are required, such as (1) for large, unusual, or nonrecurring transactions; (2) for circumstances where misstatements are difficult to define, anticipate, or predict; (3) in changing circumstances that require a control response outside the scope of an existing automated control; and (4) in monitoring the effectiveness of automated controls.
Which of the following represents an example of an inherent limitation of internal controls?
A. Shipping documents are not matched to sales invoices.
B. The CEO can override a control and request a check with no purchase order.
C. Customer credit checks are not performed.
D. Bank reconciliations are not performed on a timely basis.
Answer (B) is correct.
Inherent limitations may exist and should be considered by the auditor. Human judgment can be faulty, controls can be circumvented by collusion, and management may inappropriately override controls. Thus, the CEO’s requesting a check with no purchase order is possible because of an inherent limitation. It is an override of the internal control by management.
Which of the following best describes an inherent limitation that should be recognized by an auditor when considering the potential effectiveness of internal control?
A. Controls, whether manual or automated, whose effectiveness depends on segregation of duties can be circumvented by collusion.
B. The competence and integrity of client personnel provide an environment conducive to control and provides assurance that effective control will be achieved.
C. Procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are effective against fraud perpetrated by management.
D. The benefits expected to be derived from effective internal control usually do not exceed the costs of such control.
Answer (A) is correct.
One of the inherent limitations of internal control is that it can be circumvented by collusion among persons both within and outside the entity. Thus, a control based on segregation of duties will be ineffective if a person in a position to commit fraud colludes with a person who can conceal it.
