Exam 2

Question 1

The primary purpose for obtaining an understanding of internal control during the audit of a nonissuer is to:

A: provide a basis for making constructive suggestions in a management letter.

B: determine the nature, timing, and extent of further audit tests to be performed.

C: provide the rationale for the inherent risk assessment at the financial statement assertion level.

D: provide information for a communication of internal control–related matters to management.AA

Answer 1

B: determine the nature, timing, and extent of further audit tests to be performed.Correct

Question 2

Effectiveness of audit procedures would be reduced by

A: Performing audit procedures at the fiscal year-end date as opposed to the interim period.

B: Performing procedures during the interim period as opposed to at the fiscal year-end date.

C: Deciding to obtain external evidence instead of internal evidence.

D: Selecting larger sample sizes for audit.

Answer 2

B: Performing procedures during the interim period as opposed to at the fiscal year-end date.Correct

Question 3

To test the operating effectiveness of a control, an audit team might use a combination of each of the following tests except for:

A: Inquiry of client personnel.

B: Confirmation of balances.

C: Observation of company operations.

D: Inspection of documentation.

Answer 3

B: Confirmation of balances.

Question 4

Which of the following is a preventive control?

A: Detailed fluctuation analysis completed by the CFO for revenue.

B: Recalculation of a sample of payroll entries by internal auditors.

C: Reconciliation of a bank account.

D: Separation of duties between the payroll and personnel departments.

Answer 4

D: Separation of duties between the payroll and personnel departments.

Question 5

A material weakness is a situation in which

A: There is a remote likelihood that a material misstatement would be detected on a timely basis.

B: It is reasonably possible that a material misstatement would not be detected on a timely basis.

C: It is reasonably possible that an immaterial misstatement would not be detected on a timely basis.

D: It is probable that an immaterial financial statement misstatement would not be detected on a timely basis.

Answer 5

B: It is reasonably possible that a material misstatement would not be detected on a timely basis.

Question 6

When completing the audit of internal controls for an issuer, the severity of an internal control deficiency depends on:

A: Whether there is a reasonable possibility that the company’s controls will fail to prevent or detect a misstatement of an account balance or disclosure.

B: Whether the account has a history of errors.

C: The magnitude of the potential misstatement resulting from the deficiency or the deficiencies.

D: Both the magnitude of the potential misstatement resulting from the deficiency or the deficiencies and whether there is a reasonable possibility that the company’s controls will fail to prevent or detect a misstatement of an account balance or disclosure.

Answer 6

D: Both the magnitude of the potential misstatement resulting from the deficiency or the deficiencies and whether there is a reasonable possibility that the company’s controls will fail to prevent or detect a misstatement of an account balance or disclosure.

Question 7

When completing the audit of internal controls for an issuer, the PCAOB requires the audit team to audit internal controls over:

A: Operations.

B: Compliance with regulations.

C: Financial reporting.

D: All of the choices are correct.

Answer 7

C: Financial reporting.

Question 8

When completing the audit of internal controls for an issuer, AS 2201 requires auditors to test:

A: Operating effectiveness only.

B: Design effectiveness only.

C: Both operating and design effectiveness.

D: Neither operating nor design effectiveness.

Answer 8

C: Both operating and design effectiveness.

Question 9

Which of the following would probably not be considered an indication of a material weakness?

A: Overproduction by the manufacturing plant.

B: Ineffective oversight by the audit committee.

C: Immaterial fraud committed by senior management.

D: Evidence of a material misstatement.

Answer 9

A: Overproduction by the manufacturing plant.

Question 10

Which report would not be appropriate for a public accounting firm to provide on financial reporting controls?

A: Unqualified—no material weaknesses found.

B: Disclaimer of opinion—unable to perform all necessary procedures.

C: Disclaimer of opinion—significant deficiencies exist.

D: Adverse—material weaknesses exist.

Answer 10

C: Disclaimer of opinion—significant deficiencies exist.

Question 11

The purpose of separating the duties of hiring personnel and distributing payroll checks is to separate the

A: Human resources function from the controllership function.

B: Operational responsibility from the record-keeping responsibility.

C: Authorization of transactions from the custody of related assets.

D: Administrative controls from the internal accounting controls.

Answer 11

C: Authorization of transactions from the custody of related assets.

Question 12

If the auditors encounter a significant scope limitation in evaluating an issuer’s internal control over financial reporting, which of the following types of opinions on the effectiveness of the company’s internal control over financial reporting would be appropriate?

A: Unqualified opinion or adverse opinion.

B: Qualified opinion or adverse opinion.

C: Unqualified opinion or disclaimer of opinion.

D: Disclaimer of opinion.

Answer 12

D: Disclaimer of opinion.

Question 13

If the auditor plans to assess control risk at less than the maximum and rely on controls, and the nature, timing, and extent of further audit procedures are based on that lower assessment, the auditor must

A: Perform only substantive procedures.

B: Assess control risk at less than the maximum for all relevant assertions.

C: Provide additional examples of responses to assessed fraud risks relating to fraudulent financial reporting.

D: Obtain evidence that the controls selected for testing are designed effectively and operated effectively during the entire period of reliance.

Answer 13

D: Obtain evidence that the controls selected for testing are designed effectively and operated effectively during the entire period of reliance.

Question 14

When testing a control activity’s operating effectiveness, procedures the auditor performs to test operating effectiveness would likely include

A: Reading over the company’s code of conduct.

B: Inquiry of appropriate personnel.

C: Reperformance of the control activity.

D: Inquiry of appropriate personnel and reperformance of the control activity.

Answer 14

D: Inquiry of appropriate personnel and reperformance of the control activity.

Question 15

The auditor should assess control risk for each relevant assertion by evaluating the evidence obtained from all sources, including

A: The auditor’s testing of controls for the audit of internal control on an issuer.

B: Misstatements detected during the financial statement audit.

C: Any control deficiencies identified during the audit.

D: All of the choices are correct.

Answer 15

D: All of the choices are correct.

Question 16

Once the auditor detects a control deficiency, which of the following steps must he or she take first?

A: Evaluate the severity of the deficiency on the auditor’s control risk assessment for that assertion.

B: Test the deficient control, assuming a maximum level of risk.

C: Modify the planned substantive procedures as a result of the deficiency.

D: Perform tests of other controls related to the same assertion as the control deemed ineffective.

Answer 16

A: Evaluate the severity of the deficiency on the auditor’s control risk assessment for that assertion.

Question 17

When an auditor plans to rely on controls that have changed since they were last tested, which of the following courses of action would be most appropriate?

A) Test the operating effectiveness of such controls in the current audit.

B) Document that reliance and proceed with the original audit strategy.

C) Inquire of management as to the effectiveness of the controls.

D) Report the reliance in the report on internal controls.

Answer 17

A) Test the operating effectiveness of such controls in the current audit.

Question 18

Which of the following is a definition of control risk?

A) The risk that a material misstatement will not be prevented or detected on a timely basis by the client’s internal controls.

B) The risk that the auditor will not detect an existing material misstatement.

C) The risk that the auditor’s assessment of internal controls will be at less than the maximum level.

D) The susceptibility of material misstatement assuming there are no related internal controls, policies, or procedures.

Answer 18

A) The risk that a material misstatement will not be prevented or detected on a timely basis by the client’s internal controls.

Question 19

Which of the following statements is correct regarding internal control?

A) A well-designed internal control environment ensures the achievement of an entity’s control objectives.

B) An inherent limitation to internal control is the fact that controls can be circumvented by management override.

C) A well-designed and operated internal control environment should detect collusion perpetrated by two people.

D) Internal control is a necessary business function and should be designed and operated to detect all errors and fraud.

Answer 19

B) An inherent limitation to internal control is the fact that controls can be circumvented by management override.

Question 20

Which of the following statements best describes why an auditor would use only substantive procedures to evaluate specific relevant assertions and risks?

A) The relevant internal control components are not well documented.

B) The internal auditor already has tested the relevant controls and found them effective.

C) Testing the operating effectiveness of the relevant controls would not be efficient.

D) The cost of substantive procedures will exceed the cost of testing the relevant controls.

Answer 20

C) Testing the operating effectiveness of the relevant controls would not be efficient.

Question 21

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 accounting staff neglects the control, due to increased transactions to be processed.

B) The technology department writes a program that does not properly implement the control, due to a lack of understanding.

C) Two employees, who work in different departments, are circumventing an internal control by collusion.

D) Someone erroneously disables edit checks in a software program designed to identify control exceptions.

Answer 21

C) Two employees, who work in different departments, are circumventing an internal control by collusion.

Question 22

The “obtaining an understanding” work phase (Phase 1) of internal control evaluation would not give auditors an overall acquaintance with the client’s:

A) control environment.

B) information and communication system.

C) control activity effectiveness.

D) monitoring activities.

Answer 22

C) control activity effectiveness.

Question 23

Which of the following is the least important reason for the auditor’s obtaining an understanding of a company’s internal control?

A) To serve as a basis for constructive suggestions.

B) To plan subsequent substantive tests.

C) To identify types of possible misstatements that may occur.

D) To consider factors that may affect the risk of material misstatement.

Answer 23

A) To serve as a basis for constructive suggestions.

Question 24

If auditors assess control risk at the maximum level, they will tend to:

A) perform a great deal of additional tests of controls.

B) perform a great deal of substantive testing during the audit.

C) perform substantive tests at an interim date.

D) perform more audit procedures using internal evidence.

Answer 24

B) perform a great deal of substantive testing during the audit.

Question 25

Which of the following would most likely be classified as a material weakness?

A) Absence of appropriate separation of duties.

B) Absence of appropriate reviews and approvals of transactions.

C) Evidence of failure of control activities.

D) Ineffective oversight of the financial reporting process by the company’s audit committee.

Answer 25

D) Ineffective oversight of the financial reporting process by the company’s audit committee.

Question 26

The primary objective of procedures performed to obtain an understanding of the entity’s internal control is to provide an auditor with:

A) knowledge necessary for audit planning.

B) evidential matter to use in assessing inherent risk.

C) a basis for modifying tests of controls.

D) an evaluation of the consistency of application of management’s policies.

Answer 26

A) knowledge necessary for audit planning.

Question 27

An auditor has identified the controller’s review of the bank reconciliation as a control to test. In connection with this test, the auditor interviews the controller to understand the specific data reviewed on the reconciliation. In addition, the auditor verifies that the bank reconciliation is properly prepared by the accountant and reviewed by the controller as evidenced by their respective sign-offs. Which of the following types of audit procedures do these actions illustrate?

A) Observation and inspection of records.

B) Confirmation and reperformance.

C) Inquiry and inspection of records.

D) Analytical procedures and reperformance.

Answer 27

C) Inquiry and inspection of records.

Question 28

Which of the following situations most likely represents the highest risk of a misstatement arising from misappropriation of assets?

A) A large number of bearer bonds on hand.

B) A large number of inventory items with low sales prices.

C) A large number of transactions processed in a short period of time.

D) A large number of fixed assets with easily identifiable serial numbers.

Answer 28

A) A large number of bearer bonds on hand.

Question 29

Which of the following is ordinarily considered an “extended procedure” during the independent audit of financial statements?

A) Send positive confirmations on recorded customer accounts receivable balances.

B) Perform physical observation and test count during the client’s inventory taking.

C) Measure the time lag between the date of recording cash receipts in the books to the date of deposit credit in the bank.

D) Conduct interviews with the client’s sales billing personnel to learn about sales recording control activities.

Answer 29

C) Measure the time lag between the date of recording cash receipts in the books to the date of deposit credit in the bank.

Question 30

An audit plan of substantive procedures for cash would not include:

A) request a cutoff bank statement be mailed to the client.

B) request client to prepare bank reconciliations.

C) prepare a schedule of interbank transfers for a period of ten business days before and after year-end date.

D) obtain a written client representation concerning compensating balance agreements.

Answer 30

B) request client to prepare bank reconciliations.

Question 31

To gather evidence regarding the client’s bank balance in a bank reconciliation, an auditor would examine all of the following except the:

A) cutoff bank statement.

B) general ledger.

C) bank confirmation.

D) year-end bank statement.

Answer 31

B) general ledger.

Question 32

Which of the following sets of information does an auditor usually confirm on one form?

A) Accounts payable and purchase commitments.

B) Cash in bank and collateral for loans.

C) Inventory on consignment and contingent liabilities.

D) Accounts receivable and accrued interest receivable.

Answer 32

B) Cash in bank and collateral for loans.

Question 33

To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is:

A) supported by a vendor’s invoice.

B) stamped “paid” by the check signer.

C) prenumbered and accounted for.

D) approved for authorized purchases.

Answer 33

B) stamped “paid” by the check signer.

Question 34

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client’s financial statements most likely would withdraw from the engagement if:

A) the illegal act is a violation of generally accepted accounting principles.

B) the client does not take the remedial action that the auditor considers necessary.

C) the illegal act was committed during a prior year that was not audited.

D) the auditor has already assessed control risk at the maximum level.

Answer 34

B) the client does not take the remedial action that the auditor considers necessary.

Question 35

The sum of customers’ unpaid balances that is compared to the general ledger balance comes from:

A) a total of sales invoices.

B) a total of shipping orders.

C) the sales journal.

D) the accounts receivable trial balance.

Answer 35

D) the accounts receivable trial balance.

Question 36

Scanning sales invoices for missing numbers in the sequence would be an activity intended to satisfy what assertion?

A) Completeness.

B) Accuracy.

C) Occurrence.

D) Classification.

Answer 36

A) Completeness.

Question 37

Which of the following is not a valid reason for an auditor deciding not to send accounts receivable confirmations?

A) The balance is immaterial.

B) Confirmations would be ineffective.

C) The client requests alternative procedures be performed instead.

D) Other procedures provide sufficient competent evidence.

Answer 37

C) The client requests alternative procedures be performed instead.

Question 38

To determine whether sales transactions have been recorded in the proper accounting period, the auditor performs cutoff tests. Which of the following best describes the overall approach used when performing cutoff tests?

A) Ascertain that management has included in the representation letter a statement that transactions have been accounted for in the proper accounting period.

B) Analyze transactions occurring within a few days before and after year-end.

C) Confirm year-end transactions with regular customers.

D) Examine cash receipts in the subsequent period.

Answer 38

B) Analyze transactions occurring within a few days before and after year-end.

Question 39

The most effective audit procedure for determining the collectability of an account receivable is the:

A) review of the subsequent cash collections.

B) examination of the related sales invoice(s).

C) confirmation of the account.

D) review of authorization of credit sales to the customer and the previous history of collections.

Answer 39

A) review of the subsequent cash collections.

Question 40

An auditor confirms a representative number of open accounts receivable as of December 31 and investigates respondents’ exceptions and comments. By this procedure, the auditor would be most likely to learn of which of the following?

A) One of the cashiers has been covering a personal embezzlement by lapping.

B) One of the sales clerks has not been preparing charge slips for credit sales to family and friends.

C) One of the IT control clerks has been removing all sales invoices applicable to his account from the data file.

D) The credit manager has misappropriated remittances from customers whose accounts have been written off.

Answer 40

A) One of the cashiers has been covering a personal embezzlement by lapping.

Question 41

In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified?

A) A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.

B) A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.

C) A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.

D) A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.

Answer 41

D) A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.

Question 42

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

A) 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.

B) The accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account monthly.

C) The accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences reported by customers.

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

Answer 42

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

Question 43

In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity’s aging of receivables to support management’s financial statement assertion of:

A) existence.

B) valuation or allocation.

C) completeness.

D) rights and obligations.

Answer 43

B) valuation or allocation.

Question 44

Which of the following procedures would an auditor most likely perform for year-end accounts receivable confirmations when the auditor did not receive replies to second requests?

A) Review the cash receipts journal for the month prior to the year-end.

B) Intensify the study of the internal control structure concerning the revenue cycle.

C) Increase the assessed level of detection risk for the existence assertion.

D) Inspect the shipping records documenting the merchandise sold to the debtors.

Answer 44

D) Inspect the shipping records documenting the merchandise sold to the debtors.

Question 45

When confirming accounts payable, emphasis should be put on what kind of accounts?

A) Accounts with small or zero balances

B) All accounts should be equally emphasized.

C) Accounts with large balances

D) Accounts listed in the accounts payable subsidiary

Answer 45

A) Accounts with small or zero balances

Question 46

For the copy of the purchase order that goes to the receiving department, it is best to

A) leave off the description of the goods ordered.

B) leave off the quantity of the goods ordered.

C) leave off the name of the vendor.

D) have the receiving department forward all copies of the purchase order to accounts payable.

Answer 46

B) leave off the quantity of the goods ordered.

Question 47

When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that

A) all goods purchased before year-end are received before the physical inventory count.

B) no goods held on consignment for customers are included in the inventory balance.

C) no goods observed during the physical count are pledged or sold.

D) all goods owned at year-end are included in the inventory balance.

Answer 47

D) all goods owned at year-end are included in the inventory balance.

Question 48

Auditors may conclude that depreciation charges are too small by noting

A) insured values much larger than book values.

B) large numbers of fully depreciated assets.

C) frequent trade-ins of relatively new assets.

D) large and frequent losses on assets retired.

Answer 48

D) large and frequent losses on assets retired.

Question 49

The auditor decided to test accounts payable by sending open-ended (blank) confirmations to selected vendors. The auditor’s best approach in selecting the vendor accounts to confirm is to

A) select vendor accounts with large balances.

B) select vendor accounts at random in order to apply a statistical sampling procedure.

C) select vendor accounts based on the number of purchases from vendors during the year.

D) select vendor accounts that are past due.

Answer 49

C) select vendor accounts based on the number of purchases from vendors during the year.

Question 50

Purchase cutoff procedures should be designed to produce evidence of whether merchandise is included in the inventory of the client company if the company

A) has paid for the merchandise.

B) has physical possession of the merchandise.

C) holds legal title to the merchandise.

D) holds the shipping documents for the merchandise issued in the company’s name.

Answer 50

C) holds legal title to the merchandise.

Question 51

Which of the following accounts would most likely be reviewed by the auditor to gain reasonable assurance that additions to the equipment account are not understated?

A) Depreciation expense

B) Gain on disposal of equipment

C) Accounts payable

D) Repairs and maintenance expense

Answer 51

D) Repairs and maintenance expense

Question 52

When using confirmations to provide evidence about the completeness assertion for accounts payable, the appropriate population most likely would be

A) vendors with whom the entity has previously done business.

B) amounts recorded in the accounts payable subsidiary ledger.

C) payees of checks drawn in the month after the year-end.

D) invoices filed in the entity’s open invoice file.

Answer 52

A) vendors with whom the entity has previously done business.

Question 53

An entity’s internal control structure requires for every check request that there be an approved voucher, supported by a prenumbered purchase order and a prenumbered receiving report. To determine whether checks are being issued for unauthorized expenditures, an auditor most likely would select items for testing from the population of all

A) purchase orders.

B) canceled checks.

C) receiving reports.

D) approved vouchers.

Answer 53

B) canceled checks.

Question 54

Which of the following audit procedures is best for identifying unrecorded accounts payable?

A) Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period

B) Investigating payables recorded just prior to and just subsequent to the balance sheet date to determine whether they are supported by receiving reports

C) Examining unusual relationships between monthly accounts payable balances and recorded cash payments

D) Reconciling vendors’ statements to the file of receiving reports to identify items received just prior to the balance sheet date

Answer 54

A) Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period