Flashcards C6 - Sheet1

Question 1

Question: V1C6-0001
During a preliminary survey, an auditor notes that several accounts payable vouchers for major suppliers show adjustments for duplicate payment of prior invoices. This would indicate
Answers
A: A need for additional testing to determine related controls and the current exposure to duplicate payments made to suppliers.
B: An unrecorded liability for the amount of purchases that are not processed while awaiting supplier master file address maintenance.
C: A lack of control in the receiving area that prevents timely notice to the accounts payable area that goods have been received and inspected.
D: The existence of a sophisticated accounts payable system that correlates overpayments to open invoices and therefore requires no further audit concern.

Answer 1

Answer Explanations
Answer (a) is the correct answer. This preliminary survey information should prompt the auditor to identify the magnitude of such duplicate payments.
Answer (b) is incorrect. This situation is not identified in the question.
Answer (c) is incorrect. The existence of duplicate payments is not related to a problem in the receiving area.
Answer (d) is incorrect. Duplicate payments are not overpayments; they are exceptions and should be handled as such.

Question 2

Question: V1C6-0002
Which of the following best describes a preliminary survey?
Answers
A: A standardized questionnaire used to obtain an understanding of management objectives.
B: A statistical sample of key employee attitudes, skills, and knowledge.
C: A “walk-through” of the financial control system to identify risks and the controls that can address those risks.
D: A process used to become familiar with activities and risks in order to identify areas for audit emphasis.

Answer 2

Answer Explanations
Answer (a) is incorrect. This is only one means in fulfilling the objective of a preliminary survey.
Answer (b) is incorrect. This is only one means in fulfilling the objective of a preliminary survey.
Answer (c) is incorrect. This is only one means in fulfilling the objective of a preliminary survey.
Answer (d) is the correct answer. It is the most complete per the IIA Standards.

Question 3

Question: V1C6-0003
The following information is available from the financial statements of a manufacturing division. The director of internal auditing is reviewing the data to identify potential risks as a basis for planning the audit. The division has not been audited by the internal auditing department in the past three years. The division conducts most of its business autonomously. The division has historically relied on one major product. However, that product is aging and will soon lose its patent protection.
The division had a large increase in sales in the previous year (20X2). Which of the following hypotheses would the data support regarding the potential cause of the sales increase? The division
Answers
Ratio Current year Previous year Prior year Industry average
Current ratio 1.94 1.89 2.28 2.13
Quick ratio 0.66 0.88 1.22 1.4
Days sales in receivables 112 93 72 69
Days sales in inventory 148 167 92 73
Cost of goods sold as % of sales 0.375 0.402 0.412 0.445
Sales/tangible assets 2.89 2.58 2.53 3.01
Sales/total assets 1.33 1.31 2.53 2.78
Sales growth 0.03 0.16 0.02 0.045
Net income (thousands) ($7,600) $985 ($1,200) $4,500
A: Reduced its selling price for most of its product line.
B: Acquired another company and accounted for the purchase as a purchase transaction, not a pooling.
C: Liquidated a substantial part of its older inventory.
D: Sold off most of its intangible assets, realizing a profit on the sale.

Answer 3

Answer Explanations
Answer (a) is incorrect. There is no evidence that the company reduced its sales prices. If anything, it may have raised sales prices since the COGS/Sales ratio decreased.
Answer (b) is the correct answer. This is shown by the dramatic change between the sales/total assets ratio (large decrease) and the relatively small change in sales/tangible assets ratio. The company must have acquired a large amount of intangible assets during the year. Since purchase accounting also incorporates the results of the acquired company, it is the most likely explanation for the increase.
Answer (c) is incorrect. Inventory is increasing, not decreasing.
Answer (d) is incorrect. This is not likely since intangible assets went up not down.

Question 4

Question: V1C6-0004
The following information is available from the financial statements of a manufacturing division. The director of internal auditing is reviewing the data to identify potential risks as a basis for planning the audit. The division has not been audited by the internal auditing department in the past three years. The division conducts most of its business autonomously. The division has historically relied on one major product. However, that product is aging and will soon lose its patent protection.
Which of the following would not explain the decrease in cost of goods sold as a percentage of sales ratio? The division
Answers
A: Liquidated inventory in conjunction with a plan to bring its current ratio more in line with the industry average.
B: Increased the selling price of its products by selling to less creditworthy customers.
C: Recorded subsequent year’s sales in the current year, but adjusted inventory to actual goods on hand at year-end.
D: Is incorrectly capitalizing certain production costs.
Ratio Current year Previous year Prior year Industry average
Current ratio 1.94 1.89 2.28 2.13
Quick ratio 0.66 0.88 1.22 1.4
Days sales in receivables 112 93 72 69
Days sales in inventory 148 167 92 73
Cost of goods sold as % of sales 0.375 0.402 0.412 0.445
Sales/tangible assets 2.89 2.58 2.53 3.01
Sales/total assets 1.33 1.31 2.53 2.78
Sales growth 0.03 0.16 0.02 0.045
Net income (thousands) ($7,600) $985 ($1,200) $4,500

Answer 4

Answer Explanations
Answer (a) is the correct answer. This is not a potential explanation because (1) there has been an increase in inventory, and (2) a liquidation would have resulted in a write-down of the costs of inventory, which would have caused the ratio to move the other way.
Answer (b) is incorrect. This is a potential explanation. Although not the most likely, there is a large increase in the number of days sales in accounts receivable, which could indicate the possibility of less creditworthy customers.
Answer (c) is incorrect. This is a potential explanation. Recording subsequent year’s sales in the current year, while adjusting inventory to goods actually on hand, would cause the ratio to increase.
Answer (d) is incorrect. This is a potential explanation. Incorrectly capitalizing production costs would cause the number of day’s sales in inventory to increase and the cost of goods ratio to decrease.

Question 5

Question: V1C6-0005
The following information is available from the financial statements of a manufacturing division. The director of internal auditing is reviewing the data to identify potential risks as a basis for planning the audit. The division has not been audited by the internal auditing department in the past three years. The division conducts most of its business autonomously. The division has historically relied on one major product. However, that product is aging and will soon lose its patent protection.
Ratio Current year Previous year Prior year Industry average
Current ratio 1.94 1.89 2.28 2.13
Quick ratio 0.66 0.88 1.22 1.4
Days sales in receivables 112 93 72 69
Days sales in inventory 148 167 92 73
Cost of goods sold as % of sales 0.375 0.402 0.412 0.44
5Sales/tangible assets 2.89 2.58 2.53 3.01
Sales/total assets 1.33 1.31 2.53 2.78
Sales growth 0.03 0.16 0.02 0.045
Net income (thousands) ($7,600) $985 ($1,200) $4,500
The current ratio increased during the past year while the quick ratio decreased. Which of the following explanations would best explain the reason that the current ratio increased while the quick ration decreased?
Answers
A: A substantial increase in accounts payable that affects the current ratio but not the quick ratio.
B: The significant buildup of inventory.
C: The substantial increase in accounts receivable.
D: The large increase in the amount of intangible assets that affects the current ratio but not the quick ratio.

Answer 5

Answer Explanations
Answer (a) is incorrect. It is likely that accounts payable has increased and the increase would affect the quick ratio more so than the current ratio. However, the increase in accounts payable would affect both ratios and would not constitute an explanation for the major differences in the two ratios.
Answer (b) is the correct answer. Inventory affects the current ratio, but not the quick ratio. The division is facing liquidity problems as indicated by the quick ratio.
Answer (c) is incorrect. The substantial increase in accounts receivable affects both ratios. Moreover, the increase in receivables would have also caused the quick ratio to increase.
Answer (d) is incorrect. The amount of intangibles does not affect either ratio.

Question 6

Question: V1C6-0006
Writing an audit program occurs at which stage of the audit process?
Answers
A: During the planning stage.
B: Subsequent to testing internal controls to determine whether to rely on the controls or audit around them.
C: As the audit is performed.
D: At the end of each audit, the standard audit program should be revised for the next audit to ensure coverage of noted problem areas.

Answer 6

Answer Explanations
Answer (a) is the correct answer. Planning should include writing the audit program.
Answer (b) is incorrect. The external auditor may use this approach in designing substantive tests of balances. (AICPA SAS No. 55)
Answer (c) is incorrect. The program is prepared in advance and modified, as appropriate, during the course of the audit.
Answer (d) is incorrect. While choice (d) could be done, the program should be updated during the planning process.

Question 7

Question: V1C6-0007
In planning an audit, an on-site survey could assist with all of the following except:
Answers
A: Obtaining auditee comments and suggestions on control problems.
B: Obtaining preliminary information on internal controls.
C: Identifying areas for audit emphasis.
D: Evaluating the effectiveness of the system of internal controls.

Answer 7

Answer Explanations
Answer (a) is incorrect. Survey would assist in obtaining auditee comments.
Answer (b) is incorrect. Survey would assist in obtaining information on internal controls.
Answer (c) is incorrect. Survey would assist in identifying areas for audit emphasis.
Answer (d) is the correct answer. Determining the effectiveness of internal controls would require testing.

Question 8

Question: V1C6-0008
Fieldwork has been defined as “a systematic process of objectively gathering evidence about an entity’s operations, evaluating it, and determining if those operations meet acceptable standards.” Which of the following is not part of the work performed during fieldwork?
Answers
A: Expanding or altering audit procedures if circumstances warrant.
B: Applying the audit program to accomplish audit objectives.
C: Creating working papers that document the audit.
D: Developing a written audit program.

Answer 8

Answer Explanations
Answer (a) is incorrect. This is a requirement of the standards that relates to fieldwork.
Answer (b) is incorrect. This statement concerning fieldwork is true, and it is in harmony with the standards.
Answer (c) is incorrect. Working paper preparation is a requirement of the IIA standards, which should be met during fieldwork.
Answer (d) is the correct answer. This is a requirement of the audit-planning standard. The audit program should be developed before the fieldwork begins.

Question 9

Question: V1C6-0009
The IIA Standards require auditors to discuss conclusions and recommendations at appropriate levels of management before issuing final written reports. Auditors usually accomplish this by conducting exit conferences. Which of the following best describes the purpose of exit conferences?
Answers
A: To allow auditees to get started implementing recommendations as soon as possible.
B: To allow auditors to explain complicated findings before a written report is issued.
C: To allow auditors to “sell” findings and recommendations to management.
D: To ensure that there have been no misunderstandings or misinterpretations of facts.

Answer 9

Answer Explanations
Answer (a) is incorrect. This is a secondary benefit of exit conferences.
Answer (b) is incorrect. Complicated findings must be explained thoroughly in written reports.
Answer (c) is incorrect. This is a secondary benefit of exit conferences.
Answer (d) is the correct answer. This is the primary purpose of exit conferences.

Question 10

Question: V1C6-0010
The advantage attributed to the establishment of internal auditing field offices for work at foreign locations is best described as
Answers
A: The possibility of increased objectivity of personnel assigned to a field office.
B: A reduction of travel time and related travel expense.
C: The increased ease of maintaining uniform company-wide standards.
D: More contact with senior audit personnel leading to an increase in control.

Answer 10

Answer Explanations
Answer (a) is incorrect. Objectivity of field office personnel decreases which is a disadvantage.
Answer (b) is the correct answer. This choice is an advantage of field office.
Answer (c) is incorrect. It decreases ease of maintaining uniform standards, which is a disadvantage.
Answer (d) is incorrect. It creates greater difficulty in maintaining adequate control, which is a disadvantage.

Question 11

Question: V1C6-0011
In the preparation of an audit program, which of the following items is not essential?
Answers
A: The performance of a preliminary survey.
B: A review of material from prior audit reports.
C: The preparation of a budget identifying the costs of resources needed.
D: A review of performance standards set by management.

Answer 11

Answer Explanations
Answer (a) is incorrect. It is needed to determine audit objectives and controls in use.
Answer (b) is incorrect. To get background on the audit.
Answer (c) is the correct answer. Resources to be used is necessary. However, conversion to funds needed is not essential for the program.
Answer (d) is incorrect. This refers to obtaining information on the validity of criteria to be used or to be evaluated during the audit.

Question 12

Question: V1C6-0012
A primary purpose of the closing conference is to
Answers
A: Implement audit findings.
B: Gather audit evidence.
C: Resolve remaining issues.
D: Determine the scope of the audit.

Answer 12

Answer Explanations
Answer (a) is incorrect. Audit findings are not implemented. Audit recommendations are implemented.
Answer (b) is incorrect. Audit evidence is gathered prior to the closing conference.
Answer (c) is the correct answer. A major purpose of the closing conference is to resolve remaining issues.
Answer (d) is incorrect. The engagement scope is determined prior to the closing conference.

Question 13

Question: V1C6-0013
What action should an internal auditor take on discovering that an audit area was omitted from the audit program?
Answers
A: Document the problem in the work papers and take no further action until instructed to do so.
B: Perform the additional work needed without regard to the added time required to complete the audit.
C: Continue the audit as planned and include the unforeseen problem in a subsequent audit.
D: Evaluate whether completion of the audit as planned will be adequate.

Answer 13

Answer Explanations
Answer (a) is incorrect. Although the finding should be documented, it should be determined whether any changes may need to be made to the audit plan.
Answer (b) is incorrect. The budgeted hours should be reviewed and increases approved prior to undertaking any additional steps.
Answer (c) is incorrect. The unforeseen area may have an impact on the planned audit and need to be incorporated into the plan.
Answer (d) is the correct answer. Changes are often needed in the audit plan as work progresses. The auditor should review the plan with his or her supervisor since revised budgets may be needed.

Question 14

Question: V1C6-0014
In order to determine the extent of audit tests to be performed during fieldwork, preparing the audit program should be the next step after completing the
Answers
A: Preliminary survey.
B: Survey of company policies.
C: Assignment of audit staff.
D: Time budgets for specific audit tasks.

Answer 14

Answer Explanations
Answer (a) is the correct answer. During the preliminary survey, the internal auditor becomes acquainted with the auditee. He decides how much reliance he can place on the internal control system. This allows him to initially determine whether to extend or limit audit tests. He then prepares the audit program.
Answer (b) is incorrect. The survey of company policies may be a segment of the preliminary survey. However, completing the survey of company policies is not sufficient to begin preparing the audit program; the entire preliminary survey must be completed.
Answer (c) is incorrect. Audit staff are usually assigned to specific assignments before completing either the preliminary survey or the audit program.
Answer (d) is incorrect. Specific tasks to be performed are determined during the audit program preparation.

Question 15

Question: V1C6-0015
Which of the following is a step in an audit program?
Answers
A: The audit will commence in six weeks and include tests of compliance.
B: Determine whether the manufacturing operations are effective and efficient.
C: Auditors may not reveal findings to nonsupervisory, operational personnel during the course of this audit.
D: Observe the procedures used to identify defective units produced.

Answer 15

Answer Explanations
Answer (a) is incorrect. This is simply the proposed starting time and partial scope.
Answer (b) is incorrect. This is an audit objective.
Answer (c) is incorrect. This is a rule for the conduct of the audit personnel.
Answer (d) is the correct answer. This is an audit step because it is a procedure to be followed to obtain necessary evidence.

Question 16

Question: V1C6-0016
Audit programs testing internal controls should
Answers
A: Be tailored for the audit of each operation.
B: Be generalized to fit all situations without regard to departmental lines.
C: Be generalized so as to be usable at all locations of a particular department.
D: Reduce costly duplication of effort by ensuring that every aspect of an operation is examined.

Answer 16

Answer Explanations
Answer (a) is the correct answer. A tailor-made program will be more relevant to an operation than a generalized program.
Answer (b) is incorrect. A generalized program cannot take into account variations resulting from changing circumstances and varied conditions.
Answer (c) is incorrect. A generalized program cannot take into account variations in circumstances and conditions.
Answer (d) is incorrect. Every aspect of an operation need not be examined—only those likely to conceal problems and difficulties.

Question 17

Question: V1C6-0017
An auditor begins an audit with a preliminary evaluation of internal control, the purpose of which is to decide on the extent of future auditing activities. If the auditor’s preliminary evaluation of internal control results in a finding that controls may be inadequate, the next step would be
Answers
A: An expansion of audit work prior to the preparation of an audit report.
B: The preparation of a flowchart depicting the internal control system.
C: An exception noted in the audit report if losses have occurred.
D: To implement the desired controls.

Answer 17

Answer Explanations
Answer (a) is the correct answer. If the preliminary findings indicate control problems, the auditor usually decides to do some expanded testing.
Answer (b) is incorrect. If a flowchart were necessary, the auditor would have prepared one during the preliminary evaluation.
Answer (c) is incorrect. The auditor is not ready to make a report until more work has been performed.
Answer (d) is incorrect. Auditors do not implement controls; that is a function of management.

Question 18

Question: V1C6-0018
An internal auditor has just completed an on-site survey in order to become familiar with the company’s payroll operations.
Which of the following should be performed next?
Answers
A: Assign audit personnel.
B: Establish initial audit objectives.
C: Write the audit program.
D: Conduct fieldwork.

Answer 18

Answer Explanations
Answer (a) is incorrect. Audit personnel are normally assigned before the on-site survey takes place.
Answer (b) is incorrect. Initial audit objectives are established at the beginning of the planning process. They should be specified before the on-site survey takes place.
Answer (c) is the correct answer. The audit program is normally prepared after the on-site survey. The on-site survey allows the auditor to become familiar with the auditee, and thus provides input to the audit program.
Answer (d) is incorrect. Fieldwork can be performed only after the audit program has been written. Thus, fieldwork could not immediately follow the on-site survey.

Question 19

Question: V1C6-0019
Interviewing operating personnel, identifying the objectives of the auditee, identifying standards used to evaluate performance, and assessing the risks inherent in the auditee’s operations are activities typically performed in which phase of an internal audit?
Answers
A: The fieldwork phase.
B: The preliminary survey phase.
C: The audit programming phase.
D: The reporting phase.

Answer 19

Answer Explanations
Answer (a) is incorrect. The activities described must be performed before the audit program can be developed, the fieldwork completed, or reporting can be undertaken.
Answer (b) is the correct answer. These activities are normally accomplished during the preliminary survey phase.
Answer (c) is incorrect. The activities described must be performed before the audit programming phase.
Answer (d) is incorrect. The reporting phase is the last phase of the four choices given, hence it comes after the preliminary survey phase.

Question 20

Question: V1C6-0020
The auditor-in-charge has just been informed of the next audit assignment and the assigned audit team. Select the appropriate phase for finalizing the audit time budget.
Answers
A: During formulation of the long-range plan.
B: After the preliminary survey.
C: During the initial planning meeting.
D: After the completion of all fieldwork.

Answer 20

Answer Explanations
Answer (a) is incorrect. An initial budget is determined at this time, but revisions, based on the preliminary survey, may be required.
Answer (b) is the correct answer. The preliminary survey establishes the subject of the review, the theory of the audit approach, and the structure of the project. If the survey discloses significant differences from the project that was placed in the long-range plan, budget adjustments should be requested and authorized.
Answer (c) is incorrect. The audit project is not sufficiently well defined at this point to complete the budget.
Answer (d) is incorrect. At this point, the bulk of the audit hours have been expended and the usefulness of the budget as a control and evaluation tool would be negated.

Question 21

Question: V1C6-0021
Many administrative audit tasks are performed during the course of an audit. Various audit tasks are shown below and given a number. In the answers, the numbered tasks are grouped as being done primarily by a staff auditor, audit manager, or director of audit. Only one of the following groupings is correct. Select the answer in which listed tasks are most appropriately grouped according to the auditor position.
1. The auditee is selected and the scope of the audit assigned.
2. An initial interview is held with the auditee explaining the scope of the audit.
3. Working papers are prepared showing audit work performed.
4. Audit work is supervised during the fieldwork.
5. Working papers are reviewed.
6. Inquiry is made of auditee management to explain unusual findings.
7. Working papers are finalized and a preliminary report is prepared.
8. Review draft audit report prior to discussion with management.
9. After the audit report has been discussed with auditee management, the report and working papers receive a final review before the audit report is signed, published, and distributed.
Not all tasks are listed in each answer and some of the numbered tasks could be done by more than one of the three auditing personnel.
Staff auditor Audit manager Audit director
a. 3, 6, 7 2, 5, 8 1, 8, 9
b. 2, 4, 7 3, 4, 8 1, 6, 9
c. 3, 7, 9 2, 4, 6 2, 3, 8
d. 2, 7, 9 4, 6, 8 1, 5, 6
Answers
A: A.
B: B.
C: C.
D: D.

Answer 21

Answer Explanations
Answer (a) is the correct answer. All tasks could be accomplished by the personnel in whom the tasks are grouped.
Answer (b) is incorrect. Audit work is not supervised (4) by the staff auditor, nor are detailed working papers prepared (3) generally by the audit manager.
Answer (c) is incorrect. Final review and signing of the report (9) is not done by the staff auditor, nor are detailed working papers prepared (3) by the audit director.
Answer (d) is incorrect. Final review and signing of the report (9) is not done by the staff auditor, nor is the initial review of working papers (5) done by the audit director.

Question 22

Question: V1C6-0022
A governmental agency constrained by scarce audit and human resources wishes to know the status of its program for licensing automobiles. In particular, management is concerned about the possibility of
• A backlog in new license applications, and
• Poor controls over the collection and processing of application fees.
The results of the preliminary survey and limited audit testing conducted by the internal auditing department revealed that the licensing process was operating as intended. No major deficiencies were noted. How should the internal auditing department proceed?
Answers
A: Perform no further audit work, issue a formal audit report with the survey results, and discuss the results with management.
B: Perform no further audit work, discuss pertinent issues with management and the executive director, and prepare an audit program for future use so that another survey will not be necessary.
C: Complete the audit as scheduled to ensure that other issues do not exist that were not noted during the survey phase.
D: Send a memorandum report to the executive director and other concerned parties summarizing the preliminary survey results and indicating that the audit has been canceled.

Answer 22

Answer Explanations
Answer (a) is incorrect. Since no further audit work was performed beyond the preliminary survey and limited testing, it would not be appropriate to issue a formal audit report or to discuss it with management.
Answer (b) is incorrect. No audit program need be prepared for the future. Because events may occur, or compliance with policies and procedures may change, an audit program written now may be outdated for future use. Also, an audit report summarizing survey results should be prepared.
Answer (c) is incorrect. It is not necessary if the survey and limited testing was conducted with due professional care. Also it is a poor use of audit resources.
Answer (d) is the correct answer. This is the proper level of reporting in light of the results of the preliminary survey and limited testing.

Question 23

Question: V1C6-0023
Which of the following would not be considered an objective of the audit closing or exit conference?
Answers
A: To resolve conflicts.
B: To discuss the findings.
C: To identify concerns for future audits.
D: To identify management’s actions and responses to the findings.

Answer 23

Answer Explanations
Answer (a) is incorrect. Resolving conflicts is an objective of the exit conference.
Answer (b) is incorrect. Reaching an agreement on the facts is an objective of the exit conference.
Answer (c) is the correct answer. Identifying concerns for future audits is not a primary objective of the exit conference.
Answer (d) is incorrect. Determining management’s action plan and responses is an objective of the exit conference.

Question 24

Question: V1C6-0024
During an exit conference, an auditor and an auditee disagreed about a well-documented audit finding. Which of the following would describe an appropriate manner to handle the situation, assuming that it cannot be resolved prior to issuing the audit report?
Answers
A: Present the finding giving all of the facts and conclusions resulting from the testing.
B: Present both the audit finding and auditee’s position on the finding.
C: Defer reporting the item and plan to perform more detailed work during the next audit.
D: Change the finding to agree with the auditee’s position.

Answer 24

Answer Explanations
Answer (a) is incorrect. However, it is assumed that in compliance with Standards, the auditor discussed the matter with the auditee and that there were no problems.
Answer (b) is the correct answer. This is a requirement per the IIA Standards.
Answer (c) is incorrect. The report should present the findings (results) of the audit. Deferral of reporting would be unprofessional per the Standards.
Answer (d) is incorrect. This could be correct if the auditor was in error. However, it evades the question and infers agreement with the auditee.

Question 25

Question: V1C6-0025
An audit of an automated accounts receivable function for a single-plant furniture manufacturing company has just been completed. Significant findings include late posting of customers’ payments, late mailing of monthly invoices, and erratic follow-up on past-due accounts. Which of the following managers should attend the exit conference for this audit?
Answers
A: Director of internal auditing, chief operating officer, and controller.
B: Head of the audit team, controller and vice president of information systems.
C: Head of the audit team, manager of the accounts receivable department, and manager of the data processing department.
D: Director of internal auditing, chief financial officer, chief executive officer, and vice president of information systems.

Answer 25

Answer Explanations
Answer (a) is incorrect. It is neither necessary nor appropriate for these executives to be involved at this phase of the audit.
Answer (b) is incorrect. The controller and vice president of information systems need not be involved at this phase of the audit.
Answer (c) is the correct answer. The managers of the accounts receivable and data processing departments should be informed of the findings by the head of the audit team and given an opportunity to clarify any misunderstandings that might arise. Those managers are in the best positions to resolve the problems that were noted, and their corrective action should be mentioned in the final report.
Answer (d) is incorrect. These executives, like those in choices (a) and (b), should not be involved in an exit conference. The exit conference should discuss audit findings with those who are directly responsible for problems and who are best positioned to take corrective action.

Question 26

Question: V1C6-0026
One of the primary roles of an audit program is to
Answers
A: Serve as a tool for planning, directing, and controlling audit work.
B: Document an auditor’s understanding of the internal control system.
C: Provide for a standardized approach to the audit engagement.
D: Delineate the audit risk accepted by the auditor.

Answer 26

Answer Explanations
Answer (a) is the correct answer. This is the primary purpose of an audit program.
Answer (b) is incorrect. The internal control system should be documented in the work papers by means of narratives, flowcharts, internal control questionnaires, and so on—not in the audit program itself.
Answer (c) is incorrect. The audit program should be logical, but it may not be consistent from year to year due to changing conditions encountered by the auditee. The audit program should be tailored to the current year’s situation; thus, consistency may not be the most appropriate description.
Answer (d) is incorrect. While audit risk should be considered in planning the audit, the nature and extent of audit risk should be documented in the audit work papers, specifically in the planning section.

Question 27

Question: V1C6-0027
The IIA Standards require that internal auditors discuss conclusions and recommendations at appropriate levels of management before issuing final written reports. Which of the following is the primary reason that a closing conference should be documented by the auditor?
Answers
A: The information may be needed if a dispute arises.
B: The Standards require that closing conferences be documented.
C: The information may be needed to revise future audit programs.
D: Closing conference documentation becomes a basis for future audits.

Answer 27

Answer Explanations
Answer (a) is the correct answer. Notes taken during the course of a closing conference can be valuable in resolving disputes.
Answer (b) is incorrect. Documentation of closing conferences is not specifically required by the Standards.
Answer (c) is incorrect. Notes taken during the closing conference may lead to revised audit program, but that is not the primary use.
Answer (d) is incorrect. Information obtained during the closing conference may provide the impetus for future audits, but this is not the primary reason for documenting the closing conference.

Question 28

Question: V1C6-0028
The preliminary survey discloses that a prior audit deficiency was never corrected. Subsequent fieldwork confirms that the deficiency still exists. Which of the following courses of action should the internal auditor pursue?
Answers
A: Take no action. To do otherwise would be an exercise of operational control.
B: Discuss the issue with the director of internal auditing. The problem requires an ad hoc solution.
C: Discuss the issue with the person(s) responsible for the problem. They should know how to solve the problem.
D: Order the person(s) responsible to correct the problem. They have had long enough to do so.

Answer 28

Answer Explanations
Answer (a) is incorrect. A deficiency finding places the firm at risk until the situation changes or the deficiency is corrected.
Answer (b) is incorrect. Deficiency findings that have not been corrected are not unique, so they do not require ad hoc solutions.
Answer (c) is the correct answer. Obtaining auditee cooperation (or at least understanding) is a vital part of the solution of any problem.
Answer (d) is incorrect. The internal auditor should have no line authority over the auditee. To exercise such authority impairs the internal auditor’s objectivity.

Question 29

Question: V1C6-0029
The best control over the work on which audit opinions are based is
Answers
A: Supervisory review of all audit work.
B: Preparation of time budgets for auditing activities.
C: Preparation of working papers.
D: Staffing of audit activities.

Answer 29

Answer Explanations
Answer (a) is the correct answer. As in other activities, the best control is surveillance by knowledgeable supervisors.
Answer (b) is incorrect. Although useful in controlling audit time, time budgets do not assure the adequacy of work supporting opinions.
Answer (c) is incorrect. Working papers provide the basis for audit opinions, but review is necessary to assure the adequacy of work.
Answer (d) is incorrect. Although staffing is required, audit work reviews are essential to ensure an adequate basis for audit opinions.

Question 30

Question: V1C6-0030
A standardized internal audit program would not be appropriate for the following situation:
Answers
A: A stable operating environment undergoing only minimal changes.
B: A complex or changing operating environment.
C: Multiple locations with similar operations.
D: Subsequent inventory audits performed at same location.

Answer 30

Answer Explanations
Answer (a) is incorrect. Standard audit program would be appropriate for use in a minimum changing operating environment.
Answer (b) is the correct answer. A standard audit program would not be appropriate for a complex or changing operating environment because the audit objectives and related work steps may no longer have relevance.
Answer (c) is incorrect. Standard audit program could be used to audit multiple locations with similar operations.
Answer (d) is incorrect. Standard audit program would be acceptable for conducting subsequent inventory audits at same location.

Question 31

Question: V1C6-0031
An audit program for a comprehensive audit of a purchasing function should include
Answers
A: Work steps arranged by relative priority based on perceived risk.
B: A statement of the audit objectives of the operation under review with agreement by the auditee.
C: Specific methods to accomplish audit objectives.
D: A focus on risks impacting the financial statements as opposed to controls.

Answer 31

Answer Explanations
Answer (a) is incorrect. The program should normally be arranged in an order that would most efficiently complete the audit steps.
Answer (b) is incorrect. Audit objectives should be stated, but they do not need to be agreed to by the auditee.
Answer (c) is the correct answer. Specific methods are included in an audit program.
Answer (d) is incorrect. In a comprehensive audit, there should be a focus on controls as opposed to risks.

Question 32

Question: V1C6-0032
The finance department of a governmental unit has a computer-based model for forecasting tax revenue to use in preparing annual budgets. The internal audit group has been asked to audit the model. A reasonable objective of the audit would be to
Answers
A: Verify that for varying input values the model gives results consistent with revenue behavior.
B: Confirm that the model forecasts each kind of revenue within a small percentage of actual revenue.
C: Determine whether the programs used for this year’s forecast were identical to those used in the previous year.
D: Ensure that the model was modified so that it would have forecasted the previous year’s actual revenue.

Answer 32

Answer Explanations
Answer (a) is the correct answer. An essential component of the audit approach would be to verify that for varying input values, the model gives results consistent with prior revenue behavior.
Answer (b) is incorrect. There is no forecast technique that would always forecast all the different kinds of revenue this precisely; the overall behavior of the model is more important than the forecasting of individual revenue components.
Answer (c) is incorrect. There is no reason to believe that the programs used for this year’s forecast should be identical to those used in the previous year due to continually evolving circumstances in a state or country.
Answer (d) is incorrect. Since the model is a forecasting tool, there is no reason to require that it predict the previous year’s actual revenue, especially as conditions and tax regulations change.

Question 33

Question: V1C6-0033
An internal auditing department has scheduled an audit of a construction contract. One portion of this audit will include comparing materials purchased to those specified in the engineering drawings. The auditing department does not have anyone on staff with sufficient expertise to complete this audit step. Select the best alternative for the director of internal auditing.
Answers
A: Delete the audit from the schedule.
B: Perform the entire audit using current staff.
C: Engage an engineering consultant to perform the comparison.
D: Accept the contractor’s written representations.

Answer 33

Answer Explanations
Answer (a) is incorrect. It would be inappropriate to delete the audit.
Answer (b) is incorrect. This is a direct violation of the Standards.
Answer (c) is the correct answer. A properly qualified and adequately supervised consultant may be used as needed according to the IIA Standards.
Answer (d) is incorrect. Accepting the contractor’s representations without adequate testing or disclosure of such would violate the Standards.

Question 34

Question: V1C6-0034
One purpose of the exit conference is for the internal auditor to
Answers
A: Require corrective action for deficiencies found.
B: Review and verify the appropriateness of the audit report based on auditee input.
C: Review the performance of audit personnel assigned to the engagement.
D: Present the final audit report to management.

Answer 34

Answer Explanations
Answer (a) is incorrect. The internal auditor cannot require corrective action; only management can.
Answer (b) is the correct answer. The exit conference provides an opportunity for all parties to communicate their views. This may lead to modifications in the audit report, if justified.
Answer (c) is incorrect. Audit personnel performance is reviewed in private with the individual employee, not at the exit conference.
Answer (d) is incorrect. The exit conference is normally based on draft reports. The final report is subject to modification based on the results of the exit conference.

Question 35

Question: V1C6-0035
At a meeting with audit managers, the director of internal auditing is allocating the audit work schedule for next year’s plan. Which of the following methods would ensure that each audit manager receives an appropriate share of both the work schedule and internal auditing department resources?
Answers
A: Auditable units are assigned to each manager based on risk and skill analysis.
B: Each of the audit managers selects the individual audit assignments desired, based on preferences for the audit area and the management personnel involved in the audit.
C: Each audit manager chooses audit assignment preferences based on the total staff hours that are currently available to each manager within the department.
D: The full list of scheduled audits is published for the audit staff, and work assignments are made based on career interests and travel requirements.

Answer 35

Answer Explanations
Answer (a) is the correct answer. Assignment on the basis of risk and skill analysis ensures high-risk areas are audited by people with the skills to do it.
Answer (b) is incorrect. There is no objective basis in the audit manager’s preference for an audit area or the management involved.
Answer (c) is incorrect. Available staff hours are not an indicator of risk or composite skills necessary for individual audit assignments.
Answer (d) is incorrect. Although career interests and travel requirements are considerations for staffing audit assignments, these factors are not objective in making assignments.

Question 36

Question: V1C6-0036
An internal auditor would most likely judge an error in an account balance to be material if the error involves a(n)
Answers
A: Clerical mistake that is unlikely to occur again.
B: Large percentage of net income.
C: Unverified routine transaction.
D: Unusual transaction for the company.

Answer 36

Answer Explanations
Answer (a) is incorrect. This factor alone does not suggest materiality, since the error is not compared to other items. It also suggests a low amount of relative risk, since the error is not likely to occur again. It appears to be a random error.
Answer (b) is the correct answer. Materiality is judged based on the significance of the error compared to other items, such as net income.
Answer (c) is incorrect. This factor alone does not indicate materiality, but it does suggest high relative risk. Thus, the auditor may extend auditing procedures for the transaction, even if the error is judged to be immaterial.
Answer (d) is incorrect. Again, this factor alone does not indicate materiality. However, the transaction may involve a large amount of relative risk. If so, auditing procedures should be extended even if the error is judged to be immaterial when compared to other items.

Question 37

Question: V1C6-0037
An internal auditor judged an item to be immaterial when planning an audit. However, the auditor may still include the item if it is subsequently determined that
Answers
A: Sufficient staff is available.
B: Adverse effects related to the item are likely to occur.
C: Related evidence is reliable.
D: Miscellaneous income is affected.

Answer 37

Answer Explanations
Answer (a) is incorrect. If the auditor does not expect high relative risk, extending auditing procedures for an immaterial item would be an inefficient use of audit resources. This is because costs would exceed benefits.
Answer (b) is the correct answer. This indicates that auditing procedures may have to be extended because of the item’s relative risk, despite the item’s lack of materiality.
Answer (c) is incorrect. Auditing procedures might be extended if evidence were unreliable in hope of finding reliable evidence.
Answer (d) is incorrect. This indicates that the item is material. The statement states the item is immaterial.

Question 38

Question: V1C6-0038
In the performance of an audit, audit risk is best defined as the risk that an auditor
Answers
A: Might not select documents that are in error as part of the examination.
B: May not be able to properly evaluate an activity because of its poor internal accounting controls.
C: May fail to detect a significant error or weakness during an examination.
D: May not have the expertise to adequately audit a specific activity.

Answer 38

Answer Explanations
Answer (a) is incorrect. It describes only sampling risk.
Answer (b) is incorrect. It describes only control risks.
Answer (c) is the correct answer. The failure to communicate an error or weakness in an audit is the overall audit risk. There may be several different reasons why the failure occurred, and these may be classified as in risk categories such as sampling risk, detection risk, or control risk.
Answer (d) is incorrect. It describes the competency risk, which is a control risk.

Question 39

Question: V1C6-0039
An internal auditor discovered an error in a receivable due from a major stockholder. The receivable’s balance accounts for less than 1% of the company’s total receivables. Would the auditor be likely to consider the error to be material?
Answers
A: Yes, if relative risk is low.
B: No, if there will be further transactions with this stockholder.
C: Yes, because a related party is involved.
D: No, because a small dollar amount is in error.

Answer 39

Answer Explanations
Answer (a) is incorrect. Relative risk and materiality are two separate, but overlapping, concepts. If relative risk is low, the auditor would be less likely to consider the error to be material.
Answer (b) is incorrect. This suggests that relative risk may be high, and the auditor would thus be likely to consider the error to be material.
Answer (c) is the correct answer. The transaction probably represents high relative risk since a related party is involved, even though the error is small in dollar amount. The error may be significant enough to be considered material; materiality is based on more than just the dollar amount.
Answer (d) is incorrect. Since this is a related-party transaction, even a small error may indicate a significant risk. The auditor would be likely to consider the error to be material.

Question 40

Question: V1C6-0040
A manufacturing company has been expanding rapidly and is considering adding a new production line. Employees are currently working double shifts and receiving large amounts of overtime pay. Demand for all of the company’s products is currently high, but management worries about demand fluctuations with changes in the economy and technological developments by competitors. Management is concerned with such issues as whether it is efficiently using its resources, whether it is expanding too rapidly or not rapidly enough, whether employee morale is decreasing, and whether future expansion should be financed internally or through debt. Of the following management requests, which is within the normal audit scope as stated in the IIA Standards?
Answers
A: Perform an independent evaluation of management’s planning process as a basis for making recommendations.
B: Talk with banks to identify financing alternatives and negotiate contract alternatives, which would be presented to management for their evaluation.
C: Analyze financing alternatives and present the alternatives to the audit committee.
D: Undertake a make-or-buy decision analysis to determine whether the company should subcontract for part of its manufacturing versus adding capacity. Report the recommendation to management for approval.

Answer 40

Answer Explanations
Answer (a) is the correct answer. The planning process is part of the management control system, and its evaluation is part of the normal scope of the auditor’s activities.
Answer (b) is incorrect. Although such action may be requested, the activities are a normal management function, not an audit function. It also has the potential to impair the auditor’s independence.
Answer (c) is incorrect. The auditor should concentrate on management’s planning and evaluation process and report on that process to audit committee. The auditor may respond to a management request for such an evaluation, but it is unlikely to be an audit committee request.
Answer (d) is incorrect. This is a management function. The auditor may undertake the activity as a management request, but it is not consistent with the normal scope of activities defined in the IIA Standards.

Question 41

Question: V1C6-0041
A manufacturing company has been expanding rapidly and is considering adding a new production line. Employees are currently working double shifts and receiving large amounts of overtime pay. Demand for all of the company’s products is currently high, but management worries about demand fluctuations with changes in the economy and technological developments by competitors. Management is concerned with such issues as whether it is efficiently using its resources, whether it is expanding too rapidly or not rapidly enough, whether employee morale is decreasing, and whether future expansion should be financed internally or through debt.
Which of the following factors might best indicate the possibility of fraudulent activity in the production process?
Answers
A: Employee overtime has increased 50% during the past year.
B: Although scrap is generated, there is no income reported from scrap sales.
C: Interviews with employees indicate they have a general dissatisfaction with management and believe that productivity could be greatly improved if management listened to the employees.
D: Inventory, per accounting records, has decreased at the same time that the cost of goods sold has increased.

Answer 41

Answer Explanations
Answer (a) is incorrect. It appears that fluctuations in demand could have caused the overtime pay increase.
Answer (b) is the correct answer. If scrap is generated, there should be some evidence of scrap sales taking place.
Answer (c) is incorrect. The interviews indicate dissatisfaction with management’s ability, but do not indicate a fraud.
Answer (d) is incorrect. This would not necessarily be a fraud indicator given all the other problems identified. Cost of goods sold could be increasing because of higher sales, which is drawing down inventory.

Question 42

Question: V1C6-0042
A manufacturing company has been expanding rapidly and is considering adding a new production line.
Employees are currently working double shifts and receiving large amounts of overtime pay. Demand for all of the company’s products is currently high, but management worries about demand fluctuations with changes in the economy and technological developments by competitors. Management is concerned with such issues as whether it is efficiently using its resources, whether it is expanding too rapidly or not rapidly enough, whether employee morale is decreasing, and whether future expansion should be financed internally or through debt.
Management requests the auditor to examine factors that would help improve the efficiency with which resources are used in the purchasing and production processes. Which of the following procedures would be the least effective in addressing management’s concern?
Answers
A: Perform an evaluation of the planning process to determine goods to be ordered and the method of purchasing goods.
B: Perform a comparison of production costs over the past three years. Identify any large deviations and investigate causes.
C: Interview personnel involved in the production process to gain insight on production or acquisition problems.
D: Compare the company’s total cost of goods sold, as a percentage of total sales, with industry averages.

Answer 42

Answer Explanations
Answer (a) is incorrect. Proper planning of the purchasing process is a significant influence on the efficiency of resources.
Answer (b) is incorrect. This procedure would allow the auditor to focus on situations where costs have fluctuated and would allow the auditor to gain insight as to the causes of the fluctuations.
Answer (c) is incorrect. Interviews with appropriate personnel should allow the auditor to gain insight on potential problems.
Answer (d) is the correct answer. While such a comparison may provide useful information, it does not directly address management’s directive that the auditor identifies ways in which the efficiency of resource usage could be improved. Also, since different products will have different gross margins, the product mix will affect the results.

Question 43

Question: V1C6-0043
A manufacturing company has been expanding rapidly and is considering adding a new production line.
Employees are currently working double shifts and receiving large amounts of overtime pay. Demand for all of the company’s products is currently high, but management worries about demand fluctuations with changes in the economy and technological developments by competitors. Management is concerned with such issues as whether it is efficiently using its resources, whether it is expanding too rapidly or not rapidly enough, whether employee morale is decreasing, and whether future expansion should be financed internally or through debt.
Management is concerned that employee productivity and morale may be decreasing even though production workers are being paid more overtime wages. Which of the following audit procedures would be least effective in addressing this concern?
Answers
A: Develop a schedule of employee pay and analyze changes in overtime pay.
B: Develop a schedule of production per employee over the past two years stratified by production during standard work shifts and production during overtime periods.
C: Take a statistical sample of employees and interview selected employees regarding their morale, productivity, and views on methods to improve efficiency.
D: Obtain “best practices” production data from a comparable industry and identify areas of differences. Follow-up with interviews of production supervisors.

Answer 43

Answer Explanations
Answer (a) is the correct answer. This would be the least effective procedure because it only analyzes overtime costs. It does not relate the costs to underlying production data.
Answer (b) is incorrect. This procedure would be effective in determining whether productivity decreases during overtime periods.
Answer (c) is incorrect. Interviews with employees would be effective in understanding morale issues as well as gathering suggestions for improvement.
Answer (d) is incorrect. Best practices, where available, can be useful in providing insight on potential areas of improvement.

Question 44

Question: V1C6-0044
An internal auditor is assigned to perform an audit of the company’s insurance program, including the appropriateness of the approach to minimizing risks to the company. The company self-insures against large casualty losses and health benefits provided for all its employees. The company is a large national firm with over 15,000 employees located in various parts of the country. It uses an outside claims processor to administer its health care program. The company’s medical costs have been rising by approximately 8% per year for the past five years, and management is concerned with controlling them.
The auditor needs to determine the scope of the proposed audit of insurance coverage by the company. Which of the following statements are correct regarding the potential scope of the audit?
I. Since it is an internal audit, the audit department should concentrate on processing that occurs within the company and not on auditing the correctness of transaction processing by the health care processor.
II. The auditor should interview management prior to beginning the audit to understand (1) its concerns and (2) the underlying assumptions made and rationale used when making the self-insurance decision.
III. The auditor should consider engaging an actuarial consultant to better understand the risks involved in order to help determine the scope of the audit.
Answers
A: I only.
B: II only.
C: Both I and II.
D: II and III.

Answer 44

Answer Explanations
Answer (a) is incorrect. One concern related to increased costs is the accuracy with which the health care processor is handling claims. It should be considered as an integral part of the audit. The internal auditor is not confined to activities only within the organization.
Answer (b) is incorrect. Statement II is correct. However, Statement III is also correct, thus making it a preferred response.
Answer (c) is incorrect. Statement I is not correct.
Answer (d) is the correct answer. Both Statements II and III are correct. The audit department needs to have sufficient skills or use consultants to understand the risks associated with a proposed audit. In order to conduct the proposed audit, the auditor needs to assess the risks and may need the help of an actuary to better understand the risks to which the organization is exposed.

Question 45

Question: V1C6-0045
An internal auditor is assigned to perform an audit of the company’s insurance program, including the appropriateness of the approach to minimizing risks to the company. The company self-insures against large casualty losses and health benefits provided for all its employees. The company is a large national firm with over 15,000 employees located in various parts of the country. It uses an outside claims processor to administer its health care program. The company’s medical costs have been rising by approximately 8% per year for the past five years, and management is concerned with controlling them.
Which of the following analytical review procedures would provide the most insight into the reasonableness of the increase in health care costs?
Answers
A: Develop a comparison of the costs incurred with similar costs incurred by other companies.
B: Obtain the government index of health care costs for the comparable period of time and compare the rate of increase with that of the cost per employee incurred by the company.
C: Obtain a bid from another health care administrator to provide the same administrative services as the current health care administrator.
D: Develop a comparison of overall health insurance costs incurred by the company with similar costs incurred by companies in the same industry.

Answer 45

Answer Explanations
Answer (a) is incorrect. This approach does not consider that the number of employees covered may have changed during the time period considered.
Answer (b) is the correct answer. This is the best response because it considers that the number of employees covered may have changed.
Answer (c) is incorrect. This approach is not an analytical review procedure. Further, it considers only one aspect of the total health costs (the cost of processing) and does not consider the underlying health care coverage.
Answer (d) is incorrect. This would be effective if it were scaled by the number of employees and the coverage provided. It is a good step, but not as good as choice (b).

Question 46

Question: V1C6-0046
An internal auditor is assigned to perform an audit of the company’s insurance program, including the appropriateness of the approach to minimizing risks to the company. The company self-insures against large casualty losses and health benefits provided for all its employees. The company is a large national firm with over 15,000 employees located in various parts of the country. It uses an outside claims processor to administer its health care program. The company’s medical costs have been rising by approximately 8% per year for the past five years, and management is concerned with controlling them.
Assume that the auditor wishes to test whether the health care processor is meeting contract requirements regarding the proper payment or denial of employee claims. The best audit approach would be to take a sample of
Answers
A: Employees and interview them regarding their health care experiences with proper and timely payment by the health care processor.
B: Claims paid by the health care processor and determine whether all the payments were proper.
C: Claims filed with the health care processor and determine whether they were either appropriately paid or denied.
D: Claims paid by the health care processor and engage an outside expert to analyze whether the claims were appropriately processed.

Answer 46

Answer Explanations
Answer (a) is incorrect. This procedure provides data regarding the satisfaction of the employees with the processor, but does not provide unbiased information about the appropriateness of claim payments.
Answer (b) is incorrect. This is a good procedure and will provide evidence on the proper payment of claims that were paid. However, it does not provide any information on claims that should have been paid, but were not paid.
Answer (c) is the correct answer. This would provide evidence on both the appropriateness of claim payments as well as whether claims are being denied as specified in the contract with the health care processor.
Answer (d) is incorrect. This procedure provides evidence only on the claims that were paid.

Question 47

Question: V1C6-0047
An internal auditor is assigned to perform an audit of the company’s insurance program, including the appropriateness of the approach to minimizing risks to the company. The company self-insures against large casualty losses and health benefits provided for all its employees. The company is a large national firm with over 15,000 employees located in various parts of the country. It uses an outside claims processor to administer its health care program. The company’s medical costs have been rising by approximately 8% per year for the past five years, and management is concerned with controlling them.
When the audit was assigned, management asked the auditor to evaluate the appropriateness of using self-insurance to minimize risk to the organization. Given the scope of the audit requested by management, should the auditor engage an actuarial consultant to assist in the audit if these skills do not exist on staff?
Answers
A: No. The audit department is skilled in assessing controls, and the insurance control concepts are not distinctly different from other control concepts.
B: No. It is a normal audit function to assess risk; this audit engagement is therefore not unique.
C: Yes. An actuary is essential to determine whether the health care costs are reasonable.
D: Yes. The actuary has skills not usually found in auditors to identify and quantify self-insurance risks.

Answer 47

Answer Explanations
Answer (a) is incorrect. An actuary should be used. See choice (d).
Answer (b) is incorrect. An actuary should be used. See choice (d).
Answer (c) is incorrect. An auditor can determine if costs reasonable. See response (d).
Answer (d) is the correct answer. Management explicitly asked the auditor to assess the risks that the organization had incurred by moving to self-insurance. Auditors normally do not have these abilities. If necessary, the audit staffing should be expanded to include the expertise of an actuary.

Question 48

Question: V1C6-0048
An internal auditor is assigned to perform an audit of the company’s insurance program, including the appropriateness of the approach to minimizing risks to the company. The company self-insures against large casualty losses and health benefits provided for all its employees. The company is a large national firm with over 15,000 employees located in various parts of the country. It uses an outside claims processor to administer its health care program. The company’s medical costs have been rising by approximately 8% per year for the past five years, and management is concerned with controlling them.
Assume the auditor becomes concerned that significant fraud may be taking place by dentists who are billing the health care processor for services that were not provided. For example, employees may have their teeth cleaned, but the dentist charges the processor for pulling teeth and developing dentures. The most effective audit procedure to determine whether such a fraud exists would be to
Answers
A: Develop a schedule of payments made to individual dentists. Verify that payments were made to the dentists by confirming the payments with the health care processor.
B: Take a random sample of payments made to dentists and confirm the amounts paid with the dentists’ offices to determine that the amounts agree with the amounts billed by the dentists.
C: Take a random sample of claims submitted by dentists and trace through the system to determine whether the claims were paid at the amounts billed.
D: Take a discovery sample of employee claims that were submitted through dentist offices and confirm the type of service performed by the dentist through direct correspondence with the employee who had the service performed.

Answer 48

Answer Explanations
Answer (a) is incorrect. This procedure would only provide evidence that payments were made, not whether the payments were proper.
Answer (b) is incorrect. This only provides evidence about the amounts of the claims. The dentist is making the false claims; thus, confirmation with the dentist does not provide objective evidence.
Answer (c) is incorrect. This would primarily provide evidence that all claims submitted were processed. It might provide additional evidence on types of claims that were denied, but it would not provide meaningful information on claims that were inappropriately paid.
Answer (d) is the correct answer. The problem is that the dentist is submitting a claim on behalf of the employee for services that were not provided. The employee would be the best source of evidence as to whether the service was provided. Discovery sampling would be appropriate in this circumstance.

Question 49

Question: V1C6-0049
An internal auditor is assigned to perform an audit of the company’s insurance program, including the appropriateness of the approach to minimizing risks to the company. The company self-insures against large casualty losses and health benefits provided for all its employees. The company is a large national firm with over 15,000 employees located in various parts of the country. It uses an outside claims processor to administer its health care program. The company’s medical costs have been rising by approximately 8% per year for the past five years, and management is concerned with controlling them.
The health care processor wishes to implement controls that would help prevent the type of fraud described in the prior question. Assume further that all the claims are submitted electronically to the health care processor. Which of the following control procedures would be the most effective?
Answers
A: Develop a program that identifies procedures performed on an individual in excess of expectations based on: the age of the employee, whether a similar procedure was performed recently, or the average cost per claim.
B: Require all submitted claims to be accompanied by a signed statement by the dentist testifying to the fact that the claimed procedures were performed.
C: Send confirmations to the dentists requesting them to confirm the exact nature of the claims submitted to the health care processor.
D: Develop an integrated test facility and submit false claims to verify that the system is detecting such claims on a consistent basis.

Answer 49

Answer Explanations
Answer (a) is the correct answer. This would be the most effective procedure because it would highlight unusual transactions that could be followed up with customer inquiry or other procedures aimed at determining whether claims are fictitious.
Answer (b) is incorrect. This would slow down processing, but would not prevent the dentist who submitted the fraudulent claim from continuing to submit such claims.
Answer (c) is incorrect. If fraud were involved, the service provider would confirm that the work was done even when it was not.
Answer (d) is incorrect. The integrated test facility (ITF) would provide evidence on the correctness of the processing, not whether the claims that were submitted were proper. Also, the health care processor may not allow an ITF access to the provider’s system.

Question 50

Question: V1C6-0050
An internal auditor is assigned to perform an audit of the company’s insurance program, including the appropriateness of the approach to minimizing risks to the company. The company self-insures against large casualty losses and health benefits provided for all its employees. The company is a large national firm with over 15,000 employees located in various parts of the country. It uses an outside claims processor to administer its health care program. The company’s medical costs have been rising by approximately 8% per year for the past five years, and management is concerned with controlling them.
Assume that the auditor’s preliminary findings indicate that certain dentists are billing the health care processor for services that were not provided and that this practice is not being detected or prevented by the health care processor. The auditor wishes to present to management an estimate of the amounts involved. The auditor chooses an approach that will sample claims by dentists and will verify whether the claims are appropriate. The best audit sampling approach would be
Answers
A: Discovery sampling based on a low to moderate level of fraud expectation.
B: Dollar unit sampling of all dentists to determine if the fraud might exceed a predetermined limit.
C: Attribute sampling classifying the existence of a nonvalid claim as a deviation.
D: Classical variables estimation of claims submitted by the suspected dentists stratified by dollar amount of services performed.

Answer 50

Answer Explanations
Answer (a) is incorrect. The auditor wishes to estimate a dollar amount. Discovery sampling is best utilized to determine whether a fraud might be existing, not to estimate the dollar amount.
Answer (b) is incorrect. Stratified classical variables estimation would be more efficient in this situation because it takes advantage of existing knowledge of the population.
Answer (c) is incorrect. Attribute sampling does not provide dollar information.
Answer (d) is the correct answer. This would be the best sampling technique to estimate the potential dollar amount of fraud by the dentists most likely to be making the false claims.

Question 51

Question: V1C6-0051
An internal auditor is assigned to conduct an audit of security of a local area network (LAN) in the finance department of the organization. Investment decisions, including the use of hedging strategies and financial derivatives, use data and financial models that run on the LAN. The LAN is also used to download data from the mainframe to assist in the decisions. In determining the scope of the audit, which of the following items should be considered outside the scope of the security audit?
Answers
A: Investigation of the physical security over access to the components of the LAN.
B: The ability of the LAN application to identify data items at the field or record level and implement user access security at that level.
C: Interviews with users to determine their assessment of the level of security in the system and the vulnerability of the system to compromise.
D: The level of security of other LANs in the company that also utilize sensitive data.

Answer 51

Answer Explanations
Answer (a) is incorrect. This would be an appropriate procedure since exposures exist if the assets are not physically protected.
Answer (b) is incorrect. LAN applications are becoming increasingly sophisticated and should provide the type of security suggested in this response.
Answer (c) is incorrect. Interviews with users are often effective in identifying potential security breaches or other problems that should be addressed.
Answer (d) is the correct answer. The level of computer security at other locations in the company may be interesting for comparative purposes, but it has no effect on the level of security or the scope of examination needed at this location.

Question 52

Question: V1C6-0052
An internal auditor conducts a preliminary survey and identifies a number of significant audit issues and reasons for pursuing them in more depth. The auditee informally communicates concurrence with the preliminary survey results and asks that the auditor not report on the areas of significant concern until the auditee has an opportunity to respond to the problem areas. Which of the following audit responses would not be appropriate?
Answers
A: Keep the audit on the audit time schedule and discuss with management the need for completing the audit on a timely basis.
B: Consider the risk involved in the areas involved, and if the risk is high, proceed with the audit.
C: Consider the audit to be terminated with no report needed since the auditee has already agreed to take constructive action.
D: Work with the auditee to keep the audit on schedule and address the significant issues in more depth, as well as the auditee’s responses, during the course of the audit.

Answer 52

Answer Explanations
Answer (a) is incorrect. This would be an appropriate response consistent with the IIA Standards.
Answer (b) is incorrect. The auditor should always consider the risk associated with the potential findings as a basis for determining the need for more immediate audit attention.
Answer (c) is the correct answer. It would not be appropriate to consider the audit completed because the auditor has completed only a preliminary survey. The constructive action by the auditee may be a delaying tactic to hide additional problems.
Answer (d) is incorrect. This would be an appropriate response by the auditor because the issues may be more pervasive than shown by the preliminary survey.

Question 53

Question: V1C6-0053
The auditor has planned an audit of the effectiveness of the quality assurance function as it affects the receiving of goods, the transfer of the goods into production, and the scrap costs related to defective items. The auditee argues that such an audit is not within the scope of the internal auditing function and should come only under the purview of the quality assurance department. What would be the most appropriate audit response?
Answers
A: Refer to the audit department charter and the approved audit plan, which includes the area designated for audit in the current time period.
B: Since quality assurance is a new function, seek the approval of management as a mediator to set the scope of the audit.
C: Indicate that the audit will only examine the function in accordance with the standards set, and approved, by the quality assurance function before beginning the audit.
D: Terminate the audit because an operational audit will not be productive without the auditee’s cooperation.

Answer 53

Answer Explanations
Answer (a) is the correct answer. This is the most appropriate response. The audit department charter should specify the broad responsibilities of the department, and the approved audit plan for the year should indicate management and the audit committee’s approval for the process.
Answer (b) is incorrect. It would not be appropriate to ask management to resolve every potential scope disagreement between the auditor and auditee. The audit charter and audit plan already communicate management’s approval.
Answer (c) is incorrect. There may be other objectives that have been set by management and the auditor. The audit should not be limited to the specific standards set by the quality assurance department, but should consider such standards in the development of the audit program.
Answer (d) is incorrect. This would not be an appropriate response.

Question 54

Question: V1C6-0054
The internal auditing department of an organization has been in existence for ten years. It has established a charter, which has not yet been approved by the audit committee. However, the audit committee is chaired by the chief executive officer (CEO) and includes the controller and one outside board member. The director reports directly to the controller who approves the internal audit work plan. Thus, the auditing department has never felt the need to push for a formal approval of the charter. The organization is publicly held and has nine major divisions. The previous director of internal auditing was recently dismissed following a dispute between the director and a major auditee. The CEO accused the director of not operating “in the best interests of the organization.” A new director with significant experience in both public accounting and internal auditing has just been hired. Within the first month, the new director encountered substantial resistance from an auditee regarding the nature of an audit and the audit department’s access to records.
Which of the following combinations best illustrates a scope limitation and the appropriate response by the director of internal auditing?
a. Auditee limits scope of audit based on proprietary information. Report only to the controller
b. Auditee will not provide access to records needed for approved audit work plan. Report to the board
c. Auditee requests that the audit be delayed for two weeks to allow them to close their books. Report directly to the CEO and controller
d. Auditee will not allow auditor to contact major customers as part of a performance audit to measure efficiency of operations. No reporting needed since it is an operational audit.
Answers
A: A.
B: B.
C: C.
D: D.

Answer 54

Answer Explanations
Answer (a) is incorrect. According to the Standards, a scope restriction such as this should be reported to the board.
Answer (b) is the correct answer. This is a scope limitation, which should appropriately be reported to the board.
Answer (c) is incorrect. This would not generally be considered a scope limitation unless there was some specific reason for a “surprise audit.”
Answer (d) is incorrect. This is a scope limitation that should be communicated to the board. It does not make a difference that it is a performance or operational audit.

Question 55

Question: V1C6-0055
The internal auditing department of an organization has been in existence for ten years. It has established a charter, which has not yet been approved by the audit committee. However, the audit committee is chaired by the chief executive officer (CEO) and includes the controller and one outside board member. The director reports directly to the controller who approves the internal audit work plan. Thus, the auditing department has never felt the need to push for a formal approval of the charter. The organization is publicly held and has nine major divisions. The previous director of internal auditing was recently dismissed following a dispute between the director and a major auditee. The CEO accused the director of not operating “in the best interests of the organization.” A new director with significant experience in both public accounting and internal auditing has just been hired. Within the first month, the new director encountered substantial resistance from an auditee regarding the nature of an audit and the audit department’s access to records.
In considering the internal auditing department’s independence, which of the following facts, by themselves, could contribute to a lack of internal audit independence?
I. The CEO accused the previous director of not operating “in the best interests of the organization.”
II. The majority of audit committee members come from within the organization.
III. The internal audit charter has not been approved by the board or the audit committee.
Answers
A: I only.
B: II only.
C: II and III only.
D: I, II, III.

Answer 55

Answer Explanations
Answer (a) is incorrect. The statement that the CEO accused the previous director of not operating “in the best interests of the company” does not necessarily indicate a lack of independence, although it might be corroborating evidence if there are other factors present.
Answer (b) is incorrect. According to the referenced report by the IIARF on audit committees, the independence of all audit functions is enhanced when the audit committee is made up of a majority of outside members. However, item III is also correct.
Answer (c) is the correct answer. The charter enhances the auditor’s independence because it clearly specifies, in advance, the authority, scope, and responsibility of the internal auditing function. Having outside directors on an audit committee enhances the independence of the internal auditing department. This is consistent with the research report on the best practices of audit committees.
Answer (d) is incorrect because only two items (II and III) are correct. Item I, by itself, may indicate a problem, but does not constitute evidence of an independence problem.

Question 56

Question: V1C6-0056
The internal auditing department of an organization has been in existence for ten years. It has established a charter, which has not yet been approved by the audit committee. However, the audit committee is chaired by the chief executive officer (CEO) and includes the controller and one outside board member. The director reports directly to the controller who approves the internal audit work plan. Thus, the auditing department has never felt the need to push for a formal approval of the charter. The organization is publicly held and has nine major divisions. The previous director of internal auditing was recently dismissed following a dispute between the director and a major auditee. The CEO accused the director of not operating “in the best interests of the organization.” A new director with significant experience in both public accounting and internal auditing has just been hired. Within the first month, the new director encountered substantial resistance from an auditee regarding the nature of an audit and the audit department’s access to records.
Given the current dispute with an auditee regarding audit scope, which of the following internal auditing actions is not appropriate?
Answers
A: Meet with the board to obtain approval of the audit charter to mitigate the existence of this problem and similar problems that may occur in the future.
B: Report the dispute, if it remains unresolved, to the board.
C: Review the approved work plan with the CEO and controller and ask for immediate guidance in dealing with the auditee.
D: Indicate to the auditee that if the resistance continues, the auditing department will not be available to perform cost/benefit audits for the department in the future.

Answer 56

Answer Explanations
Answer (a) is incorrect. This would be an appropriate action since approval of a charter by the board explicitly defines the scope of activities by the audit department and expected cooperation from the auditees.
Answer (b) is incorrect. This would be an appropriate action since the Standards require significant scope limitations be reported to the board.
Answer (c) is incorrect. This would be an appropriate short-term response since management would have approved the audit program and should be in a position to secure auditee cooperation.
Answer (d) is the correct answer. This would not be an appropriate action. Future audits should be based on the risk analysis performed by the internal audit department and the audit plan approved by the board.

Question 57

Question: V1C6-0057
During the course of an audit, the auditor makes a preliminary determination that a major division has been inappropriately capitalizing research and development expense. The audit is not yet completed, and the auditor has not documented the problem or determined that it really is a problem. However, the auditor is informed that the director of internal auditing has received the following communication from the president of the company:
The controller of Division B informs me that you have discovered a questionable account classification dealing with research and development expense. We are aware of the issue. You are directed to discontinue any further investigation of this matter until informed by me to proceed. Under the confidentiality standard of your profession, I also direct you not to communicate with the outside auditors regarding this issue.
Which of the following would be an appropriate action for the director to take regarding the questionable item?
Answers
A: Immediately report the communication to the Institute of Internal Auditors and ask for an ethical interpretation and guidance.
B: Inform the president that this scope limitation will need to be reported to the chairperson of the audit committee.
C: Continue to investigate the area until all the facts are determined and document all the relevant facts in the audit work papers.
D: Immediately notify the external auditors of the problem to avoid aiding and abetting a potential crime by the organization.

Answer 57

Answer Explanations
Answer (a) is incorrect. There are other factors that should be considered, such as the organization’s code of conduct.
Answer (b) is the correct answer. The director should communicate the scope limitation to the board. However, it would be appropriate to ensure that the president is aware of this. Further, choice (b) should be pursued before seeking ethical interpretations from the IIA.
Answer (c) is incorrect. The director should first consult the audit committee. The director provides value by serving the organization, and management may, in fact, be fully aware of the problem and may not want to incur additional costs.
Answer (d) is incorrect. In this situation, the audit work is preliminary and the auditor has not yet formed a basis for an opinion. Thus, it would be too early to contact the external auditors. However, if an inquiry would be made by the external auditors, the internal auditors should share the extent of work completed to date.

Question 58

Question: V1C6-0058
The internal auditing department encounters a scope limitation from senior management that will affect its ability to meet its goals and objectives for a potential auditee. The nature of the scope limitation should be
Answers
A: Noted in the audit work papers, but the audit should be carried out as scheduled and the scope limitation worked around, if possible.
B: Communicated to the external auditors so they can investigate the area in more detail.
C: Communicated, preferably in writing, to the board.
D: Communicated to management stating that the limitation will not be accepted because it would impair the audit department’s independence.

Answer 58

Answer Explanations
Answer (a) is incorrect. The limitation should be communicated first to the board.
Answer (b) is incorrect. There is no requirement or need to communicate the limitation to the external auditor.
Answer (c) is the correct answer. This is required per the IIA Standards.
Answer (d) is incorrect. Internal auditing exists to serve the organization. Thus, the auditor’s alternative is to communicate with the board, not threaten senior management.

Question 59

Question: V1C6-0059
It is important that the auditor be able to carefully distinguish between a scope limitation and other limitations on the audit. According to the IIA Standards, which of the following would not be considered a scope limitation?
Answers
A: The divisional management of an auditee has indicated that the division is in the process of converting a major computer system and has indicated that the IT portion of the planned audit will have to be postponed until next year.
B: The audit committee reviews the audit plan for the year and deletes an audit that the director thought was important to conduct.
C: The auditee has indicated that certain customers cannot be contacted because the organization is in the process of negotiating a long-term contract with them and does not want to upset the customers.
D: None of the above.

Answer 59

Answer Explanations
Answer (a) is incorrect. This would be a scope limitation because it restricts the performance of an audit. Some scope limitations may be justified. The Standards identify scope limitations and do not distinguish between those that are justified and not justified. The limitations are reported to senior management and the board for their determination of the justification of the limitation.
Answer (b) is the correct answer. This is not a scope limitation. Rather, it is the audit committee’s responsibility to review and approve the planned scope of activities for the year.
Answer (c) is incorrect. This is a scope limitation because it restricts the performance of specific procedures. This answer is incorrect. Refer to the correct answer explanation.

Question 60

Question: V1C6-0060
According to the IIA Standards, an internal auditor’s role with respect to operating objectives and goals includes
Answers
A: Approving the operating objectives or goals to be met.
B: Determining whether underlying assumptions are appropriate.
C: Developing and implementing control procedures.
D: Accomplishing desired operating program results.

Answer 60

Answer Explanations
Answer (a) is incorrect. The approval of objectives and goals to be met is a line function; internal auditing is a staff function.
Answer (b) is the correct answer. Internal auditors can provide assistance to managers who are developing objectives and goals by determining if the underlying assumptions are appropriate.
Answer (c) is incorrect. Management is responsible for developing and implementing controls.
Answer (d) is incorrect. Management is responsible for accomplishing desired program results.

Question 61

Question: V1C6-0061
The scope of an internal audit is initially defined by the
Answers
A: Audit objectives.
B: Scheduling and time estimates.
C: Preliminary survey.
D: Audit program.

Answer 61

Answer Explanations
Answer (a) is the correct answer. The scope of the audit is specified by the audit objectives.
Answer (b) is incorrect. The scheduling and time estimates are based on the audit objectives and the scope of the audit.
Answer (c) is incorrect. The preliminary survey is performed after the audit objectives are determined.
Answer (d) is incorrect. The audit program is developed based on the audit objectives and the scope of the audit.

Question 62

Question: V1C6-0062
An outside consultant is developing a system to be used for the management of a city’s capital facilities. An appropriate scope of an audit of the consultant’s product would be to
Answers
A: Review the consultant’s contract to determine its propriety.
B: Establish the parameters of the value of the items being managed and controlled.
C: Determine the adequacy of the controls built into the system.
D: Review the handling of idle equipment.

Answer 62

Answer Explanations
Answer (a) is incorrect. This aspect is related to a procurement action.
Answer (b) is incorrect. This is a top management financial decision.
Answer (c) is the correct answer. This is a normal area of internal audit expertise.
Answer (d) is incorrect. This is a management policy. Some equipment may be retained for emergency use

Question 63

Question: V1C6-0063
Assume your company is considering purchasing a small toxic waste disposal company. As internal auditors, you are part of the team doing a due diligence review for the acquisition. Your scope (as auditors) would most likely not include
Answers
A: An evaluation of the merit of lawsuits currently filed against the waste company.
B: A review of the purchased company’s procedures for acceptance of waste material and comparison with legal requirements.
C: Analysis of the company’s compliance with, and disclosure of, loan covenants.
D: Assessment of the efficiency of the waste company’s operations and profitability.

Answer 63

Answer Explanations
Answer (a) is the correct answer. The merit of a lawsuit is a matter of legal judgment, beyond the expertise of internal audit.
Answer (b) is incorrect. Comparison of procedures to legal requirements is within scope and expertise of internal audit.
Answer (c) is incorrect. Compliance with loan covenants is within scope and expertise of internal audit.
Answer (d) is incorrect. Assessing efficiency is a common practice of internal audit.

Question 64

Question: V1C6-0064
The major purpose of an exit conference is
Answers
A: Communication with all affected parties.
B: Correction of deficiencies found.
C: Assessment of audit staff’s performance.
D: Presentation of the final audit report.

Answer 64

Answer Explanations
Answer (a) is the correct answer. The major purpose of an exit conference is to discuss problems, conclusions, and recommendations. This communication ensures that there have been no misunderstandings or misinterpretation of facts. It is not the time to correct deficiencies, which comes later. The audit staff’s performance should not be brought up at this point since it will divert the audit findings. The final report is presented after incorporating the auditee’s viewpoints expressed during the exit conference.
This answer is incorrect. Refer to the correct answer explanation.
This answer is incorrect. Refer to the correct answer explanation.
This answer is incorrect. Refer to the correct answer explanation.

Question 65

Question: V1C6-0065
Which of the following is a proper step in an audit program?
Answers
A: Notification of the audit.
B: Observation of procedures.
C: Definition of audit objectives.
D: Planning for audit reporting.

Answer 65

Answer Explanations
Answer (a) is incorrect. Notification of the audit is done during audit planning.
Answer (b) is the correct answer. Techniques such as observation and inspection are part of an audit program, which describes specific actions (steps) to be taken by the auditor. The actions mentioned in the other three choices are taken prior to the development of an audit program.
Answer (c) is incorrect. Definition of audit objectives is done during audit planning.
Answer (d) is incorrect. Planning for audit reporting is also done during audit planning.

Question 66

Question: V1C6-0066
An internal auditor suspects fraud in the purchasing department. To whom should the auditor communicate this first?
Answers
A: The board of directors.
B: The audit committee.
C: The vice president of purchasing.
D: The audit management.

Answer 66

Answer Explanations
Answer (a) is incorrect. It is too early to contact the board of directors.
Answer (b) is incorrect. It is not appropriate to contact the audit committee. Contact should be done only after the fraud is investigated and found true.
Answer (c) is incorrect. The auditor is only suspecting the fraud, it has not yet been proved, and the auditor should not contact the vice president of purchasing. Early and inappropriate notification could backfire on the auditor.
Answer (d) is the correct answer. In situations of suspected fraud, the auditor should handle the matter very carefully so as not to antagonize other members of the organization. First, the auditor should talk to audit management to see if audit management knows something more about the situation. The audit management should move the case forward. The auditor should never contact the other parties directly.