II. Internal Control - Concepts and Standards - Required Communications

Question 1

What are the basic responsibilities that the auditor must communicate according to internal control matter?

Answer 1

Significant Deficiency: A deficiency (or combination of deficiencies) in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance.

• Example: Evidence of a lack of objectivity by those responsible for accounting decisions.
• is a control deficiency in the design or operation of internal control that can adversely affect the financial statements.
• Factors to be considered in evaluating deficiencies include:
  
  • the entity’s size,
  • its complexity, and
  • the nature and diversity of its business activities.
• It is not the auditor purpose of engagement in the audit, but to report on the financial statement
  
  • BUT if the auditor does find any “Significant deficiencies” he should document it
• Letters on significant deficiencies - are restricted as to distribution. The letters are intended solely for the use of the audit committee (or those charged with governance), management, and others within the organization.

Material Weakness: A deficiency (or combination of deficiencies) in internal control such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented or detected and corrected on a timely basis.

Note:

The auditor should DETERMINE whether the deficiencies are “Significant Deficiencies” or “Material Weakneses”

These Deficiencies must be communicated in writing (Including those matters communicated verbally earlier in the audit) to Management and those charged with governance.

Question 2

How should auditor communicate “lesser matter” identified in an audit?

Answer 2

Either in writing or verbally (But should document any verbal in communications)

Question 3

What is the rule on the Timing of Comunications according to the “significant deficiencies” and “material weaknesses”?

Answer 3

Best made by the “report release date” and should be made no later than 60 days following (AFTER) the report release date.

• “report release date” is the date that the auditor grants the entity permission to use the auditor’s report in connection with the audited financial statements.
• In other words: (no later than the “documentation completion date,” that is, 60 days after the report release date). The PCAOB requires such matters be communicated prior to the release of the auditor’s report.

Note:

The Auditor Report is a byproduct, and any byproduct should be restricted on the distribution of such report to the specified users.

The auditor is NOT required to search for significant deficiencies.

The auditor is required to make seperate reports if they have found both significant deficiencies and material weakness

Question 4

Professional standards identify what type of internal control deficiencies?

Answer 4

Professional standards identify internal control deficiencies as either:

(1) a deficiency in design, or

• Example: employees have the opportunity to change their time worked after their time cards have been approved.
  
  • This is a deficiency in design

(2) a deficiency in operation.

• exists when a properly
  
  • designed control does not operate as designed or
  • when the person performing the control procedure lacks the authority or competence to properly perform the control procedure.

Question 5

Which of the following representations should not be included in a report on internal control related matters noted in an audit?

Answer 5

There are no significant deficiencies in the design or operation of the internal control structure.

Note: If there are no deficiencies that were found, the auditor should not report that none were found otherwise report might be misinterpreted.

Question 6

Why should Significant deficiencies should be reported to the audit committee?

Answer 6

because they are significant deficiencies in the design or operation of internal control that could adversely affect the entity’s financial reporting process.

Question 7

What types of items are the auditor required to review with those charges with governance?

Answer 7

• An overview of the planned scope and timing of the audit.
• The auditor’s responsibilities to complete the audit in accordance with generally accepted auditing standards.
• Any significant findings from the audit.

note: The auditor is not required to communicate all control deficiencies identified.

Question 8

Which of the following matters in a financial statement audit is most appropriate to communicate with those charged with governance?

Answer 8

The auditor would appropriately discuss the planned scope and timing of the audit at a fairly general (strategic) level with those charged with governance.

Question 9

What statements is correct concerning an auditor’s communication on internal control related matters noted in an audit of a nonpublic company?

Answer 9

The auditor may choose to communicate significant control-related matters either during the course of the audit or up to 60 days after the audit report release date.

Question 10

An auditor’s letter issued on significant deficiencies relating to an entity’s internal control observed during a financial statement audit should

Answer 10

AU-C 265 indicates that such a letter to the audit committee should

(1) indicate that the audit’s purpose was to report on the financial statements and not to express an opinion on internal control,
(2) include the definition of a significant deficiency, and
(3) restrict distribution of the report.

Note:

auditor may communicate significant deficiencies either during an audit or after the audit’s completion.

Question 11

After testing a client’s internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client’s internal control. Under these circumstances the auditor most likely would

Answer 11

such deficiencies suggest the possibility of misstatement, and accordingly suggest the need for an increase in the assessment of control risk, with a corresponding increase in the scope of substantive procedures.

Question 12

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

Answer 12

Adverse.

Question 13

Which of the following is most likely to indicate a significant deficiency relating to a client’s antifraud programs?

Answer 13

Audit committee passivity when conducting oversight functions.

Note:

An active audit committee, not a passive audit committee is needed.

Question 14

What statements is correct concerning significant deficiencies noted in an audit?

Answer 14

The auditor should separately communicate those significant deficiencies considered to be material weaknesses.

Question 15

What representations should be included in a report on internal control related matters noted in an audit?

Answer 15

Significant deficiencies related to internal control exist.

Corrective follow-up action is recommended due to the relative significance of material weaknesses discovered during the audit.

The auditor’s consideration of internal control would not necessarily disclose all significant deficiencies that exist.

Note:

auditors should not issue a report on internal control stating that no significant deficiencies were identified during the audit

Question 16

What statements concerning material weaknesses and significant deficiencies is correct?

Answer 16

A compensating control is a control that lessens the severity of a deficiency

Question 17

Which of the following statements is correct concerning an auditor’s required communication of significant deficiencies?

Answer 17

An auditor’s report on significant deficiencies should include a restriction on the distribution of the report.

note:

Distribution of an auditor’s report on significant deficiencies should be restricted to management and the audit committee.

Question 18

Following statement accurate statement about internal control weaknesses?

Answer 18

All material weaknesses are control deficiencies.

Note:

A significant deficiency may or may not be a material weakness.

Not all control deficiencies are material weaknesses.

Only significant deficiencies and material weaknesses must be communicated.

Question 19

A material weakness involves a reasonable possibility that what size misstatement will not be prevented or detected?

Answer 19

Material.

Note:

Necessary under the professional standards definition of a material weakness.

Question 20

What matters would an auditor most likely consider to be a material weakness to be communicated to those charged with governance of an audit client?

Answer 20

Ineffective oversight of financial reporting by those charged with governance is an indicator of a material weakness

Question 21

The minimum likelihood of loss involved in the consideration of a control deficiency is

Answer 21

A control deficiency is a condition in which the operation of a control does not allow management, or employees, in the normal course of performing their functions to prevent or detect misstatements on a timely basis

Note:

it does not explicitly consider likelihood of loss.

Question 22

Material weakness is a significant deficiency (or combination of significant deficiencies) that results in a reasonable possibility that a misstatement of at least what amount will not be prevented or detected?

Answer 22

A material amount.

Question 23

During the audit the independent auditor identified the existence of a significant deficiency in the client’s internal control and communicated this finding in writing to the client’s management and to those charged with governance. The auditor should

Answer 23

Auditor considers and documents his/her understanding of internal control to assist in determining the proper nature, timing, and extent of substantive tests.

Question 24

What is correct concerning the likelihood of loss and the potential amount involved with a material weakness?

Likelihood of loss

Potential amount involved

Answer 24

Reasonable possibility

Material

Note:

Professional standards indicate that a material weakness has more than a reasonable possibility of resulting in a material misstatement.

Question 25

Accurate statement about communication of internal control related matters to management on a nonissuer (nonpublic) company?

Answer 25

The auditor must communicate both material weaknesses and significant deficiencies.

The auditor must communicate in writing.

Weaknesses that were communicated in the past and not corrected must be recommunicated to management and those charged with governance.

A communication indicating that no significant deficiencies were identified should not be issued.

Question 26

How large must the actual loss identified by the auditor be for a control deficiency to possibly be considered a material weakness?

Immaterial

Material

Answer 26

Yes

Yes

note:

A material weakness is determined by whether there is more than a remote likelihood of a material loss occurring due to the control deficiency; the actual loss identified need not be material.