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Internal Control Flashcards

1
Q

If internal control is poor and a company’s accounting practices are sloppy, which risk is higher?

A

Control risk increases with poor internal controls and sloppy accounting practices.

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2
Q

If internal control is poor, what is the effect on the audit?

A

Auditor will need to perform more testing and dig deeper into accounts in order to arrive at an opinion regarding the financial statements.

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3
Q

What does internal control provide reasonable assurance for?

A

Internal control provides reasonable assurance that:

 - Material misstatements will be prevented
 - Reliability/integrity of financial statements will be 
   preserved
 - Assets are protected against misuse
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4
Q

What is required in an examination of internal control under Sarbanes-Oxley?

A
  • CEO/CFO must disclose internal control deficiencies.
  • Management must provide assessment of internal
    control.
  • Management must certify financial statements.
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5
Q

What is the relationship between internal control and substantive testing?

A

Inverse Relationship

  • Stronger Internal Controls = Less Testing Needed
  • Weaker Internal Controls = More Testing Needed
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6
Q

What are the three objectives of internal control?

A

The objectives of internal control are:

1. Reliability of financial reporting
2. Operational efficiency/effectiveness
3. Compliance with laws and regulations
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7
Q

What are the five components of internal control?

A

The components of internal control are:

  • Control Environment
  • Risk Assessment
  • Information and Communication
  • Monitoring
  • Control Activities
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8
Q

What is the purpose for a Control Environment assessment?

A

A Control Environment assessment sets tone for the entire company.

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9
Q

What are the components of the Control Environment?

A

The components of Control Environment are:

  • Integrity/Ethics of Management
  • Competence of Management
  • Organizational Structure
  • Human Resource Policies
  • Assignment of Authority/Responsibility
  • Management’s Style (riskier with a
    dominant/aggressive individual)
  • Board/Audit Committee involvement
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10
Q

What does an auditor’s assessment of Detection Risk determine?

A

Detection Risk determines nature, timing, and extent of audit procedures.

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11
Q

What determines the acceptable level of Detection Risk?

A

Risk of material misstatement determines acceptable level of Detection Risk.

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12
Q

What situations or circumstances could increase the risk of material misstatement?

A

Rapid growth in the company

Major changes to

- Operations
- Personnel
- Systems
- IT
- Products
- Corporate organization
- Foreign operations
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13
Q

What happens when Control Risk is assessed to be at the maximum level?

A

No Internal Control testing is performed. All audit procedures are increased in intensity to compensate for increased risk.

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14
Q

What happens when Control Risk is below the maximum level?

A

Auditor tests Internal Controls. Auditor evaluates Control Risk based on tests. Auditor adjusts substantive tests accordingly.

 Weaker Internal Control - More substantive tests

 Stronger Internal Control - Less substantive tests
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15
Q

Describe some common examples of Control Activities.

A

Control Activities include:

  • Performance Reviews
  • Information Processing
  • Physical Controls
  • Segregation of Duties
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16
Q

What should an auditor understand with respect to Information and Communication on an audit?

A

An auditor must understand client’s:

  • Major transaction classes
  • Transaction initiation
  • Support records/documents
  • Transaction processing
  • Financial Statement internal reporting process
  • Financial Statement external reporting process
17
Q

How must an auditor document understanding of Internal Control?

A

An auditor documents understanding of Internal Control through written documentation such as:

  • Internal Control memos,
  • flowcharts,
  • and questionnaires
18
Q

What questions should be asked to determine the risk of material misstatement?

A

Were all transactions recorded?

Were they timely?

Were they measured appropriately?

Were they recorded in correct period?

Were they presented and disclosed properly?

Did management communicate their responsibilities?

19
Q

What is the purpose of internal control testing and what procedures does the auditor perform to test internal controls?

A

Auditor needs reasonable assurance that controls are functioning as designed and effective.

Internal Control Testing should be strong as (IRON) so that nothing gets past them

- Inquiry - Interview company personnel
- Re-performance - Can it be replicated?
- Observation - Watch the control be applied
- INspection - Dig into the details/documents

If results are as expected, substantive procedures do not need to be adjusted.

20
Q

When can controls tested by an auditor in a prior year be used in the current year’s audit assessment?

A

Controls tested by auditor in a prior year can be used in the current year’s audit assuming they are re-tested every third year.

Exception: if the control has changed since the last audit

21
Q

What happens if Internal Controls are deficient?

A
  • Control Risk increases
  • Scope of substantive procedures increases
  • Detection Risk decreases
  • Material Weakness - reasonable possibility that a
    material misstatement in financial statements would
    not be found - more than a remote chance of
    occurrence.
22
Q

What is a Material Weakness?

A

Reasonable possibility exists that a material misstatement in financial statements would NOT be found, and has more than a remote chance of occurrence.

23
Q

What does Tracing test?

A

Tracing tests completeness. It starts with a source document and traces forward to the journal entry.

24
Q

What does Vouching test?

A

Vouching tests Existence. It starts with a journal entry and searches for a voucher or source document to support the entry.

25
Q

What activities represent Segregation of Duties?

A

Non-compatible duties performed by separate individuals such as:

Authorization of asset disbursement vs. Recording of assets vs. Custody of assets

- If supporting audit evidence doesn't exist, use - 
  Observation and Inquiry.
- Accounting should be segregated from production.
26
Q

With respect to signing checks, how are duties segregated?

A

Employees who prepare vouchers/invoices should not also have the authority to SIGN CHECKS.

Tip: Remember this as an underlying theme with Segregation of Duties.

The authority to make a payment should not also lie in the hands of those creating invoices/vouchers. Why? People commit fraud by setting up fake companies and basically paying themselves.

27
Q

With respect to custody of assets, how should duties be segregated?

A
  • Employees who have custody of assets should not
    also RECORD those assets.
  • Someone in charge of petty cash should not also
    control the petty cash records.
  • Treasury Department (custodians) should NOT have
    record keeping duties. They control assets and
    should not be able to adjust any recording of those
    assets.
28
Q

What are the limitations on Control Activities?

A
  • Controls can’t stop collusion or bad judgment.
  • Management can override controls.
  • Cost vs. Benefit relationship of Internal Control
29
Q

What is required if a Material Weakness is identified?

A
  • A written report to management is required.
  • Report declaring that no material weaknesses were
    found is allowed.
  • Previous weaknesses reported that still exist should
    be reported again.
  • Should be reported no later than 60 days after audit
    report release date.
  • If one or more material weaknesses is uncorrected at
    year-end, an Adverse Opinion on Internal Control
    must be given.
30
Q

What is the effect of a Significant Deficiency? What is it?

A

A significant deficiency adversely affects a company’s ability to report in the financial statements according to GAAP.

A significant deficiency is more than a remote likelihood of material misstatement by more than an inconsequential amount.

31
Q

What must occur if a Significant Deficiency is identified?

A
  • If a Significant Deficiency is identified, a written report
    to management is required.
  • Report declaring that no significant deficiencies exist
    is not allowed.
  • Previous deficiencies reported that still exist should
    be reported again.
  • Should be reported no later than 60 days after the
    audit report release date.
32
Q

What is a Control Deficiency?

A

A control is not operating as intended.

33
Q

What must an auditor ask if using the work of third parties?

A

Are they competent? Are they objective?

34
Q

What must an auditor understand with respect to internal auditors?

A
  • Auditor needs to understand the role of Internal
    Auditors within the organization because their work
    affects the audit plan.
  • Responsibility for judgments about materiality or
    appropriateness of entries or estimates cannot be
    shared with third parties like Internal Auditors.
  • Internal Auditors should be asked to do some of the
    legwork like preparing schedules or running reports.
  • They should not be asked to make any decisions or
    judgments.

AUD Flashcards (12 decks)

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