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Agency Law > Internal Control > Flashcards

Internal Control Flashcards

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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 3 objectives of Internal Control?

A

Reliability of Financial Reporting

Operational Efficiency/Effectiveness

Compliance with Law and Regulations

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7
Q

What are the 5 components of Internal Control?

A

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

Sets tone for the entire company

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9
Q

What are the components of the Control Environment?

A

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 items could increase the risk of material misstatement?

A

Rapid growth in the company.

The methods management uses to identify risk- estimate its significance and assess the likelihood of occurrence

Major changes to operations- personnel- systems- IT- products- corporate organization- and 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

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

Understand Client’s

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

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17
Q

How must an auditor document understanding of Internal Control?

A

Through written documentation such as Internal Control memos- flowcharts- and questionnaires

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18
Q

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

A

Were all transactions recorded?
Were they timely?
Measured appropriately?
Recorded in correct period?
Presented and disclosed properly?
Did Management communicate their responsibilities?

19
Q

What is the purpose of testing 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

Tests Completeness

Starts with source document and traces forward to the journal entry.

24
Q

What does Vouching test?

A

Tests Existence.

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 exit - 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 a 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 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

35
Q

What is required in an examination of Internal Control under Sarbanes-Oxley?

A

CEO/CFO must disclose deficiencies

Management must provide assessment of Internal Controls

Management must certify Financial Statements

36
Q

What is the relationship between Internal Control and Substantive Testing?

A

Has inverse relationship

Stronger Internal Control results in LESS substantive testing

Weaker Internal Control leads to MORE substantive testing

37
Q

What are the three objectives of Internal Control?

A

Reliability of Financial Reporting

Operational Efficiency/Effectiveness

Compliance with Law and Regulations

38
Q

What are the five components of Internal Control?

A

Control Activities

Risk Assessment

Information and Communications

Monitoring

Control Environment

39
Q

What are the components of the Control Environment?

A

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

40
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

41
Q

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

A

Understand Client’s

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

42
Q

How must an auditor document understanding of Internal Control?

A

Auditor must document understanding of Internal Control via Memos - Flowcharts - Questionnaires

43
Q

What is the purpose of testing 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

Agency Law (54 decks)

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