Mini Exam 2 WRONG ANSWERS Flashcards
The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the:
A. Human resources functions from the accounting functions. B. Authorization of transactions from the custody of related assets. C. Application controls from the general controls. D. Administrative function from the hiring function.
Choice “B” is correct. The hiring function provides authorization for payment. Distributing payroll is a custodial function.
Choice “A” is incorrect. Segregation of duties generally refers to the separation of authorization, recordkeeping and custody, not the separation of various functional units.
Choice “C” is incorrect. Hiring and payroll distribution are not types of application controls or general controls.
Choice “D” is incorrect. Hiring is an administrative function.
Which risk, when assessed at a high level, is most likely to result in an inappropriate opinion on financial statements which are not fairly stated?
A. The risk of assessing control risk too high. B. The risk of assessing control risk too low. C. The risk of incorrect acceptance. D. The risk of incorrect rejection.
Choice “C” is correct. If there is a high risk of incorrect acceptance, this means that it is quite possible that the auditor will incorrectly accept a balance as fairly stated, when in fact it is not fairly stated.
Choice “A” is incorrect. If control risk is assessed too high, the auditor will rely less on controls than he/she otherwise might have, and will perform an increased level of substantive testing. The auditor will do more work than is necessary, which ultimately should lead to a proper opinion on the financial statements.
Choice “B” is incorrect. If control risk is assessed too low, the auditor will rely on controls to a greater extent than he/she should. The fact that controls are not functioning as effectively as believed does make it more likely that a misstatement could occur and not be identified, but not quite as likely as is the case with a high risk of incorrect acceptance. Remember that a lack of controls does not imply that there is a misstatement in the financial statements, only that it is more likely. An incorrect acceptance situation does imply that there is an error in the financial statements.
Choice “D” is incorrect. If there is a high risk of incorrect rejection, this means that the auditor will do more work than is necessary, which ultimately should lead to a proper opinion on the financial statements.
Which should be the auditor’s primary focus when considering related party transactions?
A. The adequacy of the client’s disclosure of such transactions. B. The need to disclose payments made to top members of management under compensation arrangements and for expense allowances. C. The legality of such transactions. D. The determination as to whether such transactions were consummated under arm’s-length terms.
Choice “A” is correct. The auditor’s primary concern with related party transactions is that they are properly disclosed in accordance with GAAP.
Choice “B” is incorrect. GAAP requires disclosure of material related party transactions except compensation arrangements, expense allowances, and other similar items in the ordinary course of business.
Choice “C” is incorrect. The auditor generally would not be expected to evaluate the legality of related party transactions, although appropriate response would be necessary if the auditor became aware of a possible illegality.
Choice “D” is incorrect. Generally it will not be possible for an auditor to determine whether or not a transaction would have taken place in exactly the same manner if the parties were not related. For this reason, related-party transactions are not considered to be arm’s-length transactions.
An auditor concerned with the completeness of dividend income would most likely:
A. Review dividend record books produced by outside service companies. B. Trace recorded dividend receipts to inclusion in the cash receipts journal. C. Send confirmations to a sample of companies in which the client owns stock. D. Review the minutes of board of directors meetings for approval of dividends.
Choice “A” is correct. The auditor would likely choose a sample of companies in which the client owns stock, and review dividend record books (such as Moody’s) to determine whether such companies declared dividends during the year under audit.
Choice “B” is incorrect. An auditor concerned with the completeness assertion would be searching for unrecorded dividends. Starting an audit test with recorded dividend receipts would not provide any evidence about those items which may have been unrecorded.
Choice “C” is incorrect. Confirmations are not generally used to audit dividend income, nor would this be particularly efficient. Reference to dividend record books produced by investment advisory services such as Moody’s is a much faster way to audit dividend income.
Choice “D” is incorrect. The board of directors does not approve dividends coming from other companies, only dividends being declared by their own company.
In testing controls over cash disbursements, an auditor most likely would determine that the person who signs the check also:
A. Returns the checks to accounts payable. B. Stamps, perforates or otherwise cancels supporting documents. C. Approves the voucher for payment. D. Is denied access to the supporting documents.
Choice “B” is correct. This prevents duplicate payments of vendor invoices since cancellation occurs immediately after the check is signed.
Choice “A” is incorrect. Accounts payable should not get the signed checks, since this would allow one group to have both recordkeeping and custodial duties. The check signer should mail the check.
Choice “C” is incorrect. The responsibility for authorization and custody should be separated.
Choice “D” is incorrect. The person who signs the check should have access to the supporting documents, as they must be cancelled after payment.
Which of the following is least likely to be used as a substantive test relating to cash balances?
A. Verify that cash disbursements have been properly approved. B. Count all cash on hand. C. Obtain cutoff bank statements and perform bank reconciliations. D. Send cash confirmations to all banks with whom the client has done business.
Choice “A” is correct. Verifying that cash disbursements have been properly approved is a test of controls, not a substantive test.
Choices “D”, “B”, and “C” are incorrect. Cash confirmations, cash counts, and bank reconciliations are all a means of verifying the ending cash balance.
As the acceptable level of detection risk decreases, an auditor may change the:
A. Assessed level of inherent risk. B. Assessed level of control risk from high to low. C. Timing of substantive tests from year-end to an interim date. D. Nature of substantive tests from a less effective to a more effective procedure.
Choice “D” is correct. Better evidence must be obtained to achieve a lower level of detection risk.
Choice “A” is incorrect. The assessed level of inherent risk (based on the auditor’s evaluation of the nature of the assertion) determines the risk of material misstatement, which in turn affects the acceptable level of detection risk. The acceptable level of detection risk is therefore determined by the assessed level of inherent risk, not vice versa.
Choice “B” is incorrect. The assessed level of control risk (based on the auditor’s evaluation of the client’s controls) determines the risk of material misstatement, which in turn affects the acceptable level of detection risk. The acceptable level of detection risk is therefore determined by the assessed level of control risk, not vice versa.
Choice “C” is incorrect. Shifting tests from year-end to interim increases detection risk.
A report issued on significant deficiencies in internal control noted during a financial statement audit of a nonissuer should contain all of the following except:
A. A restriction on the use of the report. B. The definition of material weaknesses. C. A statement of compliance with laws and regulations. D. An indication that the purpose of the audit was to report on the financial statements.
Choice “C” is correct. No statement of compliance with laws and regulations is required in the report.
Choices “B”, “A”, and “D” are incorrect. The definition of material weaknesses, a restriction on the use of the report, and an indication that the purpose of the audit was to report on the financial statements all should be part of the report.
Which of the following ordinarily would not be included in the auditor’s responsibility regarding accounting estimates?
A. Determine whether estimates are properly disclosed in the financial statements. B. Establish a process for preparing accounting estimates. C. Assess management’s policies and practices regarding estimates. D. Evaluate whether management’s estimates are reasonable.
Choice “B” is correct. It is management’s responsibility (and not the auditor’s) to establish a process for preparing accounting estimates.
Choice “A” is incorrect. The auditor should determine whether estimates are properly disclosed in the financial statements.
Choice “C” is incorrect. The auditor should assess management’s policies and practices regarding estimates.
Choice “D” is incorrect. The auditor should evaluate whether management’s estimates are reasonable.
Which of the following constitutes a weakness in control related to the revenue cycle?
A. The accounts receivable clerk prepares an aging schedule. B. The cash receipts clerk prepares a credit memo. C. The shipping clerk prepares a bill of lading. D. The billing clerk prepares a sales invoice.
Choice “B” is correct. Allowing the cash receipts clerk to prepare a credit memo constitutes an inadequate segregation of duties, because the clerk can misappropriate cash and cover the theft by issuing a credit memo.
Choice “A” is incorrect. The accounts receivable clerk should prepare an aging schedule.
Choice “C” is incorrect. The shipping clerk should prepare a bill of lading.
Choice “D” is incorrect. The billing clerk should prepare a sales invoice.
When a client makes extensive use of information technology, the auditor should consider the effect this may have on internal control. Which of the following is least likely to be affected?
A. The audit objectives with respect to evaluating internal control. B. The five components of internal control. C. The audit procedures used to evaluate controls. D. The assessed level of control risk.
Choice “A” is correct. The client’s extensive use of information technology generally would not affect the auditor’s objectives, although it might affect how those objectives are achieved.
Choice “B” is incorrect. An entity’s use of information technology may affect any of the five components of internal control.
Choice “C” is incorrect. An entity’s use of information technology will affect the appropriate audit procedures to apply. For example, the extent and complexity of computer operations may require the use of computer-assisted audit techniques.
Choice “D” is incorrect. An entity’s use of information technology may create additional internal control risks, such as the risk of unauthorized access to data.
**Which of the following are required as part of an auditor’s planning process?
Understanding
the design of
controls
Determining
whether
controls have been
implemented
Evaluating
the operating
effectiveness of
controls
Documenting
the understanding
of internal
control
A. Yes
No
No
Yes
B. No
Yes
Yes
No
C. Yes
Yes
No
Yes
D. No
No
Yes
No
Choice “C” is correct. As part of planning, the auditor is required to obtain an understanding of the design of controls and determine whether they have been implemented, as well as to document this understanding. The auditor is not required to evaluate the operating effectiveness of controls during the planning process.
Choices “A”, “D”, and “B” are incorrect, based on the above explanation.
Which of the following procedures is an auditor most likely to use to test the completeness assertion for fixed assets?
A. Recalculation of depreciation on fixed assets. B. Review of large items charged to repairs and maintenance. C. Comparison of items listed in the fixed asset ledger to actual assets observed by the auditor. D. Comparison of assets acquired during the year to the approved capital budget.
Choice “B” is correct. When the auditor reviews large items charged to repairs and maintenance, he/she is looking for items that may have been erroneously expensed instead of capitalized. The completeness assertion focuses on just that – items that should have been included in fixed assets but were not.
Choice “A” is incorrect. Recalculation of depreciation addresses the valuation/allocation assertion, not the completeness assertion.
Choice “C” is incorrect. Tracing from recorded assets to actual assets tests existence, not completeness. The completeness assertion focuses on assets that are not recorded, so starting with recorded assets will not identify this problem.
Choice “D” is incorrect. Verifying that acquisitions were properly approved does not address the completeness assertion, since it does not help the auditor identify items that should have been capitalized but were not.
Which of the following types of audit evidence is the least reliable?
A. Bank statement obtained from the client. B. Purchase order. C. Canceled check. D. Vendor's invoice.
Choice “B” is correct. A purchase order is internal documentation and as such, it is more easily manipulated by the client.
Choices “D”, “C”, or “A” are incorrect. A vendor’s invoice, a canceled check, and a bank statement obtained from the client are all considered external evidence, which is less likely to be manipulated than is internal evidence.
Which of the following most likely would be an internal control procedure designed to detect errors and irregularities concerning the custody of inventory?
A. Segregation of functions between general accounting and cost accounting. B. Periodic reconciliation of work in process with job cost sheets. C. Independent comparisons of finished goods records with counts of goods on hand. D. Approval of inventory journal entries by the storekeeper.
Choice “C” is correct. Independently comparing inventory records with physical inventory counts may detect discrepancies concerning the custody of inventory.
Choice “A” is incorrect. Segregation of duties between general accounting and cost accounting relates to the recordkeeping aspects of inventory and not to its physical custody.
Choice “B” is incorrect. Periodic reconciliation of work in process with job cost sheets relates to the recordkeeping aspects of inventory and not to its physical custody.
Choice “D” is incorrect. Requiring approval of journal entries relates to the recordkeeping aspects of inventory and not to its physical custody.
