Mod 3 Internal Control Flashcards
- An auditor would most likely be concerned with controls that provide reasonable assurance about the:
a) Efficiency of management’s decision-making process.
b) Appropriate prices the entity should charge for its products.
c) Methods of assigning production tasks to employees.
d) Entity’s ability to process and summarize financial data.
d) Entity’s ability to process and summarize financial data.
This answer is correct because the controls relevant to an audit pertain to the entity’s ability to record, process, summarize, and report financial data consistent with the assertions embodied in the financial statements.
- An auditor’s tests of controls for completeness for the revenue cycle usually include determining whether:
a) Each receivable is collected subsequent to the year-end.
b) An invoice is prepared for each shipping document.
c) Each invoice is supported by a customer purchase order.
d) Each credit memo is properly approved.
b) An invoice is prepared for each shipping document.
This answer is correct because when there is a shipping document, this suggests that a sale occurred in the sense that goods have been shipped to a customer; accordingly an invoice should be prepared and recorded. A situation in which there is a shipping document and no invoice will ordinarily be one in which a sale has not been recorded.
- Which of the following best represents a key control for ensuring sales are properly authorized when assessing control risks for sales?
a) The separation of duties between the billing department and the cash receipts approval department.
b) The use of an approved price list to determine unit selling price.
c) Copies of approved sales orders sent to the shipping, billing, and accounting departments.
d) Sales orders are sent to the credit department for approval.
d) Sales orders are sent to the credit department for approval.
This answer is correct because to segregate responsibilities, sales orders should be sent to the credit department for approval (authorization).
- The safeguarding of inventory most likely includes
a) Comparison of the information contained on the purchase requisitions, purchase orders, receiving reports, and vendors’ invoices.
b) Periodic reconciliation of detailed inventory records with the actual inventory on hand by taking a physical count.
c) Analytical procedures for raw materials, goods in process, and finished goods that identify unusual transactions, theft, and obsolescence.
d) Application of established overhead rates on the basis of direct labor hours or direct labor costs.
b) Periodic reconciliation of detailed inventory records with the actual inventory on hand by taking a physical count.
This answer is correct because periodic reconciliation of detailed inventory records with the actual inventory on hand by actual count will make shortages obvious. In addition to detecting shortages, employee awareness that a count will be conducted may prevent the occurrence of fraud relating to inventory.
- Which of the following is an effective control that encourages receiving department personnel to count and inspect all merchandise received?
a) Quantities ordered are excluded from the receiving department copy of the purchase order.
b) Vouchers are prepared by accounts payable department personnel only after they match item counts on the receiving report with the purchase order.
c) Receiving department personnel are expected to match and reconcile the receiving report with the purchase order.
d) Internal auditors periodically examine, on a surprise basis, the receiving department copies of receiving reports.
a) Quantities ordered are excluded from the receiving department copy of the purchase order.
This answer is correct because if the quantities ordered are not known to the receiving department personnel, they will have to count and inspect the incoming merchandise to indicate the quantity received. They will not simply compare the goods received with the quantity on the purchase order for “reasonableness.”
- An auditor uses the assessed level of the risk of material misstatement to
a) Evaluate the effectiveness of the entity’s control activities.
b) Identify transactions and account balances where inherent risk is at the maximum.
c) Indicate whether materiality thresholds for planning and evaluating purposes are sufficiently high.
d) Determine the acceptable level of detection risk for financial statement assertions.
d) Determine the acceptable level of detection risk for financial statement assertions.
This answer is correct because an auditor uses the risk of material misstatement to determine the acceptable level of detection risk for financial statement assertions. The auditor then uses the acceptable level of detection risk to determine the nature, timing, and extent of the auditing procedures to be used to detect material misstatements in the financial statement assertions.
- Apex Manufacturing Corporation mass produces eight different products. The controller who is interested in strengthening controls over the accounting for materials used in production would be most likely to implement
a) An economic order quantity (EOQ) system.
b) A job order cost accounting system.
c) A perpetual inventory system.
d) A separation of duties among production personnel.
c) A perpetual inventory system.
This answer is correct because a perpetual inventory system will show when and where materials are being used.
- Which of the following procedures would best detect the theft of valuable items from an inventory that consists of hundreds of different items selling for $1 to $10 and a few items selling for hundreds of dollars?
a) Maintain a perpetual inventory of only the more valuable items with frequent periodic verification of the validity of the perpetual inventory record.
b) Have an independent CPA firm prepare a report on the effectiveness of internal control over inventory.
c) Have separate warehouse space for the more valuable items with sequentially numbered tags.
d) Require an authorized officer’s signature on all requisitions for the more valuable items.
a) Maintain a perpetual inventory of only the more valuable items with frequent periodic verification of the validity of the perpetual inventory record.
This answer is correct because to detect the theft of valuable items a perpetual inventory system with periodic verification will be most helpful because differences between the quantity counted and the quantity in inventory are identified.
- The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the
a) Operational responsibility from the recordkeeping responsibility.
b) Responsibilities of recording a transaction at its origin from the ultimate posting in the general ledger.
c) Authorization of transactions from the custody or related assets.
d) Human resources function from the controllership function.
c) Authorization of transactions from the custody or related assets.
This answer is correct because hiring personnel represents an authorization function while distributing checks represents a custody function, and since these two functions are related they would be incompatible if performed by the same individual. The combination of these two functions in the same position would create the possibility of the addition of a fictitious employee to the payroll and subsequent misappropriation of paychecks.
- In a consideration of the internal control, the completion of a questionnaire is most closely associated with which of the following?
a) Separation of duties.
b) Documentation.
c) Flowchart accuracy.
d) Tests of controls.
b) Documentation.
This answer is correct because a questionnaire may be completed during the auditor’s consideration of internal control to document the auditor’s understanding.
- Miller Retailing, Inc. maintains a staff of three full-time internal auditors who report directly to the controller. In planning to use the internal auditors to provide assistance in performing the audit, the independent auditor most likely will:
a) Place limited reliance on the work performed by the internal auditors.
b) Decrease the extent of the tests of controls needed to support the assessed level of detection risk.
c) Increase the extent of the procedures needed to reduce control risk to an acceptable level.
d) Avoid using the work performed by the internal auditors.
a) Place limited reliance on the work performed by the internal auditors.
This answer is correct because when internal auditors only report to a relatively low level in the organization (here the controller and not, for example, the audit committee), the independent auditor will question the internal auditors’ ability to remain objective and this will result in limited reliance being placed upon their work.
- To avoid potential errors and fraud a well-designed internal control in the accounts payable area should include a separation of which of the following functions?
a) Cash disbursements and invoice verification.
b) Invoice verification and merchandise ordering.
c) Physical handling of merchandise received and preparation of receiving reports.
d) Check signing and cancellation of payment documentation.
a) Cash disbursements and invoice verification.
This answer is correct because the requirements concern internal control in the accounts payable area and separation of cash disbursements and invoice verification is an effective control. The accounts payable function normally includes invoice verification. The important separation should be between authorization of payment and actual cash disbursements. Thus the accounts payable area (including invoice verification) should be separated from cash custodianship and disbursement.
- In the consideration of internal control, the auditor is basically concerned that internal control provides reasonable assurance that
a) Controls have not been circumvented by collusion.
b) Misstatements have been prevented or detected.
c) Operational efficiency has been achieved in accordance with management plans.
d) Management cannot override controls.
b) Misstatements have been prevented or detected.
This answer is correct because the function of internal control, from the viewpoint of the independent auditor, is to provide reasonable assurance that material misstatements may either be prevented or discovered with reasonable promptness, thus assuring the reliability and integrity of the financial records.
- Which of the following is ordinarily considered a factor indicative of increased financial reporting risk when an auditor is considering a client’s risk assessment policies?
a) Commissioned sales personnel.
b) A corporate code of conduct.
c) Rapid growth of the organization.
d) Materiality standards for determining whether to capitalize acquisitions of fixed assets.
c) Rapid growth of the organization.
This answer is correct because rapid growth of the organization is considered a risk factor when considering a client’s risk assessment policies. Note that risk factors do not necessarily indicate misstated financial statements, they are simply factors that have often been present in the past when misstatements have been identified.
- Which of the following payroll control activities would most effectively ensure that payment is made only for work performed?
a) Require all employees to record arrival and departure by using the time clock.
b) Have a payroll clerk recalculate all time cards.
c) Require all employees to sign their time cards.
d) Require employees to have their direct supervisors approve their time cards.
d) Require employees to have their direct supervisors approve their time cards.
This answer is correct because supervisors should have the most direct knowledge of the hours worked by their subordinates.
- A client’s materials-purchasing cycle begins with requisitions from user departments and ends with the receipt of materials and the recognition of a liability. An auditor’s primary objective in reviewing this cycle is to:
a) Evaluate the reliability of information generated as a result of the purchasing process.
b) Investigate the physical handling and recording of unusual acquisitions of materials.
c) Consider the need to be on hand for the annual physical count if this system is not functioning properly.
d) Ascertain that materials said to be ordered, received, and paid for are on hand.
a) Evaluate the reliability of information generated as a result of the purchasing process.
This answer is correct because the auditor’s primary objective in reviewing the materials purchasing cycle is to evaluate the reliability of the information generated as a result of the purchasing process. This answer also encompasses all the other answer choices.
- Which of the following types of transactions generally has less risk?
a) Estimation transactions.
b) Related-party transactions.
c) Routine transactions.
d) Nonroutine transactions.
c) Routine transactions.
This answer is correct because routine transactions are usual in nature and typically have low risk.
- An auditor who uses a transaction cycle approach to assessing control risk most likely would test control activities related to transactions involving the sale of goods to customers with the:
a) Collection of receivables.
b) Purchase of merchandise inventory.
c) Payment of accounts payable.
d) Sale of long-term debt.
a) Collection of receivables.
This answer is correct because collection of receivables relates to the valuation of accounts receivable, a part of the sales (revenue) cycle.
- Which of the following procedures represents a weakness in internal control for payroll?
a) The payroll clerk distributes signed payroll checks. Undistributed checks are returned to the payroll department.
b) The accounting department wires transfer funds to the payroll bank account. The transfer is based on totals from the payroll department summary.
c) The payroll department prepares checks using a signature plate. The treasurer supervises the process before payroll checks are distributed.
d) The payroll department prepares checks. The chief financial officer signs the payroll checks.
a) The payroll clerk distributes signed payroll checks. Undistributed checks are returned to the payroll department.
This answer is correct because it is a weakness to have the payroll clerk distribute signed payroll checks and for the payroll department to maintain undistributed checks. Payroll checks should be distributed by a paymaster, and undistributed checks should be deposited in a bank account.
- At which point in an ordinary sales transaction of a wholesaling business would a lack of specific authorization be of least concern to the auditor in the conduct of an audit?
a) Granting of credit.
b) Shipment of goods.
c) Determination of discounts.
d) Selling of goods for cash.
d) Selling of goods for cash.
This answer is correct because at the point of selling the goods for cash, decisions on matters such as appropriate discounts will have already been made. The fact that cash is being received eliminates any credit problem considerations. Therefore, the lack of specific authorization will not be of great concern to the auditor in this situation.
- An internal control narrative indicates that an approved voucher is required to support every check request for payment of merchandise. Which of the following procedures provides the greatest assurance that this control is operating effectively?
a) Select and examine vouchers and ascertain that the related canceled checks are dated no later than the vouchers.
b) Select and examine vouchers and ascertain that the related canceled checks are dated no earlier than the vouchers.
c) Select and examine canceled checks and ascertain that the related vouchers are dated no earlier than the checks.
d) Select and examine canceled checks and ascertain that the related vouchers are dated no later than the checks.
d) Select and examine canceled checks and ascertain that the related vouchers are dated no later than the checks.
This answer is correct because vouchers should have been prepared and approved prior to issuance of the check (otherwise the voucher was not present when the check was issued). In addition, the auditor must begin his/her test with the canceled checks to determine whether all checks are supported by an approved voucher.
One important reason why a CPA, during the course of an audit engagement, prepares internal control flowcharts is to:
a) Reduce the need for inquiries of client personnel concerning the operations of internal control.
b) Depict the organizational structure and document flow in a single chart for review and reference purposes.
c) Assemble the internal control findings into a comprehensible format suitable for analysis.
d) Prepare documentation that would be useful in the event of a future consulting engagement.
d) Prepare documentation that would be useful in the event of a future consulting engagement.
This answer is correct because flowcharts are prepared as part of the consideration of internal control. The use of structure flowcharts assembles the internal control findings into a comprehensible format.
- Which of the following would be least likely to be included in an auditor’s tests of controls?
a) Inspection.
b) Observation.
c) Inquiry.
d) Confirmation.
d) Confirmation.
This answer is correct because tests of controls provide reasonable assurance that prescribed control procedures are being followed. Confirmation is used primarily to substantiate the existence of an account balance and, therefore, is considered a substantive test.
- In meeting the control objective of safeguarding of assets, which department should be responsible for
a) Distribution of paychecks: Treasurer; Custody of paychecks: Treasurer
b) Distribution of paychecks: Payroll; Custody of paychecks: Treasurer
c) Distribution of paychecks: Payroll; Custody of paychecks: Payroll
d) Distribution of paychecks: Treasurer; Custody of paychecks: Payroll
a) Distribution of paychecks: Treasurer; Custody of paychecks: Treasurer
This answer is correct because these custody functions should not be performed by the payroll department which is a recordkeeping function. Under proper internal control recordkeeping, custody, and authorization of transactions should be segregated.
- Which of the following is necessary for an auditor to be able to issue a report on whether a previously reported material weakness disclosed in an integrated audit continues to exist?
a) The auditor must have issued the original audit report indicating the existence of the material weakness.
b) Management must adopt control criteria other than those used relating to the original reporting on internal control.
c) Management must provide a written assertion indicating that elimination of all internal control deficiencies is its responsibility.
d) Management must support its written assertion that the material weakness has been eliminated with sufficient evidence.
d) Management must support its written assertion that the material weakness has been eliminated with sufficient evidence.
This answer is correct because management must support its assertion with evidence, including documentation.
- Which of the following procedures is considered a test of controls?
a) An auditor reviews the entity’s check register for unrecorded liabilities.
b) An auditor evaluates whether a general journal entry was recorded at the proper amount.
c) An auditor interviews and observes appropriate personnel to determine segregation of duties.
d) An auditor reviews the audit workpapers to ensure proper sign-off.
c) An auditor interviews and observes appropriate personnel to determine segregation of duties.
This answer is correct because the professional standards indicate that tests of controls involve inquiry (interviews), inspection, observation, and reperformance.
- Which of the following should an auditor do when control risk is assessed at the maximum level?
a) Perform fewer substantive tests of details.
b) Perform more tests of controls.
c) Document the assessment.
d) Document the control structure more extensively.
c) Document the assessment.
This answer is correct because the professional standards require documentation of the assessment.
- Which auditor actions are possible when that auditor incurs a scope limitation relating to a public company engagement on whether a previously reported material weakness continues to exist?
a) Disclaimer of Opinion: Yes; Qualified Opinion: Yes
b) Disclaimer of Opinion: Yes; Qualified Opinion: No
c) Disclaimer of Opinion: No; Qualified Opinion: Yes
d) Disclaimer of Opinion: No; Qualified Opinion: No
b) Disclaimer of Opinion: Yes; Qualified Opinion: No
This answer is correct because while disclaimers are allowed, qualified opinions are not allowed; in addition (not included in this question) the auditor may choose to withdraw from the engagement due to a scope limitation.
- 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:
a) Consider the significant deficiency a scope limitation and therefore disclaim an opinion.
b) Document the matter in the working papers and consider the effects of the condition on the audit.
c) Suspend all audit activities pending directions from the client’s audit committee.
d) Withdraw from the engagement.
b) Document the matter in the working papers and consider the effects of the condition on the audit.
This answer is correct because the auditor considers and documents his/her understanding of internal control to assist in determining the proper nature, timing, and extent of substantive tests.
- Jackson, the purchasing agent of Judd Hardware Wholesalers, has a relative who owns a retail hardware store. Jackson arranged for hardware to be delivered by manufacturers to the retail store on a COD basis thereby enabling his relative to buy at Judd’s wholesale prices. Jackson was probably able to accomplish this because of Judd’s poor internal control over:
a) Purchase orders.
b) Purchase requisitions.
c) Cash receipts.
d) Perpetual inventory records.
a) Purchase orders.
This answer is correct because proper control over purchases would require that ordered goods only be shipped to authorized locations; proper control would also determine that all ordered goods had been received by the firm. If purchase orders are issued by Judd and the purchases are never received, there is an internal control condition over the purchase orders. All purchase orders should be accounted for (prenumbered) and followed up to assure receipt of orders that are issued.
