SU 2 - Independence & Objectivity

Question 1

A reporting structure where the governing authority sets the direction and approve the policies of the internal auditing activity. This structure provides the ultimate source of independence and authority.

Answer 1

Functional Reporting

Question 2

An unbiased mental attitude that allows internal auditors to perform engagements in such a manner that they believe in their work product and that no significant quality compromises are made. It requires that internal auditors do not subordinate their judgment on audit matters to others.

Answer 2

Objectivity

Question 3

The freedom from conditions that threaten the ability of the internal audit activity to carry out internal audit responsibilities in an unbiased manner.

Answer 3

Independence

Question 4

A reporting structure where the administrative unit facilitates the day-to-day operations of the internal audit activity.

Answer 4

Administrative reporting

Question 5

Any relationship that is or appears to be not in the best interest of the organization; would prejudice an individual’s ability to perform his or her duties and responsibilities objectively.

Answer 5

Conflict of interest

Question 6

Which statement is true?

a) Personal conflicts of interest, scope limitations, and restricted access to records may impair objectivity but not independence.

b) Personal conflicts of interest, scope limitations, and restricted access to records will not impair independence or objectivity.

c) Personal conflicts of interest, scope limitations, and restricted access to records may impair independence but not objectivity.

d) Personal conflicts of interest, scope limitations, and restricted access to records may impair both independence and objectivity.

Answer 6

d) Personal conflicts of interest, scope limitations, and restricted access to records may impair both independence and objectivity.

Rationale
Impairment to organizational independence and individual objectivity may include personal conflict of interest, scope limitations, and restricted access to records.

Question 7

Which is acceptable for an internal auditor to do while still maintaining his or her professional judgment?

a) Attending an employee event at a potential vendor

b) Participating in a birthday celebration within the department being reviewed

c) Sitting at a vendor’s table at a charitable event honoring the auditor’s company

d) Accepting a lunch invitation and allowing someone to buy lunch at an expensive restaurant

Answer 7

b) Participating in a birthday celebration within the department being reviewed

Rationale

An internal auditor must maintain objectivity in fact and in appearance. Accepting a lunch invitation or allowing someone to buy lunch should not compromise objectivity, but consider what is “reasonable” versus what could be perceived as a conflict of interest. In this case, lunch at an expensive restaurant may be perceived to be a problem. Attending an employee event at a potential vendor or sitting at a vendor’s table at a charitable event honoring the auditor’s company can likewise be perceived as lack of objectivity.

Question 8

Which of the following is most likely to enable the internal audit activity to carry out its responsibilities in an unbiased manner?

a) The chief audit executive has direct and unrestricted access to senior management and the board.

b) The chief audit executive reports functionally to the chief executive officer.

c) The chief audit executive self-assesses against a competency framework or benchmark.

d) The chief audit executive reports administratively to the board.

Answer 8

a) The chief audit executive has direct and unrestricted access to senior management and the board.

Rationale
The IPPF Glossary defines independence is “the freedom from conditions that threaten the ability of the internal audit activity to carry out internal responsibilities in an unbiased manner.

” The interpretation to Standard 1100: Independence and Objectivity states: “To achieve the degree of independence necessary to effectively carry out the responsibilities of the internal audit activity, the chief audit executive has direct and unrestricted access to senior management and the board.”

Self-assessments demonstrate an individual internal auditor’s continuing professional development (IG 1230: Continuing Professional Development).

The IIA recommends that the chief audit executive report functionally to the board and administratively to the chief executive officer (IG 1100: Independence and Objectivity).

Question 9

You have been asked to be a member of a peer review team. In assessing the independence of the internal audit department being reviewed, you should consider which factor?

a) Scope and depth of organizational objectives for the audit areas under review

b) Degree to which auditors assume consulting responsibilities

c) Education and experience considered necessary when filling vacant audit staff positions

d) Access to and frequency of communications with the board of directors or the audit committee

Answer 9

d) Access to and frequency of communications with the board of directors or the audit committee

Rationale
Education and experience are related to skill, not independence. Communication and assumption of operating duties (not consulting duties) are related to independence. The scope and depth of the audit objectives also reflect on the department’s independence (not the objectives of the audit areas under review).

Question 10

Which of the following best demonstrates conformance with objectivity?

a) Performance evaluation and compensation processes.

b) Records of a recruitment and training strategy, and job descriptions.

c) Competency assessments of the internal audit activity.

d) Internal audit workpaper templates and engagement plans.

Answer 10

a) Performance evaluation and compensation processes.

Rationale
It is widely understood that compensation practices can significantly affect objectivity. Competency assessments, workpaper templates and engagement plans, and records of recruitment better demonstrate conformance with proficiency and due professional care, and would be secondary considerations for objectivity.

Question 11

Which of the following activities undertaken by the internal auditor might be in conflict with the standard of independence?

a) Acting as external audit liaison

b) Acting as an ethics advocate

c) Acting as a product development temporary project manager

d) Acting as a risk management consultant

Answer 11

c) Acting as a product development temporary project manager

Rationale
Some activities, such as acting as the leader of a project, may conflict with the independence attribute of the internal audit activity. The auditor can be a consultant to the project but should not participate as project manager. The other options do not conflict with the independence of the internal audit activity.

Question 12

Which of the following management requests would be within the normal audit scope?

a) Do a make-or-buy decision analysis to determine whether the company should subcontract for part of its manufacturing versus adding capacity; report the recommendation to management for approval.

b) Analyze financing alternatives and present the alternatives to the audit committee.

c) Perform an independent evaluation of management’s planning process as a basis for making recommendations.

d) Talk with banks to identify financing alternatives, and negotiate contract alternatives that would be presented to management for evaluation.

Answer 12

c) Perform an independent evaluation of management’s planning process as a basis for making recommendations.

Rationale
The planning process is part of the management control system, and its evaluation is part of the normal scope of the auditor’s activities. Talking with banks and make-or-buy decisions are management, not audit, functions. They have the potential to impair the auditor’s independence. The auditor should concentrate on management’s planning and evaluation process and report on that process to the audit committee.

Question 13

The board’s involvement in which of the following demonstrates that organizational independence is effectively achieved?

a) Reviewing and approving the risk-based audit plan.

b) Reviewing and approving the engagement report.

c) Reviewing and approving the engagement work program.

d) Reviewing and approving the engagement workpapers.

Answer 13

a) Reviewing and approving the risk-based audit plan.

Rationale
The board’s involvement in approving the risk-based audit plan is an example of functional reporting to the board, thereby contributing to organizational independence. Review and approval of the engagement work program, workpapers, and engagement report are duties of the chief audit executive, and can help to demonstrate objectivity, but not independence.

Question 14

A new senior auditor was director of risk management in the organization prior to joining the internal audit department. After joining the internal audit department, when can the senior auditor participate in a risk management consulting engagement?

a) In one year.
b) In six months.
c) Immediately.
d) In ninety days.

Answer 14

c) Immediately.

Rationale
Standard 1130.A3 states that objectivity is presumed to be impaired if internal auditors provide assurance services for an activity for which they had responsibility within the previous year. The restriction does not apply to consulting services.

Question 15

Which of the following actions would be a violation of auditor independence?

a) Reviewing a purchasing agent’s contract drafts prior to their execution

b) Reducing the scope of an engagement due to budget restrictions

c) Participating on a task force that recommends standards of control for a new distribution system

d) Continuing on an audit assignment at a division for which the auditor will soon be responsible as the result of a promotion

Answer 15

d) Continuing on an audit assignment at a division for which the auditor will soon be responsible as the result of a promotion

Rationale
An auditor who has been promoted to an operating department should not continue on an audit of that department. If the chief audit executive determines that impairment exists or may be inferred, he or she needs to reassign the auditor.

Question 16

Which of the following statements is true?

a) The internal audit activity and internal auditors must be independent and objective.

b) The internal audit activity must be independent, and internal auditors must be objective.

c) The internal audit activity must be objective, and internal auditors must be independent.

d) The internal audit activity must be independent, internal auditors must be independent and objective.

Answer 16

b) The internal audit activity must be independent, and internal auditors must be objective.

Rationale
Independence relates to the internal audit activity, objectivity relates to internal auditors.

Question 17

An internal auditor has been assigned to an assurance audit of the organization’s training department. Which condition would constitute a threat to the internal auditor’s objectivity, as defined by The IIA’s Code of Ethics?

a) The auditor has a very unfavorable opinion of the department based on experience with its internal seminars.

b) The auditor has a background in developing training materials from a previous job with another organization.

c) The auditor has a very favorable opinion of the organization overall based on its national reputation.

d) The auditor is unfamiliar with the basic principles of training.

Answer 17

a) The auditor has a very unfavorable opinion of the department based on experience with its internal seminars.

Rationale
The internal auditor’s objectivity may be compromised by either a positive or negative predisposition in regard to the audit client. However, the overall organization is not the current audit client, and, in assessing objectivity, it is important to consider what would be “reasonable” versus what could be perceived as a conflict of interest. Experience with another organization’s approach to training is not necessarily a problem for objectivity.

Question 18

Which is an example of professional skepticism?

a) Verifying that vendors paid in the first quarter were listed in the vendor history file

b) Flowcharting key controls to form the basis of an audit program

c) Interviewing staff on a process within the business function being reviewed

d) Identifying best practices within the industry

Answer 18

a) Verifying that vendors paid in the first quarter were listed in the vendor history file

Rationale
Maintaining professional skepticism ensures that internal auditors don’t make undue assumptions about the validity of support, such as information received, without an appropriate level of objective verification of such support.

Question 19

An internal auditor is reviewing the construction of a bridge that is being built by his company. The auditor is not an engineer, but upon reviewing the bridge specifications, he notices that certain materials are being substituted with other products. What would the next step be?

a) Review the issue with an independent engineer obtained through a trade association or on retainer.

b) Review the issue with the project manager of the bridge construction project.

c) Do nothing, as the substituted products were approved by the project manager, who is experienced in many bridge construction projects.

d) Call the vendor that sent the material and inquire if the substituted products are within specifications.

Answer 19

a) Review the issue with an independent engineer obtained through a trade association or on retainer.

Rationale
Internal auditors should have no personal or professional involvement with or allegiance to the area being audited and should maintain an unbiased and impartial mindset in regard to all engagements. Internal auditors should not subordinate their judgment on audit matters to that of others.

Question 20

The best rationale for rotating internal auditors so that different individuals are assigned to consecutive audits of a given auditee is to

a) increase the diligence exercised by internal auditors who know that the quality of their work will be apparent to the next set of internal auditors.

b) avoid the development of bias toward a given auditee.

c) promote rapid professional development on the part of internal auditors by exposing them to the full range of organizational activities.

d) prevent burnout on the part of the internal auditor, which may lead to excessive turnover in the internal audit department.

Answer 20

b) avoid the development of bias toward a given auditee.

Rationale
Avoiding the development of bias is the primary reason. The alternatives may be desirable, but they are not the basis for the rotation preference.

Question 21

A new senior internal auditor was a compliance manager in the organization prior to joining the internal audit department. After joining the internal audit department, when can the senior auditor participate in a compliance assurance engagement?

a) Immediately.
b) In six months.
c) In one year.
d) In ninety days.

Answer 21

c) In one year.

Rationale
Standard 1130.A3 states that objectivity is “presumed to be impaired if an internal auditor provides assurance services for an activity for which they had responsibility within the previous year.”

Question 22

An internal auditor is assigned to an operations audit to assess the efficiency of recently introduced just-in-time manufacturing procedures. The auditor finds out that he knows the external consultant who is on site managing the implementation of the new system; this person was the adviser on the auditor’s thesis and was instrumental in getting him his first job. Which of the following responses by the auditor would be most consistent with The IIA’s International Professional Practices Framework?

a) The internal auditor should disclose the relationship to the chief audit executive (CAE), and the CAE may choose to assign a different internal auditor.

b) The internal auditor need not disclose the relationship but should be certain that he has no contact, such as an audit interview, with the consultant during the course of the audit.

c) The internal auditor should disclose the potential conflict of interest to the board or audit committee, preferably in writing.

d) The potential conflict should be disclosed to the engagement client before accepting the engagement.

Answer 22

a) The internal auditor should disclose the relationship to the chief audit executive (CAE), and the CAE may choose to assign a different internal auditor.

Rationale
Potential impairments to objectivity or independence should be disclosed to the CAE before accepting the engagement. In a consulting engagement such as this one, the CAE would be likely to remove the internal auditor only if the CAE were concerned about conformance to the Code of Ethics and the auditor’s ability to perform and maintain objectivity.

Question 23

Which of the following would most likely cause an internal auditor to lose objectivity?

a) The passage of time between audits.
b) Asking a colleague for input or feedback.
c) Corroboration of judgement by others.
d) A bonus largely based on client satisfaction surveys.

Answer 23

d) A bonus largely based on client satisfaction surveys.

Rationale
If an internal auditor’s bonus is based on client satisfaction, the auditor may hesitate to report negative results that may cause the client to report low satisfaction ratings. Corroboration of judgement by others, the passage of time between audits, and asking a colleague for input or feedback are factors that mitigate threats to objectivity.

Question 24

The chief audit executive (CAE) is informed by a client just before a scheduled assurance engagement is about to begin that the agreed-upon schedule will have to be significantly shortened to accommodate an unexpected crisis that has tied up most of the client’s resources. The internal auditors will have less time for interviews and observations because of the difficulties the unit is experiencing. Which of the following actions should the CAE take?

a) The CAE should consider the situation a red flag and schedule a fraud audit.

b) The CAE should change the schedule according to the client’s needs and document the change in the final report.

c) Since schedules are not specified in the audit charter, the situation is not a limitation of scope, and the CAE can use his or her judgment about informing the board.

d) Inform the board of the situation, preferably in writing, because it is a limitation of scope.

Answer 24

d) Inform the board of the situation, preferably in writing, because it is a limitation of scope.

Rationale
Restrictions of an approved schedule are a limitation of scope and should therefore be reported to the board, preferably in writing (Implementation Guide 1130). Difficulties arise in the normal course of business and do not, of themselves, constitute sufficient evidence to warrant a fraud audit.

Question 25

Management has requested the internal auditing department to perform an operational audit of the telephone marketing operations of a major division and to recommend procedures and policies for improving management control over the operation. The auditor should

a) not accept the engagement, because audit departments are presumed to have expertise in accounting controls, not marketing controls.

b) accept the engagement, but indicate to management that recommending controls would impair audit independence so management knows that near-future audits of the area by the same auditor would be impaired.

c) accept the audit engagement, because objectivity would not be impaired.

d) not accept the engagement, because recommending controls would impair the future objectivity of the department regarding this auditee.

Answer 25

c) accept the audit engagement, because objectivity would not be impaired.

Rationale
The auditor should accept the engagement, assign staff with sufficient control knowledge, and make recommendations where appropriate. This would not impair objectivity.

Question 26

Which is the best example of an internal auditor’s professional skepticism?

a) Noting conditions that indicate compliance with policies and procedures

b) Reviewing the external auditor’s management letter

c) Placing emphasis on audit evidence that contradicts other evidence obtained

d) Noting that policies and procedures were revised after the audit was announced

Answer 26

c) Placing emphasis on audit evidence that contradicts other evidence obtained

Rationale
Maintaining professional skepticism ensures that internal auditors do not make undue assumptions about the validity of support, such as verbal explanations from management or other information received, without an appropriate level of objective verification of such support. Audit evidence that contradicts other evidence obtained would be the best example of professional skepticism.

Question 27

An auditor makes a preliminary determination that a major division has been inappropriately capitalizing research and development expense. The audit is not yet completed, and the auditor has not documented the problem or determined that it really is a problem. However, the auditor is informed that the director of internal auditing has received the following communication from the president of the company:

“The controller of Division B informs me that you have discovered a questionable account classification dealing with research and development expense. We are aware of the issue. You are directed to discontinue any further investigation of this matter until informed by me to proceed. Under the confidentiality standard of your profession, I also direct you not to communicate with the outside auditors regarding this issue.”

Which of the following would be an appropriate action for the director to take regarding the questionable item?

a) Immediately report the communication to The Institute of Internal Auditors and ask for an ethical interpretation and guidance.

b) Immediately notify the external auditors of the problem to avoid aiding and abetting a potential crime by the organization.

c) Continue to investigate the area until all the facts are determined, and document all the relevant facts in the audit workpapers.

d) Inform the president that this scope limitation will need to be reported to the chairperson of the audit committee.

Answer 27

d) Inform the president that this scope limitation will need to be reported to the chairperson of the audit committee.

Rationale
The chief audit executive should communicate the scope limitation to the board. However, it would be appropriate to ensure that the president is aware of this.

Question 28

In which of the following situations does the internal auditor potentially lack objectivity?

a) Four months after being transferred to the internal audit activity, a former purchasing assistant performs a review of internal controls over purchasing.

b) An internal auditor recommends standards of control and performance measures for contracting with a service organization.

c) A payroll accounting employee assists an internal auditor in verifying the physical inventory of small motors.

d) An internal auditor reviews the procedures for a new electronic data interchange connection for a customer before it is implemented.

Answer 28

a) Four months after being transferred to the internal audit activity, a former purchasing assistant performs a review of internal controls over purchasing.

Rationale
Per Standard 1120, a conflict of interest is “a situation in which an internal auditor, who is in a position of trust, has a competing professional or personal interest. Such competing interests can make it difficult to fulfill his or her duties impartially. A conflict of interest exists even if no unethical or improper act results. A conflict of interest can create an appearance of impropriety that can undermine confidence in the internal auditor, the internal audit activity, and the profession.” In this scenario, the purchasing assistant has a conflict of interest because he or she worked in the purchasing department within the last year. Standard 1130.A1 states that “Objectivity is presumed to be impaired if an internal auditor provides assurance services for an activity for which the internal auditor had responsibility within the previous year.” This presumption of lack of objectivity exists because the auditor may not be wholly objective in auditing his or her previous department and colleagues’ work.

Question 29

A company is in the process of restructuring to enhance future growth. The chief audit executive (CAE) currently reports both functionally and administratively to the compliance director, who reports both functionally and administratively to the chief legal officer (CLO). In order to maximize the independence of the audit function, what changes should be made to the CAE’s reporting structure?

a) The audit function is positioned appropriately and does not require any reporting changes.

b) The CAE should report functionally to the board or a similar governing body, but no changes to the administrative reporting line are needed.

c) The CAE should report functionally to the board or a similar governing body and should report administratively to the CEO.

d) The CAE should report both functionally and administratively to the CLO.

Answer 29

c) The CAE should report functionally to the board or a similar governing body and should report administratively to the CEO.

Rationale
The Implementation Guide for Standard 1110 states:

“To ensure effective organizational independence, the CAE has a direct functional reporting line to the board. Generally, the CAE also has an administrative, or ‘dotted,’ reporting line to a member of senior management.”

“To enhance stature and credibility, The IIA recommends that the CAE report administratively to the chief executive officer (CEO) so that the CAE is clearly in a senior position, with the authority to perform duties unimpeded.”

Question 30

Which of the following is a safeguard implemented to protect the independence of the internal audit function?

a) The chief audit executive has a direct functional reporting relationship with the chairperson of the audit committee of the board or other governing body.

b) The CEO may determine the scope of audit activities without the input of the board or other governing body.

c) Internal auditors are awarded annual bonuses commensurate with the number of audit issues they document.

d) The chief audit executive is assigned to manage the quality control department as an extension of his or her duties.

Answer 30

a) The chief audit executive has a direct functional reporting relationship with the chairperson of the audit committee of the board or other governing body.

Rationale
The Practice Guide “Independence and Objectivity” states, “An internal audit activity with a broad assurance and consulting role ideally should report directly to the governing board of the organization, and more specifically, to the audit committee of the board or other similar body.”

Question 31

Which of the following is most likely to enable the internal audit activity to carry out its responsibilities in an unbiased manner?

a) The chief audit executive self-assesses against a competency framework or benchmark.

b) The chief audit executive has direct and unrestricted access to senior management and the board.

c) The chief audit executive reports functionally to the chief executive officer.

d) The chief audit executive reports administratively to the board.

Answer 31

b) The chief audit executive has direct and unrestricted access to senior management and the board.

Rationale
The IPPF Glossary defines independence is “the freedom from conditions that threaten the ability of the internal audit activity to carry out internal responsibilities in an unbiased manner.” The interpretation to Standard 1100: Independence and Objectivity states: “To achieve the degree of independence necessary to effectively carry out the responsibilities of the internal audit activity, the chief audit executive has direct and unrestricted access to senior management and the board.” Self-assessments demonstrate an individual internal auditor’s continuing professional development (IG 1230: Continuing Professional Development). The IIA recommends that the chief audit executive report functionally to the board and administratively to the chief executive officer (IG 1100: Independence and Objectivity).

Question 32

An internal auditor has been assigned to an assurance audit of the organization’s training department. Which condition would constitute a threat to the internal auditor’s objectivity, as defined by The IIA’s Code of Ethics?

a) The auditor is unfamiliar with the basic principles of training.

b) The auditor has a very favorable opinion of the organization overall based on its national reputation.

c) The auditor has a background in developing training materials from a previous job with another organization.

d) The auditor has a very unfavorable opinion of the department based on experience with its internal seminars.

Answer 32

d) The auditor has a very unfavorable opinion of the department based on experience with its internal seminars.

Rationale
The internal auditor’s objectivity may be compromised by either a positive or negative predisposition in regard to the audit client. However, the overall organization is not the current audit client, and, in assessing objectivity, it is important to consider what would be “reasonable” versus what could be perceived as a conflict of interest. Experience with another organization’s approach to training is not necessarily a problem for objectivity.

Question 33

To manage internal audit objectivity effectively, the chief audit executive (CAE) should establish expectations and requirements for an unbiased mindset for every internal auditor. Such expectations would be most evident in the internal auditor’s review of

a) laws and regulations.
b) inventory estimates.
c) going-concern assessments.
d) industry best-practices guides.

Answer 33

b) inventory estimates.

Rationale
A review of inventory estimates would require an auditor to maintain a high level of individual objectivity due to the subjectivity potential of estimates. There is little room for subjectivity in industry best-practice guides or laws and regulations. Going-concern assessments may involve some subjectivity, but much of the data will be objective financial data.

Question 34

An internal auditor takes the advice of a manager and modifies a planned assurance audit test. The test may not be as thorough, but the modification could save some time. Which is this an example of?

a) Functionally reporting to management
b) Administratively reporting to management
c) Impairment of objectivity
d) Impairment of independence

Answer 34

c) Impairment of objectivity

Rationale
This is an example of an impairment to objectivity. The internal auditor has modified a planned approach based on what is likely the undue influence of another person, someone probably senior to the internal auditor, without appropriate justification.

Question 35

Which of the following best demonstrates conformance with objectivity?

a) Competency assessments of the internal audit activity.

b) Records of a recruitment and training strategy, and job descriptions.

c) Internal audit workpaper templates and engagement plans.

d) Performance evaluation and compensation processes.

Answer 35

d) Performance evaluation and compensation processes.

Rationale
It is widely understood that compensation practices can significantly affect objectivity. Competency assessments, workpaper templates and engagement plans, and records of recruitment better demonstrate conformance with proficiency and due professional care, and would be secondary considerations for objectivity.

Question 36

Which is acceptable for an internal auditor to do while still maintaining his or her professional judgment?

a) Sitting at a vendor’s table at a charitable event honoring the auditor’s company

b) Accepting a lunch invitation and allowing someone to buy lunch at an expensive restaurant

c) Attending an employee event at a potential vendor

d) Participating in a birthday celebration within the department being reviewed

Answer 36

d) Participating in a birthday celebration within the department being reviewed

Rationale
An internal auditor must maintain objectivity in fact and in appearance. Accepting a lunch invitation or allowing someone to buy lunch should not compromise objectivity, but consider what is “reasonable” versus what could be perceived as a conflict of interest. In this case, lunch at an expensive restaurant may be perceived to be a problem. Attending an employee event at a potential vendor or sitting at a vendor’s table at a charitable event honoring the auditor’s company can likewise be perceived as lack of objectivity.

Question 37

When reviewing and evaluating the organizational status of the internal audit activity to increase and improve independence, the governing body should consider which of the following factors?

a) Previous organizational statuses implemented throughout the life of the organization and the relevant purposes for change

b) Internal political impact of the reporting lines of the chief audit executive

c) Individual preferences of executive management and the chief audit executive

d) Governing board’s involvement in decisions to hire or remove the chief audit executive and in drafting and approving an internal audit charter

Answer 37

d) Governing board’s involvement in decisions to hire or remove the chief audit executive and in drafting and approving an internal audit charter

Rationale
The Practice Guide “Independence and Objectivity” lists five factors to consider in this case:

• Reporting level of the chief audit executive (CAE) within the organization
• CAE’s unrestricted access to information throughout the organization and the governing board
• Governing board’s involvement in decisions to hire or remove the CAE and in drafting and approving an internal audit charter
• Role of the governing board in influencing the budget for, and the scope of, internal audit activities and remuneration and retention of the CAE
• Active involvement, oversight, review, and follow-up by the governing board with the internal audit activity

Question 38

What attribute is most likely to be impaired when internal audit reports to the chief financial officer?
a) Confidentiality.
b) Independence.
c) Objectivity.
d) Competence.

Answer 38

b) Independence.

Rationale
When internal audit reports within other functions in an organization, it is not considered independent of that function, which is subject to audit.

Question 39

A bonus structure based on client satisfaction surveys is most likely to significantly and negatively affect which of the following?
a) Competence.
b) Confidentiality.
c) Objectivity.
d) Independence.

Answer 39

c) Objectivity.

Rationale
It is widely understood that performance and compensation practices can significantly and negatively affect and individual’s objectivity. Such conditions are less likely to significantly and negatively affect independence, competence, or confidentiality.

Question 40

A new senior auditor was director of risk management in the organization prior to joining the internal audit department. After joining the internal audit department, when can the senior auditor participate in a risk management consulting engagement?
a) In six months.
b) Immediately.
c) In ninety days.
d) In one year.

Answer 40

b) Immediately.

Rationale
Standard 1130.A3 states that objectivity is presumed to be impaired if internal auditors provide assurance services for an activity for which they had responsibility within the previous year. The restriction does not apply to consulting services.

Question 41

The chief audit executive (CAE) of an organization’s internal audit activity should have the authority to do which of the following without seeking specific approval from senior management?

a) Alter the approved audit plan in response to scope limitations.

b) Assign an internal auditor to an assurance engagement in an area where the auditor was employed within the preceding year without disclosing the action.

c) Implement the audit plan, including consulting audits.

d) Take on expected roles and responsibilities that fall outside of internal auditing, without limits.

Answer 41

c) Implement the audit plan, including consulting audits.

Rationale
Senior management cannot interfere with the delivery of the audit plan. Standard 2020 requires that an audit plan be approved by the audit committee, not senior management. The approved plan cannot be altered without senior management and board approval, however. According to Attribute Standard 1112, if the CAE “has or is expected to have roles and/or responsibilities that fall outside of internal auditing, safeguards must be in place to limit impairments to independence or objectivity.”

Question 42

The chief audit executive (CAE) has been appointed to a committee to evaluate the appointment of the external auditors. The engagement partner for the external accounting firm wants the director to join him for a week of hunting at his private lodge. The CAE should

a) ask the comptroller if this would be a violation of the company’s code of ethics.

b) accept, as long as it is not charged to company time.

c) refuse on the grounds of conflict of interest.

d) accept, assuming that both their schedules allow it.

Answer 42

c) refuse on the grounds of conflict of interest.

Rationale
The CAE has to avoid conflict of interest or activities that might prejudice his/her ability to carry out assigned duties. The CAE may not accept anything of value that might impair his/her professional judgment.

Question 43

Which of the following most likely represents the highest level of independence?

a) The executive team receives communications from the chief audit executive on internal audit’s performance.

b) The chief executive officer approves the risk-based audit plan.

c) The board asks the chief audit executive to determine whether there are inappropriate scope or resource limitations.

d) The audit committee approves the chief audit executive’s requests for time off.

Answer 43

c) The board asks the chief audit executive to determine whether there are inappropriate scope or resource limitations.

Rationale
The interpretation to Standard 1110: Independence and Objectivity notes that to have the degree of independence necessary, internal audit needs to report functionally to the board, and cites an example of the board making appropriate inquiries of management and the chief audit executive to determine whether there are inappropriate scope or resource limitations. The chief audit executive’s approval of the risk-based plan and the executive team’s receipt of communications do not provide independence because management is responsible for managing risk. Independence is achieved through functional reporting to the board – the audit committee’s approval of the chief audit executive’s requests for time off is an example of administrative reporting.

Question 44

The internal auditing department encounters a scope limitation from senior management that will affect its ability to meet its goals and objectives for a potential auditee. The nature of the scope limitation should be

a) communicated to management, stating that the limitation will not be accepted because it would impair the audit department’s independence.

b) communicated to the board, preferably in writing.

c) communicated to the external auditors so they can investigate the area in more detail.

d) noted in the audit working papers, but the audit should be carried out as scheduled and the scope limitation worked around, if possible.

Answer 44

b) communicated to the board, preferably in writing.

Rationale
A scope limitation, along with its potential effect, needs to be communicated to the board, preferably in writing.

Question 45

In which of the following situations does the internal auditor potentially lack objectivity?

a) An internal auditor reviews the procedures for a new electronic data interchange connection for a customer before it is implemented.

b) An internal auditor recommends standards of control and performance measures for contracting with a service organization.

c) Four months after being transferred to the internal audit activity, a former purchasing assistant performs a review of internal controls over purchasing.

d) A payroll accounting employee assists an internal auditor in verifying the physical inventory of small motors.

Answer 45

c) Four months after being transferred to the internal audit activity, a former purchasing assistant performs a review of internal controls over purchasing.

Rationale
Per Standard 1120, a conflict of interest is “a situation in which an internal auditor, who is in a position of trust, has a competing professional or personal interest. Such competing interests can make it difficult to fulfill his or her duties impartially. A conflict of interest exists even if no unethical or improper act results. A conflict of interest can create an appearance of impropriety that can undermine confidence in the internal auditor, the internal audit activity, and the profession.” In this scenario, the purchasing assistant has a conflict of interest because he or she worked in the purchasing department within the last year. Standard 1130.A1 states that “Objectivity is presumed to be impaired if an internal auditor provides assurance services for an activity for which the internal auditor had responsibility within the previous year.” This presumption of lack of objectivity exists because the auditor may not be wholly objective in auditing his or her previous department and colleagues’ work.

Question 46

An external reviewer of an internal audit department found that auditor evaluations were heavily focused on the number of observations and staying within the audit budget. These conditions most strongly suggest that which of the following attributes might be compromised?
a) Objectivity.
b) Independence.
c) Competency.
d) Integrity.

Answer 46

a) Objectivity.

Rationale
According to IG 1120, if an internal auditor evaluation process is heavily focused on the number of evaluations, or on staying within the audit budget, it could cause the auditor to lose objectivity and either report a relatively minor issue as an audit finding, or ignore warning signs of new issues that arise near the end of an engagement when the budget is nearly depleted.

Question 47

Which of the following is a safeguard implemented to protect the independence of the internal audit function?

a) Internal auditors are awarded annual bonuses commensurate with the number of audit issues they document.

b) The chief audit executive is assigned to manage the quality control department as an extension of his or her duties.

c) The chief audit executive has a direct functional reporting relationship with the chairperson of the audit committee of the board or other governing body.

d) The CEO may determine the scope of audit activities without the input of the board or other governing body.

Answer 47

c) The chief audit executive has a direct functional reporting relationship with the chairperson of the audit committee of the board or other governing body.

Rationale
The Practice Guide “Independence and Objectivity” states, “An internal audit activity with a broad assurance and consulting role ideally should report directly to the governing board of the organization, and more specifically, to the audit committee of the board or other similar body.”

Question 48

Which of the following management requests would be within the normal audit scope?

a) Perform an independent evaluation of management’s planning process as a basis for making recommendations.

b) Analyze financing alternatives and present the alternatives to the audit committee.

c) Do a make-or-buy decision analysis to determine whether the company should subcontract for part of its manufacturing versus adding capacity; report the recommendation to management for approval.

d) Talk with banks to identify financing alternatives, and negotiate contract alternatives that would be presented to management for evaluation.

Answer 48

a) Perform an independent evaluation of management’s planning process as a basis for making recommendations.

Rationale
The planning process is part of the management control system, and its evaluation is part of the normal scope of the auditor’s activities. Talking with banks and make-or-buy decisions are management, not audit, functions. They have the potential to impair the auditor’s independence. The auditor should concentrate on management’s planning and evaluation process and report on that process to the audit committee.