Internal Control in a Financial Statement Audit (1-27 Answer Key)

Auditing & Assurance Services: A Systematic Approach Internal Control in a Financial Statement Audit 1) The concept of internal control includes IT systems and manual systems. Answer: TRUE 2) The auditor must understand internal control before assessing inherent risk. Answer: FALSE 3) The extent of an entity's use of IT can affect internal control. Answer: TRUE 4) One of the risks associated with internal control from IT is potential loss of data. Answer: TRUE 5) Internal control consists of six components. Answer: FALSE 6) Internal control includes monitoring of controls. Answer: TRUE 7) A reliance strategy is used when control risk has been set at high. Answer: FALSE 8) A substantive strategy is used when control risk has been set at high. Answer: TRUE 9) Once a level of control risk has been established, it cannot be changed. Answer: FALSE 10) Tests of controls must be performed if control risk is set at a lower level. Answer: TRUE 11) Internal controls are not designed to provide reasonable assurance that: A) transactions are executed in accordance with management's authorization. B) embezzlement will be eliminated. C) access to assets is permitted only in accordance with management's authorization. D) amounts recorded for assets are compared with the actual existing assets at reasonable intervals. Answer: B 12) The basic concept of internal control that recognizes the cost of internal control should not exceed the benefits expected to be derived is known as: A) Reasonable assurance. B) Management responsibility. C) Limited liability. D) Management by exception. Answer: A 13) An auditor would most likely be concerned with internal control policies and procedures that provide reasonable assurance about the: A) efficiency of management's decision-making process. B) appropriate prices that the entity should charge for its products. C) methods of assigning production tasks to employees. D) entity's ability to accurately process and summarize financial data. Answer: D 14) Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when: A) external policies established by parties outside the entity affect its accounting practices. B) management is dominated by one individual. C) internal audit personnel have direct access to the board of directors and the entity's management. D) the audit committee is active in overseeing the entity's financial reporting policies. Answer: B 15) Management philosophy and operating style most likely would have a significant influence on an entity's control environment when: A) internal audit personnel have direct access to the board of directors and the entity's management. B) the entity does not have sound personnel policies for hiring, training, and evaluating competent individuals. C) accurate management job descriptions delineate specific duties. D) the audit committee actively oversees the financial reporting process. Answer: B 16) Proper monitoring within an internal control framework may include all of the following except: A) an external auditor. B) an effective audit committee. C) an internal audit function. D) the internal revenue service. Answer: D 17) An entity's control activities include all of the following except: A) Performance reviews. B) Information processing. C) External auditor's tests of controls. D) Segregation of duties. Answer: C 18) Potential benefits of an entity's controls in an IT environment include all of the following except: A) reduction in the risk that controls will be circumvented. B) eliminate human errors or mistakes. C) consistent application of predefined business rules. D) more timely information. Answer: B 19) An entity's IT infrastructure refers to: A) Hardware components. B) Programmers. C) Software. D) Data provided by the system. Answer: A 20) Auditors are most likely to gather audit evidence solely using substantive procedures: A) if transactions are recurring. B) if the implemented controls are assessed as ineffective. C) if control risk is very low. D) if the entity has a well-designed automated system. Answer: B 21) Proper segregation of functional responsibilities in an effective system of internal control calls for separation of the functions of: A) authorization, execution, and payment. B) authorization, recording, and custody. C) custody, execution, and reporting. D) authorization, payment, and recording. Answer: B 22) Factors that the auditor should consider as increasing the effectiveness of the audit committee include all of the following except whether: A) It is independent of management. B) It is comprised almost exclusively of members of management, ensuring detailed knowledge of the company's operations. C) It asks management difficult questions. D) It interacts regularly with internal audit personnel. Answer: B 23) The documentation of an auditor's understanding of internal controls: A) is optional. B) must be exclusively in narrative, questionnaires, or flowchart form. C) must include flowcharts. D) can include any combination of narratives, questionnaires, or flowcharts. Answer: D 24) A well-prepared flowchart should make it easier for the auditor to: A) prepare audit procedure manuals. B) prepare detailed job descriptions. C) perform walkthroughs. D) assess the degree of accuracy of financial data. Answer: C 25) A flowchart is most frequently used by an auditor in connection with the: A) preparation of generalized computer audit programs. B) review of the entity's internal controls. C) use of statistical sampling in performing an audit. D) performance of analytical procedures of account balances. Answer: B 26) An advantage of using systems flowcharts to document information about internal control instead of using internal control questionnaires is that systems flowcharts: A) identify whether segregation of duties prevent collusion. B) provide a visual depiction of the entity's activities. C) indicate whether controls are operating effectively. D) reduce the need to observe the entity's employees performing routine tasks. Answer: B 27) Which of the following audit tests would be regarded as a test of controls? A) Tests of the specific items making up the balance in a given general ledger account. B) Tests comparing inventory pricing to vendors' invoices. C) Tests of the signatures on canceled checks to the board of directors' authorizations. D) Tests of the additions to property, plant, and equipment by physical inspections. Answer: C