Auditing Internal Control Answer Key

Internal Control and COSO Framework 1) Which of the following is not one of the three primary objectives of effective internal control? A) reliability of financial reporting B) efficiency and effectiveness of operations C) compliance with laws and regulations D) assurance of elimination of business risk 2) With which of management's assertions with respect to implementing internal controls is the auditor primarily concerned? A) efficiency of operations B) reliability of financial reporting C) effectiveness of operations D) compliance with applicable laws and regulations 3) Internal controls A) are implemented by and are the responsibility of the auditors. B) consist of policies and procedures designed to provide reasonable assurance that the company achieves its objectives and goals. C) guarantee that the company complies with all laws and regulations. D) only apply to SEC companies. 4) Internal controls are not designed to provide reasonable assurance that A) all frauds will be detected. B) transactions are executed in accordance with management's authorization. C) the company's resources are used efficiently and effectively. D) company personnel comply with applicable rules and regulations. 5) Describe each of the three broad objectives management typically has for internal control. With which of these objectives is the auditor primarily concerned? - Reliability of financial reporting. Management has both a legal and professional responsibility to be sure that the information is fairly presented in accordance with reporting requirements - Efficiency and effectiveness of operations. Using its resources efficiently and effectively to optimize the company's goals. - Compliance with laws and regulations. All organizations are required to follow many laws and regulations. Some relate to accounting only indirectly, such as environmental protection and civil rights laws True false 6) Section 404 of the Sarbanes-Oxley Act requires that both private and public companies issue an internal control report. FALSE 7) Management has a legal and professional responsibility to be sure that the financial statements are prepared in accordance with reporting requirements of applicable accounting frameworks. 1 TRUE 11.2 Learning Objective 11-2 1) Who is responsible for establishing a private company's internal control? A) senior management B) internal auditors C) FASB D) audit committee 2) Two key concepts that underlie management's design and implementation of internal control are A) costs and materiality. B) absolute assurance and costs. C) inherent limitations and reasonable assurance. D) collusion and materiality. 3) The PCAOB places responsibility for the reliability of internal controls over the financial reporting process on A) the company's board of directors. B) the audit committee of the board of directors. C) management. D) the CFO and the independent auditors. 4) Which of the following parties provides an assessment of the effectiveness of internal control over financial reporting for public companies? A) Management Financial statement auditors Yes Yes B) Management No Financial statement auditors No Management Yes Financial statement auditors No Management No Financial statement auditors Yes C) D) 5) An act of two or more employees to steal assets and cover their theft by misstating the accounting records would be referred to as A) collusion. B) a material weakness. C) a control deficiency. D) a significant deficiency. 2 6) Sarbanes-Oxley requires management to issue an internal control report that includes two specific items. Which of the following is one of these two requirements? A) a statement that management is responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting B) a statement that management and the board of directors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting C) a statement that management, the board of directors, and the external auditors are jointly responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting D) a statement that the external auditors are solely responsible for establishing and maintaining an adequate system of internal control 7) When management is evaluating the design of internal control, management evaluates whether the control can do which of the following? A) Detect material misstatements Yes Correct material misstatements Yes Detect material misstatements No Correct material misstatements No Detect material misstatements Yes Correct material misstatements No Detect material misstatements No Correct material misstatements Yes B) C) D) 8) When one material weakness is present at the end of the year, management of a public company must conclude that internal control over financial reporting is A) insufficient. B) inadequate. C) ineffective. D) inefficient. 9) The auditors primary purpose in auditing the client's system of internal control over financial reporting is A) to prevent fraudulent financial statements from being issued to the public. B) to evaluate the effectiveness of the company's internal controls over all relevant assertions in the financial statements. C) to report to management that the internal controls are effective in preventing misstatements from appearing on the financial statements. 3 D) to efficiently conduct the Audit of Financial Statements. 10) The internal control framework used by most U.S. companies is the ________ framework. A) FASB B) PCAOB C) COSO D) SEC 11) In performing the audit of internal control over financial reporting, the auditor emphasizes internal control over classes of transactions because A) the accuracy of accounting system outputs depends heavily on the accuracy of inputs and processing. B) the class of transaction is where most fraud schemes occur. C) account balances are less important to the auditor then the changes in the account balances. D) classes of transactions tests are the most efficient manner to compensate for inherent risk. 12) Internal controls can never be regarded as completely effective. Even if company personnel could design an ideal system, its effectiveness depends on the A) adequacy of the computer system. B) proper implementation by management. C) ability of the internal audit staff to maintain it. D) competency and dependability of the people using it. 13) When considering internal controls, A) auditors can ignore controls affecting internal management information. B) auditors are concerned with the client's internal controls over the safeguarding of assets if they affect the financial statements. C) management is responsible for understanding and testing internal control over financial reporting. D) companies must use the COSO framework to establish internal controls. 14) Of the following statements about internal controls, which one is least likely to be correct? A) No one person should be responsible for the custodial responsibility and the recording responsibility for an asset. B) Transactions must be properly authorized before such transactions are processed. C) Because of the cost-benefit relationship, a client may apply controls on a test basis. D) Control procedures reasonably ensure that collusion among employees cannot occur. 15) The Sarbanes-Oxley Act requires A) all public companies to issue reports on internal controls. B) all public companies to define adequate internal controls. C) the auditor of public companies to design effective internal controls. D) the auditor of public companies to withdraw from an engagement if internal controls are weak. 16) Which of the following is an accurate statement regarding the auditor's responsibility for understanding internal control? A) Transaction-related audit objectives typically have no impact on the rights and obligations 4 objectives. B) Transaction-related audit objectives typically have a significant impact on the balance-related audit objective of realizable value. C) Auditors generally emphasize internal control over account balances rather than classes of transactions. D) Auditors and management are both equally concerned about controls that affect the efficiency and effectiveness of company operations. 17) The primary emphasis by auditors is on controls over A) classes of transactions. B) account balances. C) both A and B, because they are equally important. D) both A and B, because they vary from client to client. 18) An auditor should consider two key issues when obtaining an understanding of a client's internal controls. These issues are A) the effectiveness and efficiency of the controls. B) the frequency and effectiveness of the controls. C) the design and operating effectiveness of the controls. D) the implementation and operating effectiveness of the controls. 19) Reasonable assurance allows for A) low likelihood that material misstatements will not be prevented or detected by internal controls. B) no likelihood that material misstatements will not be prevented or detected by internal control. C) moderate likelihood that material misstatements will not be prevented or detected by internal control. D) high likelihood that material misstatements will not be prevented or detected by internal control. 20) Which of the following is most correct regarding the requirements under Section 404 of the Sarbanes-Oxley Act? A) The audits of internal control and the financial statements provide reasonable assurance as to misstatements. B) The audit of internal control provides absolute assurance of misstatement. C) The audit of financial statements provides absolute assurance of misstatement. D) The audits of internal control and the financial statements provide absolute assurance as to misstatements. True false 21) Under the Dodd-Frank federal financial reform legislation, all public companies are required to obtain an audit report on internal control over financial reporting. FALSE 22) When a company designs and implements internal controls, cost of the controls is not a valid consideration. FALSE 11.3 Learning Objective 11-3 5 1) Which of the following activities would be least likely to strengthen a company's internal control? A) separating accounting from other financial operations B) maintaining insurance for fire and theft C) fixing responsibility for the performance of employee duties D) carefully selecting and training employees 2) Which of the following components of the control environment define the existing lines of responsibility and authority? A) organizational structure B) management philosophy and operating style C) human resource policies and practices D) management integrity and ethical values 3) Which of the following factors may increase risks to an organization? A) Geographic dispersion of Presence of new information company operations technologies Yes Yes B) Geographic dispersion of company operations No Presence of new information technologies No Geographic dispersion of company operations Yes Presence of new information technologies No Geographic dispersion of company operations No Presence of new information technologies Yes C) D) 4) Which of the following statements is most correct with respect to separation of duties? A) A person who has temporary or permanent custody of an asset should account for that asset. B) Employees who authorize transactions should not have custody of related assets. C) Employees who open cash receipts should record the amounts in the subsidiary ledgers. D) Employees who authorize transactions should have recording responsibility for these transactions. 5) Authorizations can be either general or specific. Which of the following is not an example of a general authorization? A) automatic reorder points for raw materials inventory B) a sales manager's authorization for a sales return C) credit limits for various classes of customers 6 D) a sales price list for merchandise 6) Which of the following is correct with respect to the design and use of business documents? A) The documents should be in paper format. B) Documents should be designed for a single purpose to avoid confusion in their use. C) Documents should be designed to be understandable only by those who use them. D) Documents should be prenumbered consecutively to facilitate control over missing documents. 7) Which of the following best describes the purpose of control activities? A) the actions, policies and procedures that reflect the overall attitudes of management B) the identification and analysis of risks relevant to the preparation of financial statements C) the policies and procedures that help ensure that necessary actions are taken to address risks to the achievement of the entity's objectives D) activities that deal with the ongoing assessment of the quality of internal control by management 8) Which of the following deals with ongoing or periodic assessment of the quality of internal control by management? A) verifying activities B) monitoring activities C) oversight activities D) management activities 9) Which of the following best describes an entity's accounting information and communication system? A) Monitor transactions Yes Record and process transactions Yes Initiate transactions Yes Monitor transactions No Record and process transactions No Initiate transactions No Monitor transactions Yes Record and process transactions No Initiate transactions No Monitor transactions No Record and process transactions Yes Initiate transactions Yes B) C) D) 7 10) Which of the following is a risk assessment principle? A) accountability B) use relevant, quality information to support the functioning of internal controls C) consider the potential for fraud D) develop general controls over technology 11) Which of the following is not an underlying principle related to risk assessment? A) The organization should have clear objectives in order to be able to identify and assess the risks relating to the objectives. B) The auditors should determine how the company's risks should be managed. C) The organization should consider the potential for fraudulent behavior. D) The organization should monitor changes that could impact internal controls. 12) Which of the following is not one of the subcomponents of the control environment? A) management's philosophy and operating style B) organizational structure C) adequate separation of duties D) commitment to competence 13) It is important for the CPA to consider the competence of the clients' personnel because their competence has a direct impact upon the A) cost/benefit relationship of the system of internal control. B) achievement of the objectives of internal control. C) comparison of recorded accountability with assets. D) timing of the tests to be performed. 14) Proper segregation of functional responsibilities calls for separation of A) authorization, execution, and payment. B) authorization, recording, and custody. C) custody, execution, and reporting. D) authorization, payment, and recording. 15) Without an effective ________, the other components of the COSO framework are unlikely to result in effective internal control, regardless of their quality. A) risk assessment policy B) monitoring policy C) control environment D) system of control activities 16) Which of the following is an accurate statement regarding control activities? A) As the level of complexity of IT systems increases, the separation of duties often becomes blurred. B) Segregation of duties would be violated if the same person authorizes the payment of a vendor's invoice and also approves the disbursement of funds to pay the bill. C) The most important type of protective measure for safeguarding assets and records is the us of physical precautions. D) all of the above 17) If a company has an effective internal audit department, 8 A) the internal auditors can express an opinion on the fairness of the financial statements. B) their work cannot be used by the external auditors per PCAOB Standard 5. C) it can reduce external audit costs by providing direct assistance to the external auditors. D) the internal auditors must be CPAs in order for the external auditors to rely on their work. 18) To promote operational efficiency, the internal audit department would ideally report to A) line management. B) the PCAOB. C) the Chief Accounting Officer. D) the audit committee. 19) Hanlon Corp. maintains a large internal audit staff that reports directly to the accounting department. Audit reports prepared by the internal auditors indicate that the system is functioning as it should and that the accounting records are reliable. An independent auditor will probably A) eliminate tests of controls. B) increase the depth of the study and evaluation of administrative controls. C) avoid duplicating the work performed by the internal audit staff. D) place limited reliance on the work performed by the internal audit staff. 20) External financial statement auditors must obtain evidence regarding what attributes of an internal audit (IA) department if the external auditors intend to rely on IA's work? A) integrity B) objectivity C) competence D) all of the above 21) To obtain an understanding of an entity's control environment, an auditor should concentrate on the substance of management's policies and procedures rather than their form because A) management may establish appropriate policies and procedures but not act on them. B) the board of directors may not be aware of management's attitude toward the control environment. C) the auditor may believe that the policies and procedures are inappropriate for that particular entity. D) the policies and procedures may be so weak that no reliance is contemplated by the auditor. 22) The ________ is helpful in preventing classification errors if it accurately describes which type of transaction should be in each account. A) general ledger B) general journal C) trial balance D) chart of accounts 23) Control activities help assure that the necessary actions are taken to address risks to the achievement of the company's objectives. List the five types of control activities. - Adequate separation of duties - Proper authorization of transactions and activities - Adequate documents and records - Physical control over assets and records 9 - Independent checks on performance 24) Certain principles dictate the proper design and use of documents and records. Briefly describe several of these principles. - Documents should be prenumbered consecutively to facilitate control over missing documents and as an aid in locating documents when they are needed at a later date. - Documents and records should be prepared at the time a transaction takes place, or as soon as possible thereafter, to minimize timing errors. - Documents and records should be designed for multiple uses, when possible, to minimize the number of different forms. - Documents and records should be constructed in a manner that encourages correct preparation. This can be done by providing internal checks within the form or record. 25) Management's identification and analysis of risk is an ongoing process and is a critical component of effective internal control. An important first step is for management to identify factors that may increase risk. Identify at least five factors, observable by management, which may lead to increased risk in a typical business organization. - Failure to meet prior objectives - Quality of personnel - Geographic dispersion of company operations - Significance and complexity of core business processes - Introduction of new information technologies - Entrance of new competitors - Economic downturns - Rapid technology changes 26) Separation of duties is essential in preventing errors and intentional misstatements on the financial statements. List below the four general guidelines. 1. Separation of custody of the assets from accounting 2. Separation of the authorization of transactions from custody of related assets 3. Separation of operational responsibility from record keeping responsibility 4. Separation of IT duties from user departments 27) The internal control framework developed by COSO includes five so-called "components" of internal control. Discuss each of these five components. - The control environment. The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management, directors, and owners of an entity about internal control and its importance to the company. - Risk assessment. This is management's identification and analysis of risks relevant to the preparation of financial statements in accordance with appropriate accounting frameworks such as GAAP or IFRS. - Information and communication. These are the methods used to initiate, record, process, and report the entity's transactions and to maintain accountability for the related assets. - Control activities. These are the policies and procedures that management has established to meet its objectives for financial reporting. - Monitoring. This is management's ongoing and periodic assessment of the quality of internal control performance to determine whether controls are operating as intended and are modified when needed. 28) Discuss what is meant by the term "control environment" and identify four control environment subcomponents that the auditor should consider. - Integrity and ethical values 10 - Commitment to competence - Board of director or audit committee participation - Accountability - Organizational structure 29) List the four underlying principles of risk assessment per the COSO framework - Have clear objectives in order to identify risks related to those objectives - Determine how risks should be managed - Consider the potential for fraud - Monitor changes True false 30) Control activities are a subcomponent of the information and communication component of internal control. F 31) Adequate documents and records is a subcomponent of the control environment. F 32) The chart of accounts is helpful in preventing classification errors if it accurately describes which type of transaction should be in each account. T 33) Auditing standards prohibit reliance on the work of internal auditors due to the lack of independence of the internal auditors. F 34) If an auditor wishes to rely on the work of internal auditors (IA), the auditor must obtain satisfactory evidence related to the IA's competence, integrity, and objectivity. T 35) An example of a specific authorization is management setting a policy authorizing the ordering of inventory when less than a one-week supply is on hand. F 36) Personnel responsible for performing internal verification procedures must be independent of those originally responsible for preparing the data.T 11