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AUDITING REVIEW

Spring, 2012 Exam - Internal Control Note: Remember to record your answers on this exam

Answer the following questions on the enclosed answer sheet. Remember to also record your answers on this test. 1. Which of the following controls would be most effective in assuring that recorded purchases are free of material errors? a. The receiving department compares the quantity ordered on purchase orders with the quantity received on receiving reports. b. Vendors' invoices are compared with purchase orders by an employee who is independent of the receiving department. c. Receiving reports require the signature of the individual who authorized the purchase. d. Purchase orders, receiving reports, and vendors' invoices are independently matched in preparing vouchers. Which of the following types of evidence would an auditor most likely examine to determine whether internal control structure policies and procedures are operating as designed? a. Gross margin information regarding the client's industry. b. Confirmations of receivables verifying account balances. c. Client records documenting the use of EDP programs. d. Anticipated results documented in budgets or forecasts. Which of the following control procedures is not usually performed in the vouchers payable department? a. Determining the mathematical accuracy of the vendor's invoice. b. Having an authorized person approve the voucher. c. Controlling the mailing of the check and remittance advice. d. Matching the receiving report with the purchase order. Which of the following would be least likely to be considered an objective of an internal control structure? a. Checking the accuracy and reliability of accounting data. b. Detecting management fraud. c. Encouraging adherence to managerial policies. d. Safeguarding assets. An auditor observes the mailing of monthly statements to a client's customers and reviews evidence of a follow-up on errors reported by the customers. This test of controls most likely is performed to support management's financial statement assertions of Presentation Existence and disclosure or occurrence A Yes Yes b. Yes No c. No Yes d. No No

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To determine whether the internal control structure operated effectively to minimize errors of failure to invoice a shipment, the auditor would select a sample of transactions from the population represented by the a. Customer order file. b. Bill of lading file. c. Subsidiary customer accounts ledger. d. Sales invoice file. The physical count of inventory of a retailer was higher than shown by the perpetual records. Which of the following could explain the difference? a. Inventory items had been counted but the tags placed on the items had not been taken off the items and added to the inventory accumulation sheets. b. Credit memos for several items returned by customers had not been prepared. c. No journal entry had been made on the retailer's books for several items returned to its suppliers. d. An item purchased "FOB shipping point" had not arrived at the date of inventory count and had not been reflected in the perpetual records. In determining the effectiveness of an entity's policies and procedures relating to the existence or occurrence assertion for payroll transactions, an auditor most likely would inquire about and a. Observe the segregation of duties concerning human resources responsibilities and payroll disbursement. b. Inspect evidence of accounting for prenumbered payroll checks. c. Recompute the payroll deductions for employee fringe benefits. d. Verify the preparation of the monthly payroll account bank reconciliation. An auditor would most likely be concerned with internal control structure policies and procedures 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. Which of the following departments should have the responsibility for authorizing payroll rate changes? a. Human resources. b. Payroll. c. Treasurer. d. Timekeeping.

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After obtaining an understanding of an entity's internal control and assessing control risk, an auditor may next a. Perform tests of controls to verify management's assertions that are embodied in the financial statements. b. Consider whether evidential matter is available to support a further reduction in the assessed level of control risk. c. Apply analytical procedures as substantive tests to validate the assessed level of control risk. d. Evaluate whether controls detected material misstatements in the financial statements. Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? a. Understating the sales journal. b. Overstating the accounts receivable control account. c. Overstating the accounts receivable subsidiary ledger. d. Understating the cash receipts journal. Computer Services Company (CSC) processes payroll transactions for schools. Drake, CPA, is engaged to report on CSC's policies and procedures placed in operation as of a specific date. These policies and procedures are relevant to the schools' internal control structure, so Drake's report will be useful in providing the schools' independent auditors with information necessary to plan their audits. Drake's report expressing an opinion on CSC's policies and procedures placed in operation as of a specific date should contain a(an) a. Description of the scope and nature of Drake's procedures. b. Statement that CSC's management has disclosed to Drake all design deficiencies of which it is aware. c. Opinion on the operating effectiveness of CSC's policies and procedures. d. Paragraph indicating the basis for Drake's assessment of control risk. An auditor wishes to perform tests of controls on a client's cash disbursements procedures. If the control procedures leave no audit trail of documentary evidence, the auditor most likely will test the procedures by a. Inquiry and analytical procedures. b. Confirmation and observation. c. Observation and inquiry. d. Analytical procedures and confirmation.

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In connection with the examination of financial statements by an independent auditor, the client suggests that members of the internal audit staff be utilized to minimize audit costs. Which of the following tasks could most appropriately be delegated to the internal audit staff a. Selection of accounts receivable for confirmation, based upon the internal auditor's judgment as to how many accounts and which accounts will provide sufficient coverage. b. Preparation of schedules for negative accounts receivable responses. c. Evaluation of the internal control for accounts receivable and sales. d. Determination of the adequacy of the allowance for doubtful accounts. A procedure that would most likely be used by an auditor in performing tests of controls that involve segregation of functions and that leave no transaction trail is a. Inspection. b. Observation. c. Reperformance. d. Reconciliation. When considering the internal control structure, an auditor should be aware of the concept of reasonable assurance, which recognizes that a. Internal control policies and procedures may be ineffective due to mistakes in judgment and personal carelessness. b. Adequate safeguards over access to assets and records should permit an entity to maintain proper accountability. c. Establishing and maintaining the internal control structure is an important responsibility of management. d. The cost of an entity's internal control structure should not exceed the benefits expected to be derived. Proper authorization of write-offs of uncollectible accounts should be approved in which of the following departments? a. Accounts receivable. b. Credit. c. Accounts payable. d. Treasurer. Which of the following procedures concerning accounts receivable would an auditor most likely perform to obtain evidential matter in support of an assessed level of control risk below the maximum level? a. Observing an entity's employee prepare the schedule of past due accounts receivable. b. Sending confirmation requests to an entity's principal customers to verify the existence of accounts receivable. c. Inspecting an entity's analysis of accounts receivable for unusual balances. d. Comparing an entity's uncollectible accounts expense to actual uncollectible accounts receivable.

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In identifying matters for communication with an entity's audit committee, an auditor most likely would ask management whether a. The turnover in the accounting department was unusually high. b. It consulted with another CPA firm about accounting matters. c. There were any subsequent events of which the auditor was unaware. d. It agreed with the auditor's assessed level of control risk. Which of the following procedures most likely would not be an internal control procedure designed to reduce the risk of errors in the billing process? a. Comparing control totals for shipping documents with corresponding totals for sales invoices. b. Using computer programmed controls on the pricing and mathematical accuracy of sales invoices. c. Matching shipping documents with approved sales orders before invoice preparation. d. Reconciling the control totals for sales invoices with the accounts receivable subsidiary ledger. 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 who is also a shareholder. c. Internal auditors 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. Which of the following procedures most likely would provide an auditor with evidence about whether an entity's internal control activities are suitably designed to prevent or detect material misstatements? a. Reperforming the controls for a sample of transactions. b. Performing analytical procedures using data aggregated at a high level. c. Vouching a sample of transactions directly related to the controls. d. Observing the entity's personnel applying the controls. Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatements in an entity's financial statements? a. The entity's industry is experiencing declining customer demand. b. Employees who handle cash receipts are not bonded. c. Bank reconciliations usually include in-transit deposits. d. Equipment is often sold at a loss before being fully depreciated.

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Which of the following internal control procedures is not usually performed in the vouchers payable department? a. Matching the vendor's invoice with the related receiving report. b. Approving vouchers for payment by having an authorized employee sign the vouchers. c. Indicating the asset and expense accounts to be debited. d. Accounting for unused prenumbered purchase orders and receiving reports. Which of the following questions would an auditor least likely include on an internal control questionnaire concerning the initiation and execution of equipment transactions? a. Are requests for major repairs approved at a higher level than the department initiating the request? b. Are prenumbered purchase orders used for equipment and periodically accounted for? c. Are requests for purchases of equipment reviewed for consideration of soliciting competitive bids? d. Are procedures in place to monitor and properly restrict access to equipment? Which of the following information discovered during an audit most likely would raise a question concerning possible illegal acts? a. Related-party transactions, although properly disclosed, were pervasive during the year. b. The entity prepared several large checks payable to cash during the year. c. Material internal control weaknesses previously reported to management were not corrected. d. The entity was a campaign contributor to several local political candidates during the year. An auditor should obtain sufficient knowledge of an entity's accounting system to understand the a. Safeguards used to limit access to computer facilities. b. Process used to prepare significant accounting estimates. c. Procedures used to assure proper authorization of transactions. d. Policies used to detect the concealment of irregularities. Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle? a. Fictitious transactions may be recorded that cause an understatement of revenues and an overstatement of receivables. b. Claims received from customers for goods returned may be intentionally recorded in other customers' accounts. c. Authorization of credit memos by personnel who receive cash may permit the misappropriation of cash. d. The failure to prepare shipping documents may cause an overstatement of inventory balances.

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An auditor plans to apply substantive tests to the details of asset and liability accounts as of an interim date rather than as of the balance sheet date. The auditor should be aware that this practice a. Eliminates the use of certain statistical sampling methods that would otherwise be available. b. Presumes that the auditor will reperform the tests as of the balance sheet date. c. Should be especially considered when there are rapidly changing economic conditions. d. Potentially increases the risk that errors that exist at the balance sheet date will not be detected.

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Which of the following procedures would an auditor most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet? a. Observe the consistency of the employees' use of cash registers and tapes. b. Inquire about employees' access to recorded but undeposited cash. c. Trace deposits in the cash receipts journal to the cash balance in the general ledger. d. Compare the cash balance in the general ledger with the bank confirmation request. In assessing the competence of an internal auditor, an independent CPA most likely would obtain information about the a. Quality of the internal auditor's working paper documentation. b. Organization's commitment to integrity and ethical values. c. Influence of management on the scope of the internal auditor's duties. d. Organizational levels to which the internal auditor reports. An auditors letter issued on reportable conditions relating to an entitys internal control structure observed during a financial statement audit should a. Include a brief description of the tests of controls performed in searching for reportable conditions and material weaknesses. b. Indicate that the reportable conditions should be disclosed in the annual report to the entitys shareholders. c. Include a paragraph describing managements assertion concerning the effectiveness of the internal control structure. d. Indicate that the audits purpose was to report on the financial statements and not to provide assurance on the internal control structure. An auditor suspects that certain client employees are ordering merchandise for themselves over the Internet without recording the purchase or receipt of the merchandise. When vendors' invoices arrive, one of the employees approves the invoices for payment. After the invoices are paid, the employee destroys the invoices and the related vouchers. In gathering evidence regarding the fraud, the auditor most likely would select items for testing from the file of all a. Cash disbursements. b. Approved vouchers. c. Receiving reports. d. Vendors' invoices.

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When assessing control risk at below the maximum level, an auditor is required to document the auditor's understanding of the I. Entity's control activities that help ensure management directives are carried out. II. Entity's control environment factors that help the auditor plan the engagement. a. I only. b. II only. c. Both I and II. d. Neither I nor II. In assessing the competence of a client's internal auditor, an independent auditor most likely would consider the a. Internal auditor's compliance with professional internal auditing standards. b. Client's policies that limit the internal auditor's access to management salary data. c. Evidence supporting a further reduction in the assessed level of control risk. d. Results of ratio analysis that may identify unusual transactions and events. Which of the following factors should an auditor consider in making a judgment about whether an internal control deficiency is so significant that it is a reportable condition? I. Diversity of the entity's business. II. Size of the entity's operations. a. I only. b. II only. c. Both I and II. d. Neither I nor II. The purpose of segregating the duties of hiring personnel and distributing payroll checks is to separate the a. Human resources function from the controllership function. b. Administrative controls from the internal accounting controls. c. Authorization of transactions from the custody of related assets. d. Operational responsibility from the record keeping responsibility. Which of the following matters would an auditor most likely communicate to an entity's audit committee? a. A list of negative trends that may lead to working capital deficiencies and adverse financial ratios. b. The level of responsibility assumed by management for the preparation of the financial statements. c. Difficulties encountered in achieving a satisfactory response rate from the entity's customers in confirming accounts receivables. d. The effects of significant accounting policies adopted by management in emerging areas for which there is no authoritative guidance.

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When communicating internal control structure related matters noted in an audit, an auditor's report issued on reportable conditions should indicate that a. Errors or irregularities may occur and not be detected because there are inherent limitations in any internal control structure. b. The issuance of an unqualified opinion on the financial statements may be dependent on corrective follow-up action. c. The deficiencies noted were not detected within a timely period by employees in the normal course of performing their assigned functions. d. The purpose of the audit was to report on the financial statements and not to provide assurance on the internal control structure. The objectives of the internal control structure for a production cycle are to provide assurance that transactions are properly executed and recorded, and that a. Production orders are prenumbered and signed by a supervisor. b. Custody of work in process and of finished goods is properly maintained. c. Independent internal verification of activity reports is established. d. Transfers to finished goods are documented by a completed production report and a quality control report. Which of the following matters would an auditor most likely consider to be a reportable condition to be communicated to the audit committee? a. Management's failure to renegotiate unfavorable long-term purchase commitments. b. Recurring operating losses that may indicate going concern problems. c. Evidence of a lack of objectivity by those responsible for accounting decisions. d. Management's current plans to reduce its ownership equity in the entity. Which of the following procedures would an auditor most likely include in the planning phase of a financial statement audit? a. Obtain an understanding of the entity's risk assessment process. b. Identify specific internal control activities designed to prevent fraud. c. Evaluate the reasonableness of the entity's accounting estimates. d. Perform cutoff tests of the entity's sales and purchases. When an auditor increases the assessed level of control risk because certain control activities were determined to be ineffective, the auditor most likely would increase the a. Level of detection risk. b. Extent of tests of details. c. Level of inherent risk. d. Extent of tests of controls.

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In a well-designed internal control structure, employees in the same department most likely would approve purchase orders, and also a. Reconcile the open invoice file. b. Inspect goods upon receipt. c. Authorize requisitions of goods. d. Negotiate terms with vendors. Which of the following statements describes an auditor's obligation to identify deficiencies in the design or operation of internal control? a. The auditor should design and apply tests of controls to discover reportable conditions that could result in material misstatements. b. The auditor need not search for reportable conditions unless management requests an attestation that "no reportable conditions were noted in the audit." c. The auditor should search for reportable conditions if the auditor expects to assess control risk at below the maximum. d. The auditor need not search for reportable conditions but should document and communicate any reportable conditions that are discovered. Which of the following audit techniques ordinarily would provide an auditor with the least assurance about the operating effectiveness of an internal control activity? a. Inquiry of client personnel. b. Inspection of documents and reports. c. Observation of client personnel. d. Preparation of system flowcharts. To determine whether internal control relative to the revenue cycle of a wholesaling entity is operating effectively in minimizing the failure to prepare sales invoices, an auditor most likely would select a sample of transactions from the population represented by the a. Sales order file. b. Customer order file. c. Shipping document file. d. Sales invoice file. Which of the following procedures represents a weakness in internal controls 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.

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In assessing the objectivity of internal auditors, the independent CPA who is auditing the entity's financial statements most likely would consider the a. Internal auditing standards developed by The Institute of Internal Auditors. b. Tests of internal control activities that could detect errors and fraud. c. Materiality of the accounts recently inspected by the internal auditors. d. Results of the tests of transactions recently performed by the internal auditors. Which of the following events occurring in the year under audit would most likely indicate that internal controls utilized in previous years may be inadequate in the year under audit? a. The entity announced that the internal audit function would be eliminated after the balance sheet date. b. The audit committee chairperson unexpectedly resigned during the year under audit. c. The chief financial officer waived approvals on all checks to one vendor to expedite payment. d. The frequency of accounts payable check runs was changed from biweekly to weekly. When an auditor assesses control risk at the maximum level, the auditor is required to document the auditor's Understanding of the entity's accounting system No No Yes Yes Basis for concluding that control risk is at the maximum level No Yes No Yes

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Which of the following factors would most likely be considered an inherent limitation to an entity's internal control? a. The complexity of the information processing system. b. Human judgment in the decision-making process. c. The ineffectiveness of the board of directors. d. The lack of management incentives to improve the control environment. Which of the following factors would least likely affect the extent of the auditor's consideration of the client's internal controls? a. The amount of time budgeted to complete the engagement. b. The size and complexity of the client c. The nature of specific relevant controls. d. The auditor's prior experience with client operations.

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Sound internal control procedures dictate that immediately upon receiving checks from customers by mail, a responsible employee should a. Add the checks to the daily cash summary. b. Verify that each check is supported by a prenumbered sales invoice. c. Prepare a duplicate listing of checks received. d. Record the checks in the cash receipts journal. Which of the following statements is correct concerning an auditor's required communication of reportable conditions? a. A reportable condition previously communicated during the prior year's audit that remains uncorrected causes a scope limitation. b. An auditor should perform tests of controls on reportable conditions before communicating them to the client. c. An auditor's report on reportable conditions should include a restriction on the distribution of the report. d. An auditor should communicate reportable conditions after tests of controls, but before commencing substantive tests. 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. Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both a. Journalize cash receipts and disbursements and prepare financial statements. b. Monitor internal controls and evaluate whether the controls are operating as intended. c. Adopt new accounting pronouncements and authorize the recording of transactions. d. Record and conceal fraudulent transactions in the normal course of assigned tasks. Management's emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when a. Internal auditors have direct access to the entity's board of directors. b. A significant portion of management compensation is represented by stock options. c. External policies established by parties outside the entity affect accounting policies. d. The audit committee is active in overseeing the entity's financial reporting policies.

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Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle? a. Merchandise received is not promptly reconciled to the outstanding purchase order file. b. Obsolete items included in inventory balances are rarely reduced to the lower of cost or market value. c. The write-off of receivables by personnel who receive cash permits the misappropriation of cash. d. Fictitious transactions are recorded that cause an understatement of revenue and an overstatement of receivables.

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After testing a client's internal control activities, an auditor discovers a number of significant deficiencies in the operation of a client's internal controls. Under these circumstances the auditor most likely would a. Issue a disclaimer of opinion about the internal controls as part of the auditor's report. b. Increase the assessment of control risk and increase the extent of substantive tests. c. Issue a qualified opinion of this finding as part of the auditor's report. d. Withdraw from the audit because the internal controls are ineffective. Which of the following is an inherent limitation in internal control? a. Incompatible duties. b. Lack of segregation of duties. c. Faulty human judgment. d. Lack of an audit committee. The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that a. Specific internal control activities are not operating as designed. b. The collective effect of the control environment may not achieve the control objectives. c. Tests of controls may fail to identify activities relevant to assertions. d. Material misstatements may exist in the financial statements. After making inquiries about credit granting policies, an auditor selects a sample of sales transactions and examines evidence of credit approval. This test of controls most likely supports management's financial statement assertion(s) of Rights and obligations Yes Yes No No Valuation or allocation Yes No Yes No

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Which of the following matters is an auditor required to communicate to an entity's audit committee? a. Adjustments that were suggested by the auditor and recorded by management that have a significant effect on the entity's financial reporting process. b. The auditor's consideration of risk factors in assessing the risk of material misstatement arising from the misappropriation of assets. c. The results of the auditor's analytical procedures performed in the review stage of the engagement that indicate significant variances from expected amounts. d. Changes in the auditor's preliminary judgment about materiality that were caused by projecting the results of statistical sampling for tests of transactions.

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What is the most likely course of action that an auditor would take after determining that performing substantive tests on inventory will take less time than performing tests of controls? a. Assess control risk at the minimum level. b. Perform both tests of controls and substantive tests on inventory. c. Perform only substantive tests on inventory. d. Perform only tests of controls on inventory. In testing controls over cash disbursements, an auditor most likely would determine that the person who signs checks also a. Reviews the monthly bank reconciliation. b. Returns the checks to accounts payable. c. Is denied access to the supporting documents. d. Is responsible for mailing the checks. Which of the following questions would an auditor most likely include on an internal control questionnaire for notes payable? a. Are assets that collateralize notes payable critically needed for the entitys continued existence? b. Are two or more authorized signatures required on checks that repay notes payable? c. Are the proceeds from notes payable used for the purchase of noncurrent assets? d. Are direct borrowings on notes payable authorized by the board of directors? Evidence concerning the proper segregation of duties for receiving and depositing cash receipts ordinarily is obtained by a. Completing an internal control questionnaire that describes the control activities. b. Observing the employees who are performing the control activities. c. Performing substantive tests to verify the details of the bank balance. d. Preparing a flow chart of the duties performed and the entity's available personnel. 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. In assessing the competence of internal auditors, an independent CPA most likely would obtain information about the a. Influence of management on the scope of the internal auditors' duties. b. Policies limiting internal auditors from communicating with the audit committee. c. Quality of the internal auditors' working paper documentation. d. Entity's ability to continue as a going concern for a reasonable period of time. 16

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A client maintains a large data center where access is limited to authorized employees. How may an auditor best determine the effectiveness of this control activity? a. Inspect the policy manual establishing this control activity. b. Ask the chief technology officer about known problems. c. Observe whether the data center is monitored. d. Obtain a list of current data center employees. To provide assurance that each voucher is submitted and paid only once, an auditor most likely would examine a sample of paid vouchers and determine whether each voucher is a. Stamped "paid" by the check signer. b. Returned to the vouchers payable department. c. Supported by the vendor's invoice and purchase order. d. Prenumbered and accounted for. Which of the following is an inherent limitation of internal controls? a. Judgmental sampling. b. Collusion. c. Segregation of duties. d. Employee peer review. An auditor is auditing a mutual fund company that uses a transfer agent to handle accounting for shareholders. Which of the following actions by the auditor would be most efficient for obtaining information about the transfer agent's internal controls? a. Review reports on internal control placed in operation and its operating effectiveness produced by the agent's own auditor. b. Review prior-year workpapers to determine whether the number of transactions processed by the agent has materially increased. c. Perform an audit on the internal control function of the agent. d. Perform tests of controls on a sample of the audited firm's transactions through the agent. An auditor is determining if internal control relative to the revenue cycle of a wholesaling entity is operating effectively in minimizing the failure to prepare sales invoices. The auditor most likely would select a sample of transactions from the population represented by the a. Cash receipts file. b. Shipping document file. c. Customer order file. d. Sales invoice file.

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An audit client failed to maintain copies of its procedures manuals and organizational flowcharts. What should the auditor do in an audit of financial statements? a. Issue a qualified opinion on the basis of a scope limitation. b. Document the auditor's understanding of internal controls. c. Assess control risk at the maximum level. d. Restrict the auditor's responsibility to assess the effectiveness of controls in the audit engagement letter. Which of the following factors most likely would assist an independent auditor in assessing the objectivity of the internal auditor? a. The organizational status of the director of internal audit. b. The professional certifications of the internal audit staff. c. The consistency of the internal audit reports with the results of work performed. d. The appropriateness of internal audit conclusions in the circumstances. Which of the following describes a weakness in accounts payable procedures? a. The accounts payable clerk files invoices and supporting documentation after payment. b. The accounts payable clerk manually verifies arithmetic on the vendor invoice. c. The accounts payable system compares the receiving report to the vendor invoice. d. The accounts payable manager issues purchase orders. Which of the following situations most likely could lead to an embezzlement scheme? a. The accounts receivable bookkeeper receives a list of payments prepared by the cashier and personally makes entries in the customers' accounts receivable subsidiary ledger. b. Each vendor invoice is matched with the related purchase order and receiving report by the vouchers payable bookkeeper who personally approves the voucher for payment. c. Access to blank checks and signature plates is restricted to the cash disbursements bookkeeper who personally reconciles the monthly bank statements. d. Vouchers and supporting documentation are examined and then canceled by the treasurer who personally mails the checks to the vendors. Which of the following actions should the auditor take in response to discovering a deviation from the prescribed control procedure? a. Make inquiries to understand the potential consequence of the deviation. b. Assume that the deviation is an isolated occurrence without audit significance. c. Report the matter to the next higher level of authority within the entity. d. Increase sample size of tests of controls. Which of the following represents an inherent limitation of internal controls? a. Bank reconciliations are not performed on a timely basis. b. The CEO can request a check with no purchase order. c. Customer credit checks are not performed. d. Shipping documents are not matched to sales invoices.

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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. When assessing the competence of the internal auditors, an independent CPA should obtain information about the a. Organizational level to which the internal auditors report. b. Quality of the internal auditors' working paper documentation. c. Policies prohibiting internal auditors from auditing sensitive matters. d. Internal auditors' preliminary assessed level of control risk. Which of the following factors is most relevant when an auditor considers the client's organizational structure in the context of control risk? a. Management's attitude toward information processing and accounting departments. b. The organization's recruiting and hiring practices. c. Physical proximity of the accounting function to upper management. d. The suitability of the client's lines of reporting. 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. Which of the following factors is most likely to affect the extent of the documentation of the auditor's understanding of a client's system of internal controls? a. The industry and the business and regulatory environments in which the client operates. b. The degree to which information technology is used in the accounting function. c. The relationship between management, the board of directors, and external stakeholders. d. The degree to which the auditor intends to use internal audit personnel to perform substantive tests. 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.

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Which of the following activities performed by a department supervisor most likely would help in the prevention or detection of a payroll fraud? a. Distributing paychecks directly to department employees. b. Setting the pay rate for departmental employees. c. Hiring employees and authorizing them to be added to the payroll. d. Approving a summary of hours each employee worked during the pay period. An auditor is concerned about a policy of management override as a limitation of internal control. Which of the following tests would best assess the validity of the auditor's concern? a. Matching purchase orders to accounts payable. b. Verifying that approved spending limits are not exceeded. c. Tracing sales orders to the revenue account. d. Reviewing minutes of board meetings.

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When an auditor plans to rely on controls that have changed since they were last tested, which of the following courses of action would be most appropriate? a. Test the operating effectiveness of such controls in the current audit. b. Document that reliance and proceed with the original audit strategy. c. Inquire of management as to the effectiveness of the controls. d. Report the reliance in the report on internal controls. In which of the following circumstances would an auditor expect to find that an entity implemented automated controls to reduce risks of misstatement? a. When errors are difficult to predict. b. When misstatements are difficult to define. c. When large, unusual, or nonrecurring transactions require judgment. . d. When transactions are high-volume and recurring. According to COSO, the use of ongoing and separate evaluations to identify and address changes in internal control effectiveness can best be accomplished in which of the following states of the monitoring-for-change continuum? a. Control baseline. b. Change identification. c. Change management. d. Control revalidation/update. Which of the following is necessary to be an audit committee financial expert according to the criteria specified in the Sarbanes-Oxley Act of 2002? a. A limited understanding of generally accepted auditing standards. b. Education and experience as a certified financial planner. c. Experience with internal accounting controls. d. Experience in the preparation of tax returns. Which of the following positions best describes the nature of the Board of Directors of XYZ Co.s, relationship to the company? a. Agent. b. Executive. c. Fiduciary. d. Representative. In order to comply with a directors duty of loyalty to a corporation, what action(s) should a director take when presented with a corporate opportunity? a. Reject the opportunity and not offer it to the corporation. b. Accept the opportunity and not offer it to the corporation. c. Accept the opportunity and disclose the acceptance to the corporation. d. Offer the opportunity to the corporation and accept it if the corporation rejects it.

92.

93.

94.

95.

96.

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97.

Each of the following is a limitation of enterprise risk management (ERM), except a. ERM deals with risk, which relates to the future and is inherently uncertain. b. ERM operates at different levels with respect to different objectives. c. ERM can provide absolute assurance with respect to objective categories. d. ERM is effective as the people responsible for its functioning. An auditor has identified the controller's review of the bank reconciliation as a control to test. In connection, with this test, the auditor interviews the controller to understand the specific data reviewed on the reconciliation. In addition, the auditor verifies that the bank reconciliation is properly prepared by the accountant and reviewed by the controller as evidenced by their respective sign-offs. Which of the following types of audit procedures do these actions illustrate? a. Observation and inspection of records. b. Confirmation and reperformance. c. Inquiry and inspection of records. d. Analytical procedures and reperformance. Which of the following is not a component of internal control? a. Control environment. b. Control activities. c. Inherent risk. d. Monitoring. Each of the following types of controls is considered to be an entity-level control, except those a. Relating to the control environment. b. Pertaining to the company's risk assessment process. c. Regarding the company's annual stockholder meeting. d. Addressing policies over significant risk management practices. Which of the following statements is correct regarding internal control? a. A well-designed internal control environment ensures the achievement of an entity's control objectives. b. An inherent limitation to internal control is the fact that controls can be circumvented by management override. c. A well-designed and operated internal control environment should detect collusion perpetrated by two people. d. Internal control is a necessary business function and should be designed and operated to detect all errors and fraud.

98.

99.

100.

101.

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102.

When assessing internal auditors' objectivity, an independent auditor should a. Consider the policies that prohibit the internal auditors from auditing areas where they were recently assigned. b. Review the internal auditors' reports to determine that their conclusions are consistent with the work performed. c. Verify that the internal auditors' assessment of control risk is comparable to the independent auditor's assessment. d. Evaluate the quality of the internal auditors' working paper documentation and their recent audit recommendations. During a financial statement audit an internal auditor may provide direct assistance to the independent CPA in performing Tests of controls Substantive tests a. Yes Yes b. Yes No c. No Yes d. No No 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. The company being audited has an internal auditor that is both competent and objective. The independent auditor wants to assign tasks for the internal auditor to perform. Under these circumstances, the independent auditor may a. Allow the internal auditor to perform tests of internal controls. b. Allow the internal auditor to audit a major subsidiary of the company. c. Not assign any task to the internal auditor because of the internal auditor's lack of independence. d. Allow the internal auditor to perform analytical procedures, but not be involved with any test of details.

103.

104.

105.

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Essay Number I - Answer the following question on the enclosed answer sheet.
Smith, CPA, is the supervising partner of the financial statement audit of Digit Sales Co., a publicly held entity that files reports with the SEC. Hall, the senior auditor assigned to the engagement, had the following conversation with Smith at the end of the field work: Smith: Don't you think that Digit's board of directors will be surprised about those huge inventory adjustments that we had Digit book last week? Hall: I guess so, but what about that new assistant controller, Green? What incompetence! Hall: They never did collect a penny on that account.

Smith: I heard the customer finally filed for bankruptcy last month. Hall: At least Dodd finally booked the write-off after that poorly timed vacation.

Smith: I suppose so, but I still can't believe that Dodd took two weeks off near the end of our field work.. Hall: Actually, that was great. With Dodd gone, Green booked that inventory adjustment without much of a battle.

Smith: Well, I suppose Green has a bit to learn about GAAP, but I was really upset when Dodd, the controller, contacted that other CPA firm about the contingent liability I wanted booked. Hall: Which one was that?

Smith: Sure, but we couldn't finish the field work until Dodd signed the rep letter and booked that receivable write-off. The report was late, and it caused me grief with our managing partner. Hall: But that's not fair. It wasn't our fault. The bottom line is they got a clean opinion and this job is history.

Smith: You know, the employment discrimination suit filed by the union. Hall: Oh, now I remember. Digit's going to lose that one big time.

Smith: Not really. We haven't communicated with the audit committee yet. Hall: What do we have to tell them? They got an unqualified opinion ... and remember, there were only a few reportable conditions. I'm out of here.

Smith: Right! You know it. I know it. The lawyer knows it. Even Dodd knows it. But it wasn't booked until the other CPAs agreed with me. Hall: Well, the important thing is that they did book it. I was more upset about their twoweek delay in having the financial statements completed on time.

Required: a. From this discussion, what specific matters is Smith required to communicate to Digits audit committee? Do not include matters that are not required to be communicated under GAAS. What other matters (omitted from the discussion above) is Smith required to communicate to Digits audit committee under GAAS.

Smith: I know it cost us a lot of time, but Dodd was never late on that before. Maybe I should change the dates on next year's engagement letter rather than complain to the board. Hall: How about that large receivable? b.

Smith: What a joke! Dodd wouldn't write that overdue account off, and Digit doesn't even sell that model anymore. At least Green was on our side.

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Essay Problem II An auditor's working papers include the narrative description below of the cash receipts and billing portions of Southwest Medical Center's internal control. Southwest is a health care provider that is owned by a partnership of 5 physicians. It employs 11 physicians, including the 5 owners, 20 nurses, 5 laboratory and X lay technicians, and 4 clerical workers. The clerical workers perform such tasks as reception, correspondence, cash receipts, billing, accounts; receivable, bank deposits, and appointment scheduling. These clerical workers are referred to in the narrative as "office manager." "clerk #1," "clerk # and "clerk #3." Assume that the narrative is a complete description of the system. Required: a. Using only the information in the narrative, describe the strengths in Southwest's internal control that an auditor most likely could consider in assessing control risk below the maximum level. b. Using only the information in the narrative, describe the weaknesses in Southwest's internal control that could permit material misstatements to occur in the financial statements. In addition, for each weakness, identify one internal control activity that most likely could help correct that weakness. Use the following format for requirement b. Weaknesses Internal Control Activities

NARRATIVE About two-thirds of Southwest's patients receive medical services only after insurance coverage is verified by the office manager and communicated to the clerks. Most of the other patients pay for services by cash or check when services are rendered, although the office manager extends credit on a case by case basis to about 5% of the patients. When services are rendered, the attending physician prepares a prenumbered service slip for each patient and gives the slip to clerk #1 for pricing. Clerk #1 completes the slip and gives the completed slip to clerk #2 and a copy to the patient. Using the information on the completed slip, clerk #2 performs one of the following three procedures for each patient. Clerk #2 files all insurance claims and records a receivable from the insurance company if the office manager has verified the patient's coverage, or Clerk #2 posts a receivable from the patient on clerk #2's PC if the office manager has approved the patient's credit, or 25

Clerk #2 receives cash or a check from the patient as the patient leaves the medical center, and clerk #2 records the cash receipt.

At the end of each day, clerk #2 prepares a revenue summary. Clerk #l performs correspondence functions and opens the incoming mail. Clerk #1 gives checks from insurance companies and patients to clerk #2 for deposit. Clerk #2 posts the receipt of patients' checks on clerk #2's PC patient receivable records and insurance companies' checks to the receivables from the applicable insurance companies. Clerk #1 gives mail requiring correspondence to clerk #3. Clerk #2 stamps all checks "for deposit only" and each day prepares a list of checks and cash to be deposited in the bank. (This list also includes the cash and checks personally given to clerk #2 by patients.) Clerk #2 keeps a copy of the deposit list and gives the original to clerk #3. Clerk #3 personally makes the daily bank deposit and maintains a file of the daily bank deposits. Clerk #3 also performs appointment scheduling for all of the doctors and various correspondence functions. Clerk #3 also maintains a list of patients whose insurance coverage the office manager has verified. When insurance claims or patient receivables are not settled within 60 days, clerk #2 notifies the office manager. The office manager personally inspects the details of each instance of nonpayment. The office manager converts insurance claims that have been rejected by insurance companies into patient receivables. Clerk #2 records these patient receivables on clerk #2's PC and deletes these receivables from the applicable insurance companies. Clerk #2 deletes the patient receivables that appear to be uncollectible from clerk #2's PC when authorized by the office manager. Clerk #2 prepares a list of patients with uncollectible balances and gives a copy of the list to clerk #3, who will not allow these patients to make appointments for future services. Once a month an outside accountant posts clerk #2's daily revenue summaries to the general ledger, prepares a monthly trial balance and monthly financial statements, accounts for the prenumbered service slips, files payroll forms and tax returns, and reconciles the monthly bank statements to the general ledger. This accountant reports directly to the physician who is the managing partner. All four clerical employees perform their tasks on PCs that are connected through a local area network. Each PC is accessible with a password that is known only to the individual employee and the managing partner. Southwest uses a standard software package that was acquired from a software company and that cannot be modified by Southwest's employees. None of the clerical employees have access to Southwest's checkwriting capabilities.

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Answer essay question I Here


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Answer Essay Question II Part a Here ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________

Answer Essay Question II Part b Here

Weaknesses

Internal Control Activities

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