exercise10

CHAPTER 10Multiple-Choice Questions1. Which of the following parties is responsible for establishing an entity’s internal controls?easy a. Management.a c. Auditors.b. Management and auditors.d. Committee of Sponsoring Organizations.2. For an internal audit function to be effective, it is essential that the internal audit staffeasy a. be independent of the operating departments.d b. be independent of the accounting department.c. report directly to a high level of authority within the organization such as the auditcommittee.d. achieve all of the above.3. Management is often unwilling to implement an ideal system of internal controls becauseeasy a. control failures are infrequent.b b. such a system is too expensive.c. sufficient technology does not exist to afford an ideal system.d. risks are often overstated.4. Internal controls can never be considered as absolutely effective becauseeasy a a. their effectiveness is limited by the competency and dependabilit y of the company’spersonnel.b. controls always have inherent weaknesses that can be exploited.c. controls are designed to prevent and detect only material misstatements.d. none of the above.5. easy A major control available in a small company, which might not be feasible in a large company, isd a. a wider segregation of duties.b. a voucher system.c. fewer transactions to process.d. the owner-manager’s personal interest and close relationship with personnel.6. easy An auditor’s attempt to gain an understanding of the accounting system is typically accomplished and documented byd a. a narrative description of the system.b. a flowchart.c. a questionnaire.d. using any of the above.7. easy When the auditor attempts to understand the operation of the accounting system by tracing a few transactions through the accounting system, this is referred to asc a. tracing.b. vouching.c. a walk-through.d. tests of controls.8. Control risk is a measure of the aud itor’s expectation that the internal controls easy a. will prevent material misstatements from occurring.d b. will detect material misstatements.c. will either prevent material misstatements or detect them.d. will neither prevent material misstatements nor detect them.9. easy The procedures to test effectiveness of control policies and procedures in support of a lower assessment of control risk are calleda a. tests of controls.b. tests of transactions.c. analytical tests.d. a walk-through.10. The auditor can conclude that control risk is loweasy d a. after obtaining an understanding of the control environment and the accounting system at afairly detailed level.b. after identifying specific controls that will reduce control risk and making an assessment ofcontrol risk.c. after testing the controls for effectiveness.d. only after all three steps above are completed.11. Each key control that the auditor intends to rely on must be supported by sufficient easy a. tests of transactions.b b. tests of controls.c. analytical review procedures.d. reperformance procedures.12. easy If evidence was obtained in the prior year’s audit that indicates a key control was operating effectively,d a. it will be unnecessary to test that control this year.b. the tests of that control will be reduced this year.c. the auditor would not test this area again this year.d. the extent of tests of that control may be reduced this year if the auditor determines that thecontrol is still in place.13. easy With which one of management’s concerns with respect to implementing internal controls is the auditor primarily concerned?b a. Efficiency of operations.b. Reliability of financial reporting.c. Effectiveness of operations.d. Compliance with applicable laws and regulations.14. easy Which of the following activities would be least likely to strengthen a company’s internal control?b 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.15. easy Which of the following statements best describes the CPA’s primary objective in reviewing internal control?b a. To provide reasonable protection against client fraud and defalcations by client employees.b. To provide a basis for reliance on the system and determining the scope of other auditingprocedures.c. To provide a basis for constructive suggestions to the client for improving the accountingsystem.d. To provide a method for safeguarding assets, checking the accuracy and reliability ofaccounting data, promoting operational efficiency, and encouraging adherence toprescribed managerial policies.16. Which of the following audit tests would be regarded as a test of a control?easy a. Tests of the specific items making up the balance in a given general ledger account.c b. Tests of the inventory pricing to vendors’ invoices.c. Tests of the signatures on canceled checks to board of directors’ authorizations.d. Tests of the additions to property, plant, and equipment by physical inspections.17. During which part of an audit examination is the preparation of flowcharts most appropriate? easy a. When performing preliminary analytical procedures.d b. When performing tests of controls.c. When evaluating the system of internal administrative control.d. When reviewing the system of internal accounting control.18. easy The ______ consists of the actions, policies, and procedures that reflect the overall attitudes of top management.c a. control activities.b. management philosophy.c. control environment.d. monitoring function.19. The auditor’s study of the client’s internal control is medium a. required by GAAP.b b. required by GAAS.c. required by the IRS.d. recommended by the AICPA.20. medium b There are major differences between a simple microcomputer-based accounting system using purchased software for a small service company and a complex IT system for an international manufacturing business.a. Therefore, the general transaction-related audit objectives must be different for each.b. Nevertheless, the general transaction-related audit objectives are the same for each.c. Therefore, the general transaction-related audit objectives cannot be compared.d. Nevertheless, the general transaction-related audit objectives, while different, are stillcomparable.21. The essence of an effectively controlled organization lies in the medium a. effectiveness of its independent auditor.d b. effectiveness of its internal auditor.c. attitude of its employees.d. attitude of its management.22. medium After an auditor obtains information about the subcomponents of the control environment, the auditora a. uses this understanding to assess management’s attitude about the importance of controls.b. uses this understanding to assess control risk.c. uses this understanding to identify potential areas of concern in assessing control risk.d. uses this understanding to determine the extent of tests of controls.23. medium Authorizations can be either general or specific. Which of the following is not an example of a general authorization?b 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.d. A sales price list for merchandise.24. medium Which of the following statements is correct with respect to the design and use of business documents?d a. Only documents used for internal purposes must be prenumbered.b. Documents should be designed for single purposes only to avoid confusion in their use.c. Documents should be designed to be understandable only to those responsible for their use.d. None of the above statements is correct.25. All of the following are substantive tests exceptmedium a. tests of controls.a b. tests of details of transactions.c. tests of details of balances.d. analytical procedures.26. Narratives, flowcharts, and internal control questionnaires are three common methods of medium a. testing the internal controls.b b. documenting the study of internal controls.c. designing the audit manual and procedures.d. documenting the auditor’s understanding of client’s organizational structure.27. Which of the following statements is not correct?medium a. It would be unusual to use both a narrative and a flowchart to describe the same system.c b. The use of both questionnaires and flowcharts on the same engagement is highly desirablefor understanding the client’s system.c. The advantage of the narrative description is the ease of describing the details of theinternal controls.d. When reliable and understandable narratives, flowcharts, and questionnaires are availablefrom client, it is desirable to use them rather than have the auditor prepare his/her owndocuments.28. When controls leave no documentary evidence or trail,medium c a. it is impossible for the auditor to verify them so he/she will have to rely on substantivetests.b. the only thing available as verification of their effectiveness is inquiry of management.c. the auditor generally observes them being applied.d. it is impossible to audit that area of client’s system.29. The purpose of an entity’s accounting information and communication system is to ______. medium a. initiate transactions.d b. record and process transactions.c. monitor transactions.d. a and b only.30. medium A procedure that would most likely be used by an auditor in performing tests of control procedures that involve segregation of functions and that leave no transaction trail isb a. inspection.b. observation.c. reperformance.d. reconciliation.31. medium A secondary objective of the auditor’s study and evaluation of internal control is that the study and evaluation provideb a. a basis for reliance on the system of internal accounting control.b. a basis for constructive suggestions concerning improvements in internal control.c. a basis for the determination of the resultant extent of the tests to which auditingprocedures are to be restricted.d. an assurance that the records and documents have been maintained in accordance withexisting company policies and procedures.32. Which of the following is not a component of an entity’s internal control?medium a. Control risk.a b. Control procedures.c. The accounting system.d. The control environment.33. medium Understanding components of internal control and assessing the level of control risk are primarily used by the auditor tod a. determine whether procedures and records concerning the safeguarding of assets arereliable.b. ascertain whether the opportunities to allow any person to both perpetrate and concealirregularities are minimized.c. modify the initial assessments of inherent risk and preliminary judgments about materiality.d. determine the nature, timing, and extent of substantive tests for financial statementassertions.34. Which of the following is not one of the subcomponents of the control environment?medium a. Human resource policies and procedures.c b. Organizational structure.c. Adequate separation of duties.d. Commitment to competence.35. medium Effective internal control in a small company that has an insufficient number of employees to permit proper division of responsibilities can best be enhanced byb a. employment of temporary personnel to aid in the separation of duties.b. direct participation by the owner of the business in the record-keeping activities of thebusiness.c. engaging a CPA to perform monthly “write-up” work.d. delegation of full, clear-cut responsibility to each employee for the functions assigned toeach.36. medium Which of the following statements regarding auditor documentation of the client’s internal controls is correct?d a. Documentation must include flow charts.b. Documentation must include procedural write-ups.c. No documentation is necessary although it is desirable.d. No one particular form of documentation is necessary, and the extent of documentationmay vary.37. medium Significant deficiencies are matters t hat come to an auditor’s attention, which should be communicated to an entity’s audit committee because they representb a. material frauds perpetrated by high-level management.b. internal control deficiencies that could adversely affect the ability to properly initiate,record, process, and report financial data.c. flagrant violations of the entity’s documented conflict-of-interest policies.d. intentional attempts by client personnel to limit the scope of the auditor’s field work.38. challenging When considering internal control, an auditor should be aware of the concept of reasonable assurance, which recognizes that thed a. segregation of incompatible functions is necessary to ascertain that internal control iseffective.b. employment of competent personnel provides assurance that the objectives of internalcontrol will be achieved.c. establishment and maintenance of internal control is an important responsibility of themanagement and not of the auditor.d. cost of internal control should not exceed the benefits expected to be derived from internalcontrol.39. The primary emphasis by auditors is on controls overchallenging a. classes of transactions.a b. account balances.c. both a and b, because they are equally weighted.d. both a and b, because they vary from client to client.40. challenging An auditor should consider two key issues when obtaining an understanding of a client’s internal controls. These issues arec a. the effectiveness and efficiency of the controls.b. the frequency and effectiveness of the controls.c. the design and utilization of the controls.d. none of the above.Essay Questions41. easy An effective accounting information and communication system must satisfy six transaction-related objectives. One of these objectives is that transactions are recorded on the correct dates (timing). Identify the five remaining objectives.Answer:The five remaining objectives are:•Recorded transactions exist (existence).•Existing transactions are recorded (completeness).•Recorded transactions are stated at the correct amounts (accuracy).•Transactions are properly classified (classification).•Recorded transactions are properly included in the master files and correctly summarized (posting and summarization).42. medium Internal control includes five categories of controls which are called the components of internal control. Discuss each of these five components of internal control.Answer:Five components of internal control are:•The control environment. The control environment consists of the actions, policies, and procedures that reflect the overall attitudes of top management about control andits importance to the company.•Risk assessment. This is management’s identification and analysi s of risks relevant to the preparation of financial statements in accordance with GAAP.•Information and communication. This is the set of manual and/or computerized procedures that identifies, assembles, classifies, analyzes, records, and reports acompany’s transactions and maintains accountability for the related assets.•Control activities. These are the policies and procedures that help ensure necessary actions are taken to address risks in the achievement of the company’s objectives.•Monitoring. This is management’s ongoing and periodic assessment of the quality of internal control performance to determine that controls are operating as intended andmodified when needed.43. medium Discuss what is meant by the term “control environment” and identify f our control environment subcomponents that the auditor should consider.Answer: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 control and its importance to the entity. Subcomponents include:•Integrity and ethical values.•Commitment to competence.•Board of directors or audit committee.•Management’s philosophy and operating style.•Organizational structure.•Assignment of authority and responsibility.•Human resource policies and practices.44. medium Control activities, one of the five components of internal control, are defined as “the policies and procedures, in addition to those included in the other four components, that help ensure necessary actions are taken to address risks in the achievement of the entity’s objectives.” There are five categories of control activities. Please describe the five categories of control activities. Answer:The five categories of control activities are:•Adequate separation of duties.a. Custody of assets should be separated from accounting.b. Authorizing transactions should be separated from custody of related assets.c. Operational responsibility should be separated from record-keeping.d. Duties within IT should be separated.•Proper procedures for authorization of transactions.a. General authorization is given for transactions meeting established criteria.b. Specific authorization is required for individual transactions that don’t confirm tothe criteria.•Adequate document and records.a. Documents should be prenumbered and simple to understand and use.b. A chart of accounts should be available.c. Systems manuals should be available.•Physical control over assets and records. These should include fireproof safes and limited access storerooms.•Independent checks on performance by internal verification should be used.Other Objective Answer Format Questions45.mediumMatch seven of the terms (a-i) with the definitions provided below (1-7):a. Control environmentb. Control activitiesc. Independent checks on performanced. Internal controle. Monitoringf. Separation of dutiesg. General authorizationh. Specific authorizationi. Risk assessmente 1. Management’s ongoing and periodic assessment of the quality of internalcontrol performance to determine that controls are operating as intended andmodified when needed.g 2. Company-wide policies for the approval of all transactions within stated limits.a 3. The actions, policies, and procedures that reflect the overall attitudes of topmanagement, directors, and owners of an entity about control and itsimportance to the entity.f 4. Segregation of the following activities in an organization: custody of assets,accounting, authorization, and operational responsibility.i 5. Management’s identification and analysis of risks relevant to the preparationof financial statements in accordance with generally accepted accountingprinciples.b 6. Policies and procedures that help ensure necessary actions are taken to addressrisks in the achievement of the entity’s objectives.d 7. A process designed to provide reasonable assurance regarding theachievement of management’s objectives in the following cat egories: (1)reliability of financial reporting, (2) effectiveness and efficiency of operations,and (3) compliance with applicable laws and regulations.。