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Auditing Theory - Internal Control



1.          Which statement is not one of the objectives of internal control as included in the definition of internal control developed by the Committee of Sponsoring Organizations (COSO)?
a)      Asset safeguarding.
b)      Compliance.
c)      Financial reporting.
d)      Operations.

Answer A is correct.  AU 319 designed objectives to provide reasonable assurance regarding the achievement of objectives in three categories:  (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations.

Answer B is incorrect.  Compliance is an objective of internal control.

Answer C is incorrect.  Financial reporting is an objective of internal control.

Answer D is incorrect.  An operation is an objective of internal control.


2.          The definition of internal control developed by the Committee of Sponsoring Organizations (COSO) in the professional standards includes the reliability of financial reporting, compliance with applicable laws and
a)      Effectiveness and efficiency of operations.
b)      Effectiveness of prevention of fraudulent occurrences.
c)      Incorporating of ethical business practice standards.
d)      Safeguarding of entity assets.

The requirement is to identify the reply which is a part of the definition of internal control developed by the Committee of Sponsoring Organizations (COSO)  Answer A is correct because COSO defines internal control as a process--effected by an entity's board of directors, management, and other personnel--designed to provide reasonable assurance regarding the achievement of objectives in the following categories:  (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations.

Answer B is incorrect.  Refer to the correct answer explanation.

Answer C is incorrect.  Refer to the correct answer explanation.

Answer D is incorrect.  Refer to the correct answer explanation.


3.          The COSO definition of internal control considers control activities a(n):
a)      Components of internal control.
b)      Control objective.
c)      Element of the control environment.
d)      Portion of information and communication.

Answer A is correct.  AU 319 divides internal control into five interrelated components as follows:  (1) control environment, (2) risk assessment, (3) control activities, (4) information and communication, and (5) monitoring.

Answer B is incorrect.  The control objectives are (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations.

Answer C is incorrect.  The control environment elements set the tone of an organization, influencing the control consciousness of its people.

Answer D is incorrect.  Information and communication consists of the methods and records established to record, process, summarize and report entity transactions and to maintain accountability of the related assets and liabilities.


4.          Which of the following is not a factor included in the control environment?
a)      Board of directors or audit committee participation.
b)      Commitment to competence.
c)      Monitoring.
d)      Organizational structure.

Answer A is incorrect.  Board of directors or audit committee participation is a factor of the control environment.

Answer B is incorrect.  Commitment to competence is a factor of the control environment.

Answer C is correct.  Monitoring is one of the five interrelated components of internal control, not a factor of the control environment.  The seven control environment factors are as follows:  (1) integrity and ethical values, (2) commitment to competence, (3) human resource policies and practices, (4) assignment of authority and responsibility, (5) management's philosophy and operating style, (6) board of directors or audit committee participation, and (7) organizational structure.

Answer D is incorrect.  Organizational structure is a factor of the control environment.


5.          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)      The audit committee is active in overseeing the entity’s financial reporting policies.
b)      External policies established by parties outside the entity affect its accounting practices.
c)      Management is dominated by one individual who also a shareholder.
d)      Internal auditors have direct access to the board of directors and entity management.

Answer A is incorrect.  An active audit committee tends to temper management's aggressive stance.

Answer B is incorrect.  External policies tend to moderate such management tendencies.

Answer C is correct because these noted factors tend to have an especially significant influence on the control environment when management is dominated by one or a few individuals.  Such a circumstance allows management to effectively implement aggressive financial reporting and emphasize meeting profit goals.

Answer D is incorrect.  Internal auditors tend to mitigate management's aggressive attitude.


6.          Which of the following is ordinarily considered a factor indicative of increased financial reporting risk when an auditor is considering a client’s risk assessment policies?
a)      Commission sales personnel.
b)      A corporate code of conduct.
c)      Rapid growth of the organization.
d)      Materiality standards for determining whether to capitalize acquisition of fixed assets.

Answer A is incorrect.  Sales personnel are often remunerated on a commission basis and this is not considered a factor ordinarily indicative of increased financial reporting risk.

Answer B is incorrect.  A corporate code of conduct may be developed to serve as guidelines while conducting business and this is not considered a factor ordinarily indicative of increased financial reporting risk.

Answer C is correct.  Rapid growth of the organization is considered a risk factor when considering a client's risk assessment policies.

Answer D is incorrect.  Materiality standards for determining whether to capitalize acquisitions of fixed assets relates to auditor's judgment and is not ordinarily considered a factor indicative of increased financial reporting risk.


7.          While obtaining an understanding of a client’s risk assessment policies, an auditor ordinarily considers how management
a)      Identifies risks.
b)      Eliminates significant risks.
c)      Assesses the likelihood of occurrence of subsequent events.
d)      Relate risk assessment to compliance with marketing objectives.

Answer A is correct.  An auditor should obtain sufficient knowledge of the entity's risk assessment process to understand how management considers risks relevant to financial reporting objectives and decide about actions to address those risks; that knowledge might include understanding of how management identifies risks, estimates their significance, and assesses the likelihood of their occurrence, and relates them to financial reporting.

Answer B is incorrect.  Refer to the correct answer explanation.

Answer C is incorrect.  Refer to the correct answer explanation.

Answer D is incorrect.  Refer to the correct answer explanation.


8.          When an auditor considers a client’s internal control, control activities ordinarily relate to performance reviews, information processing, segregation of duties and
a)      Information and communication.
b)      Operating decisions.
c)      Physical controls.
d)      Risk assessment.

Answer A is incorrect because information and communication is a separate component of internal control.

Answer B is incorrect because operating decisions are not considered control activities.

Answer C is correct because control activities include performance reviews, information processing, physical controls, and segregation of duties.

Answer D is incorrect because risk assessment is a separate component of internal control.


9.          If internal control is properly designed, the same employee should not be permitted to
a)      Sign checks and cancel supporting documents.
b)      Receive merchandise and prepare a receiving report.
c)      Prepared disbursement vouchers and sign checks.
d)      Initiate a request to order merchandise and approved merchandise received.

Answer A is incorrect because the person signing the checks should cancel supporting documents to avoid duplicate payment.

Answer B is incorrect because the individual receiving the merchandise should prepare a receiving report so as to establish control over the goods.

Answer C is correct because the preparation of disbursement vouchers and signing of checks places an individual in a position in which s/he can both prepare erroneous vouchers and then pay them.

Answer D is incorrect because the person requesting the merchandise will be able to determine whether the appropriate merchandise has been received and should, therefore, approve its receipt.


10.        Which of the following sets of duties would ordinarily be considered basically incompatible in terms of good internal control?
a)      Preparation of monthly statements to customer and maintenance of the accounts receivable subsidiary ledger.
b)      Posting to the general ledger and approval of additions and termination relating to the payroll.
c)      Custody of unmailed signed checks and maintenance of expense subsidiary ledger.
d)      Collection of receipts on account and maintaining accounts receivable records.

Answer A is incorrect because, while it represents two duties for which segregation is often desirable, both functions relate to recording and, therefore, no custody of assets or authorization capability is involved.

Answer B is incorrect because while often separated, the combined responsibility of these functions will not pose a threat to internal control.

Answer C is incorrect because while the individuals will have both custody of assets (the checks) and recordkeeping responsibility, they relate to different areas.

Answer D is correct because collection of receipts on account and maintaining accounts receivable records combine both custody and recording of assets.


11.        For good internal control, which of the following functions should not be the responsibility of the treasurer’s department?
a)      Data processing.
b)      Handling of cash.
c)      Custody of securities.
d)      Establishing credit policies.
 

12.        Proper segregation of functional responsibilities calls for separation of the
a)      Authorization, approval and execution functions.
b)      Authorization, approval and payment functions.
c)      Receiving, shipping and custodial functions.
d)      Authorization, recording, and custodial functions.

Answer A is incorrect.  Refer to the correct answer explanation.

Answer B is incorrect.  Refer to the correct answer explanation.

Answer C is incorrect.  Refer to the correct answer explanation.

Answer D is correct because proper segregation of the functional responsibilities requires separation of (1) authorization, (2) recording, and (3) custodial functions.  Incompatible functions are those that place any person in a position both to perpetrate and to conceal errors and irregularities.  Thus, those that authorize transactions must be separated from those who account for the transactions and from those who have custody of any related assets.


13.        Effective internal control requires organizational independence of departments.  Organizational independence would be impaired in which of the following situations?
a)      The internal auditors report to the audit committee of the board of directors.
b)      The controller reports to the vice president of production.
c)      The payroll accounting department reports to the chief accountant.
d)      The cashier reports to the treasurer.

Answer A is incorrect because internal auditors typically report to the audit committee of the board of directors.

Answer B is correct.  The requirement is to determine a situation causing the impairment of organizational independence.  The controller, who is in charge of accounting, should be independent of the production function.  Since the accounting function reports on the production function, there would be a conflict of interest if the controller reported to the vice president of production.

Answer C is incorrect because the payroll department should report to the chief accountant, as the chief accountant has responsibility for the payroll accounting function.

Answer D is incorrect because cashiers typically account and report to the treasurer because the treasurer has responsibility for cash custodianship.


14.        An auditor would most likely be concerned with controls 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.

Answer A is incorrect.  While important to the company, this item ordinarily does not relate to a financial statement audit.

Answer B is incorrect.  While important to the company, this item ordinarily does not relate to a financial statement audit.

Answer C is incorrect.  While important to the company, this item ordinarily does not relate to a financial statement audit.

Answer D is correct.  The controls relevant to an audit pertain to the entity's ability to record, process, summarize, and report financial data consistent with the assertions embodied in the financial statements.


15.        In an audit of financial statements, an auditor’s primary consideration regarding a control is whether the control
a)      Reflects management’s philosophy style.
b)      Affects management’s financial statements assertions.
c)      Provides adequate safeguards over access to assets.
d)      Enhance management’ decision-making processes.

Answer A is incorrect because while management's philosophy and operating style is a control environment factor, it is not the primary consideration regarding a control.

Answer B is correct because control risk should be assessed in terms of financial statement assertions.

Answer C is incorrect because while providing safeguards over access to assets is a control, it also is not the primary consideration.

Answer D is incorrect because while enhancing management's decision-making processes is an advantage of a good internal control, it is not the auditor's primary consideration.


16.        In a consideration of the internal control, the completion of a questionnaire is most closely associated with which of the following?
a)      Separation of duties.
b)      Documentation.
c)      Flowchart accuracy.
d)      Tests of control.

Answer A is incorrect because information on the separation of duties is only one type of information which may be obtained from a questionnaire.

Answer B is correct.  The requirement is to determine what a questionnaire is most closely associated with.  A questionnaire may be completed during the auditor's consideration of internal control to document the auditor's understanding.

Answer C is incorrect because no necessary relationship between the accuracy of a flowchart and a questionnaire exists.

Answer D is incorrect because tests of compliance, if performed, follow the review of the system.


17.        In general, a material weakness in internal control may be defined as a condition in which material misstatements would ordinarily not be detected within a timely period by
a)      An auditor during the normal consideration of internal control.
b)      A controller when recording accounts in the general ledger.
c)      Employees in the normal course of performing their assigned functions.
d)      The chief financial officer when reviewing interim financial statements.

Answer A is incorrect because it bases detection on actions of the auditor.

Answer B is incorrect because it bases detection on the actions of the controller. Material weaknesses in internal control are prevented by more than any one individual.

Answer C is correct because a material weakness in internal control does not provide reasonable assurance that material misstatements of the financial statements would be prevented or detected within a timely period by employees performing their normal functions.

Answer D is incorrect because it bases detection of misstatements on the actions of the chief financial officer.  Material weaknesses in internal control are prevented by more than any one individual.


18.        Which of the following controls would an auditor be least likely to review?
a)      Segregation of the asset-handling and recordkeeping functions.
b)      Company policy regarding credit and collection efforts.
c)      Cost records classified by date of product introduction.
d)      Authorization of addition to plant and equipment.

Answer A is incorrect because the segregation of asset custody (handling) from recordkeeping and authorization functions is essential.

Answer B is incorrect because an auditor will be concerned with credit and collection efforts in testing the adequacy of the allowance for doubtful accounts.

Answer C is correct because an auditor is usually not concerned with the date a product was introduced.

Answer D is incorrect because additions to plant and equipment are major expenditures which need to be properly controlled.


19.        An auditor considers existing internal control in order to
a)      Determine the extent of analytical procedures which must be performed.
b)      Determine the extent of substantive tests which must be performed.
c)      Ascertain whether irregularities are probable.
d)      Ascertain whether any employees have incompatible functions.

Answer A is incorrect because determination of the extent of analytical procedures is only a part of the reason the auditor considers the client's internal control.

Answer B is correct.  The auditor's consideration of internal control allows him/her to determine the nature, timing, and extent of substantive tests which must be performed.

Answer C is incorrect because irregularities are only one of several types of internal control problems which may lead to financial statement errors.

Answer D is incorrect because, although the auditor is certainly concerned about incompatible functions, this is not the primary reason for the consideration of internal control.


20.        In the consideration of internal control, the auditor is basically concerned that internal control provides reasonable assurance that
a)      Controls have not been circumvented by collusion.
b)      Misstatements have been prevented or detected.
c)      Operational efficiency has been achieved in accordance with management plans.
d)      Management cannot override the structure.

Answer A is incorrect because circumvention of controls by collusion is an inherent limitation of internal control.

Answer B is correct because the function of internal control, from the viewpoint of the independent auditor, is to provide reasonable assurance that material misstatements may either be prevented or discovered with reasonable promptness, thus assuring the reliability and integrity of the financial records.

Answer C is incorrect because operational efficiency normally does not relate directly to audits.
Answer D is incorrect because override of controls by management is an inherent limitation of internal control.


21.        A primary objective of procedures performed to obtain an understanding of internal control is to provide an auditor with
a)      Evidential matter to use in reducing detection risk.
b)      Knowledge necessary to plan the audit.
c)      A basis from which to modify tests of controls.
d)      Information necessary to prepare flowcharts.

Answer A is incorrect because evidential matter collected through tests of controls performed while obtaining an understanding of internal control will affect the auditor's assessment of control risk more directly than detection risk.

Answer B is correct because the auditor must obtain a sufficient understanding of an entity's control structure to plan the audit and to assess control risk.

Answer C is incorrect because while tests of controls may be modified during the consideration of internal control, modification is not a primary objective.

Answer D is incorrect because while flowcharts may be used to document the auditor's understanding of internal control, this is not a primary objective.


22.        Which of the following statements concerning control risk is correct?
a)      Assessing control risk and obtaining an understanding of an entity’s internal control may be performed concurrently.
b)      When control risk is at the maximum level, an auditor is required to document the basis for that assessment.
c)      Control risk may be assessed sufficiency low to eliminate substantive testing for significant transaction classes.
d)      When assessing control risk an auditor should not consider evidence obtained in prior audits about the operations of internal control.

Answer A is correct because assessing control risk and obtaining an understanding of the entity's internal control may be performed concurrently during an audit.

Answer B is incorrect because when control risk is assessed at the maximum level the auditor need only document that assessment, not the basis for the assessment.

Answer C is incorrect because ordinarily the assessed level of control risk cannot be sufficiently low to eliminate the need to perform any substantive tests for significant transaction classes.  Note that in this situation limited tests may be performed.

Answer D is incorrect because the auditor may consider evidence obtained in prior audits about the operation of internal control.


23.        An auditor uses the knowledge provided by the understanding of internal control and the assessed level of control risk primarily to
a)      Determine whether procedures and records concerning the safeguarding of asset are reliable.
b)      Ascertain whether the opportunities to allow any person to both perpetrate and conceal irregularities are minimized.
c)      Modify the initial assessments of inherent risk and preliminary judgments about materiality levels.
d)      Determine the nature, timing, and extent of substantive tests for financial statements assertions.

Answer A is incorrect.  This answer is incorrect because it is incomplete.  For example, while auditors are concerned with the safeguarding of assets, they also need to determine whether the financial statement information is accurate.

Answer B is incorrect.  An understanding of internal control and the assessed level of control risk is used for more than determining whether opportunities are available for committing and concealing irregularities.  This knowledge is also used to ascertain whether the chance of errors is minimized.

Answer C is incorrect.  Knowledge provided by the understanding of internal control and the assessed level of control risk is not used to modify initial assessments of inherent risk and preliminary judgments about materiality levels.  This knowledge is unrelated to those processes.

Answer D is correct.  The auditor uses the knowledge provided by his understanding of internal control and the assessed level of control risk in determining the nature, timing, and extent of substantive tests for financial statement assertions.


24.        When tests of controls reveal that controls are not operating as anticipated, it is most likely that the assessed level of control risk will:
a)      Be less than the planned assessed level of control risk.
b)      Equal the planned assessed level of control risk.
c)      Be greater than the planned assessed level of control risk.
d)      Be less than the actual control risk.

Answer A is incorrect.  The assessed level of control risk will be less than the planned assessed level of control risk when controls are operating more effectively and efficiently than anticipated.

Answer B is incorrect.  When controls are operating as anticipated, the assessed level of control risk will ordinarily equal the planned assessed level of control risk.

Answer C is correct.  When controls are not operating as anticipated, additional tests of controls will be necessary.  Therefore, the auditor's assessed level of control risk will be greater than the planned assessed level of control risk.

Answer D is incorrect.  For any assertion, the actual effectiveness of a control at preventing or detecting misstatements, the actual control risk is unknown.


25.        Which of the following is a step in an auditor’s decision to assess control risk at below the maximum?
a)      Apply analytical procedures to both financial and nonfinancial information to detect conditions that may indicate weak controls.
b)      Perform test of details of transaction and account balances to identify potential errors and irregularities.
c)      Identify specific controls that are likely to detect or prevent material misstatements.
d)      Document that the additional audit effort to perform test of control exceeds the potential reduction in substantive testing.

Answer A is incorrect because applying analytical procedures is not directly related to assessing control risk.  See AU 329 for information on analytical procedures.

Answer B is incorrect because tests of details of transactions and account balances to identify potential errors and irregularities are substantive tests used to restrict detection risk.

Answer C is correct because assessing control risk below the maximum involves (1) identifying specific controls relevant to specific assertions, and (2) performing tests of controls to evaluate their effectiveness.

Answer D is incorrect because the auditor need not document that the additional audit effort to perform tests of controls exceeds the potential reduction in substantive testing; in fact, in such a situation, it is doubtful that tests of controls would be performed since they are not cost effective.


26.        Which of the following is not a reason an auditor should obtain an understanding of the components of an entity’s internal control in planning an audit?
a)      Identify the type of potential misstatements that can occur.
b)      Design substantive tests.
c)      Consider the operating effectiveness of internal control.
d)      Consider factors that affect the risk of material misstatements.

Answer A is incorrect.  In planning an audit, auditors need to obtain an adequate understanding of the components of an entity's internal control so that types of potential misstatements can be identified.

Answer B is incorrect.  In planning an audit, auditors need to obtain an adequate understanding of the components of an entity's internal control in order to design substantive tests.

Answer C is correct.  Procedures directed toward either the effectiveness of the design or operation of internal control are referred to as tests of controls.  Tests of controls provide the auditor with evidential matter to use in assessing control risk, not to plan an audit.

Answer D is incorrect.  In planning an audit, auditors need to obtain an adequate understanding of the components of an entity's internal control in order to consider factors that affect the risk of material misstatements occurring.


27.        The auditor would be least likely to be concerned about internal control as it relates to
a)      Land and buildings.
b)      Common stock.
c)      Shareholder meeting.
d)      Minutes of board of directors’ meetings

Answer A is incorrect because the auditor would be concerned with the internal control of land and buildings which may involve a substantial portion of the client's assets.

Answer B is incorrect because the auditor would be concerned with the internal control related to common stock which may involve a substantial portion of the client's equity.

Answer C is correct because a client's internal control will not relate directly to shareholder meetings.  CPAs will often attend the shareholder meetings and be aware of what has transpired, but important matters at such meetings are generally publicly available.

Answer D is incorrect because the minutes of the meetings of the board of directors must be received by the auditor in complete form so that the auditor may be aware of matters of significance.


28.        Which of the following would not typically be a control relied upon during an audit?
a)      Use of the double-entry system.
b)      An internal audit staff.
c)      Competent personnel.
d)      A comparison-shopping staff.

Answer A is incorrect because use of the double-entry system is an internal control which aids in more accurate recording of transactions.

Answer B is incorrect because the presence of an internal audit staff is an internal control.  An internal audit staff strengthens internal control by determining if controls are functioning effectively.

Answer C is incorrect because competent personnel relate to internal control.  Competent personnel would strengthen internal control because they would be less likely to commit errors in performing their duties.

Answer D is correct because a comparison-shopping staff is not generally relevant to recording, processing, summarizing, and reporting financial data.


29.        Which of the following computer documentation would an auditor most likely utilize in obtaining an understanding of internal control?
a)      Systems flowcharts.
b)      Record counts.
c)      Program listings.
d)      Record layouts.

Answer A is correct because a systems flowchart provides a graphic representation of internal control and therefore may help the auditor to obtain an understanding.

Answer B is incorrect because record counts provide the auditor with information of how many transactions have been processed, but will not provide the auditor with an understanding of overall internal control.

Answer C is incorrect because a program listing will provide the auditor with a listing of program steps, but will not provide evidence relating to overall internal control.

Answer D is incorrect because a record layout will aid in the understanding of the detailed design of records, but will not provide evidence relating to overall internal control.


30.        One important reason why a CPA, during the course of an audit engagement, prepares internal control flowcharts is to
a)      Reduce the need for inquiries of client personnel concerning the operations of internal control.
b)      Depict the organizational structure and document flow in a single chart for review and reference purposes.
c)      Assemble the internal control findings into a comprehensible format suitable for analysis.
d)      Prepare documentation that would be useful in the event of a future consulting engagement.

Answer A is incorrect because flowcharts are prepared as part of the consideration of internal control.  The need for inquiries of client personnel would not necessarily be reduced due to the preparation of the flowchart.

Answer B is incorrect because the entire organizational structure and document flow of a large company usually cannot be depicted in a single flowchart.

Answer C is correct because flowcharts are prepared as part of the consideration of internal control.  The use of structure flowcharts assembles the internal control findings into a comprehensible format.

Answer D is incorrect because flowcharts are prepared as part of the consideration of internal control.  The flowchart is not prepared for the primary reason of obtaining documentation useful for a future consulting engagement.


31.        When preparing a record of a client’s internal control, the independent auditor sometimes uses a flowchart, which can best be described as a
a)      Pictorial presentation of the flow of instruction in a client’s internal computer system.
b)      Diagram which clearly indicates an organization’s internal reporting structure.
c)      Graphic illustration of the flow of operations which is used to replace the auditor’s internal control questionnaire.
d)      Symbolic representation of a system or series of sequential processes.

Answer A is incorrect because it refers to processing within the computer rather than the entire internal control structure.

Answer B is incorrect because it deals with reporting structure rather than with internal controls.

Answer C is incorrect because an internal control flowchart depicts the organization and recordkeeping system rather than a flow of operations.

Answer D is correct because the flowchart prepared during the consideration of internal control is a symbolic representation of a system of sequential processes.  It can be used in lieu of the internal control questionnaire which has the same purpose (i.e., to prepare a record of prescribed internal control).


32.        When obtaining and documenting an understanding of internal control, the auditor would ordinarily prepare and obtain answers to an internal control questionnaire based upon a tentative flowchart of the system.  The next step should ordinarily be to
a)      Determine the extent of audit work necessary to form n opinion.
b)      Arrive at a decision regarding the operating effectiveness of internal control.
c)      Gather enough evidence to determine if internal control is functioning as described by performing additional tests of controls.
d)      Assess control risk based upon the understanding of internal control.

Answer A is incorrect.  Determining the extent of substantive testing necessary to form an audit opinion will most likely occur after the auditor determines the assessed level of control risk.  However, the assessed level of control risk will most likely not be determined by an auditor's understanding of internal control.  Refer to the correct answer explanation.

Answer B is incorrect.  Ordinarily an evaluation of the operating effectiveness of internal control will be made after the auditor performs additional tests of controls.  Refer to the correct answer explanation.

Answer C is incorrect.  Ordinarily the performance of additional tests of controls to determine if internal control is functioning as described will occur after the preliminary assessment of control risk.  Refer to the correct answer explanation.

Answer D is correct.  Ordinarily once the auditor has obtained an understanding and documented internal control, the next step is to form a preliminary assessment of control risk.  Note, the normal progression of steps with regard to this question would be D, C, B, A.


33.        On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of control risk from that originally planned.  To achieve an overall audit risk level that is substantially the same as the planned audit risk level, the auditor would
a)      Increase inherent risk.
b)      Increase materiality levels.
c)      Decrease substantive testing.
d)      Decrease detection risk.

Answer A is incorrect because a decrease in the assessed level of inherent risk, not an increase, would be necessary.

Answer B is incorrect because, unless other circumstances have changed, it is doubtful whether increasing the materiality levels is appropriate.

Answer C is incorrect because decreasing the substantive testing will increase detection risk, the opposite of the requirements of this situation.

Answer D is correct because it suggests a decrease in detection risk to accompany the increase in control risk.


34.        After obtaining an understanding of an entity’s internal control and assessing control risk, an auditor may
a)      Perform tests of controls to verify management’s assertion 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 the company’s controls detected material misstatements in the financial statements.

Answer A is incorrect.  Tests of controls may or may not be performed depending upon whether the auditor believes a further reduction in the assessed level of control risk is both possible and cost justified.

Answer B is correct.  After obtaining an understanding of an entity's internal control and assessing control risk, the auditor will next consider whether evidential matter is available to support a further reduction in the assessed level of control risk.

Answer C is incorrect.  AU 329 states that analytical procedures are used to assist the auditor in planning the nature, timing, and extent of other auditing procedures, as a substantive test to obtain evidential matter and as an overall review of the financial information in the final review stage of the audit.  They are not used to validate the assessed level of control risk.

Answer D is incorrect.  Evaluating whether controls have detected material misstatements in the financial statements occurs after the auditor has performed tests of controls designed to provide evidential matter concerning the effectiveness of the design and operation of such policies and procedures.  These tests of controls are performed after control risk is assessed.


35.        In connection with the consideration of internal control during an examination of financial statements, the independent auditor
a)      Must perform tests of controls for all important controls.
b)      Must issue a written communication on reportable conditions, including situations in which none have been identified.
c)      Must flowchart major client transaction cycles.
d)      Must perform tests of controls to assess control risk at a level lower than the maximum.

Answer A is incorrect.  Refer to the correct answer explanation.

Answer B is incorrect.  Refer to the correct answer explanation.

Answer C is incorrect.  Refer to the correct answer explanation.

Answer D is correct.  When the auditor assesses control risk at below the maximum level, the auditor believes that specific controls are likely to prevent or detect material misstatements relevant to specific assertions.  The auditor must then perform tests of controls to evaluate the effectiveness of such controls.

 
36.        When an auditor increases the planned assessed level of control risk because certain control procedures were determined to be ineffective, the auditor would most likely increase the
a)      Extent of tests of details.
b)      Level of inherent risk.
c)      Extent of tests of controls.
d)      Level of detection risk.

Answer A is correct because increases in the assessed level of control risk lead to decreases in the acceptable level of detection risk.  Accordingly, the auditor will need to increase the extent of substantive tests such as tests of details.

Answer B is incorrect because the level of inherent risk pertains to the susceptibility of an account to material misstatement independent of related internal control structure procedures.

Answer C is incorrect because tests of controls are performed to reduce the assessed level of control risk only when control procedures are believed to be effective.

Answer D is incorrect because the level of detection risk must be decreased, not increased.


37.        An auditor uses the assessed level of control risk to
a)      Evaluate the effectiveness of the entity’s control activities.
b)      Identify transactions and account where inherent risk as at the maximum.
c)      Indicate whether materiality threshold for planning and evaluation purposes are sufficiently high.
d)      Determine the acceptable level of detection risk for financial statement assertions.

Answer A is incorrect because assessing control risk is the process of evaluating the effectiveness of the entity's controls in preventing or detecting material misstatements in the financial statements; it is not used to evaluate effectiveness.

Answer B is incorrect because the assessed level of control risk is not used to identify transactions and account balances where inherent risk is at the maximum.

Answer C is incorrect because materiality thresholds are not directly affected by the assessed level of control risk.

Answer C is incorrect because materiality thresholds are not directly affected by the assessed level of control risk.

Answer D is correct because an auditor uses the assessed level of control risk (together with the assessed level of inherent risk) to determine the acceptable level of detection risk for financial statement assertions.  The auditor then uses the acceptable level of detection risk to determine the nature, timing, and extent of the auditing procedures to be used to detect material misstatements in the financial statement assertions.


38.        After obtaining an understanding of internal control and assessing control risk of an entity, an auditor decided not to perform tests of controls.  The auditor most likely decided that
a)      The available evidential matter obtained through tests of controls would not support an increased level of control risk.
b)      A reduction in the assessed level of control risk is justified for certain financial statement assertions.
c)      It would be inefficient to perform tests of controls that would result in a reduction in planned substantive tests.
d)      The assessed level of inherent risk exceeded the assessed level of control risk.

Answer A is incorrect because the available evidential matter generally would relate to a possible decreased assessed level of control risk, not an increased level.

Answer B is incorrect because tests of controls will be performed if a reduction in the assessed level of control risk is justified.

Answer C is correct because an auditor may conclude that it is inefficient to obtain additional evidential matter through tests of controls and may use the assessed level of control risk to plan the substantive tests for those assertions.

Answer D is incorrect because the fact that the assessed level of inherent risk exceeds the assessed level of control risk has no definite relationship to tests of controls.


39.        When control risk is assessed at the maximum level for all financial statement assertions, an auditor should document the auditor’s

Understanding of the entity’s internal control components
Conclusion that control risk is at the maximum level
Basis for concluding that control risk is at the maximum level
A
Yes
No
Yes
B
Yes
Yes
No
C
No
Yes
Yes
D
Yes
Yes
Yes

Answer A is incorrect.  Refer to the correct answer explanation.

Answer B is correct because an auditor must always document his/her understanding of internal control components and, when control risk is assessed at the maximum, the auditor must also document that conclusion.

Answer C is incorrect.  Refer to the correct answer explanation.

Answer D is incorrect.  Refer to the correct answer explanation.


40.        Which of the following is not a step in an auditor’s decision to assess control risk at below the maximum?
a)      Evaluate the effectiveness of the controls with test of controls.
b)      Obtain an understanding of the entity’s accounting system and control environment.
c)      Perform test of details of transaction to detect material misstatements in the financial statements.
d)      Consider whether controls can have pervasive effect on financial statement assertions.

Answer A is incorrect.  Auditors evaluate the effectiveness of internal control procedures with tests of controls.

Answer B is incorrect.  Obtaining an understanding of the entity's accounting system and control environment is a preliminary step for considering control risk.

Answer C is correct.  Performing tests of details of transactions to detect material misstatements pertains more directly to detection risk rather than inherent or control risk.

Answer D is incorrect.  Auditors will consider the effect of control procedures on the various financial statement assertions.


41.        The auditor should perform tests of controls on
a)      Those controls that the auditor plans to use to support an assessment of control risk below the maximum.
b)      Those controls in which reportable condition were identified.
c)      Those controls that have a material effect upon the financial statement balances.
d)      A random sample of the controls that were reviewed.

Answer A is correct because tests of controls are only performed on controls that the auditor plans to rely upon as a basis for assessing control risk below the maximum.  Performance of tests of controls on these controls may reduce the scope of substantive tests needed.

Answer B is incorrect because the auditor is unlikely to test controls in which reportable conditions exist since they cannot be relied upon.

Answer C is incorrect because even though some controls have a material effect upon financial statement balances, they may not be relied upon if substantive testing may be more efficient.

Answer D is incorrect because the decision of whether or not to perform tests of controls is determined by employing professional judgment based upon the results of assessing control risk, not by a random sample.


42.        For certain controls, such as segregation of duties, documentary evidence may not exist.  An auditor would most likely test the procedures by
a)      Reperformance and corroboration.
b)      Observation and inquiry.
c)      Inspection and vouching.
d)      Confirmation and recomputation.

Answer A is incorrect.  Reperformance is not possible for testing controls such as the segregation of duties when no documentary evidence is available; also, corroboration is a general term that adds little to the answer choice.

Answer B is correct.  AU 319 suggests that when no audit trail exists an auditor should use the observation and inquiry techniques.

Answer C is incorrect.  The lack of documentary evidence makes it impossible to inspect or vouch.

Answer D is incorrect.  The confirmation and recomputation techniques are not effective for controls such as segregation of duties and because the confirmation technique is a substantive test, and not a test of a control.


43.        When considering internal control to determine whether the necessary procedures are designed and operating effectively, an auditor must
a)      Develop questionnaires and checklists.
b)      Perform tests of controls.
c)      Perform analytical procedures.
d)      Perform substantive tests.

Answer A is incorrect because questionnaires and checklists only apply to the preliminary review of the system and because other means may be used at that stage (e.g., decision tables, flowcharts).

Answer B is correct.  The requirement is to identify the statement that describes what an auditor must do when evaluating internal control to determine whether necessary procedures are prescribed and are being followed satisfactorily.  A preliminary review is first made and then tests of controls are used to provide reasonable assurance that the accounting control procedures on which the auditor intends to rely are being followed as prescribed.

Answer C is incorrect because analytical review procedures are substantive tests.

Answer D is incorrect because substantive tests are used to test account balances, not to test controls.


44.        An independent auditor has concluded that the client’s records, procedures, and representation can be relied upon based on tests made during the year when internal control was found to be effective.  The auditor should test the records, procedures, and representations again at year end if
a)      Inquiries and observations lead the auditor to believe that conditions have changed significantly.
b)      Comparisons of year-end balances with balances at prior dates reveled significant fluctuations.
c)      Unusual transactions occurred subsequent to the completion of the interim audit work.
d)      Client records are in a condition that facilities effective and efficient testing.

Answer A is correct.  The requirement is to determine the situation in which auditors should retest records and procedures as well as apply new tests of controls at year end, when these tests have already been done during the year and internal control has been found to be effective.  Auditors should retest records and transactions if year-end inquiries and observations lead the auditor to believe conditions have changed significantly.

Answer B is incorrect because significant fluctuations in account balances are acceptable if they can be explained by a change in business conditions.  If, however, the conditions of the records and internal control have changed, additional year-end work is required.

Answer C is incorrect because unusual transactions subsequent to the interim audit work should be examined on an individual basis.

Answer D is incorrect because significantly changed conditions would require retesting whether or not client records are in a condition to facilitate the retesting.


45.        Which of the following is ordinarily considered a test of a control?
a)      Send confirmation letters to banks.
b)      Count and list cash on hand.
c)      Examine signatures on checks.
d)      Test the clerical accuracy of inventory listings as of the balance sheet date.

Answer A is incorrect because sending confirmation letters to banks helps substantiate the existence of cash at year end.  Therefore, this is a substantive rather than a test of a control.

Answer B is incorrect because a cash count is a test of transactions and balances which is a substantive test rather than a test of a control.

Answer C is correct because tests of controls are directed toward the effectiveness of the design or operation of controls.  In this case the control procedure is to determine that only authorized persons sign checks.

Answer D is incorrect because testing the clerical accuracy of inventory listings as of the balance sheet date is primarily a substantive test to determine whether inventory listings are accurately compiled.


46.        The reliance placed on substantive tests in relation to the reliance placed on internal control varies in a relationship that is ordinarily
a)      Parallel.
b)      Inverse.
c)      Direct.
d)      Equal.

Answer A is incorrect.  Refer to the correct answer explanation.

Answer B is correct because as internal control is relied upon to a lesser extent, substantive tests are relied upon to a greater extent.

Answer C is incorrect.  Refer to the correct answer explanation.

Answer D is incorrect.  Refer to the correct answer explanation.


47.        Which of the following would be least likely to be included in an auditor’s tests of controls?
a)      Inspection.
b)      Observation.
c)      Inquiry.
d)      Confirmation.

Answer A is incorrect because inspection procedures are used to test whether and by whom controls were performed and to permit an evaluation of the propriety of their performance.

Answer B is incorrect because observation is a test of control which allows the auditor to obtain direct personal knowledge of the activity in the form of visual evidence.

Answer C is incorrect because inquiry is a test of control which allows the auditor to obtain evidence in the form of either oral or written representation.

Answer D is correct because tests of controls provide reasonable assurance that prescribed control procedures are being followed.  Confirmation is used primarily to substantiate the existence of an account balance and, therefore, is considered a substantive test.


48.        Tests of controls are performed in order to determine whether
a)      Controls are functioning as designed.
b)      Necessary controls are absent.
c)      Incompatible functions exist.
d)      Material peso errors exist.

Answer A is correct because the purpose of tests of controls is to provide reasonable assurance that the internal control procedures are designed and operating effectively.

Answer B is incorrect because the existence of necessary controls is primarily determined prior to tests of controls.

Answer C is incorrect because the existence of incompatible functions and other conditions in internal control is primarily determined prior to tests of controls.

Answer D is incorrect because substantive tests more directly address the existence of material dollar errors.


49.        The auditor is examining copies of sales invoices only for the initials of the person responsible for checking the extensions.  This is an example of a
a)      Test of control.
b)      Substantive test.
c)      Dual-purpose test.
d)      Test of balances.

Answer A is correct because tests of controls are used to test the effectiveness of the design or operation of a control.  The auditor's examination of sales invoices for specific initials would be an example of a procedure which provides assurance concerning the effectiveness of the operation of a control.

Answer B is incorrect because substantive tests involve analytical procedures and tests of details of transactions and balances.  An examination of sales invoices for specific initials would not be a substantive test.

Answer C is incorrect because a dual-purpose test would involve both testing a control and substantive testing.  In this situation, only the control and not the substantive aspect is being tested.

Answer D is incorrect because a test of balances is a type of substantive test.  In this situation, a substantive test is not being performed.


50.        Which of the following would be least likely to suggest to an auditor that the client’s management may have overridden internal control?
a)      There are numerous delays in preparing timely internal financial reports.
b)      Management does not correct control weakness that it knows about.
c)      Differences are always disclosed on a computer exception report.
d)      There have been two new controllers this year.

Answer A is incorrect because delays in the preparation of financial reports may suggest that inappropriate entries are being made by the client's management.

Answer B is incorrect because the auditor must question why management would choose not to eliminate internal control weaknesses.  The failure of management to correct weaknesses would be a definite indication that management may have overridden internal control.

Answer C is correct because differences are expected to be disclosed on a computer exception report; disclosing these differences is the primary purpose of the report.  Thus, this would not indicate that there are problems in the client's internal control.

Answer D is incorrect because a high turnover of controllers (the position normally responsible for the recordkeeping function) may be indicative of a management override of internal control.


51.        Of the following statements about internal control, which one is not valid?
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)      Controls reasonably ensure that collusion among employees cannot occur.

Answer A is incorrect because the custody and recording responsibilities should be segregated.

Answer B is incorrect because transactions should be properly authorized.

Answer C is incorrect because under the concept of reasonable assurance the cost/benefit relationship must be considered.

Answer D is correct.  Controls whose effectiveness depends on segregation of duties cannot be relied upon to ensure that collusion among employees will not occur.  Segregation of employees may be circumvented by collusion.


52.        The use of fidelity bonds protects a company from embezzlement losses and also
a)      Minimizes the possibility of employing persons with dubious records in postions of trust.
b)      Reduces the company’s need to obtain expensive business interruption insurance.
c)      Allows the company to substitute the fidelity bonds for various parts of internal control.
d)      Protects employees who made unintentional errors form possible monetary damages resulting from such errors.

Answer A is correct because bonding companies will typically investigate the backgrounds of new employees.

Answer B is incorrect since business interruption insurance relates to events which temporarily stop the firm's production (e.g., strikes).

Answer C is incorrect because even with the existence of fidelity bonds, internal controls must be maintained.

Answer D is incorrect because fidelity bonds protect the employer from irregularities committed by employees.


53.        Which of the following controls will most likely prevent the concealment of a cash shortage resulting from the improper write-off of a trade account receivable?
a)      Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence.
b)      Write-offs must be supported by an aging schedule showing that only receivables overdue several months have been written off.
c)      Write-offs must be approved by the cashier who is in a position to know if the receivables have, in fact, been collected.
d)      Write-offs must be authorized by company field sales employees who are in a position to determine the financial standing of the customers.

Answer A is correct because if accounts receivable write-offs must be approved by an officer on the basis of credit department recommendations including supporting evidence, there is very little likelihood of improper write-offs to conceal cash shortages.

Answer B is incorrect because receivable overdue by several months is not a basis for write-off; uncollectibility is.

Answer C is incorrect because the cashier could conceal cash shortages by approving the write-offs of accounts receivable.

Answer D is incorrect because sales employees could accept payments from customers and then authorize the accounts to be written off.


54.        Which of the following would be the best protection for a company that wishes to prevent the “lapping” of trade accounts receivable?
a)      Segregated duties so that the bookkeeper in charge of the general ledger has no access to incoming mail.
b)      Segregated duties so that no employee has access to both checks from customers and currently from daily cash receipts.
c)      Have customers send payments directly to the company’s depositary bank.
d)      Request that customers’ payment checks be made payable to the company and addressed to the treasurer.

Answer A is incorrect because lapping involves incorrect entries in the accounts receivable subsidiary ledger, not the general ledger.

Answer B is incorrect because lapping occurs by misappropriating mail receipts (checks).  Lapping does not necessarily involve abstraction directly from currency.

Answer C is correct because lapping of trade accounts receivable involves an abstraction of funds and subsequent delay in crediting receipts to accounts receivable.  If customers send payments directly to a depository bank, there is no opportunity for abstraction of funds or subsequent misapplication.

Answer D is incorrect because requiring that customer's checks be addressed to the treasurer will not reduce the risk of lapping significantly compared to having the checks directly deposited.


55.        When a customer fails to include a remittance advice with a payment, it is a common practice for the person opening the mail to prepare one.  Consequently, mail should be opened by which of the following four company employees?
a)      Credit manager.
b)      Receptionist.
c)      Sales manager.
d)      Accounts receivable clerk.

Answer A is incorrect because remittances should be opened by an individual independent of the sales function.  The credit manager performs a function related to sales and should not be allowed to open remittances.

Answer B is correct because remittances should be opened by an individual such as a receptionist who is independent of the sales function.  That individual will prepare any needed remittance advice.

Answer C is incorrect because remittances should be opened by an individual independent of the sales function.  The sales manager is not independent of the sales function and should not be allowed to open remittances.

Answer D is incorrect because the functions of recordkeeping and custodianship should be segregated.  Allowing the accounts receivable clerk to open remittances would violate this segregation of duties and not be good internal control.


56.        Which of the following is not a basic rule for achieving strong internal control over cash?
a)      Separate the cash handling and recordkeeping functions.
b)      Decentralized the receiving of cash as much as possible.
c)      Deposit each day’s cash receipts by the end of the day.
d)      Have bank reconciliations performed by employees independent with respect to handling cash.

Answer A is incorrect because separation of cash handling and recordkeeping is a proper segregation of the recordkeeping function from the custodial function.

Answer B is correct because decentralization of cash receipts generally would not increase internal control; in fact, the additional points of cash receipt may well be more difficult to control.

Answer C is incorrect because the daily deposit of cash receipts helps to deter irregularities and theft.

Answer D is incorrect because separating the reconciliation from the handling of cash is a proper segregation of the recordkeeping function from the custodial function.


57.        Which one of the following would the auditor consider to be an incompatible operation if the cashier receives remittances from the mailroom?
a)      The cashier prepares the daily deposit.
b)      The cashier makes the daily deposit at a local bank.
c)      The cashier post the receipts to the accounts subsidiary ledger cards.
d)      The cashier endorses the checks.

Answer A is incorrect because preparing the daily deposit is a part of the cashier's custodial function.

Answer B is incorrect because depositing cash receipts is part of the cashier's custodial function.

Answer C is correct because posting the receipts to the accounts receivable subsidiary ledger cards provides the cashier with both recordkeeping and custodial responsibilities.

Answer D is incorrect because check endorsement may be assigned to the cashier even though it would be preferred to have checks immediately endorsed when they are received in the mailroom.


58.        An entity with a large volume of customer remittances by mail could most likely reduce the risk of employee misappropriation of cash by using
a)      Employee fidelity bonds.
b)      Independent prepared mailroom prelists.
c)      Daily check summaries.
d)      A bank lockbox system.

Answer A is incorrect because while fidelity bonds do provide control, they are not generally as effective as a lockbox system since employees still handle cash.

Answer B is incorrect because independently prepared mailroom prelists are a less effective control than is a lockbox system--cash may still be misappropriated.

Answer C is incorrect because a summary of checks received daily is unlikely to be as effective as a lockbox system.

Answer D is correct because a bank lockbox system will result in collection of receivables by a bank, thereby eliminating employee contact with the cash.


59.        At which point in an ordinary sales transaction of a wholesaling business would a lack of specific authorization be of least concern to the auditor in the conduct of an audit?
a)      Granting of credit.
b)      Shipment of goods.
c)      Determination of discounts.
d)      Selling of goods for cash.

Answer A is incorrect because specific authorization will be needed for the granting of credit and, therefore, is of concern to the auditor.

Answer B is incorrect because specific authorization will be needed for shipment of goods and, thus, is of concern to the auditor.

Answer C is incorrect because specific authorization is required for determination of discounts and will be of concern to the auditor.

Answer D is correct because at the point of selling the goods for cash, decisions on matters such as appropriate discounts will have already been made.  The fact that cash is being received eliminates any credit problem considerations.  Therefore, the lack of specific authorization will not be of great concern to the auditor in this situation.


60.        To verify that all sales transactions for which shipment has occurred have been recorded, a test of transactions should be completed on a representative sample drawn from
a)      Entries in the sales journal.
b)      The billing clerk’s file of sales orders.
c)      A file duplicate copies of sales invoices for which all prenumbered forms in the series have been accounted for.
d)      The shipping clerk’s file of duplicate of bills of lading.

Answer A is incorrect because the sales journal reflects only sales which have actually been recorded.

Answer B is incorrect because the sales orders will not generally provide as specific of information on shipment (if any) as will the bills of lading.

Answer C is incorrect because the sales invoices reflect only those sales which have properly reached the invoice stage.  There may exist shipments which have not been properly invoiced.

Answer D is correct because items actually shipped (as evidenced by bills of lading) represent the client's sales.


61.        Proper authorization procedures in the revenue cycle usually provide for the approval of bad debt write-offs by an employee in which of the following departments?
a)      Treasurer.
b)      Sales.
c)      Billing.
d)      Accounts receivable.

Answer A is correct because the department responsible for bad debt write-offs should be independent of the sales authorization and recordkeeping functions.

Answer B is incorrect because the sales department authorizes sales.

Answer C is incorrect because this department has recordkeeping responsibilities over sales.

Answer D is incorrect because this department has recordkeeping responsibilities over sales.


62.        In order to safeguard the assets through proper internal control, accounts receivable that are written off are transferred to a(n)
a)      Separate ledger.
b)      Attorney for evidence in collection proceedings.
c)      Tax deductions files.
d)      Credit manager since customers may seek to reestablish credit by paying.

Answer A is correct.  Once accounts receivable are written off they should be controlled for possible future collection.  Accordingly, they should be recorded to maintain accountability in a separate ledger.  If they were simply written off and forgotten, there would be no means of maintaining accountability over these contingent assets.

Answer B is incorrect because accounts transferred to an attorney for collection would not be written off (i.e., if they were bad debts, there would be no basis for collection proceedings).

Answer C is incorrect because the requirement is for proper internal control over the receivables rather than information to prepare tax returns.

Answer D is incorrect because credit managers should not have control over accounts that have been written off because there is not sufficient separation of functional responsibilities.


63.        For effective internal control, the billing function should be performed by the
a)      Accounting department.
b)      Sales department.
c)      Shipping department.
d)      Credit and collection department.

Answer A is correct because the accounting department serves a recording function and billing is an example of a recording function.  Therefore, the accounting department's performance of the billing function would allow effective internal control.

Answer B is incorrect because the sales department will often authorize sales.  Thus, recording and authorization would not be segregated if billing were also performed, which would prohibit effective internal control.

Answer C is incorrect because shipping is primarily a custodial function.  The custodial function should be segregated from the recording function of billing to enhance effective internal control.

Answer D is incorrect because credit and collections authorize credit and make collections.  The recording function of billing should be segregated from the credit and collection department for effective internal control.


64.        Tracing bills of lading to sales invoices provides evidence that
a)      Shipments to customers were invoiced.
b)      Shipments to customers were recorded as sales.
c)      Recorded sales were shipped.
d)      Invoiced sales were shipped.

Answer A is correct because by tracing bills of lading to sales invoices, the auditor obtains evidence that merchandise which has been shipped (as evidenced by a bill of lading) has been invoiced.

Answer B is incorrect because the sales invoices do not provide sufficient evidence that the sale was recorded.

Answer C is incorrect because to determine whether recorded sales were shipped the auditor would trace from the population of recorded sales in the sales journal to bills of lading.

Answer D is incorrect because to determine whether invoiced sales were shipped the auditor would trace from sales invoices to bills of lading (the opposite of this question).


65.        Tracing copies of sales invoices to shipping documents will provide evidence that all
a)      Shipments to customers were recorded as receivables.
b)      Billed sales were shipped.
c)      Debits to the subsidiary accounts receivable ledger are for sales shipped.
d)      Shipments to customers were billed.

Answer A is incorrect because no examination of accounts receivable has taken place.

Answer B is correct because sales invoices will often serve as "bills," and by tracing them to shipping documents, the auditor discovers whether those "bills" are supported by shipments.

Answer C is incorrect because no examination of accounts receivable has taken place.

Answer D is incorrect because to test whether shipments to customers were billed, the auditor would trace from the shipping documents to the sales invoices.


66.        A client erroneously recorded a large purchase twice.  Which of the following controls would be most likely to detect this error in a timely and efficient manner?
a)      Footing the purchase journal.
b)      Reconciling vendors’ monthly statements with subsidiary payable ledger accounts.
c)      Tracing totals form the purchases journal to the ledger accounts.
d)      Sending written quarterly conformations to all vendors.

Answer A is incorrect because footing the purchases journal is unlikely to detect the error since the journal's totals will have been mathematically accumulated properly.

Answer B is correct because reconciling the vendors' monthly statements with the subsidiary ledger for payables should disclose a difference in the month following the error.

Answer C is incorrect because the incorrect total will be reflected in both the purchases journal and in the ledger accounts.  Thus, the error would not be detected by this internal control measure.

Answer D is incorrect because such confirmations will only detect the error quarterly which is neither timely nor efficient.


67.        Jackson, the purchasing agent of Judd Hardware Wholesalers, has a relative who owns a retail hardware store.  Jackson arranged for hardware to be delivered by manufacturers to the retail store on a COD basis thereby enabling his relative to buy at Judd’s wholesale prices.  Jackson was probably able to accomplish this because of Judd’s poor internal control over
a)      Purchase orders.
b)      Purchase requisitions.
c)      Cash receipts.
d)      Perpetual inventory records.

Answer A is correct because proper control over purchases would require that ordered goods only be shipped to authorized locations; proper control would also determine that all ordered goods had been received by the firm.  If purchase orders are issued by Judd and the purchases are never received, there is an internal control condition over the purchase orders.  All purchase orders should be accounted for (prenumbered) and followed up to assure receipt of orders that are issued.

Answer B is incorrect because purchase requisitions are internal documents which are prepared by user departments and sent to the purchasing department for action.

Answer C is incorrect because the failure to detect purchase orders that were not received has nothing to do with cash receipts.

Answer D is incorrect because perpetual inventory records cannot be relied upon to detect the nonreceipt of purchase orders (i.e., perpetual inventory records are only activated once the goods are received).


68.        To avoid potential errors and fraud a well-designed internal control in the accounts payable area should include a separation of which of the following functions?
a)      Cash disbursement and invoice verification.
b)      Invoice verification and merchandise ordering.
c)      Physical handling of merchandise received and preparation of receiving reports.
d)      Check signing and cancellation pf payment documentation.

Answer A is correct.  The requirements concern internal control in the accounts payable area.  The accounts payable function normally includes invoice verification.  The important separation should be between authorization of payment and actual cash disbursements.  Thus the accounts payable area (including invoice verification) should be separated from cash custodianship and disbursement.

Answer B is incorrect because the accounts payable area does not usually include the purchasing department.

Answer C is incorrect because those receiving merchandise usually prepare the receiving report (e.g., on the loading dock).

Answer D is incorrect because the person signing checks should cancel the supporting documentation as checks are signed.


69.        An internal control narrative indicates that an approved voucher is required to support every check request for payment of merchandise.  Which of the following procedures provides the greatest assurance that this control is operating effectively?
a)      Select and examine vouchers and ascertain that the related cancelled checks are dated no later than the vouchers.
b)       Select and examine vouchers and ascertain that the related cancelled checks are dated no earlier than the vouchers.
c)      Select and examine cancelled checks and ascertain that the related vouchers are dated no earlier than the checks.
d)      Select and examine cancelled checks and ascertain that the related vouchers are dated no later than the checks.

Answer A is incorrect because the checks must be issued after the approved voucher has been prepared.

Answer B is incorrect since the direction of the test (i.e., from vouchers to canceled checks) would not detect any checks which had been prepared without the support of an approved voucher.

Answer C is incorrect because the vouchers should be dated prior to the checks.

Answer D is correct because vouchers should have been prepared and approved prior to issuance of the check (otherwise the voucher was not present when the check was issued).  In addition, the auditor must begin his/her test with the canceled checks to determine whether all checks are supported by an approved voucher.

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Submit a 2-3 pages paper assignment, (excluding the title page and reference page) double-spaced in  Times New Roman  font which is no greater than  12-points in size . Paper and all citations should be in APA format. Send it to  maggrabillo@rtu.edu.ph  once completely accomplished.    1. List the 7 Es according to importance or with the greatest impact on the organization. Explain how they impact the business. 2. Link the concept of excellence to the work of internal auditors and how can it be incorporated in audit programs. 3. How can failure in ethics affect organizational success? Choose one company that failed as to its ethics. 4. Describe ways to monetize the concept of ecology. How can you encourage others to observe environmental stewardship? After sending through email,  kindly post in rich text format your case analysis by commenting  on this post.  Deadline for accomplishment:  November 28, 2021 11:59PM

2014 Quizzers on Philippine Corporate Taxation

Instruction: Determine the best answer per question given. This quizzer is intended to test your knowledge on Corporate Taxation under the Philippine Income Tax System. Estimated time: One (1) hour (1)     Hungry Shark corporation, in its third year of operations, had the following data: Gross Income, Philippines                                                            P             2,000,000.00 Gross Income, foreign                                                                                   1,000,000.00 Expenses, Philippines                                                                                    1,000,000.00 Expenses, foreign                                                                                                500,000.00 If the corporation is a domestic corporation, the taxable income is: (a)     P1,000,000 (b)    P2,000,000 (c)     P500,000 (d)    P1,500,000 (2)     One of the following statements is not correct. Which is