Harvard University

AUDIT 111

Chapter 1-Auditing and Internal Control

TRUE/FALSE

1)Corporate management (including the CEO) must certify monthly and annually their organization’s internal controls over financial reporting.

 

                                          

 

2. Both the SEC and the PCAOB require management to use the COBIT framework for assessing internal control adequacy.

 

                                          

 

3. Both the SEC and the PCAOB require management to use the COSO framework for assessing internal control adequacy.

 

                                          

 

4. A qualified opinion on management’s assessment of internal controls over the financial reporting system necessitates a qualified opinion on the financial statements?

 

                                          

 

5. The same internal control objectives apply to manual and computer-based information systems.

 

                                          

 

6. The external auditor is responsible for establishing and maintaining the internal control system.

                            

7. Segregation of duties is an example of an internal control procedure.

                            

8. Preventive controls are passive techniques designed to reduce fraud.

                            

9. The Sarbanes-Oxley Act requires only that a firm keep good records.

                            

10. A key modifying assumption in internal control is that the internal control system is the responsibility of management.

             

11. While the Sarbanes-Oxley Act prohibits auditors from providing non-accounting services to their audit clients, they are not prohibited from performing such services for non-audit clients or privately held companies.

                                          

 

12. The Sarbanes-Oxley Act requires the audit committee to hire and oversee the external auditors.

 

                                          

 

13. Section 404 requires that corporate management (including the CEO) certify their organization’s internal controls on a quarterly and annual basis.

 

                                          

 

14. Section 302 requires the management of public companies to assess and formally report on the effectiveness of their organization’s internal controls.

 

                                          

 

15. Application controls apply to a wide range of exposures that threaten the integrity of all programs processed within the computer environment.

 

                                          

 

16. IT auditing is a small part of most external and internal audits.

 

                                          

 

17. Advisory services is an emerging field that goes beyond the auditor’s traditional attestation function.

 

                                          

 

18. An IT auditor expresses an opinion on the fairness of the financial statements.

 

                                          

 

19. External auditing is an independent appraisal function established within an organization to examine and evaluate its activities as a service to the organization.

 

                                          

 

20. External auditors can cooperate with and use evidence gathered by internal audit departments that are organizationally independent and that report to the Audit Committee of the Board of Directors.

 

                                          

 

21. Tests of controls determine whether the database contents fairly reflect the organization's transactions.

 

                                          

 

22. Audit risk is the probability that the auditor will render an unqualified opinion on financial statements that are materially misstated.

 

                                          

23. A strong internal control system will reduce the amount of substantive testing that must be performed.

 

                                          

 

24. Substantive testing techniques provide information about the accuracy and completeness of an application's processes.

 

                                          

 

 

 

 

MULTIPLE CHOICE

 

1. The concept of reasonable assurance suggests that

a.	the cost of an internal control should be less than the benefit it provides
b.	a well-designed system of internal controls will detect all fraudulent activity
c.	the objectives achieved by an internal control system vary depending on the data processing method
d.	the effectiveness of internal controls is a function of the industry environment

                                          

 

2. Which of the following is not a limitation of the internal control system?

a.	errors are made due to employee fatigue
b.	fraud occurs because of collusion between two employees
c.	the industry is inherently risky
d.	management instructs the bookkeeper to make fraudulent journal entries

                                          

 

3. The most cost-effective type of internal control is

a.	preventive control
b.	accounting control
c.	detective control
d.	corrective control

                                          

 

4. Which of the following is a preventive control?

a.	credit check before approving a sale on account
b.	bank reconciliation
c.	physical inventory count
d.	comparing the accounts receivable subsidiary ledger to the control account

                                          

5. A well-designed purchase order is an example of a

a.	preventive control
b.	detective control
c.	corrective control
d.	none of the above

                                          

6. A physical inventory count is an example of a

a.	preventive control
b.	detective control
c.	corrective control
d.	Feed-forward control

                                          

 

7. The bank reconciliation uncovered a transposition error in the books. This is an example

of a

a.	preventive control
b.	detective control
c.	corrective control
d.	none of the above

                                          

 

8. Which of the following is not an element of the internal control environment?

a.	management philosophy and operating style
b.	organizational structure of the firm
c.	well-designed documents and records
d.	the functioning of the board of directors and the audit committee

                                          

 

9. Which of the following suggests a weakness in the internal control environment?

a.	the firm has an up-to-date organizational chart
b.	monthly reports comparing actual performance to budget are distributed to managers
c.	performance evaluations are prepared every three years
d.	the audit committee meets quarterly with the external auditors

                                          

 

10. Which of the following indicates a strong internal control environment?

a.	the internal audit group reports to the audit committee of the board of directors
b.	there is no segregation of duties between organization functions
c.	there are questions about the integrity of management
d.	adverse business conditions exist in the industry

                                          

 

 

 

 

 

11. According to COSO, an effective accounting system performs all of the following except

a.	identifies and records all valid financial transactions
b.	records financial transactions in the appropriate accounting period
c.	separates the duties of data entry and report generation
d.	records all financial transactions promptly

                                          

 

12. Which of the following is the best reason to separate duties in a manual system?

a.	to avoid collusion between the programmer and the computer operator
b.	to ensure that supervision is not required
c.	to prevent the record keeper from authorizing transactions
d.	to enable the firm to function more efficiently

                                          

 

13. Which of the following is not an internal control procedure?

a.	authorization
b.	management’s operating style
c.	independent verification
d.	accounting records

                                          

 

14. The decision to extend credit beyond the normal credit limit is an example of

a.	independent verification
b.	authorization
c.	segregation of functions
d.	supervision

                                          

 

15. When duties cannot be segregated, the most important internal control procedure is

a.	supervision
b.	independent verification
c.	access controls
d.	accounting records

                                          

 

16. An accounting system that maintains an adequate audit trail is implementing which internal control procedure?

a.	access controls
=b.	segregation of functions
c.	independent verification
d.	accounting records

                                          

 

 

 

17. The importance to the accounting profession of the Sarbanes-Oxely Act is that

a.	bribery will be eliminated
b.	management will not override the company’s internal controls
c.	management are required to certify their internal control system
d.	firms will not be exposed to lawsuits

                                          

 

18. The board of directors consists entirely of personal friends of the chief executive officer. This indicates a weakness in

a.	the accounting system
b.	the control environment

c.	control procedures
d.	this is not a weakness

 

                                          

 

19. The office manager forgot to record in the accounting records the daily bank deposit. Which control procedure would most likely prevent or detect this error?

a.	segregation of duties
b.	independent verification
c.	accounting records
d.	supervision

                                          

 

20. Control activities under SAS 109/COSO include

a.	IT Controls, preventative controls, and Corrective controls
b.	physical controls, preventative controls, and corrective controls.
c.	general controls, application controls, and physical controls.
d.	transaction authorizations, segregation of duties, and risk assessment

                                          

 

21. Internal control system have limitations. These include all of the following except

a.	possibility of honest error
b.	circumvention
c.	management override
d.	stability of systems

                                          

 

22. Management can expect various benefits to follow from implementing a system of strong internal control. Which of the following benefits is least likely to occur?

a.	reduced cost of an external audit.
b.	prevents employee collusion to commit fraud.
c.	availability of reliable data for decision-making purposes.
d.	some assurance of compliance with the Foreign Corrupt Practices Act of 1977.
e.	some assurance that important documents and records are protected.

                                          

 

23. Which of the following situations is not a segregation of duties violation?

a.	The treasurer has the authority to sign checks but gives the signature block to the assistant treasurer to run the check-signing machine.
b.	The warehouse clerk, who has the custodial responsibility over inventory in the warehouse, selects the vendor and authorizes purchases when inventories are low.
c.	The sales manager has the responsibility to approve credit and the authority to write off accounts.
d.	The department time clerk is given the undistributed payroll checks to mail to absent employees.
e.	The accounting clerk who shares the record keeping responsibility for the accounts receivable subsidiary ledger performs the monthly reconciliation of the subsidiary ledger and the control account.

                                          

24. Which concept is not an integral part of an audit?

a.	evaluating internal controls
b.	preparing financial statements
c.	expressing an opinion
d.	analyzing financial data

                                          

 

25. Which statement is not true?

a.	Auditors must maintain independence.
b.	IT auditors attest to the integrity of the computer system.
c.	IT auditing is independent of the general financial audit.
d.	IT auditing can be performed by both external and internal auditors.

                                          

 

26. Typically, internal auditors perform all of the following tasks except

a.	IT audits
b.	evaluation of operational efficiency
c.	review of compliance with legal obligations
d.	internal auditors perform all of the above tasks

                                          

 

27. The fundamental difference between internal and external auditing is that

a.	internal auditors represent the interests of the organization and external auditors represent outsiders
b.	internal auditors perform IT audits and external auditors perform financial statement audits
c.	internal auditors focus on financial statement audits and external auditors focus on operational audits and financial statement audits
d.	external auditors assist internal auditors but internal auditors cannot assist external auditors

                                          

 

 

28. Internal auditors assist external auditors with financial audits to

a.	reduce audit fees
b.	ensure independence
c.	represent the interests of management
d.	the statement is not true; internal auditors are not permitted to assist external auditors with financial audits

                                          

 

29. Which statement is not correct?

a.	Auditors gather evidence using tests of controls and substantive tests.
b.	The most important element in determining the level of materiality is the mathematical formula.
c.	Auditors express an opinion in their audit report.
d.	Auditors compare evidence to established criteria.

                                          

 

30. All of the following are steps in an IT audit except

a.	substantive testing
b.	tests of controls
c.	post-audit testing
d.	audit planning

                                          

 

31. When planning the audit, information is gathered by all of the following methods except

a.	completing questionnaires
b.	interviewing management
c.	observing activities
d.	confirming accounts receivable

                                          

 

32. Substantive tests include

a.	examining the safety deposit box for stock certificates
b.	reviewing systems documentation
c.	completing questionnaires
d.	observation

                                          

 

33. Tests of controls include

a.	confirming accounts receivable
b.	counting inventory
c.	completing questionnaires
d.	counting cash

                                          

 

 

 

34. All of the following are components of audit risk except

a.	control risk
b.	legal risk
c.	detection risk
d.	inherent risk

                                          

 

35. Control risk is

a.	the probability that the auditor will render an unqualified opinion on financial statements that are materially misstated
b.	associated with the unique characteristics of the business or industry of the client
c.	the likelihood that the control structure is flawed because controls are either absent or inadequate to prevent or detect errors in the accounts
d.	the risk that auditors are willing to take that errors not detected or prevented by the control structure will also not be detected by the auditor

                                          

 

36. Which of the following is true?

a.	In the CBIS environment, auditors gather evidence relating only to the contents of databases, not the reliability of the computer system.
b.	Conducting an audit is a systematic and logical process that applies to all forms of information systems.
c.	Substantive tests establish whether internal controls are functioning properly.
d.	IT auditors prepare the audit report if the system is computerized.

                                          

 

37. Inherent risk

a.	exists because all control structures are flawed in some ways.
b.	is the likelihood that material misstatements exist in the financial statements of the firm.
c.	is associated with the unique characteristics of the business or industry of the client.
d.	is the likelihood that the auditor will not find material misstatements.

                                          

 

38. Attestation services require all of the following except

a.	written assertions and a practitioner’s written report
b.	the engagement is designed to conduct risk assessment of the client’s systems to verify their degree of SOX compliance
c.	the formal establishment of measurements criteria
d.	the engagement is limited to examination, review, and application of agreed-upon procedures

                                          

39. The financial statements of an organization reflect a set of management assertions about the financial health of the business. All of the following describe types of assertions except

a.	that all of the assets and equities on the balance sheet exist
b.	that all employees are properly trained to carry out their assigned duties
c.	that all transactions on the income statement actually occurred
d.	that all allocated amounts such as depreciation are calculated on a systematic and rational basis

                                          

 

40. Which of the following is NOT an implication of section 302 of the Sarbanes-Oxley Act?

a.	Auditors must determine, whether changes in internal control has, or is likely to, materially affect internal control over financial reporting.
b.	Auditors must interview management regarding significant changes in the design or operation of internal control that occurred since the last audit.
c.	Corporate management (including the CEO) must certify monthly and annually their organization’s internal controls over financial reporting.
d.	Management must disclose any material changes in the company’s internal controls that have occurred during the most recent fiscal quarter.

                                          

 

SHORT ANSWER

 

1. List the four broad objectives of the internal control system.

 

2. Explain the purpose of the PCAOB

 

 

 

 

3. What are the five internal control components described in the COSO framework

 

 

 

4. What are management responsibilities under section 302 and 404?

 

 

 

 

5. Indicate whether each procedure is a preventive or detective control.

 

a.	authorizing a credit sale	Preventive	Detective
b.	preparing a bank reconciliation	Preventive	Detective
c.	locking the warehouse	Preventive	Detective
d.	preparing a trial balance	Preventive	Detective
e.	counting inventory	Preventive	Detective

 

 

Use the internal control procedures listed below to complete statements 6 through 12.

 

	segregation of duties	specific authorization
	general authorization	accounting records
	access controls	independent verification
	supervision

 

 

6. A clerk reorders 250 items when the inventory falls below 25 items. This is an example of                                            .

 

7. The internal audit department recalculates payroll for several employees each pay period. This is an example of   .

 

 

 

8. Locking petty cash in a safe is an example of                                                                .
9. Approving a price reduction because goods are damaged is an example of

                                                               .

 

10. Using cameras to monitor the activities of cashiers is an example of

                                                               .

 

11. Not permitting the computer programmer to enter the computer room is an example of

                                                                            .

 

12. Sequentially numbering all sales invoices is an example of

                                                               .

 

 

 

13. Both the SEC and the PCAOB have expressed an opinion as which internal control framework an organization should use to comply with SOX legislation. Explain.

 

 

 

 

 

 

 

 

 

14. COSO identifies two broad groupings of information system controls. What are they?

 

15. The Sarbanes-Oxley Act contains many sections. Which sections are the focus of this chapter?

 

 

16. What are the objectives of application controls?

 

 

 

 

17. Define general controls.

 

 

 

 

18. Discuss the key features of Section 302 of the Sarbanes-Oxley Act.

 

 

 

 

 

 

 

 

 

 

 

19. Explain the relationship between internal controls and substantive testing.

 

20. Distinguish between errors and irregularities. Which do you think concern the auditors the most?

 

 

 

21. Distinguish between inherent risk and control risk. How do internal controls and detection risk fit in?

 

22. Contrast internal and external auditing.

 

 

 

23. What are the components of audit risk?

 

 

 

 

24. How do the tests of controls affect substantive tests?

 

 

 

25. Define and contrast attestation services and advisory services.

 

 

 

 

 

 

 

 

ESSAY

1. What are the key points of the section 404 of the Sarbanes-Oxley Act?

 

 

 

2. Section 404 requires management to make a statement identifying the control framework used to conduct their assessment of internal controls. Discuss the options in selecting a control framework.

 

 

 

3. Explain how general controls impact transaction integrity and the financial reporting

process.

 

 

 

 

4. Prior to SOX, external auditors were required to be familiar with the client organization’s internal controls, but not test them. Explain.

 

 

 

5. Does a qualified opinion on management’s assessment of internal controls over the financial reporting system necessitate a qualified opinion on the financial statements? Explain.

 

 

 

 

 

 

 

6. The PCAOB’s standard No. 2 specifically requires auditors to understand transaction flows in designing their test of controls. What steps does this entail?

 

 

 

 

 

1. 7. The text describes six internal control activities. List four of them and provide a specific example of each one.

 

 

 

 

1. 8. Explain the purpose of the PCAOB.

 

 

 

 

1. 9. Why is an Independent Audit Committee important to a company?

 

 

 

 

 

1. 10. What are the key points of the “Issuer and Management Disclosure” of the Sarbanes- Oxley Act?

 

 

 

 

1. 11. In this age of high technology and computer based information systems, why are accountants concerned about physical (human) controls?

 

 

 

 

 

1. 12. Discuss the advisory services that external auditors are no longer permitted to render to audit clients under SOX legislation.

 

 

 

 

1. 13. Internal control in a computerized environment can be divided into two broad categories. What are they? Explain each.