Far Eastern University

ACCOUNTING 1.1

Chapter 3: INTERNAL CONTROL OVER FINANCIAL REPORTING

1)In an audit of financial statements, an auditor’s primary consideration regarding control is whether it

1. 1. Reflects management’s philosophy and operating style.
   2. Affects management’s financial statement assertions.
   3. Provides adequate safeguards over access to assets.
   4. Enhances management’s decision-making processes.

2. Which of the following is correct about internal control?
   1. Accounting and internal control systems provide management with conclusive evidence that objectives are reached.
   2. One of the inherent limitations of accounting and internal control systems is the possibility that the procedures may become inadequate due to changes in conditions, and compliance with procedures may deteriorate.
   3. Most internal controls tend to be directed at non-routine transactions.
   4. Management does not consider costs of the accounting and internal control systems.

3. Corporate directors, management, external auditors, and internal auditors all play important roles in creating a proper control environment. Top management is primarily responsible for
   1. Establishing a proper environment and specifying overall internal control.
   2. Reviewing the reliability and integrity of financial information and the means used to collect and report such information.
   3. Ensuring that external and internal auditors adequately monitor the control environment.
   4. Implementing and monitoring controls designed by the board of directors.

4. Which of the following best describe the interrelated components of internal control?
   1. Organizational structure, management philosophy, and planning.
   2. Control environment, risk assessment, control activities, information and communication systems, and monitoring.
   3. Risk assessment, backup facilities, responsibility accounting and natural laws.
   4. Legal environment of the firm, management philosophy, and organizational structure.
5. Effective internal control
   1. Eliminates risk and potential loss to the organization.
   2. Cannot be circumvented by management.
   3. Is unaffected by changing circumstances and conditions encountered by the organization.
   4. Reduces the need for management to review exception reports on a day-to-day basis.
6. Which of the following statements about internal control is correct?
   1. Properly maintained internal controls reasonably assure that collusion among employees cannot occur.
   2. Establishing and maintaining internal control is the internal auditor’s responsibility.
   3. Exceptionally strong control allows the auditor to eliminate substantive tests.

6. 4. The cost-benefit relationship should be considered in designing internal control.
7. The ultimate purpose of assessing control risk is to contribute to the auditor’s evaluation of the risk that
   1. Tests of controls may fail to identify controls relevant to assertions.
   2. Material misstatements may exist in the financial statements.
   3. Specified controls requiring segregation of duties may be circumvented by collusion.
   4. Entity policies may be overridden by senior management.
8. A proper understanding of the client’s internal control is an integral part of the audit planning process. The results of the understanding
   1. Must be reported to the shareholders and the SEC.
   2. Bear no relationship to the extent of substantive testing to be performed.
   3. Are not reported to client management.
   4. May be used as the basis for withdrawing from an audit engagement.

9. An entity should consider the cost of a control in relationship to the risk. Which of the following controls best reflects this philosophy for a large peso investment in heavy machine tools?
   1. Conducting a weekly physical inventory.
   2. Placing security guards at every entrance 24 hours a day.
   3. Imprinting a controlled identification number on each tool.
   4. Having all dispositions approved by the vice president of sales.

10. Audit evidence concerning segregation of duties ordinarily is best obtained by

1. Performing tests of transactions that corroborate management’s financial statement assertions
2. Observing the employees as they apply specific controls.
3. Obtaining a flowchart of activities performed by available personnel.
4. Developing audit objectives that reduce control risk.

11. Which of the following statements about preliminary assessment of control risks is correct?

1. After obtaining an understanding of the accounting and internal control systems, the auditors should make a preliminary assessment of control risks, at the assertion level, for all accounts or transaction classes.
2. The preliminary assessment of control risk can be done only after completing tests of controls.
3. The preliminary assessment of control risk for a financial assertion is normally low, unless the auditor is able to identify weaknesses that may indicate ineffectiveness of accounting and internal control system.
4. The auditor ordinarily assesses control risk at high level for some or all assertions when it is not cost efficient to do tests of controls.

12. Which of the following statements concerning control risk is correct?

1. When control risk is at the maximum level, an auditor is required to document the basis for that assessment.
2. Control risk may be assessed sufficiently low to eliminate substantive testing for significant transaction classes.

3. When assessing control risk, an auditor should not consider evidence obtained in prior audits about the operation of controls.
4. Assessing control risk and obtaining an understanding of an entity’s internal control may be performed concurrently.

13. Based on a consideration of internal control completed at an interim date, the auditor assessed control risk at a low level and performed interim substantive tests. The records and procedures would most likely be tested again at year-end if

1. Tests of controls were not performed by the internal auditor during the remaining period.
2. Internal control provides a basis for limiting the extent of substantive testing.
3. The auditor used non-statistical sampling during the interim period testing of controls.
4. Inquiries and observations lead the auditor to believe that conditions have changed.

14. Although substantive tests may support the accuracy of underlying records, these tests frequently provide no affirmative evidence of segregation of duties because

1. Substantive tests rarely guarantee the accuracy of the records if only a person who performs incompatible functions.
2. The records may be accurate even though they are maintained by a person who performs incompatible functions.
3. Substantive tests relate to the entire period under audit, but tests of controls ordinarily are confined to the period during which the auditor is on the client’s premises.
4. Many computerized procedures leave no audit trail of who performed them, so substantive tests may necessarily be limited to inquiries and observation of office personnel.

15. After obtaining an understanding of internal control and assessing control risk, an auditor decided not to perform additional tests of controls. The auditor most likely concluded that the

1. Additional evidence to support a further reduction in control risk was not cost-beneficial to obtain.
2. Assessed level of inherent risk exceeded the assessed level of control risk.
3. Internal control was properly designed and justifiably may be relied on.
4. Evidence obtainable through tests of controls would not support an increased assessment of control risk.

16. The objective of tests of details of transactions performed as tests of controls is to

1. Monitor the design and use of entity documents such as pre-numbered shipping form
2. Determine whether controls have been placed in operation.
3. Detect material misstatements in the account balances of the financial statements.
4. Evaluate whether controls operated effectively.

17. An auditor wishes to perform tests of controls on a client’s cash disbursements procedures. If the controls leave no audit trail of documentary evidence, the auditor most likely will test the procedures by

1. Confirmation and observation.
2. Observation and inquiry.
3. Analytical procedures and confirmation.
4. Inquiry and analytical procedures.

18. Which of the following types of evidence would an auditor most likely examine to determine whether controls are operating as designed?

1. Confirmations of receivables verifying account balances.
2. Letters of representations corroborating inventory pricing.
3. Attorneys’ responses to the auditor’s inquiries.
4. Client records documenting the use of computer programs.

19. Which of the following procedures concerning accounts receivable is an auditor most likely to perform to obtain evidential matter in support of an assessed level of control risk below the maximum level?

1. Sending confirmation requests to an entity’s principal customers to verify the existence of accounts receivable.
2. Inspecting an entity’s analysis of accounts receivable for unusual balances.
3. Comparing an entity’s uncollectible accounts expense to actual uncollectible accounts receivable.
4. Observing an entity’s employee prepare the schedule of past due accounts receivable.

20. Which of the following audit techniques most likely would provide an auditor with the most assurance about the effectiveness of the operation on an internal control procedure?

1. Confirmation with outside parties
2. Observation of client personnel
3. Re--computation of account balance
4. Inquiry of client personnel