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Chapter 16 Ans

Chapter 16 Ans

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Published by Dave Manalo
Auditing, Theory, Cabrera, Solution, Manual
Auditing, Theory, Cabrera, Solution, Manual

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Published by: Dave Manalo on Aug 04, 2010
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11/30/2013

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CHAPTER 16CONSIDERATION OF INTERNAL CONTROLIN A FINANCIAL STATEMENTS AUDIT
I.
 Review Questions
1.An auditor obtains an understanding of a client’s internal control structure as a part of the control risk assessment process in order (1) to plan the nature, timing,and extent of subsequent substantive audit procedures, and (2) to obtaininformation about reportable conditions (control deficiencies) to report to theclient.2.The primary reason for conducting an evaluation of a client’s existing internalcontrol system is to give the auditors a basis for finalizing the details of theaccount balance audit program – to determine the nature, timing and extent of subsequent substantive audit procedures.A secondary purpose for conducting an evaluation of internal control is to beable to make constructive suggestions for improvements. Officially, the profession considers these suggestions a part of the audit function and does notdefine the work as a MAS consultation.Another purpose of the evaluation is to report to management and the board of directors or its audit committee any discovery of “any reportable conditions” of internal control deficiencies.3.Refer to page 590, 1
st
paragraph of the textbook.4.1.Advantages of control questionnaire:Easy to complete.Checklist of questions.Less chance of overlooking something important.Disadvantages:May contain numerous irrelevant questions.Tendency to treat it like another form to fill out.2.Advantages of memorandum documentation:Can explain the precise controls applicable to the particular client.(precise tailoring)Requires penetrating analysis.
 
16-2
Solutions Manual - Principles of Auditing and Other AssuranceServices
Minimizes tendency toward perfunctory review.Disadvantages:Hard to write. Often lengthy.Hard to revise in subsequent years.3.Advantages of flowchart:Graphic presentation of systems.Shows the steps required and the flow of forms and documents.Easy to read and analyze.Easy to update in subsequent years.Disadvantages:Takes some time to draw neatly.5.“Observation,” in a test of control procedure, refers to auditors looking to seewhether client personnel stamped, initialed, or left other signs that their assignedcontrol procedures had been performed.“Reperformance,” in a test of control procedure, refers to auditors doing againthe control that was supposed to have been performed by the client personnel(recalculating, looking up the right price, comparing quantities, and so forth).6.Written reports on internal accounting control (IAC) for external use.
Type of EngagementCharacter of Repor
Special IAC studyReport on IAC with opinion on IACsystem taken as a whole.Service auditor engaged to report for  benefit of user auditor and their mutual client.A special-purpose report on IAC cantake special forms, the main feature of which includes an opinion relating tothe controls applied by the serviceorganization to the clientorganization’s transactions.7.The auditor must obtain a sufficient understanding of the client’s system of internal financial controls to identify the types of potential materialmisstatements of financial statement components, and the risks associated witheach. Such understanding is obtained by gathering evidence relating to the basicelements of the client’s internal financial controls.8.The auditor obtains an initial understanding of the client’s financial controls bystudying the organizational structure, inquiring of management, and studyinglast year’s working papers if a recurring audit.
 
Consideration of Internal Control in a Financial Statements Audit 
 
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9.The documentation of the auditor’s understanding must provide clear evidenceof support for the auditor’s conclusions regarding the assessed level of controlrisk. This is especially necessary if control risk is assessed below the maximumlevel. The documentation at this point typically consists of some combination of narrative memoranda, questionnaires or checklists, and internal controlflowcharts, as well as documentation of the auditor’s conclusions, and thereason(s) for assessing control risk below maximum, if applicable.10.Testing of internal financial controls may permit the auditor to further reduce theassessed level of control risk. This, in turn, should lead to a decrease in thenature, timing, and/or extent of substantive audit testing in the circumstances.11.The following factors may cause the auditor to decide not to test the client’sinternal financial controls beyond obtaining an initial understanding:a.Controls may already have been evaluated as ineffective; b.Further testing is not cost effective (i.e., the cost of further testing isgreater than the cost savings resulting from reduced substantive testing)12.Some combination of the following means is typically utilized by the auditor intesting a client’s internal financial controls:a.Reprocessing transactions through the client’s system; b.Observation of controls; andc.Document examination and testing.13.
Misrepresentation
is a form of financial statement misstatement caused byintentional efforts by management to distort reported financial position and/or results of operations.
Misappropriation
is a form of fraud whereby one or moreemployees effect a transfer of assets from employer to employee, accompanied by concealment in the form of account or substance alteration.14.The following are some examples of internal control weaknesses and suggestedexpanded substantive testing, given the weaknesses:a.Perpetual inventory records not maintained: Expand test counts duringinventory observation b.Bank accounts not reconciled: Expand year-end audit of cash accountsc.Customer exceptions to monthly statements not investigated andcleared: Expand accounts receivable confirmation at year-end.15.Reportable conditions are matters coming to the auditor’s attention, as a result of his/her study and evaluation of the client’s internal financial controls, relating tosignificant deficiencies in the design or operation or of the internal controls thatcould adversely affect the organization’s ability to record, process, summarize,and report financial data consistent with the assertions of management in thefinancial statements. The purpose of the reportable conditions letter is to inform

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