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Chapter 07 - Auditing Internal Control over Financial Reporting

Chapter 07 Auditing Internal Control over Financial Reporting


True / False Questions

1. All companies must follow the guidelines of AS . !rue False

". #ost pu$lic companies must follow the guidelines of AS . !rue False

%. In a pu$lic compan&' management must assess and report on internal control over financial reporting. !rue False

(. In a pu$lic compan&' management)s report on internal control must $e signed $& the mem$ers of the audit committee. !rue False

. *ased on +CA,* guidelines' the audit of ICFR and financial statements audit should $e conduced as an -integrated audit.!rue False

.. !he +CA,* ma/es it clear that the C0, and CF, are responsi$le for the internal control over financial reporting and the preparation of the statements. !rue False

7. !he li/elihood of an event is -more than remote- when it is -highl& possi$le.!rue False

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Chapter 07 - Auditing Internal Control over Financial Reporting

1. 2hen auditing a pu$lic compan&' the auditor must form an opinion on the effectiveness of internal control over financial reporting' or issue a disclaimer in the event of a scope limitation. !rue False

Multiple Choice Questions

3. In order for an e4ternal auditor to complete an audit of a pu$licl& traded entit&' the entit&)s management must compl& with all of the following e4cept5 A. Accept responsi$ilit& for the effectiveness of the entit&)s internal control over financial reporting *. 0valuate the effectiveness of the entit&)s internal control over financial reporting using suita$le control criteria C. Support its evaluation with sufficient evidence' including documentation 6. +resent an oral assessment of the effectiveness of the entit&)s internal control over financial reporting as of the end of the entit&)s most recent fiscal &ear

10. An -integrated audit- as stated in Section (0( of the Sar$anes-,4le& Act means A. !he auditor must consider the integrated thoughts and ideas of ever&one on the audit staff *. !he auditor must conduct two audits' one on the effectiveness of internal control and one on the financial statements' in an integrated wa& C. !he auditor must integrate the same o$7ectives whether auditing internal control or auditing the financial statements 6. !wo independent C+A firms must wor/ together on the audit

11. Section (0( of the Sar$anes-,4le& Act re8uires the auditor to provide which of the following A. Reasona$le assurance on the financial statements' a$solute assurance on internal control *. Reasona$le assurance on internal control' a$solute assurance on the financial statements C. A$solute assurance on $oth the financial statements and internal control 6. Reasona$le assurance on $oth the financial statements and internal control

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Chapter 07 - Auditing Internal Control over Financial Reporting

1". According to the +CA,*' who is responsi$le for the relia$ilit& of the internal controls over financial reporting process of an entit&9 A. !he entit&)s C0, and:or CF, *. !he entit&)s $oard of directors C. An internal control specialist 6. !he e4ternal auditor

1%. !he person in charge of authori;ing credit to customers does not properl& understand what constitutes a credit ris/. !his is an e4ample of A. A management deficienc& *. A design deficienc& C. A deficienc& in operation 6. !his is not an internal control deficienc&

1(. A deficienc& that implies that there is reasona$le possi$ilit& of misstatement in the financial statements that is significant $ut not material is A. A material wea/ness *. A significant deficienc& C. An insignificant deficienc& 6. A pro$a$le deficienc&

1 . 2hich of the following is not a topic that re8uires special consideration $& management during management)s internal control assessment process and $& the auditor during the audit of internal control9 A. #ultiple locations and $usiness units *. Service organi;ations C. !he role of the auditor in internal control 6. Safeguarding assets

1.. #anagement documentation should include all of the following e4cept5 A. 6ocumentation regarding the auditor)s evaluation of internal controls *. 6ocumentation regarding management)s testing and evaluation of the controls C. 6ocumentation regarding the safeguarding of assets 6. 6ocumentation on the controls designed in all five components of internal control

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Chapter 07 - Auditing Internal Control over Financial Reporting

17. 2hich of the following is not a primar& o$7ective of internal control as esta$lished $& C,S,9 A. 0fficienc& and effectiveness of operations *. 0ffective purchasing s&stems C. Compliance with laws and regulations 6. Relia$le financial reporting

11. !he main goal of auditing internal control is5 A. !o allow the auditor to fi4 an& internal control deficiencies *. !o form an opinion on the a$ilit& of internal controls to prevent fraud C. !o assure management that internal control is preventing all material misstatements on the financial statements 6. !o evaluate the effectiveness of controls over all relevant financial statement disclosures in the financial statements

13. An auditor performing an audit of internal control over financial reporting would $e re8uired to5 A. Rel& on the wor/ of internal auditors *. !est all of the entit&)s internal controls C. Form an opinion on the effectiveness of internal control 6. Randoml& identif& accounts for an audit of internal control

"0. In determining the e4tent to which the auditor ma& use the wor/ of others in the audit of ICFR' the auditor should do all of the following e4cept A. !est some of the wor/ performed $& others to evaluate the 8ualit& and effectiveness of their wor/ *. 0valuate the nature of the controls su$7ected to the wor/ of others C. 0valuate the competence and o$7ectivit& of the individuals who performed the wor/ 6. All of the a$ove are re8uired

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Chapter 07 - Auditing Internal Control over Financial Reporting

"1. 2hich of the following is the least li/el& to represent a material wea/ness in internal control for Fl&nt Corporation9 A. Fl&nt Corporation)s computer s&stems were not wor/ing properl& for two da&s< conse8uentl&' emplo&ees needed to do all reconciliations manuall& *. Fl&nt Corporation)s CF, was arrested last &ear for em$e;;ling mone& from the compan& C. For the current &ear' the auditor found a material misstatement in Fl&nt)s sales recognition that was undetected $& the internal controls 6. Fl&nt)s audit committee is deemed to $e ineffective

"". S=> Accounting has 7ust performed an audit of *o$)s *i/es. S=> was una$le to o$tain a written representation from management a$out internal control. 2hich of the following is true9 A. S=> must still assume that management has assessed the effectiveness of internal control *. 6epending on other factors in the audit' S=> can still issue an un8ualified opinion C. S=> should consider this situation a limitation on the scope of the audit 6. #anagement does not need to give S=> a letter if the& have disclosed all /nown internal control deficiencies

"%. +u$lic reporting on the effectiveness of internal control over financial reporting' as re8uired $& the Sar$anes-,4le& Act' includes5 A. A statement that the pu$lic accounting firm that audited the financial statements has provided input on the design of internal controls *. A statement of management)s responsi$ilit& for esta$lishing and maintaining ade8uate internal control over financial reporting C. An e4plicit statement as to whether management agrees with the pu$lic accounting firm)s assessment of internal controls 6. A detailed statement descri$ing changes or additions to the internal control environment that occurred in the current &ear

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Chapter 07 - Auditing Internal Control over Financial Reporting

"(. 2hich of the following concerning the auditor)s report on internal control over financial reporting is correct9 A. !he auditor)s report contains an opinion on the effectiveness of internal control over financial reporting $ased on the auditor)s independent wor/ *. In the report on internal control over financial reporting' the auditor can issue onl& a 8ualified or an un8ualified opinion C. !he auditor needs to state management)s assessment of internal control over financial reporting' $ut does not necessaril& need to comment on whether he or she agrees 6. An un8ualified opinion is re8uired if a material wea/ness is identified

" . +rior to issuing a report on internal controls over financial reporting' an auditor is re8uired to5 A. +erform procedures sufficient to identif& all control deficiencies *. Communicate to management' in writing' all control deficiencies previousl& included in written communication from the internal auditors C. Communicate to management' in writing' all control deficiencies identified during the audit and inform the audit committee when such a communication has $een made 6. Represent that no significant deficiencies were noted during the audit of internal control

".. 2hich of the following is not true9 A. !he auditor should not communicate with management at all until the audit of internal control over financial reporting is finished *. 2ritten communication $etween the auditor and management a$out internal control over financial reporting should include the definitions of control deficiencies' significant deficiencies' and material wea/nesses C. !he auditor should not include in the audit report that no significant deficiencies were noted during an audit of internal control over financial reporting 6. If fraud is discovered' the auditor must report it to the appropriate level of management

"7. An -integrated auditA. 2ill' in most cases' lead to a su$stantive audit strateg& *. 6enies the auditor access to information a$out the client)s controls C. #a& $e performed $& two separate audit firms 6. Is comprised of audits of internal control over financial reporting and of financial statements

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Chapter 07 - Auditing Internal Control over Financial Reporting

"1. !he primar& purpose of a generali;ed computer audit program is to allow the auditor to A. ?se the client)s emplo&ees to perform routine audit chec/s of the electronic data processing records that otherwise would $e done $& the auditor)s staff accountants *. !est the logic of computer programs used in the client)s electronic data processing s&stems C. Select larger samples from the client)s electronic data processing records than would otherwise $e selected without the generali;ed program 6. Independentl& process client electronic data processing records

"3. 2hich of the following audit procedures would an auditor $e least li/el& to perform using a generali;ed computer audit program9 A. Searching records of accounts receiva$le $alances for credit $alances *. Investigating inventor& $alances for possi$le damaged goods C. Selecting accounts receiva$le for positive and negative confirmation 6. @isting of unusuall& large inventor& $alances

%0. !he auditor is least li/el& to use generali;ed audit software to A. +erform anal&tical procedures on the client)s data *. Access information stored on the client)s I! files C. Identif& material wea/nesses in the client)s I! controls 6. !est the accurac& of the client)s computations

%1. !he five step process in the audit of ICFR includes A. Form an opinion on the safeguarding of the entit&)s assets *. Identif& controls to test using a top-down' ris/-$ased approach C. Form an opinion on the fairness of the presentation of the financial statements 6. Form an opinion on the effectiveness of internal controls in meeting operational goals

%". 2hich of the following is an advantage of generali;ed computer audit pac/ages9 A. !he& are all written in one identical computer language *. !he& can $e used for audits of clients that use differing I! e8uipment and file formats C. !he& have reduced the need for the auditor to stud& input controls for I!-related procedures 6. !heir use can $e su$stituted for a relativel& large part of the re8uired compliance testing

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Chapter 07 - Auditing Internal Control over Financial Reporting

%%. AC@ is an e4ample of A. An 06I software pac/age *. An I! software pac/age C. Software that allows auditors to retrieve and evaluate data from client s&stems 6. A t&pe of networ/ing

%(. !he +CA,*)s definition of internal control over financial reporting specificall& mentions all of the following control activities' e4cept A. !he maintenance of asset records *. !he segregation of duties C. !he authori;ation $& management of receipts and e4penditures 6. !he safeguarding of assets

% . 2hich of the following is not an element of management)s assessment process for the effectiveness of internal control9 A. 0valuate the li/elihood that failure of a control could result in a misstatement *. 6etermining the locations and $usiness units to include in the evaluation C. 6etermining significant deficiencies and material wea/nesses in controls 6. ,$taining the auditor)s assessment of the internal control effectiveness

%.. 2hich of the following is true regarding management)s documentation of internal controls9 A. Some documentation should focus on controls designed to detect fraud *. 6ocumentation should focus on controls over the interim financial reporting process C. 6ocumentation must $e done on paper 6. Inade8uate documentation is usuall& considered an insignificant deficienc& in internal control

%7. 2hich of the following statements is false9 A. !he +CA,* focuses on the financial reporting o$7ective of internal controls *. #anagement is re8uired to $ase internal controls on a recogni;ed control framewor/ C. #ost ?nited States entities use the internal control framewor/ developed $& C,S, in the earl& 1330s 6. All controls relevant to financial reporting are accounting controls

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Chapter 07 - Auditing Internal Control over Financial Reporting

%1. !o o$tain an understanding of significant processes and relevant su$processes' auditors would $e least li/el& to use which of the following techni8ues5 A. Reviewing management documentation *. In8uir& C. Scanning 6. !ransaction wal/throughs

%3. #anagement)s written representations concerning internal control are5 A. Addressed to the users of the financial statements *. Aormall& drafted $& management C. Included in the auditor)s final report 6. Signed $& the C0, and CF,

(0. In the conte4t of an audit of internal controls' the auditor must document all of the following e4cept A. !he e4tent to which he or she relied upon wor/ performed $& others *. !he auditor)s understanding and evaluation of the design of each of the components of the entit&)s internal control over financial reporting C. !ranscripts of the auditor)s discussion with management concerning the points at which misstatements could occur 6. !he evaluation of an& deficiencies discovered that could result in a modification of the auditor)s report

(1. 04amples of compan&-level controls include5 A. #anagement)s ris/ assessment process *. Controls to monitor results of operations C. !he period-end financial reporting process 6. All of the a$ove are e4amples of compan&-level controls

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Chapter 07 - Auditing Internal Control over Financial Reporting

(". 2hich of the following statements included in management)s assessment of the effectiveness of internal control over financial reporting would $e considered accepta$le for issuing an un8ualified opinion9 A. Aothing has come to management)s attention to suggest that the compan&)s internal control is less than effective *. Statements suggesting onl& negative assurance C. A conclusion that the compan&)s internal control over financial reporting is effective when a material wea/ness e4ists at the end of the reporting period 6. 6isclosure of material wea/nesses corrected during the period

(%. A modification of the standard report is re8uired for all of the following conditions' e4cept5 A. !here is a restriction on the scope of the engagement *. !here is other information contained in management)s report on internal control C. #anagement has concluded that internal controls are not effective 6. A significant su$se8uent event has occurred since the date $eing reported on

((. AAA Accounting recentl& finished auditing @in/the0arth Corporation)s internal control over financial reporting. AAA found a num$er of material wea/nesses in the compan&)s internal control. @in/the0arth)s management remediated all of the wea/nesses that AAA found. >owever' the auditors did not have sufficient time to retest the controls. 2hat report should AAA issue with regards to internal control over financial reporting at &ear end9 A. ?n8ualified report *. Adverse report C. Bualified report 6. 6isclaimer on opinion

( . According to the C,S, definition of safeguarding of assets5 A. Controls over financial reporting are effective if the& provide reasona$le assurance that asset losses will not occur *. Controls over financial reporting are effective if the& provide reasona$le assurance that losses are properl& reflected in the financial statements C. *oth A and * 6. Aeither A nor *

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Chapter 07 - Auditing Internal Control over Financial Reporting

(.. An auditor will use the I! test data method in order to gain certain assurances with respect to the A. Input data *. #achine capacit& C. +rocedures contained within the program 6. 6egree of /e&punching accurac&

(7. 2hich of the following is true of generali;ed audit software pac/ages9 A. !he& can $e used onl& in auditing on-line computer s&stems *. !he& can $e used on an& computer without modification C. !he& each have their own characteristics which the auditor must carefull& consider $efore using in a given audit situation 6. !he& ena$le the auditor to perform all manual test procedures less e4pensivel&

(1. !he advantages of generali;ed audit software include all of the following e4cept A. It involves auditing while the data are $eing processed Creal-timeD *. It is eas& to use C. !he time to develop the application is usuall& short 6. An entire population can $e e4amined in some instances

(3. Section (0( of the Sar$anes-,4le& Act includes which of the following9 A. A re8uirement that management of a pu$licl& traded compan& issues an assessment of internal control that covers the entire &ear *. Specific guidance on what constitutes ade8uate internal control C. A re8uirement that management of a pu$licl& traded compan& accepts responsi$ilit& for esta$lishing and maintaining ade8uate internal controls 6. A re8uirement that management of a pu$licl& traded compan& issues an assessment regarding the efficienc& of internal control for the &ear

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Chapter 07 - Auditing Internal Control over Financial Reporting

0. For which of the following internal controls would an auditor $e least li/el& to perform tests of internal controls closer to the -as of- date9 A. 2ithdrawals from Federal *an/ of more than E million must include a manager)s signature *. At the end of each da& at Federal *an/' the total cash in the vault is reconciled with dail& registers of deposits and withdrawals C. Federal *an/ has 7ust started esta$lishing trusts for its customers and it has onl& set up ten. *efore ma/ing an investment for a trust' $an/ emplo&ees must verif& that the investment is in accordance with stated investment policies 6. ,n an annual $asis' Federal *an/ management performs credit chec/s on its loan customers $efore determining the value of loans it will not $e a$le to collect on

1. 2hich of the following is false9 A. Regardless of the achieved level of control ris/ in connection with the audit of the financial statements' auditing standards re8uire the auditor to perform some su$stantive procedures for all significant accounts and disclosures *. !he a$sence of misstatements in financial statements is considered convincing evidence that e4isting controls are effective C. !he audit of internal control is intended to draw conclusions a$out the effectiveness of internal control over financial reporting as of a specific date 6. !he auditor is re8uired $& AS to evaluate the implications of the financial statement audit for the effectiveness of internal control over financial reporting

". 2hen testing a computeri;ed accounting s&stem' which of the following is false regarding the test data approach9 A. !he test data need to consist of onl& those valid and invalid conditions in which the auditor is interested *. ,nl& one transaction of each t&pe need $e tested C. !est data are processed $& the client)s computer programs under the auditor)s control 6. !he test data must consist of all possi$le valid and invalid conditions

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Chapter 07 - Auditing Internal Control over Financial Reporting

%. 2hen an auditor tests a computeri;ed accounting s&stem' which of the following is true of the test data approach9 A. !est data are processed $& the client)s computer programs under the auditor)s control *. !est data must consist of all possi$le valid and invalid conditions C. !esting a program at &ear end provides assurance that the client)s processing was accurate for the full &ear 6. Several transactions of each t&pe must $e tested

Short Answer Questions

(. Fou are an e4perienced audit senior. !he new staff accountant on &our audit team does not understand what a control deficienc& is. Give him a definition of -control deficienc&.Include e4amples of two t&pes of control deficiencies.

. Fou are performing an audit on Aorth South Aatural Gas CASAGD. Alana' an ASAG emplo&ee' has responsi$ilit& for reconciling $an/ statements with the compan&)s cash records. Fou determine' however' that Alana has never $een taught how to reconcile statements. In effect' the statements have not $een properl& reconciled for two &ears. >ow would &ou 7udge the significance of this control deficienc&9 >ow would &ou classif& this deficienc&9

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Chapter 07 - Auditing Internal Control over Financial Reporting

.. C*A Accounting is auditing a large pu$licl& traded compan&. !he audit of internal controls over financial reporting has $een properl& planned and the auditors have alread& identified controls to test using a top-down' ris/-$ased approach. 2hat is the ne4t step9 Give three e4amples of procedures that ma& $e completed in the ne4t step in the audit.

7. !rumpeter Corporation is a small pu$licl& traded compan& that speciali;es in the restoration and sale of fine musical instruments. !he audit committee is made up of a C0, from a technolog& compan&' a college accounting professor' and a local mar/eting e4ecutive. All are sufficientl& independent from management. !he audit committee meets three times a &ear. 0ach time the& meet' a different mem$er' who chooses the topics to discuss' leads each meeting. !he audit committee then sends the minutes of their meetings to the compan&)s CF,. Solel& from this information' what are &our conclusions a$out this audit committee)s role within the control environment9

1. Identif& indicators of a material wea/ness in internal control over financial reporting.

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Chapter 07 - Auditing Internal Control over Financial Reporting

3. AS re8uires that the auditor appropriatel& document the processes' procedures' 7udgments' and results relating to the audit of internal control. Specificall&' what must this documentation include9

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Chapter 07 - Auditing Internal Control over Financial Reporting

.0. 2hat is wrong with the following report on internal control over financial reporting for A* Corporation9 !he auditor $elieves an un8ualified opinion on the effectiveness of internal control over financial reporting is warranted. Report of Registered +u$lic Accounting Firm 2e have audited A* Corporation)s internal control over financial reporting as of 6ecem$er %1' "003' $ased on criteria esta$lished in Internal Control - Integrated Framewor/' issued $& the Committee of Sponsoring ,rgani;ations of the !readwa& Commission CC,S,D. A*C)s management is responsi$le for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. ,ur responsi$ilit& is to e4press an opinion on the compan&)s internal control over financial reporting $ased on our audit. 2e conducted our audit in accordance with the standards of the +u$lic Compan& Accounting ,versight *oard C?nited StatesD. !hose standards re8uire that we plan and perform the audit to o$tain reasona$le assurance a$out whether effective internal control over financial reporting was maintained in all material respects. ,ur audit included o$taining an understanding of internal control over financial reporting' testing and evaluating the design and operating effectiveness of internal control' and performing such other procedures as we considered necessar& in the circumstances. 2e $elieve that our audit provides a reasona$le $asis for our opinion. A compan&)s internal control over financial reporting is a process designed to provide reasona$le assurance regarding the relia$ilit& of financial reporting and the preparation of financial statements for e4ternal purposes in accordance with generall& accepted accounting principles. A compan&)s internal control over financial reporting includes those policies and procedures that C1D pertain to the maintenance of records that' in reasona$le detail' accuratel& and fairl& reflect the transactions and dispositions of the assets of the compan&< C"D provide reasona$le assurance that transactions are recorded as necessar& to permit preparation of financial statements in accordance with generall& accepted accounting principles' and that receipts and e4penditures of the compan& are $eing made onl& in accordance with authori;ations of management and directors of the compan&< and C%D provide reasona$le assurance regarding prevention or timel& detection of unauthori;ed ac8uisition' use' or disposition of the compan&)s assets that could have a material effect on the financial statements. In our opinion' A*C maintained' in all material respects' effective internal control over financial reporting as of 6ecem$er %1' "003' $ased on criteria esta$lished in Internal Control Integrated Framewor/' issued $& the Committee of Sponsoring ,rgani;ations of the !readwa& Commission CC,S,D. 2e have also audited' in accordance with the standards of the +u$lic Compan& Accounting ,versight *oard C?nited StatesD' the consolidated financial statements of A*C' and our report dated Fe$ruar& "0' "010 e4pressed an un8ualified opinion. +rot;man = >ull #organ >ill' CA Fe$ruar& 10' "010

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Chapter 07 - Auditing Internal Control over Financial Reporting

.1. ,n the audit of !echnolog& ?nlimited' a leading manufacturer of computer chips' the e4ternal audit staff discovers that the internal audit staff has performed e4tensive evaluation and testing on the control environment. 2hat should the e4ternal auditors do to determine the e4tent to which the& ma& use the wor/ of the internal audit staff9 Can the e4ternal audit staff rel& on the internal audit staff for evaluating and testing the control environment9

.". Information Aation has two hundred locations spread across the fift& states. !went& of the locations are considered to $e individuall& important' $ut fift& of the locations are not important even when aggregated from the others. Five locations deal with foreign e4change trading. !hese locations are not considered important' $ut the& are important when aggregated with the other locations. As an auditor' discuss the considerations involved in testing multiple locations and group the locations accordingl& Cprovide how man& locations are included in each groupD. Include the treatment that each group should receive from the auditor.

.%. 6iscuss the differences $etween a control deficienc&' a significant deficienc&' a material wea/ness' and the two dimensions of the control deficienc& - li/elihood and magnitude.

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Chapter 07 - Auditing Internal Control over Financial Reporting

.(. 6iscuss entit&-level controls and provide e4amples of these t&pes of controls.

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Chapter 07 - Auditing Internal Control over Financial Reporting

Chapter 07 Auditing Internal Control over Financial Reporting Answer He&

True / False Questions

1. All companies must follow the guidelines of AS . FALS

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

". #ost pu$lic companies must follow the guidelines of AS . TR!

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

%. In a pu$lic compan&' management must assess and report on internal control over financial reporting. TR!

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

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Chapter 07 - Auditing Internal Control over Financial Reporting

(. In a pu$lic compan&' management)s report on internal control must $e signed $& the mem$ers of the audit committee. FALS

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

. *ased on +CA,* guidelines' the audit of ICFR and financial statements audit should $e conduced as an -integrated audit.TR!

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: (

.. !he +CA,* ma/es it clear that the C0, and CF, are responsi$le for the internal control over financial reporting and the preparation of the statements. TR!

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: )

7. !he li/elihood of an event is -more than remote- when it is -highl& possi$le.FALS

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: *

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Chapter 07 - Auditing Internal Control over Financial Reporting

1. 2hen auditing a pu$lic compan&' the auditor must form an opinion on the effectiveness of internal control over financial reporting' or issue a disclaimer in the event of a scope limitation. TR!

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: +

Multiple Choice Questions

3. In order for an e4ternal auditor to complete an audit of a pu$licl& traded entit&' the entit&)s management must compl& with all of the following e4cept5 A. Accept responsi$ilit& for the effectiveness of the entit&)s internal control over financial reporting *. 0valuate the effectiveness of the entit&)s internal control over financial reporting using suita$le control criteria C. Support its evaluation with sufficient evidence' including documentation "# +resent an oral assessment of the effectiveness of the entit&)s internal control over financial reporting as of the end of the entit&)s most recent fiscal &ear

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '

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Chapter 07 - Auditing Internal Control over Financial Reporting

10. An -integrated audit- as stated in Section (0( of the Sar$anes-,4le& Act means A. !he auditor must consider the integrated thoughts and ideas of ever&one on the audit staff $# !he auditor must conduct two audits' one on the effectiveness of internal control and one on the financial statements' in an integrated wa& C. !he auditor must integrate the same o$7ectives whether auditing internal control or auditing the financial statements 6. !wo independent C+A firms must wor/ together on the audit

AACSB: Communications AICPA BB: "egal AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: (

11. Section (0( of the Sar$anes-,4le& Act re8uires the auditor to provide which of the following A. Reasona$le assurance on the financial statements' a$solute assurance on internal control *. Reasona$le assurance on internal control' a$solute assurance on the financial statements C. A$solute assurance on $oth the financial statements and internal control "# Reasona$le assurance on $oth the financial statements and internal control

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: (

1". According to the +CA,*' who is responsi$le for the relia$ilit& of the internal controls over financial reporting process of an entit&9 A# !he entit&)s C0, and:or CF, *. !he entit&)s $oard of directors C. An internal control specialist 6. !he e4ternal auditor

AACSB: Communications AICPA BB: "egal AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: )

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Chapter 07 - Auditing Internal Control over Financial Reporting

1%. !he person in charge of authori;ing credit to customers does not properl& understand what constitutes a credit ris/. !his is an e4ample of A. A management deficienc& *. A design deficienc& C# A deficienc& in operation 6. !his is not an internal control deficienc&

AACSB: Communications AICPA BB: Industry AICPA FN: ,isk Analysis Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: '. "earning #$%ecti&e: *

1(. A deficienc& that implies that there is reasona$le possi$ilit& of misstatement in the financial statements that is significant $ut not material is A. A material wea/ness $# A significant deficienc& C. An insignificant deficienc& 6. A pro$a$le deficienc&

AACSB: Communications AICPA BB: Industry AICPA FN: ,isk Analysis Bloom's: Com-re/ension Di iculty: !asy "earning #$%ecti&e: '. "earning #$%ecti&e: *

1 . 2hich of the following is not a topic that re8uires special consideration $& management during management)s internal control assessment process and $& the auditor during the audit of internal control9 A. #ultiple locations and $usiness units *. Service organi;ations C# !he role of the auditor in internal control 6. Safeguarding assets

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: 0

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Chapter 07 - Auditing Internal Control over Financial Reporting

1.. #anagement documentation should include all of the following e4cept5 A# 6ocumentation regarding the auditor)s evaluation of internal controls *. 6ocumentation regarding management)s testing and evaluation of the controls C. 6ocumentation regarding the safeguarding of assets 6. 6ocumentation on the controls designed in all five components of internal control

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: 0

17. 2hich of the following is not a primar& o$7ective of internal control as esta$lished $& C,S,9 A. 0fficienc& and effectiveness of operations $# 0ffective purchasing s&stems C. Compliance with laws and regulations 6. Relia$le financial reporting

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: 0

11. !he main goal of auditing internal control is5 A. !o allow the auditor to fi4 an& internal control deficiencies *. !o form an opinion on the a$ilit& of internal controls to prevent fraud C. !o assure management that internal control is preventing all material misstatements on the financial statements "# !o evaluate the effectiveness of controls over all relevant financial statement disclosures in the financial statements

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: +

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Chapter 07 - Auditing Internal Control over Financial Reporting

13. An auditor performing an audit of internal control over financial reporting would $e re8uired to5 A. Rel& on the wor/ of internal auditors *. !est all of the entit&)s internal controls C# Form an opinion on the effectiveness of internal control 6. Randoml& identif& accounts for an audit of internal control

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: +

"0. In determining the e4tent to which the auditor ma& use the wor/ of others in the audit of ICFR' the auditor should do all of the following e4cept A. !est some of the wor/ performed $& others to evaluate the 8ualit& and effectiveness of their wor/ *. 0valuate the nature of the controls su$7ected to the wor/ of others C. 0valuate the competence and o$7ectivit& of the individuals who performed the wor/ "# All of the a$ove are re8uired

AACSB: Communications AICPA BB: ,esource Management AICPA FN: Decision Making Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: 1

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Chapter 07 - Auditing Internal Control over Financial Reporting

"1. 2hich of the following is the least li/el& to represent a material wea/ness in internal control for Fl&nt Corporation9 A# Fl&nt Corporation)s computer s&stems were not wor/ing properl& for two da&s< conse8uentl&' emplo&ees needed to do all reconciliations manuall& *. Fl&nt Corporation)s CF, was arrested last &ear for em$e;;ling mone& from the compan& C. For the current &ear' the auditor found a material misstatement in Fl&nt)s sales recognition that was undetected $& the internal controls 6. Fl&nt)s audit committee is deemed to $e ineffective

AACSB: Communications AICPA BB: Industry AICPA FN: ,isk Analysis Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: 1

"". S=> Accounting has 7ust performed an audit of *o$)s *i/es. S=> was una$le to o$tain a written representation from management a$out internal control. 2hich of the following is true9 A. S=> must still assume that management has assessed the effectiveness of internal control *. 6epending on other factors in the audit' S=> can still issue an un8ualified opinion C# S=> should consider this situation a limitation on the scope of the audit 6. #anagement does not need to give S=> a letter if the& have disclosed all /nown internal control deficiencies

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: '(

7-".

Chapter 07 - Auditing Internal Control over Financial Reporting

"%. +u$lic reporting on the effectiveness of internal control over financial reporting' as re8uired $& the Sar$anes-,4le& Act' includes5 A. A statement that the pu$lic accounting firm that audited the financial statements has provided input on the design of internal controls $# A statement of management)s responsi$ilit& for esta$lishing and maintaining ade8uate internal control over financial reporting C. An e4plicit statement as to whether management agrees with the pu$lic accounting firm)s assessment of internal controls 6. A detailed statement descri$ing changes or additions to the internal control environment that occurred in the current &ear

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '*

"(. 2hich of the following concerning the auditor)s report on internal control over financial reporting is correct9 A# !he auditor)s report contains an opinion on the effectiveness of internal control over financial reporting $ased on the auditor)s independent wor/ *. In the report on internal control over financial reporting' the auditor can issue onl& a 8ualified or an un8ualified opinion C. !he auditor needs to state management)s assessment of internal control over financial reporting' $ut does not necessaril& need to comment on whether he or she agrees 6. An un8ualified opinion is re8uired if a material wea/ness is identified

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '. "earning #$%ecti&e: '*

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Chapter 07 - Auditing Internal Control over Financial Reporting

" . +rior to issuing a report on internal controls over financial reporting' an auditor is re8uired to5 A. +erform procedures sufficient to identif& all control deficiencies *. Communicate to management' in writing' all control deficiencies previousl& included in written communication from the internal auditors C# Communicate to management' in writing' all control deficiencies identified during the audit and inform the audit committee when such a communication has $een made 6. Represent that no significant deficiencies were noted during the audit of internal control

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '0

".. 2hich of the following is not true9 A# !he auditor should not communicate with management at all until the audit of internal control over financial reporting is finished *. 2ritten communication $etween the auditor and management a$out internal control over financial reporting should include the definitions of control deficiencies' significant deficiencies' and material wea/nesses C. !he auditor should not include in the audit report that no significant deficiencies were noted during an audit of internal control over financial reporting 6. If fraud is discovered' the auditor must report it to the appropriate level of management

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '0

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Chapter 07 - Auditing Internal Control over Financial Reporting

"7. An -integrated auditA. 2ill' in most cases' lead to a su$stantive audit strateg& *. 6enies the auditor access to information a$out the client)s controls C. #a& $e performed $& two separate audit firms "# Is comprised of audits of internal control over financial reporting and of financial statements

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: (

"1. !he primar& purpose of a generali;ed computer audit program is to allow the auditor to A. ?se the client)s emplo&ees to perform routine audit chec/s of the electronic data processing records that otherwise would $e done $& the auditor)s staff accountants *. !est the logic of computer programs used in the client)s electronic data processing s&stems C. Select larger samples from the client)s electronic data processing records than would otherwise $e selected without the generali;ed program "# Independentl& process client electronic data processing records

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: '3

"3. 2hich of the following audit procedures would an auditor $e least li/el& to perform using a generali;ed computer audit program9 A. Searching records of accounts receiva$le $alances for credit $alances $# Investigating inventor& $alances for possi$le damaged goods C. Selecting accounts receiva$le for positive and negative confirmation 6. @isting of unusuall& large inventor& $alances

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: '3

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Chapter 07 - Auditing Internal Control over Financial Reporting

%0. !he auditor is least li/el& to use generali;ed audit software to A. +erform anal&tical procedures on the client)s data *. Access information stored on the client)s I! files C# Identif& material wea/nesses in the client)s I! controls 6. !est the accurac& of the client)s computations

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: '3

%1. !he five step process in the audit of ICFR includes A. Form an opinion on the safeguarding of the entit&)s assets $# Identif& controls to test using a top-down' ris/-$ased approach C. Form an opinion on the fairness of the presentation of the financial statements 6. Form an opinion on the effectiveness of internal controls in meeting operational goals

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: +

%". 2hich of the following is an advantage of generali;ed computer audit pac/ages9 A. !he& are all written in one identical computer language $# !he& can $e used for audits of clients that use differing I! e8uipment and file formats C. !he& have reduced the need for the auditor to stud& input controls for I!-related procedures 6. !heir use can $e su$stituted for a relativel& large part of the re8uired compliance testing

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: Knowledge Di iculty: !asy "earning #$%ecti&e: '3

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Chapter 07 - Auditing Internal Control over Financial Reporting

%%. AC@ is an e4ample of A. An 06I software pac/age *. An I! software pac/age C# Software that allows auditors to retrieve and evaluate data from client s&stems 6. A t&pe of networ/ing

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: !asy "earning #$%ecti&e: '3

%(. !he +CA,*)s definition of internal control over financial reporting specificall& mentions all of the following control activities' e4cept A. !he maintenance of asset records $# !he segregation of duties C. !he authori;ation $& management of receipts and e4penditures 6. !he safeguarding of assets

AACSB: Communications AICPA BB: "egal AICPA FN: Decision Making Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: )

% . 2hich of the following is not an element of management)s assessment process for the effectiveness of internal control9 A. 0valuate the li/elihood that failure of a control could result in a misstatement *. 6etermining the locations and $usiness units to include in the evaluation C. 6etermining significant deficiencies and material wea/nesses in controls "# ,$taining the auditor)s assessment of the internal control effectiveness

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: 0

7-%1

Chapter 07 - Auditing Internal Control over Financial Reporting

%.. 2hich of the following is true regarding management)s documentation of internal controls9 A# Some documentation should focus on controls designed to detect fraud *. 6ocumentation should focus on controls over the interim financial reporting process C. 6ocumentation must $e done on paper 6. Inade8uate documentation is usuall& considered an insignificant deficienc& in internal control

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: 0

%7. 2hich of the following statements is false9 A. !he +CA,* focuses on the financial reporting o$7ective of internal controls *. #anagement is re8uired to $ase internal controls on a recogni;ed control framewor/ C. #ost ?nited States entities use the internal control framewor/ developed $& C,S, in the earl& 1330s "# All controls relevant to financial reporting are accounting controls

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: 0

%1. !o o$tain an understanding of significant processes and relevant su$processes' auditors would $e least li/el& to use which of the following techni8ues5 A. Reviewing management documentation *. In8uir& C# Scanning 6. !ransaction wal/throughs

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: 4

7-%"

Chapter 07 - Auditing Internal Control over Financial Reporting

%3. #anagement)s written representations concerning internal control are5 A. Addressed to the users of the financial statements *. Aormall& drafted $& management C. Included in the auditor)s final report "# Signed $& the C0, and CF,

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: '(

(0. In the conte4t of an audit of internal controls' the auditor must document all of the following e4cept A. !he e4tent to which he or she relied upon wor/ performed $& others *. !he auditor)s understanding and evaluation of the design of each of the components of the entit&)s internal control over financial reporting C# !ranscripts of the auditor)s discussion with management concerning the points at which misstatements could occur 6. !he evaluation of an& deficiencies discovered that could result in a modification of the auditor)s report

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's:A--lication Di iculty: Moderate "earning #$%ecti&e: ')

(1. 04amples of compan&-level controls include5 A. #anagement)s ris/ assessment process *. Controls to monitor results of operations C. !he period-end financial reporting process "# All of the a$ove are e4amples of compan&-level controls

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: +

7-%%

Chapter 07 - Auditing Internal Control over Financial Reporting

(". 2hich of the following statements included in management)s assessment of the effectiveness of internal control over financial reporting would $e considered accepta$le for issuing an un8ualified opinion9 A. Aothing has come to management)s attention to suggest that the compan&)s internal control is less than effective *. Statements suggesting onl& negative assurance C. A conclusion that the compan&)s internal control over financial reporting is effective when a material wea/ness e4ists at the end of the reporting period "# 6isclosure of material wea/nesses corrected during the period

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: '*

(%. A modification of the standard report is re8uired for all of the following conditions' e4cept5 A. !here is a restriction on the scope of the engagement *. !here is other information contained in management)s report on internal control C# #anagement has concluded that internal controls are not effective 6. A significant su$se8uent event has occurred since the date $eing reported on

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: '*

7-%(

Chapter 07 - Auditing Internal Control over Financial Reporting

((. AAA Accounting recentl& finished auditing @in/the0arth Corporation)s internal control over financial reporting. AAA found a num$er of material wea/nesses in the compan&)s internal control. @in/the0arth)s management remediated all of the wea/nesses that AAA found. >owever' the auditors did not have sufficient time to retest the controls. 2hat report should AAA issue with regards to internal control over financial reporting at &ear end9 A. ?n8ualified report $# Adverse report C. Bualified report 6. 6isclaimer on opinion

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: '*

( . According to the C,S, definition of safeguarding of assets5 A. Controls over financial reporting are effective if the& provide reasona$le assurance that asset losses will not occur $# Controls over financial reporting are effective if the& provide reasona$le assurance that losses are properl& reflected in the financial statements C. *oth A and * 6. Aeither A nor *

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: '1

7-%

Chapter 07 - Auditing Internal Control over Financial Reporting

(.. An auditor will use the I! test data method in order to gain certain assurances with respect to the A. Input data *. #achine capacit& C# +rocedures contained within the program 6. 6egree of /e&punching accurac&

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: '3

(7. 2hich of the following is true of generali;ed audit software pac/ages9 A. !he& can $e used onl& in auditing on-line computer s&stems *. !he& can $e used on an& computer without modification C# !he& each have their own characteristics which the auditor must carefull& consider $efore using in a given audit situation 6. !he& ena$le the auditor to perform all manual test procedures less e4pensivel&

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: '3

(1. !he advantages of generali;ed audit software include all of the following e4cept A# It involves auditing while the data are $eing processed Creal-timeD *. It is eas& to use C. !he time to develop the application is usuall& short 6. An entire population can $e e4amined in some instances

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: '3

7-%.

Chapter 07 - Auditing Internal Control over Financial Reporting

(3. Section (0( of the Sar$anes-,4le& Act includes which of the following9 A. A re8uirement that management of a pu$licl& traded compan& issues an assessment of internal control that covers the entire &ear *. Specific guidance on what constitutes ade8uate internal control C# A re8uirement that management of a pu$licl& traded compan& accepts responsi$ilit& for esta$lishing and maintaining ade8uate internal controls 6. A re8uirement that management of a pu$licl& traded compan& issues an assessment regarding the efficienc& of internal control for the &ear

AACSB: Communications AICPA BB: "egal AICPA FN: Decision Making Bloom's: Knowledge Di iculty: 5ard "earning #$%ecti&e: '

0. For which of the following internal controls would an auditor $e least li/el& to perform tests of internal controls closer to the -as of- date9 A. 2ithdrawals from Federal *an/ of more than E million must include a manager)s signature $# At the end of each da& at Federal *an/' the total cash in the vault is reconciled with dail& registers of deposits and withdrawals C. Federal *an/ has 7ust started esta$lishing trusts for its customers and it has onl& set up ten. *efore ma/ing an investment for a trust' $an/ emplo&ees must verif& that the investment is in accordance with stated investment policies 6. ,n an annual $asis' Federal *an/ management performs credit chec/s on its loan customers $efore determining the value of loans it will not $e a$le to collect on

AACSB: Communications AICPA BB: Industry AICPA FN: ,isk Analysis Bloom's: A--lication Di iculty: 5ard "earning #$%ecti&e: 4

7-%7

Chapter 07 - Auditing Internal Control over Financial Reporting

1. 2hich of the following is false9 A. Regardless of the achieved level of control ris/ in connection with the audit of the financial statements' auditing standards re8uire the auditor to perform some su$stantive procedures for all significant accounts and disclosures $# !he a$sence of misstatements in financial statements is considered convincing evidence that e4isting controls are effective C. !he audit of internal control is intended to draw conclusions a$out the effectiveness of internal control over financial reporting as of a specific date 6. !he auditor is re8uired $& AS to evaluate the implications of the financial statement audit for the effectiveness of internal control over financial reporting

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: A--lication Di iculty: 5ard "earning #$%ecti&e: +

". 2hen testing a computeri;ed accounting s&stem' which of the following is false regarding the test data approach9 A. !he test data need to consist of onl& those valid and invalid conditions in which the auditor is interested *. ,nl& one transaction of each t&pe need $e tested C. !est data are processed $& the client)s computer programs under the auditor)s control "# !he test data must consist of all possi$le valid and invalid conditions

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: 5ard "earning #$%ecti&e: '3

7-%1

Chapter 07 - Auditing Internal Control over Financial Reporting

%. 2hen an auditor tests a computeri;ed accounting s&stem' which of the following is true of the test data approach9 A# !est data are processed $& the client)s computer programs under the auditor)s control *. !est data must consist of all possi$le valid and invalid conditions C. !esting a program at &ear end provides assurance that the client)s processing was accurate for the full &ear 6. Several transactions of each t&pe must $e tested

AACSB: 2ec/nology AICPA BB: "e&eraging 2ec/nology AICPA FN: "e&eraging 2ec/nology Bloom's: A--lication Di iculty: 5ard "earning #$%ecti&e: '3

Short Answer Questions

(. Fou are an e4perienced audit senior. !he new staff accountant on &our audit team does not understand what a control deficienc& is. Give him a definition of -control deficienc&.Include e4amples of two t&pes of control deficiencies. A control deficienc& e4ists when the design or operation of a control does not allow management or emplo&ees' in the normal course of performing their assigned functions' to prevent or detect misstatements on a timel& $asis. A design deficienc& e4ists when C1D a control necessar& to meet the relevant control o$7ective is missing< or C"D an e4isting control is not properl& designed so that' even if the control operates as designed' the control o$7ective would not $e met. A deficienc& in operation e4ists when a properl& designed control does not operate as designed or when the person performing the control does not possess the necessar& authorit& or 8ualifications to perform the control effectivel&. Specific e4amples of control deficiencies will var&.

AACSB: Communications AICPA BB: Industry AICPA FN: ,isk Analysis Bloom's: Com-re/ension Di iculty: !asy "earning #$%ecti&e: '. "earning #$%ecti&e: *

7-%3

Chapter 07 - Auditing Internal Control over Financial Reporting

. Fou are performing an audit on Aorth South Aatural Gas CASAGD. Alana' an ASAG emplo&ee' has responsi$ilit& for reconciling $an/ statements with the compan&)s cash records. Fou determine' however' that Alana has never $een taught how to reconcile statements. In effect' the statements have not $een properl& reconciled for two &ears. >ow would &ou 7udge the significance of this control deficienc&9 >ow would &ou classif& this deficienc&9 !o 7udge the materialit& of a control deficienc&' the auditor could consider the pro$lem in terms of magnitude and li/elihood. !he li/elihood of an event must $e either reasona$l& possi$le or pro$a$le to $e a significant deficienc& or a material wea/ness. !his deficienc& is o$viousl& pro$a$le' $ecause the auditor /nows the control has not operated for two &ears. After the li/elihood is determined' the auditor could consider the magnitude of a possi$le misstatement. A misstatement is not material if a reasona$le person would conclude' after considering the possi$ilit& of further undetected misstatements' that the misstatement' either individuall& or when aggregated with other misstatements' would $e clearl& immaterial to the financial statements. A remote li/elihood and insignificant magnitude would result in an insignificant deficienc&. A significant deficienc& occurs when there is reasona$le possi$ilit& that a misstatement in the financial statements is not material $ut significant. A material wea/ness is a significant deficienc& that results when the li/elihood is reasona$l& possi$le and material. Aote5 Students should then ma/e and defend a 7udgment on whether this pro$lem is an insignificant deficienc&' significant deficienc&' or material wea/ness.

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: '. "earning #$%ecti&e: *

7-(0

Chapter 07 - Auditing Internal Control over Financial Reporting

.. C*A Accounting is auditing a large pu$licl& traded compan&. !he audit of internal controls over financial reporting has $een properl& planned and the auditors have alread& identified controls to test using a top-down' ris/-$ased approach. 2hat is the ne4t step9 Give three e4amples of procedures that ma& $e completed in the ne4t step in the audit. !he ne4t step is testing the design and operating effectiveness of selected controls. For a pu$lic compan&' the auditor must o$tain an understanding of the design of controls related to each component of internal control. !he procedures the auditor can perform to test the design of specific controls include in8uiring of appropriate management' supervisor&' and staff personnel' inspecting compan& documents' o$serving the application of specific controls' and tracing a sample of transactions through the information s&stem.

AACSB: Analytic AICPA BB: Industry AICPA FN: Decision Making Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: +

7-(1

Chapter 07 - Auditing Internal Control over Financial Reporting

7. !rumpeter Corporation is a small pu$licl& traded compan& that speciali;es in the restoration and sale of fine musical instruments. !he audit committee is made up of a C0, from a technolog& compan&' a college accounting professor' and a local mar/eting e4ecutive. All are sufficientl& independent from management. !he audit committee meets three times a &ear. 0ach time the& meet' a different mem$er' who chooses the topics to discuss' leads each meeting. !he audit committee then sends the minutes of their meetings to the compan&)s CF,. Solel& from this information' what are &our conclusions a$out this audit committee)s role within the control environment9 An effective audit committee sets the overall tone for a compan&)s internal control. 2hile it is independent from management' the auditor would pro$a$l& consider the audit committee to $e ineffective. First' there appears to $e no clear articulation or understanding of the audit committee)s responsi$ilities. In fact' it is not even clear that the committee discusses relevant topics and issues. !here is apparentl& little interaction with /e& mem$ers of financial management< the onl& interaction consists of delivering a report of each meeting. In addition' there is no apparent interaction with the internal audit function' if there is one. !he auditor would pro$a$l& consider this lac/ of control as a significant deficienc& and a strong indicator of a material wea/ness.

AACSB: Communications AICPA BB: "egal AICPA FN: ,isk Analysis Bloom's: Analysis Di iculty: !asy "earning #$%ecti&e: '. "earning #$%ecti&e: * "earning #$%ecti&e: +

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Chapter 07 - Auditing Internal Control over Financial Reporting

1. Identif& indicators of a material wea/ness in internal control over financial reporting. Indicators of a material wea/ness in ICFR include Csee !a$le 7-7D5 Identification of fraud' whether or not material' committed $& senior management< Restatement of previousl& issued financial statements to reflect the correction of a material misstatement< Identification $& the auditor of a material misstatement of financial statements in the current period in circumstances that indicate that the misstatement would not have $een detected $& the compan&)s ICFR< and Ineffective oversight of the compan&)s e4ternal financial reporting and ICFR $& the compan&)s audit committee.

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3. AS re8uires that the auditor appropriatel& document the processes' procedures' 7udgments' and results relating to the audit of internal control. Specificall&' what must this documentation include9 !he auditor)s documentation must include the auditor)s understanding and evaluation of the design of each of the components of the entit&)s internal control over financial reporting. !he auditor also documents the process used to determine and the points at which misstatements could occur within' significant accounts' disclosures' and ma7or classes of transactions. !he auditor must 7ustif& and document the e4tent to which he or she relied upon wor/ performed $& others. Finall&' the auditor must descri$e the evaluation of an& deficiencies discovered' as well as an& other findings that could result in a modification to the auditor)s report.

AACSB: Communications AICPA BB: "egal AICPA FN: ,e-orting Bloom's: Knowledge Di iculty: Moderate "earning #$%ecti&e: ')

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Chapter 07 - Auditing Internal Control over Financial Reporting

.0. 2hat is wrong with the following report on internal control over financial reporting for A* Corporation9 !he auditor $elieves an un8ualified opinion on the effectiveness of internal control over financial reporting is warranted. Report of Registered +u$lic Accounting Firm 2e have audited A* Corporation)s internal control over financial reporting as of 6ecem$er %1' "003' $ased on criteria esta$lished in Internal Control - Integrated Framewor/' issued $& the Committee of Sponsoring ,rgani;ations of the !readwa& Commission CC,S,D. A*C)s management is responsi$le for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. ,ur responsi$ilit& is to e4press an opinion on the compan&)s internal control over financial reporting $ased on our audit. 2e conducted our audit in accordance with the standards of the +u$lic Compan& Accounting ,versight *oard C?nited StatesD. !hose standards re8uire that we plan and perform the audit to o$tain reasona$le assurance a$out whether effective internal control over financial reporting was maintained in all material respects. ,ur audit included o$taining an understanding of internal control over financial reporting' testing and evaluating the design and operating effectiveness of internal control' and performing such other procedures as we considered necessar& in the circumstances. 2e $elieve that our audit provides a reasona$le $asis for our opinion. A compan&)s internal control over financial reporting is a process designed to provide reasona$le assurance regarding the relia$ilit& of financial reporting and the preparation of financial statements for e4ternal purposes in accordance with generall& accepted accounting principles. A compan&)s internal control over financial reporting includes those policies and procedures that C1D pertain to the maintenance of records that' in reasona$le detail' accuratel& and fairl& reflect the transactions and dispositions of the assets of the compan&< C"D provide reasona$le assurance that transactions are recorded as necessar& to permit preparation of financial statements in accordance with generall& accepted accounting principles' and that receipts and e4penditures of the compan& are $eing made onl& in accordance with authori;ations of management and directors of the compan&< and C%D provide reasona$le assurance regarding prevention or timel& detection of unauthori;ed ac8uisition' use' or disposition of the compan&)s assets that could have a material effect on the financial statements. In our opinion' A*C maintained' in all material respects' effective internal control over financial reporting as of 6ecem$er %1' "003' $ased on criteria esta$lished in Internal Control Integrated Framewor/' issued $& the Committee of Sponsoring ,rgani;ations of the !readwa& Commission CC,S,D. 2e have also audited' in accordance with the standards of the +u$lic Compan& Accounting ,versight *oard C?nited StatesD' the consolidated financial statements of A*C' and our report dated Fe$ruar& "0' "010 e4pressed an un8ualified opinion. +rot;man = >ull #organ >ill' CA Fe$ruar& 10' "010

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Chapter 07 - Auditing Internal Control over Financial Reporting

First' the title of the report should include the word -independent.- Second' the report should include a paragraph stating that' $ecause of inherent limitations' internal control over financial reporting ma& not prevent or detect misstatements and that pro7ections of an& evaluation of effectiveness to future periods are su$7ected to certain ris/s and uncertainties. Finall&' the date of $oth the auditor)s report on the compan&)s financial statements and the auditor)s report on the compan&)s internal control over financial reporting should $e the same.

AACSB: Communications AICPA BB: Industry AICPA FN: ,e-orting Bloom's: Analysis Di iculty: Moderate "earning #$%ecti&e: '*

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Chapter 07 - Auditing Internal Control over Financial Reporting

.1. ,n the audit of !echnolog& ?nlimited' a leading manufacturer of computer chips' the e4ternal audit staff discovers that the internal audit staff has performed e4tensive evaluation and testing on the control environment. 2hat should the e4ternal auditors do to determine the e4tent to which the& ma& use the wor/ of the internal audit staff9 Can the e4ternal audit staff rel& on the internal audit staff for evaluating and testing the control environment9 !he auditor should also evaluate the competence and o$7ectivit& of the individuals who performed the wor/. Internal auditors are generall& e4pected to have greater competence and o$7ectivit& than other compan& personnel. If internal auditors have performed an e4tensive amount of relevant wor/ and the auditor determines the& possess a high degree of competence and o$7ectivit&' the auditor can rel& on the results of their wor/ to the e4tent possi$le while still providing the principal evidence for his or her opinion. !he auditor should also evaluate the nature of the controls su$7ected to the wor/ of others. As the ris/ of material misstatement in the accounts and disclosures addressed $& the control' the degree of 7udgment re8uired to evaluate the operating effectiveness of the control' the pervasiveness of the control and the potential for management override increase in significance' the auditor should increase his or her own wor/ on those controls and decrease reliance on the wor/ of others. !he e4ternal auditor should test some of the wor/ performed $& others to evaluate the 8ualit& and effectiveness of their wor/. In performing this' the auditor should evaluate such factors as the scope of their wor/' the ade8uac& of their wor/ programs' the ade8uac& of the wor/ performed' the appropriateness of their conclusions' and the consistenc& of their reports with the wor/ performed. 0ven considering these steps' the auditor is not permitted to rel& on the wor/ of others in evaluating and testing the control environment. !he auditor must perform enough of the testing that his or her own wor/ provides the principal evidence for the auditor)s opinion.

AACSB: Communications AICPA BB: Industry AICPA FN: Decision Making Bloom's: A--lication Di iculty: Moderate "earning #$%ecti&e: 1

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Chapter 07 - Auditing Internal Control over Financial Reporting

.". Information Aation has two hundred locations spread across the fift& states. !went& of the locations are considered to $e individuall& important' $ut fift& of the locations are not important even when aggregated from the others. Five locations deal with foreign e4change trading. !hese locations are not considered important' $ut the& are important when aggregated with the other locations. As an auditor' discuss the considerations involved in testing multiple locations and group the locations accordingl& Cprovide how man& locations are included in each groupD. Include the treatment that each group should receive from the auditor. First' the auditor should determine which locations are individuall& important. !here are twent& locations and the auditor should evaluate documentation and test controls over relevant assertions for significant accounts at each location. Second' the auditor should determine the locations with specific ris/s. Foreign e4change trading is normall& considered a specific ris/. ,f the 110 locations left' five have specific ris/s. For these' the auditor should evaluate documentation and test controls over specific ris/s. ,f the 17 locations left' the auditor should ne4t determine which are not important even when aggregated with others. !his group includes fift& locations. Ao further action is re8uired for such units. Aow 1" locations are left. !he auditor should determine if there are documented compan&level controls over this group. If there are' the auditor should evaluate documentation and test compan&-level controls over the group. If documented compan&-level controls are not present' some testing of controls at individual locations is re8uired.

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Chapter 07 - Auditing Internal Control over Financial Reporting

.%. 6iscuss the differences $etween a control deficienc&' a significant deficienc&' a material wea/ness' and the two dimensions of the control deficienc& - li/elihood and magnitude. A control deficienc& e4ists when the design or operation of a control does not allow management or emplo&ees' in the normal course of performing their assigned functions' to prevent or detect misstatements on a timel& $asis. A design deficienc& e4ists when5 C1D a control necessar& to meet the relevant control o$7ective is missing or C"D an e4isting control is not properl& designed so that' even if the control operates as designed' the control o$7ective is not alwa&s met. Significant 6eficienc&. A significant deficienc& is a control deficienc&' or com$ination of control deficiencies' in ICFR that is less sever than a material wea/ness' &et important enough to merit attention $& those responsi$le for oversight of the compan&)s financial reporting. #aterial 2ea/ness. A material wea/ness is a deficienc&' or com$ination of deficiencies' in ICFR' such that there is a reasona$le possi$ilit& that a material misstatement of the annual or interim financial statements will not $e prevented or detected on a timel& $asis. @i/elihood and #agnitude. According to the a$ove definitions' in 7udging the significance of a control deficienc&' management and the auditor must consider two dimensions of the deficienc&5 li/elihood and magnitude. !he definition of material wea/ness includes the phrase -reasona$le possi$ilit&.- !his term is to $e interpreted using the guidance in ASC !opic ( 0' Contingencies. Accordingl&' the li/elihood of an event is a -reasona$le possi$ilit&- if it is either reasona$l& possi$le or pro$a$le. #agnitude refers to the si;e of the potential misstatement that could occur due to the deficienc&. In determining whether it is reasona$l& possi$le that a financial statement misstatement resulting from a deficienc& is material' the auditor relies on the same concept of materialit& as is used in determining financial statement materialit&.

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Chapter 07 - Auditing Internal Control over Financial Reporting

.(. 6iscuss entit&-level controls and provide e4amples of these t&pes of controls. 0ntit&-level controls can have a pervasive effect on the entit&)s a$ilit& to meet the C,S, control criteria. If general controls are not effective' the specific controls are pro$a$l& unrelia$le. 0ntit&-level controls addressing management)s a$ilit& to override specific controls are thus of central importance. !he pervasiveness of entit&-level controls suggests that it ma& $e appropriate for the auditor to test and evaluate them $efore evaluating the other aspects of internal control over financial reporting. >owever' testing entit&-level controls alone is not sufficient for the purpose of e4pressing an opinion on the effectiveness of an entit&)s internal control over financial reporting. 04amples of entit&-level controls include5 1. Controls within the control environment' which includes the tone at the top' assignment of authorit& and responsi$ilit&' consistent policies and procedures' and compan&-wide programs that appl& to all locations and $usiness units Csuch as codes of conduct and fraud preventionD. ". Controls over management override. %. #anagement)s ris/ assessment process. (. Centrali;ed processing and controls' including shared service environments. . Controls to monitor results of operations. .. Controls to monitor other controls' including activities of the internal audit function' the audit committee and self-assessment programs. 7. !he period-end financial reporting process. 1. +olicies that address significant $usiness control and ris/ management practices.

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