Auditing Theory - Internal Control Consideration audit engagement?

 
a) To comply with the requirements of GAAS. 
1. The independent auditor should acquire an b) To interpret the operational effectiveness of the
understanding of a client's internal audit function to client's existing organizational structure. 
determine whether the work of internal auditors will be c) To classify the client's documents and transactions
a factor in determining the nature, timing and extent of by major operating functions e.g., cash receipts, cash
the independent auditor's procedures. The work disbursements, etc. 
performed by internal auditors might be such a factor d) To record the auditor's understanding of the client's
when the work includes I/C. 
a) Verification of the mathematical accuracy of
invoices.  7. The independent auditor should acquire an
b) Review of administrative practices to improve understanding of the internal audit function as it
efficiency and achieve management objectives.  relates to the independent auditor's consideration of
c) Consideration of the internal control structure.  the I/C because
d) Preparation of internal financial reports for a) The audit program, working papers and reports of
management purposes.  internal auditors can often be used as a substitute for
the work of the independent auditor's staff. 
2. Effective I/C in a small company that has b) The procedures performed by the internal audit
insufficient employees to permit proper division of staff may eliminate the independent auditor's need for
responsibilities can be best enhanced by an extensive consideration of the I/C. 
a) Employment of temporary personnel to aid in the c) The work performed by internal auditors may be a
separation of duties.  factor in determining the nature, timing and extent of
b) Direct participation by the owner of the business in the independent auditor's procedures. 
the recordkeeping activities of the business.  d) The understanding of the internal audit function is
c) Engaging a CPA to perform monthly "write-up" an important substantive test to be performed by the
work.  independent auditor. 
d) Delegation of full, clear-cut responsibility to each
employee for the functions assigned to each.  8. The auditor's understanding of the client's I/C is
documented in order to substantiate
3. An auditor is considering the internal control a) Conformity of the accounting records with generally
system for purchasing and disbursement procedures. accepted accounting principles. 
The auditor will be least influenced by b) Compliance with generally accepted auditing
a) The availability of a company manual describing standards. 
purchasing and disbursement procedures.  c) Adherence to requirements of management. 
b) The scope and results of audit work by the d) The fairness of the financial statement
company's internal auditor.  presentation. 
c) The existence within the purchasing and
disbursement area of internal control strengths that 9. The ICS normally would include procedures that
offset weaknesses.  are designed to provide reasonable assurance that
d) The strength or weakness of internal control in a) Employees act with integrity when performing their
other areas, e.g., sales and accounts receivable.  assigned tasks. 
b) Transactions are executed in accordance with
4. In general, material irregularities perpetrated by management's general or specific authorization. 
which of the following are most difficult to detect?  c) Decision processes leading to management's
a) Cashier authorization of transactions are sound. 
b) Key-punch operator d) Collusion activities would be detected by
c) Internal auditor segregation of employee duties. 
d) Controller
10. In general, a reportable condition may be defined
5. If, during the course of an annual audit of a publicly as a condition in which material errors or irregularities
held manufacturing company, an independent auditor ordinarily would not be detected within a timely period
becomes aware of a reportable condition in the by
company's internal control, the auditor is required to a) An auditor during the normal consideration of the
communicate the reportable condition to internal controls. 
a) The senior management and the board of directors b) A controller when reconciling accounts in the
of the company.  general ledger. 
b) The senior management of the company.  c) Employees in the normal course of performing their
c) The board of directors of the company.  assigned duties. 
d) The audit committee of the board of directors.  d) The chief financial officer when reviewing interim
F/S. 
6. Which of the following best describes the primary
reason for the auditor's use of flowcharts during an 11. Proper segregation of functional responsibilities
 calls for separation of the d) That would aid in preventing irregularities. 
a) Authorization, approval and execution functions. 
b) Authorization, execution and payment functions.  17. A consideration of the ICS made in connection
c) Receiving, shipping and custodial functions.  with an annual audit is usually not sufficient to
d) Authorization, recording and custodial functions.  express an opinion on an entity's internal control
because
12. The ultimate risk against which the auditor a) Weaknesses in the ICS may go unnoticed during
requires reasonable protection is a combination of two the audit period. 
separate risks. The first of these is that material errors b) A consideration of the ICS is not necessarily made
will occur in the accounting process by which the F/S during an audit engagement. 
are developed, and the second is that c) Only those controls on which an auditor intends to
a) A company's internal control system is not rely are reviewed, tested and evaluated. 
adequate to detect errors and irregularities.  d) Internal controls can change each year. 
b) Those errors that occur will not be detected by the
auditor's examination.  18. Which of the following would be least likely to
c) Management may possess an attitude that lacks suggest to an auditor that the client's management
integrity.  may have overridden the ICS? 
d) Evidential matter is not competent enough for the a) There are numerous delays in preparing timely
auditor to form an opinion based on reasonable internal financial reports. 
assurance.  b) Management does not correct I/C weaknesses that
it knows about. 
13. When an independent auditor decides that the c) Differences are always disclosed on a computer
work performed by internal auditors may have a exception report. 
bearing on the nature, extent and timing of the d) There have been two new controllers this year. 
independent auditor's procedures, the independent
auditor should evaluate the competence and 19. Which of the following is intended to detect
objectivity of the internal auditors. Relative to deviation from prescribed Accounting Department
objectivity, the independent auditor should procedures? 
a) Consider the organizational level to which internal a) Substantive test specified by a standardized audit
auditors report the results of their work.  program. 
b) Review the training program in effect for the b) Tests of controls designed specifically for the
internal auditors.  client. 
c) Examine the quality of the internal audit reports.  c) Analytical procedures as designed in the industry
d) Consider the qualifications of the internal audit audit guide. 
staff.  d) Computerized analytical tests tailored for the
configuration of EDP equipment in use. 
14. To provide the greatest degree of independence
in performing internal auditing functions, an internal 20. The independent auditor selects several
auditor should probably report to the transactions in each functional area and traces them
a) Financial vice-president.  through the entire system, paying special attention to
b) Corporate controller.  evidence about whether or not the control features
c) Board of directors.  are in operation. This is an example of a
d) Corporate stockholders.  a) Control test. 
b) Tests of controls
15. When considering the client's ICS to determine c) Substantive test
whether the necessary procedures are prescribed and d) Functional test. 
are followed satisfactorily, an auditor must
a) Develop questionnaires and checklists.  21. In the consideration of the ICS, the auditor is
b) Review the ICS and perform tests of controls.  basically concerned that the system provides
c) Perform tests of controls and analytical reasonable assurance that 
procedures.  a) Management can not override the system. 
d) Evaluate administrative policies.  b) Operational efficiency has been achieved i/a/w
management plans. 
16. After the auditor has prepared a flowchart of the c) Errors have been prevented or detected. 
I/C surrounding sales and evaluated the design of the d) Controls have not been circumvented by collusion. 
ICS, the auditor would perform tests of controls on all
internal control procedures 22. During the audit, the independent auditor
a) Documented in the flowchart.  identified the existence of a reportable condition in the
b) Considered to be weaknesses that might allow client's system of internal controls and orally
errors to enter the accounting system.  communicated this finding to the client's senior
c) Considered to be strengths that the auditor plans to management and audit committee. The auditor should
rely on.  a) Consider the reportable condition a scope limitation
 and therefore disclaim an opinion.  28. The use of fidelity bonds may indemnify a
b) Document the matter in the working papers and company from embezzlement losses. The use also
consider the effects of the condition on the audit.  a) Reduces the company's need to obtain expensive
c) Suspend all audit activities pending directions from business interruption insurance. 
the client's audit committee.  b) Protects employees who make unintentional errors
d) Withdraw from the engagement.  from possible monetary damages resulting from such
errors. 
23. Which of the following statements concerning the c) Allows the company to substitute the fidelity bonds
independent auditor's required communication of for various parts of internal control. 
reportable conditions is correct?  d) Reduces the possibility of employing persons with
a) Conditions reported at interim dates must be dubious records in positions of trust. 
repeated in the final communication. 
b) If the auditor does not become aware of any 29. Which of the following procedures most likely
reportable conditions during the examination, that fact would be included as part of an auditor's tests of
must be communicated.  controls? 
c) Conditions that had been reported in prior year's a) Inspection. 
communications and have not been corrected need b) Reconciliation. 
not be repeated in the current year's communication.  c) Confirmation. 
d) Although written communication is preferable, the d) Analytical procedures. 
auditor may communicate the findings orally. 
30. If the independent auditors decide that the work
24. Which of the following is least likely to be performed by the internal auditor may have bearing
evidence the auditor examines to determine whether on their own procedures, they should consider the
operations are in compliance with the internal control internal auditor's
system?  a) Competence and objectivity. 
a) Records documenting usage of EDP programs.  b) Efficiency and experience. 
b) Canceled supporting documents.  c) Independence and review skills. 
c) Confirmations of accounts receivable.  d) Training and supervisory skills. 
d) Signatures on authorization forms. 
31. Which statement is correct concerning the
25. The auditor's communication of reportable definition of internal control developed by the
conditions in internal control is Committee of Sponsoring Organizations (COSO)? 
a) Required to enable the auditor to state that the a) Its applicability is largely limited to internal auditing
examination has been made in accordance with applications. 
GAAS.  b) It is recognized in the Statement on Auditing
b) The principal reason for considering the ICS.  Standards. 
c) Incident to the auditor's objective of forming an c) It emphasizes the effectiveness and efficiency of
opinion as to the fair presentation of the financial operations rather than the reliability of financial
statements.  reporting. 
d) Required to be documented in a written report to d) It suggests that it is important to view internal
the board of directors or the board's audit committee.  control as an end product as contrasted to a process
or means to obtain an end. 
26. An auditor may compensate for a condition in the
ICS by increasing the 32. Monitoring is considered
a) Level of detection risk.  a) A component of internal control. 
b) Extent of tests of controls.  b) An element of the control environment. 
c) Preliminary judgment about audit risk.  c) The primary asset safeguarding technique. 
d) Extent of analytical procedures d) A portion of information and communication. 

27. After considering the client's internal controls, an 33. Which of the following is not a factor included in
auditor has concluded that I/C is well designed and is the control environment? 
functioning as intended. Under these circumstances, a) Integrity and ethical values. 
the auditor would most likely b) Risk assessment. 
a) Perform tests of controls to the extent outlined in c) Commitment to competence. 
the audit program.  d) Organizational structure. 
b) Determine the control procedures that should
prevent or detect errors and irregularities.  34. An entity's ongoing monitoring activities often
c) Not increase the extent of predetermined include
substantive tests.  a) Periodic audits by the audit committee. 
d) Determine whether transactions are recorded to b) Reviewing the purchasing function. 
permit preparation of F/S in conformity with GAAP.  c) The audit of the annual financial statements. 
d) Control risk assessment in conjunction with
 quarterly reviews.  d) Be less than the actual control risk. 

35. The definition of internal control developed by the 41. Which of the following is not a control that is
Committee of Sponsoring Organizations (COSO) and designed to protect investment securities? 
included in the professional standards includes the a) Custody over securities should be limited to
reliability of financial reporting, the effectiveness and individuals who have record keeping responsibility
efficiency of operations and over the securities. 
a) Compliance with applicable laws and regulations.  b) Securities should be properly controlled physically
b) Effectiveness of prevention of fraudulent in order to prevent unauthorized usage. 
occurrences.  c) Access to securities should be vested in more than
c) Safeguarding of entity assets.  one individual. 
d) Incorporation of ethical business practice d) Securities should be registered in the name of the
standards.  owner. 

36. Which statement is correct concerning the Answers - Internal Controls Questions
relevance of various types of controls to a financial 1. C
audit?  2. B
a) An auditor may ordinarily ignore a consideration of 3. D
controls when a substantive audit approach is taken.  4. D
b) Controls over the reliability of financial reporting are 5. D
ordinarily most directly relevant to an audit but other 6. D
controls may also be relevant.  7. C
c) Controls over safeguarding of assets and liabilities 8. B
are of primary importance, while controls over the 9. B
reliability of financial reporting may also be relevant.  10. C
d) All controls are ordinarily relevant to an audit.  11. D
12. B
37. Which of the following is not ordinarily considered 13. A
a factor indicative of increased financial reporting risk 14. C
when an auditor is considering a client's risk 15. B
assessment policies?  16. C
a) Commissioned sales personnel.  17. C
b) Implementation of a new information system.  18. C
c) Rapid growth organization.  19. B
d) Corporate restructuring.  20. B
21. C
38. While obtaining an understanding of a client's risk 22. B
assessment policies, an auditor does not ordinarily 23. D
include how management 24. C
a) Identifies risk.  25. C
b) Eliminates significant risks.  26. D
c) Assesses the likelihood of occurrence of events 27. C
due to significant risks.  28. D
d) Relates risk assessment to financial reporting.  29. A
30. A
39. When an auditor considers a client's internal 31. B
control, which of the following is ordinarily a type of 32. A
control activity that is considered?  33. B
a) Risk assessment over cash disbursements.  34. C
b) Segregation of duties over payroll.  35. A
c) Inclusion of the president as a member of the audit 36. B
committee.  37. A
d) Management's monitoring policies over cash 38. B
receipts.  39. B
40. B
40. When tests of controls reveal that controls are 41. A
operating as anticipated, it is most likely that the
assessed level of control risk will
a) Be less than the planned assessed level of control
risk. 
b) Equal the planned assessed level of control risk. 
c) Equal the actual control risk. 
 Audit Planning: Assessment of Control Risk
MULTIPLE CHOICE:
1. Which of the following is ordinarily considered a
test of internal control procedures?
a. Send confirmation letters to banks.
b. Count and list cash on hand.
c. Examine signatures on checks.
d. Obtain or prepare reconciliations of bank accounts
as of the balance sheet date.
ANSWER: C
2. When obtaining an understanding of an entity's
control environment, an auditor should concentrate on
the substance of management's policies and
procedures rather than their form because
a. The auditor may believe that the policies and
procedures are inappropriate for that particular
entity.
b. The board of directors may not be aware of
management's attitude toward the control
environment.
c. Management may establish appropriate policies
and procedures but not act on them.
d. The policies and procedures may be so weak that
no
reliance is contemplated by the auditor.
ANSWER: C
3. After the study and evaluation of a client's internal
control policies and procedures has been completed,
an auditor might decide to
a. Increase the extent of substantive testing in areas
where the internal control policies and procedures are
strong.
b. Reduce the extent of control testing in areas where
the internal control policies and procedures are
strong.
c. Reduce the extent of both substantive and control
testing in areas where the internal control policies and
procedures are strong.
d. Increase the extent of substantive testing in areas
where the internal controls are weak.
ANSWER: D
4. A conceptually logical approach to the auditor's
evaluation of internal accounting control consists of
the following four steps:
I. Determine whether the necessary procedures are
prescribed and are being followed satisfactorily.
II. Consider the types of errors and fraud that could
occur.
III. Determine the internal control policies and
procedures
that should prevent or detect errors and fraud.
IV. Evaluate any weakness to determine its effect on
the nature, timing, or extent of auditing procedures to
be applied and suggestions to be made to the client.
What should be the order in which these four steps
are performed?
a. III, IV, I, II
b. III, I, II, IV
c. II, III, I, IV
d. II, I, III, IV
ANSWER: C
5. An auditor evaluates the existing internal control in
order to
a. Determine the extent of substantive tests which
must be performed.
b. Determine the extent of control tests which must be
performed.
c. Ascertain whether irregularities are probable.
d. Ascertain whether any employees have
incompatible functions.
ANSWER: A
6. The auditor is studying internal control policies and
procedures within the sales, shipping, and billing
subset of the revenue cycle. Which of the following
conditions suggests a need for additional testing of
controls?
a. Internal control is found to be weak with regard to
shipping and billing.
b. Internal control over sales, billing, and shipping
appears strong, but 80% of sales revenue is
attributable to three major customers.
c. Internal control over billing and shipping is thought
to be strong and the auditor considers additional
testing of selected controls will result in a major
reduction in substantive testing.
d. Internal control over the recording of sales is found
to be weak and the sales are evenly divided among a
large number of customers.
ANSWER: C
7. A secondary objective of the auditor's study and
evaluation of internal control is that the study and
evaluation provide
a. A basis for constructive suggestions concerning
improvements in internal control.
b. A basis for reducing the auditor's assessed level of
control risk below the maximum level.
c. An assurance that the records and documents have
been maintained in accordance with existing company
policies and procedures.
d. A basis for determination of the resultant extent of
the tests to which auditing procedures are to be
restricted.
ANSWER: A
8. In studying the design and implementation of a
client's internal controls, the auditor needs to identify
necessary control points. Controls existing at these
points may be classified as "accuracy" controls and
"safeguard" controls. Which of the following controls
may be regarded as a safeguard control?
a. In processing sales orders, the computer is
programmed to compare the customer's credit limit
minus the prior balance with the current sales order
amount.
b. Sales prices are stored in computer memory and
are automatically applied as stock numbers are
entered from customer orders.
c. Although the payroll is prepared manually, a
second employee recalculates gross pay,
withholdings, and net pay.
d. Negotiable securities are kept in a locked vault and
are accessible only by the treasurer accompanied by
one of her assistants.
ANSWER: D
9. The auditor's review of the client's internal control is
documented in order to substantiate
a. Conformity of the accounting records with generally
accepted accounting principles.
b. Representation as to adherence to requirements of
management.
c. Representation as to compliance with generally
accepted auditing standards.
d. The fairness of the financial statement
presentation.
ANSWER: C
10. An internal control questionnaire indicates that an
approved receiving report is required to accompany
every check request for payment of merchandise.
Which of the following procedures provides the
greatest assurance that this control is operating
effectively?
a. Select and examine canceled checks and ascertain
that the related receiving reports are dated no earlier
than the checks.
b. Select and examine canceled checks and ascertain
that the related receiving reports are dated no later
than the checks.
c. Select and examine receiving reports and ascertain
that the related canceled checks are dated no earlier
than the receiving reports.
d. Select and examine receiving reports and ascertain
that the related canceled checks are dated no later
than the receiving reports.
ANSWER: B
11. When considering internal control, an auditor must
be aware of the concept of reasonable assurance
which recognizes that
a. The employment of competent personnel provides
assurance that the objectives of internal control will be
achieved.
b. The establishment and maintenance of a system of
internal control is an important responsibility of the
management and not of the auditor.
c. The cost of internal control should not exceed the
benefits expected to be derived from internal control.
d. The segregation of incompatible functions is
necessary to obtain assurance that the internal
control is effective.
ANSWER: C
12. Statement on Auditing Standards No. 60 requires
the auditor to communicate "reportable conditions" to
the audit committee of the board of directors or, in the
absence of an audit committee, to a body having
similar oversight authority. Of the following, which
does not represent a reportable condition?
a. Bank accounts have not been reconciled in the last
nine months, including the last month of the fiscal
year.
b. The corporate controller, unknown to the board of
directors, has submitted her resignation effective two
months from now.
c. Perpetual inventory records contain numerous
errors and can no longer be relied upon to reflect
proper inventory levels.
d. Although documents are prenumbered, they are
not safeguarded and are not being used in numerical
sequence.
ANSWER: B
13. In connection with the examination of financial
statements by an independent auditor, the client
suggests that members of the internal audit staff be
utilized to minimize audit costs. Which of the following
tasks could most appropriately be delegated to the
internal audit staff?
a. Selection of accounts receivable for confirmation,
based upon the internal auditor's judgment as to how
many accounts and which accounts will provide
sufficient coverage.
b. Preparation of schedules for negative accounts
receivable responses.
c. Evaluation of the internal control for accounts
receivable and sales.
d. Determination of the adequacy of the allowance for
doubtful accounts.
ANSWER: B
14. An auditor uses the knowledge provided by the
understanding of internal control and the final
assessed level of control risk primarily to determine
the nature, timing, and extent of the
a. Attribute tests. b. Compliance tests. c. Tests of
controls. d. Substantive tests.
ANSWER: D
15. Flowcharting as a means of internal control
evaluation provides the following advantage over the
use of questionnaires and descriptive narratives:
a. Ease of preparation.
b. Comprehensive coverage of controls.
c. Simplicity.
d. Ease in following information flow.
ANSWER: D
16. Which of the following factors most likely affects
the auditor's judgment about the quantity, type, and
content of working papers?
a. The effectiveness of the existing internal control.
b. The content of the client's representation letter.
c. The timing of substantive tests completed prior to
the balance sheet date.
d. The usefulness of the working papers as a
reference source for the client.
ANSWER: A
17. If the independent auditors decide that the work
performed by the internal auditor may have a bearing
on their own procedures, they should consider the
internal auditor's
a. Competence and objectivity.
b. Efficiency and experience.
c. Independence and review skills.
d. Training and supervisory skills.
ANSWER: A
18. An auditor's purpose for further testing of internal
control procedures is to
a. Provide a basis for reducing the assessed level of
control risk below that which resulted from the
auditor's initial understanding of internal control.
 b. Reduce the risk that errors or fraud which are not
prevented or detected by internal control are not
detected by the independent audit.
c. Provide assurance that transactions are executed
in accordance with management's authorization and
accessed to assets is limited by a segregation of
functions.
d. Provide assurance that transactions are recorded
as
necessary to permit the preparation of the financial
statements in conformity with GAAP.
ANSWER: A
19. Control testing is performed in order to determine
whether or not
a. The assessed level of control risk can be reduced.
b. Necessary controls are absent.
c. Incompatible functions exist.
d. Material dollar errors exist.
ANSWER: A
20. The independent auditor should acquire an
understanding of the internal audit function as it
relates to the independent auditor's study and
evaluation of internal control because
a. The audit programs, working papers, and reports of
internal auditors can often be used as a substitute for
the work of the independent auditor's staff.
b. The procedures performed by the internal audit
staff may eliminate the independent auditor's need for
an extensive study and evaluation of internal control.
c. The work performed by internal auditors may be a
factor in determining the nature, timing, and extent of
the independent auditor's procedures.
d. The understanding of the internal audit function is
an important substantive test to be performed by the
independent auditor.
ANSWER: C
21. In the assessment of control risk, the auditor is
basically concerned that the client's internal control
provides reasonable assurance that
a. Management cannot override the system.
b. Operational efficiency has been achieved in
accordance with management plans.
c. Errors and fraud have been prevented or detected.
d. Controls have not been circumvented by collusion.
ANSWER: C
22. Which of the following may be considered an
appropriate means for further testing controls over
vendor payments?
a. Confirm year-end balances with vendors.
b. Search for unrecorded invoices at year-end.
c. Develop a set of hypothetical transactions designed
to test existing controls over vendor payments (e.g.,
introduce into the system, a voucher containing an
invoice for raw materials but lacking a purchase order
and/or receiving report.)
d. Construct an internal control flowchart covering the
payment processing function.
ANSWER: C
23. Which of the following statements concerning the
independent auditor's required communication of
material weaknesses in internal control is correct?
a. Weaknesses reported at interim dates must be
repeated in the final communication.
b. If the auditor does not become aware of any
material weaknesses during the examination, that fact
must be communicated.
c. Weaknesses that had been reported in prior years'
communications and have not been corrected need
not be repeated in the current year's communication.
d. Although written communication is preferable, the
auditor may communicate the findings orally.
ANSWER: D
24. Which of the following would be the best
procedure to determine whether purchases were
properly authorized?
a. Discuss authorization procedures with personnel in
the controller's and purchasing functions.
b. Review and evaluate a flowchart of purchasing
procedures.
c. Determine whether a sample of entries in the
purchase journal is supported by properly executed
purchase orders.
d. Vouch payments for selected purchases to
supporting
receiving reports.
ANSWER: C
25. After studying and evaluating a client's existing
internal control, an auditor has concluded that the
policies and procedures are well designed and
functioning as intended. Under these circumstances,
the auditor would most likely
a. Perform further control tests to the extent outlined
in the audit program.
b. Determine the control policies and procedures that
should prevent or detect errors and fraud.
c. Set detection risk at a higher level than would be
set under conditions of weak internal control.
d. Set detection risk at a lower level than would be set
under conditions of weak internal control.
ANSWER: C
26. An auditor is required to obtain a basic
understanding of the client's internal control to plan
the audit. The auditor may then decide to perform
tests of controls on all internal control procedures
a. That would aid in preventing fraud.
b. Documented in the flowchart.
c. Considered to be weaknesses that might allow
errors to enter the accounting system.
d. Considered to be strengths for which the auditor
desires further reduction in the assessed level of
control risk.
ANSWER: D
27. The auditor's understanding of the client's internal
control is documented in order to substantiate
a. Conformity of the accounting records with generally
accepted accounting principles.
b. Compliance with generally accepted auditing
standards.
c. Adherence to requirements of management.
d. The fairness of the financial statement
presentation.
ANSWER: B
 28. To determine whether the client's system of
internal control operated effectively to minimize errors
of failure to invoice a shipment, the auditor would
select a sample of transactions from the population
represented by the
a. Customer order file.
b. Bill of lading file.
c. Open invoice file.
d. Sales invoice file.
ANSWER: B
29. When evaluating a client's system of internal
control to determine whether the necessary
procedures are prescribed and have been
implemented satisfactorily, an auditor must
a. Develop questionnaires and checklists.
b. Obtain an understanding of internal control.
c. Perform tests of internal control procedures.
d. Evaluate administrative policies.
ANSWER: B
30. Of the following internal control policies or
procedures, which would most likely allow for a
reduction in the scope of the auditor's tests of
depreciation expense?
a. Review and approval of the periodic equipment
depreciation entry by a supervisor who does not
actively participate in its preparation.
b. Comparison of equipment account balances for the
current year with the current-year budget and prior-
year actual balances.
c. Review of the miscellaneous income account for
salvage credits and scrap sales of partially
depreciated equipment.
d. Authorization of payment of vendors' invoices by a
designated employee who is independent of the
equipment receiving function.
ANSWER: A
31. Tracing copies of sales invoices to shipping
documents will provide evidence that all
a. Shipments to customers were recorded as
receivables.
b. Billed sales were shipped.
c. Debits to the subsidiary accounts receivable ledger
are for sales shipped.
d. Shipments to customers were billed.
ANSWER: B
32. In assessing control risk, the auditor must, as a
minimum
a. Perform tests of all significant controls.
b. Obtain an understanding of the design and
implementation of the client's internal control.
c. Obtain an understanding of the design of the
client's internal control.
d. Obtain an understanding of the design,
implementation, and operating effectiveness of the
client's internal control.
ANSWER: B
33. An independent auditor has concluded that the
client's records, procedures and representations can
be relied upon based on tests made during the year
when internal control was found to be effective. The
auditor should test the records, procedures, and
representations again at year-end if
a. Inquiries and observations lead the auditor to
believe that conditions have changed significantly.
b. Comparisons of year-end balances with like
balances at prior dates revealed significant
fluctuations.
c. Unusual transactions occurred subsequent to the
completion of the interim audit work.
d. Client records are in a condition that facilitate
effective and efficient testing.
ANSWER: A
34. An auditor is least likely to further test control
procedures by examining documents with respect to
controls relating to
a. Segregation of the functions of recording
disbursements and reconciling the bank account.
b. Comparison of receiving reports and vendors'
invoices with purchase orders.
c. Approval of the purchase and sale of marketable
securities.
d. Classification of revenue and expense transactions
by product line.
ANSWER: A
35. An auditor usually examines receiving reports to
support
entries in the
a. Voucher register and sales returns journal.
b. Sales journal and sales returns journal.
c. Voucher register and sales journal.
d. Check register and sales journal.
ANSWER: A
36. Regardless of whether the auditor decides to test
controls for operating effectiveness, he/she must fully
document his or her understanding of the internal
control policies and procedures obtained through
whatever means. Which of the following
does notdescribe an appropriate means for
documenting such understanding?
a. Internal control flowchart.
b. Internal control implementation.
c. Internal control memorandum.
d. Internal control questionnaire.
ANSWER: B
37. Which of the following best describes the primary
reason for the auditor's use of flowcharts during an
audit engagement?
a. To comply with the requirements of generally
accepted auditing standards.
b. To classify the client's documents and transactions
by major operating functions, e.g., cash receipts, cash
disbursements, etc.
c. To record the auditor's understanding of the client's
internal control policies and procedures.
d. To interpret the operational effectiveness of the
client's existing organizational structure.
ANSWER: C
38. An auditor generally tests physical security
controls over inventory by
a. Test counts and cutoff procedures.
b. Examination and reconciliation.
c. Inspection and recomputation.
d. Inquiry and observation.
ANSWER: D
 39. Which of the following is not an auditing
procedure that is commonly used in performing
control tests?
a. Inquiring.
b. Observing.
c. Confirming.
d. Inspecting.
ANSWER: C
40. If the independent auditor decides that the work
performed by internal auditors may have a bearing on
the independent auditor's own procedures, the
independent auditor should consider the objectivity of
the internal auditors. One method of judging
objectivity is to
a. Review the recommendations made in the reports
of the internal auditor.
b. Examine, on a test basis, documentary evidence of
the work performed by internal auditors.
c. Inquire of management about the qualifications of
the internal audit staff.
d. Consider the client's practices for hiring, training,
and supervising the internal audit staff.
ANSWER: A
41. Tracing bills of lading to sales invoices will provide
evidence that
a. Recorded sales were shipped.
b. Invoiced sales were shipped.
c. Shipments to customers were invoiced.
d. Shipments to customers were recorded as sales.
ANSWER: C
42. The development of constructive suggestions to
clients for
improvements in internal accounting control is
a. A requirement of the auditor's study and evaluation
of internal accounting control.
b. A desirable byproduct of an audit engagement.
c. Addressed by the auditor only during a special
engagement.
d. As important as establishing a basis for reliance
upon the internal accounting control system.
ANSWER: B
43. Which of the following statements with respect to
the independent auditor's evaluation of internal control
is correct?
a. The auditor should decrease control testing when
weaknesses in cash receipts are mitigated by strong
controls in cash disbursement procedures.
b. The auditor should increase control testing when
weaknesses in billing procedures are mitigated by
strong controls in collection procedures.
c. The auditor generally should not evaluate the
overall effectiveness of internal control, but should
separately evaluate each of the transaction cycles.
d. The auditor should evaluate all internal control
weaknesses before determining the control
procedures that should prevent or detect errors or
irregularities.
ANSWER: C
44. Which of the following statements best describes
the auditor's responsibility regarding the detection of
material fraud?
a. Because of the inherent limitations of an audit, the
auditor is not responsible for the failure to detect
material fraud.
b. The auditor is responsible for the failure to detect
material fraud when such failure results from
nonperformance of audit procedures specifically
described in the engagement letter.
c. The auditor should design audit programs that will
provide reasonable assurance that material errors
and fraud will be detected in the ordinary course of
the examination.
d. The auditor is responsible for the failure to detect
material fraud when the auditor's evaluation of internal
control procedures indicates that they are ineffective.
ANSWER: C
45. Which of the following procedures most likely
would be included as part of an auditor's tests of
control procedures?
a. Inspection.
b. Reconciliation.
c. Confirmation.
d. Analytical procedures.
ANSWER: A
46. If, after obtaining an initial understanding of a
client's internal control, the auditor wishes to further
reduce the assessed level of control risk relating to
plant asset transactions, the auditor should next
a. Make extensive substantive tests of plant asset
balances.
b. Establish the physical existence of current year
additions.
c. Complete the plant asset section of the internal
accounting control questionnaire.
d. Further test those internal control procedures
relating to processing and recording plant asset
transactions.
ANSWER: D
47. The auditor is most likely to presume that a high
risk of defalcation exists if
a. The client is a multinational company that does
business in numerous foreign countries.
b. The client does business with several related
parties.
c. Inadequate segregation of duties places an
employee in a position to perpetrate and conceal
thefts.
d. Inadequate employee training results in lengthy
CBIS exception reports each month.
ANSWER: C
48. After obtaining an understanding of the client’s
internal control, the auditor should consider whether
a. The projected degree of effectiveness of internal
control is justified.
b. The evidential matter obtained from the study of the
internal control system can provide a reasonable
basis for an opinion.
c. Further testing of internal control procedures is
likely to permit further reduction of assessed control
risk.
d. Sufficient knowledge has been obtained about the
entity's entire system of internal control.
ANSWER: C
 49. Which of the following is the correct order of
performing the auditing procedures A through C
below?
A = Tests of internal control procedures.
B = Preparation of a flowchart depicting the client's
internal control system.
C = Substantive tests.
a. ABC.
b. ACB.
c. BAC.
d. BCA.
ANSWER: C
50. Auditors frequently use flowcharts in connection
with which
of the following
a. Preparation of generalized computer audit
programs.
b. Review of the client's internal control procedures.
c. Use of statistical sampling in performing an audit.
d. Performance of analytical review procedures of
account balances.
ANSWER: B
51. Which of the following conditions suggest
alowering of the aggregate materiality threshold?
a. Internal controls in the area of payroll processing
are found to be much stronger than the auditor's initial
assessment.
b. The application of analytical procedures reveals a
favorable sales budget variance that is material and
that remains unexplained.
c. Study of the business and industry reveals a
material decline in both industry and client revenue
during the current year.
d. Tests of internal controls in nearly all transaction
cycle subsets have produced numerous and
widespread errors.
ANSWER: D
52. If, during the course of an annual audit of a
publicly held manufacturing company, an independent
auditor becomes aware of a material weakness in the
company's internal control, the auditor is required to
communicate the weakness to
a. The audit committee of the board of directors, or to
a similar body having financial oversight
responsibility.
b. The senior management of the company.
c. The board of directors of the company.
d. The treasurer and controller of the client entity.
ANSWER: A
53. Under which of the following conditions would you
consider lowering individual itemmateriality
thresholds.
a. Study of the business and industry, together with
the application of analytical procedures, reveals that
the client has enjoyed a surge in sales and gross
profit during an industry downturn.
b. Application of analytical procedures shows that the
client's gross profit rate is significantly below last year
and also is materially lower than the industry average.
c. Study of internal controls within the revenue cycle
reveal material weaknesses.
d. Study of internal controls within the payroll cycle
confirm the auditor's belief that few errors have
occurred.
ANSWER: A
54. Which of the following is not a medium that can
normally be used by an auditor to record information
concerning a client's internal control policies and
procedures?
a. Narrative memorandum.
b. Procedures manual.
c. Flowchart.
d. Questionnaire.
ANSWER: B
55. With respect to the client's system of internal
control, the auditor is concerned that the existing
policies and procedures provide reasonable
assurance that
a. Operational efficiency has been achieved in
accordance with management plans.
b. Errors and fraud have been prevented or detected.
c. Controls have not been circumvented by collusion.
d. Management cannot override the internal controls.
ANSWER: B
56. The auditor observes client employees during the
review of the client's system of internal control in
order to
a. Prepare a flowchart.
b. Update information contained in the organization
and procedure manuals.
c. Assist in obtaining an understanding of the client's
internal control policies and procedures.
d. Determine the extent of compliance with quality
control standards.
ANSWER: C
57. An auditor's flowchart of a client's accounting
system is a diagrammatic representation that depicts
the auditor's
a. Program for tests of controls.
b. Understanding of the system.
c. Understanding of the types of fraud that are
probable, given the present system.
d. Documentation of the study and evaluation of the
system.
ANSWER: B
58. An independent auditor might consider the
procedures performed by the internal auditors
because
a. They are employees whose work must be reviewed
during substantive testing.
b. They are employees whose work might be relied
upon.
c. Their work impacts upon the cost/benefit tradeoff in
evaluating inherent limitations.
d. Their degree of independence may be inferred by
the
nature of their work.
ANSWER: B
59. A procedure that would most likely be used by an
auditor in performing tests of control procedures that
involve segregation of functions and that leave no
transaction trail is
a. Inspection.
 b. Observation.
c. Reprocessing.
d. Reconciliation.
ANSWER: B
60. It is important for the CPA to consider the
competence of the audit client's employees because
their competence bears directly and importantly upon
the
a. Cost/benefit relationship of the internal control
system.
b. Achievement of the objectives of the internal
control system.
c. Comparison of recorded accountability with assets.
d. Timing of the tests to be performed.
ANSWER: B
61. In studying internal control and assessing control
risk, the auditor applies the following steps:
a. Determine the internal control policies and
procedures necessary to prevent or detect errors or
fraud that could occur in the absence of controls.
b. Identify control weaknesses.
c. Determine whether the necessary policies and
procedures have been designed and whether they
have been placed in operation.
d. Design substantive audit programs.
e. Consider the types of errors or fraud that could
occur in the absence of necessary controls.
The proper sequence in applying these steps is:
a. CDEAB
b. CBAED
c. EACBD
d. AECBD
ANSWER: C
62. The primary purpose of performing further control
tests is to provide
a. A basis for reducing the assessed level of control
risk below the maximum level.
b. A basis for understanding the flow of transactions
through the accounting system.
c. Assurance that transactions are properly recorded.
d. All accounting control procedures leave visible
evidence.
ANSWER: A
63. To determine whether refunds granted to
customers were properly approved, the auditor should
trace accounts receivable entries to:
a. Sales invoices.
b. Remittance advices.
c. Shipping documents.
d. Credit memos.
ANSWER: D
64. A well-prepared flowchart should make it easier
for the auditor to
a. Prepare audit procedure manuals.
b. Prepare detailed job descriptions.
c. Trace the origin and disposition of documents.
d. Assess the degree of accuracy of financial data.
ANSWER: C