Test bank auditing and assurance principles ch07 audit planning assessment of control risk

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 are

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 policiesand 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 fromcustomer 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

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 thanthe 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 thereceiving 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 independentauditor'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 forthe 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 year actual balances

prior-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 equipmentreceiving 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 not describe 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?