Audit Exam 2 - MC questions

The most important fundamental component of an entity's internal control is:

A. Effectiveness and efficiency of operations

B. People who operate the control system

C. Reliability of financial reporting

D. Compliance with applicable laws and regulations

B. People who operate the control system

The primary purpose for obtaining an understanding of a nonpublic audit client's internal control is to:

A. Provide a basis for making constructive suggestions in a management letter

B. Determine the nature, timing, and extent of further audit tests to be performed

C. Provide the rationale for the inherent risk assessment at the financial statement assertion level

D. Provide information for a communication of internal control-related matters to management

B. Determine the nature, timing, and extent of further audit tests to be performed

Effectiveness of audit procedures would be reduced by:

A. Selecting larger sample sizes for audit

B. Performing audit procedures at the fiscal year-end date as opposed to the interim period

C. Deciding to obtain external evidence instead of internal evidence

D. Performing audit procedures during the interim period as opposed to at the fiscal year-end date

D. Performing procedures during the interim period as opposed to at the fiscal year-end date

According to the PCAOB, during the audit of internal controls for an issuer, the ultimate objective of testing the design effectiveness of internal controls is to:

A. Determine whether the company's controls are processing company date effectively

B. Determine that the company's controls will satisfy the company's control objectives and can effectively prevent or detect errors or fraud that could result in material misstatements, if they operate as prescribed

C. Determine that the company's employees are processing the controls according to the policy and procedures manuals at the company

D. None of the above

B. Determine that the company's controls will satisfy the company's control objectives and can effectively prevent or detect errors or fraud that could result in material misstatements, if they operate as prescribed

To test the operating effectiveness of a control, an audit team might use a combination of each of the following tests except for:

A. Inquiry of client personnel

B. Observation of company operations

C. Confirmation of balances

D. Inspection of documentation

C. Confirmation of balances

Which of the following is a preventive control?

A. Reconciliation of a bank account

B. Recalculation of a sample of payroll entries by internal auditors

C. Separation of duties between the payroll and personnel departments

D. Detailed fluctuation analysis completed by the CFO for revenue

C. Separation of duties between the payroll and personnel departments

(A, B, and D are detective controls)

In most audits of large entities, control risk assessment contributes to audit efficiency, which means that:

A. The cost of substantive procedures will exceed the cost of control evaluation work

B. Auditors will be able to reduce the cost of substantive procedures by an amount more than the control evaluation costs

C. The cost of control evaluation work will exceed the cost of substantive procedures

D. Auditors will be able to reduce the cost of substantive procedures by an amount less than the cost of test of controls

B. Auditors will be able to reduce the cost of substantive procedures by an amount more than the control evaluation costs

Which of the following is a device designed to help the audit team obtain evidence about the accounting and control activities of an audit client?

A. A narrative memorandum describing the control system

B. An internal control questionnaire

C. A flowchart of the documents and procedures used by the company

D. All of the above

B. An internal control questionnaire

Tests of controls in a GAAS audit are required for:

A. Obtaining evidence about the financial statement assertions

B. Accomplishing control over the occurrence of recorded transactions

C. Applying analytical procedures to financial statement balances

D. Obtaining evidence about operating effectiveness of client control activities

D. Obtaining evidence about the operating effectiveness of client control activities

A transaction-level internal control activity is best described as:

A. An action taken by auditors to obtain evidence

B. An action taken by client personnel for the purpose of preventing, detecting, and correcting errors and frauds in transactions to eliminate or mitigate risks identified by the company

C. A method for recording, summarizing, and reporting financial info

D. The functioning of the board of directors in support of its audit committee

B. An action taken by client personnel for the purpose of preventing, detecting, and correcting errors and frauds in transactions to eliminate or mitigate risks identified by the company

When planning the audit of internal controls for an issuer, the audit team should:

Identify significant accounts, locations, and assertions

A material weakness is a situation in which:

It is reasonably possible that a material misstatement would not be detected on a timely basis

When completing the audit of internal controls for an issuer, the severity of an internal control deficiency depends on:

Whether there is a reasonable possibility that the company's controls will fail to prevent or detect a misstatement of an account balance or disclosure;

The magnitude of the potential misstatement resulting from the deficiency or the deficiencies

When completing the audit of internal controls for a public company, the PCAOB requires auditors to audit internal controls over

Financial reporting

Which of the following does not accurately summarize auditors' requirements regarding internal control?

Test controls: public entity - yes, nonpublic entity - yes

(Testing controls are required only for audits of public companies under AS 5)

When completing the audit of internal controls for a public company, AS 5 requires auditors to report on:

An audit of internal control, but not management's report on internal control

When completing the audit of internal controls for a public company, AS 5 requires auditors to test

Both operating and design effectiveness

Which of the following would probably not be considered an indication of a material weakness?

A. Evidence of a material misstatement

B. Ineffective oversight by the audit committee

C. Immaterial fraud committed by senior management

D. Overproduction by the manufacturing plant

D. Overproduction by the manufacturing plant

Which report would not be appropriate for a public accounting firm to provide on financial reporting controls?

Disclaimer of opinion - significant deficiencies exist

The purpose of separating the duties of hiring personnel and distributing payroll checks is to separate the:

Authorization of transactions from the custody of related assets

Which of the following statements is not true with respect to the auditors' report on internal control over financial reporting?

A. The report will be dated as of the date of the financial statements

B. The report will express an opinion on the effectiveness of internal control over financial reporting

C. The auditor will issue an adverse opinion if one or more material weaknesses exist

D. The report may be presented with the report on the entity's financial statements as a combined report

A. The report will be dated as of the date of the financial statements

If the auditor encounters a significant scope limitation in evaluating a public company's internal control over financial reporting, which of the following types of opinions on the effectiveness of the company's internal control over financial reporting would be appropriate?

Disclaimer of opinion

Which of the following information would be included in the introductory paragraph of the auditors' report on internal control over finacial reporting if the report is presented separately from the auditors' report on the entity's financial statements?

Statements identifying the responsibility of the auditors and management for internal control over financial reporting

If the auditor plans to assess control risk at less than the maximum and rely on control, and the nature, timing, and extent of further audit procedures are based on that lower assessment, the auditor must

Obtain evidence that the controls selected for testing are designed effectively and operated effectively during the period of relevance

When testing a control activity's operating effectiveness, procedures the auditor performs to test operating effectiveness wold likely include

Inquiry of appropriate personnel, and

Re performance of the control activity

Matters that could affect the necessary extent of testing for a control activity as it related to the degree of auditor reliance on a control activity would not include the following:

The relevance and reliability of the audit evidence to be obtained to test the operating effectiveness of a control activity

The auditor should assess control risk for each relevant assertion by evaluating the evidence obtained from all sources, including:

A. The auditor's testing of controls for the audit of internal control on a public company

B. Misstatements detected during the financial statement audit

C. Any control deficiencies identified during the audit

D. All of the above

D. All of the above

Once the auditor detects a control deficiency, which of the following steps must he or she take first?

A. Perform tests of other controls related to the same assertion as the control deemed ineffective

B. Evaluate the severity of the deficiency on the auditor's control risk assessment for that assertion

C. Modify the planned substantive procedures as a result of the deficiency

D. Test the deficient control, assuming a maximum level of risk

B. Evaluate the severity of the deficiency on the auditor's control risk assessment for that assertion.

When auditing with "fraud awareness," auditors should especially notice and follow up employee activities under which of these conditions?

A. The company always estimates the inventory but never takes a complete physical count

B. The petty cash box is always locked in the desk of the custodian

C. Management has published a company code of ethics and sends frequent communication newsletters about it

D. The board of directors reviews and approves all investment transactions

A. The company always estimates the inventory but never takes a complete physical count

The best way to enact a broad fraud prevention program is to

A. Install airtight control systems of checks and supervision

B. Name an "ethics officer" who is responsible for receiving and acting on fraud tips

C. Place dedicated hotline telephones on walls around the workplace with direct communication to the company ethics officer

D. Practice management "of the people and for the people" to help them share personal and professional problems

D. Practice management "of the people and for the people" to help them share personal and professional problems

(Since "people" are essential to a fraud prevention program, practice management "of the people and for the people" to help them share personal and professional problems is the best long-run way to stop fraud)

A good fraud prevention program should always address employees' motivation to steal from the company. The best method for doing this is to

A. Establish employee assistance programs

B. Require a fidelity bond on all employees

C. Require reconciliations of all accounts to be reviewed by a supervisor

D. Ensure that all accounts with high inherent risk of fraud are audited

A. Establish employee assistance programs

(Problems due to debt, addictions, or family problems motivate employees to commit frauds. Establishing an employee assistance program addresses these issues and ultimately may reduce the motivation to commit fraud for some employees)

A code of ethics is an important element of a fraud prevention program. Which of the following would diminish the effectiveness of a company's code of conduct?

A. The establishment of a chief executive officer

B. The establishment of a hotline for reporting unethical behavior

C. The violation of the code of ethics by senior management

D. The posting of the code of ethics in the company workplace

C. The violation of the code of ethics by senior management

Which of the following is LEAST indicative of fraudulent activity?

A. Numerous cash refunds have been made to different people at the same post office box address

B. Internal auditors cant locate several credit memos to support reductions of customers' balances

C. Bank reconciliation has no outstanding checks or deposits older than 15 days

D. Three people were absent the day the auditors handed out the paychecks and have not picked them up four weeks later

C. Bank reconciliation has no outstanding checks or deposits older than 15 days

Which of the following combinations is a good way to conceal employee fraud but an ineffective means of perpetrating management (financial reporting) fraud?

A. Overstating sales revenue and overstating customer accounts receivable balances

B. Overstating sales revenue and overstating bad debt expense

C. Understating interest expense and understating accrued interest payable

D. Omitting the disclosure of info about related-party sales to the president's relatives at below-market prices

B. Overstating sales revenue and overstating bad debt expense

(Overstating sales revenue and overstating bad debt expense by the same amount does not overstate net income or total assets -- which is often a goal of financial reporting fraud. However, this action would help to hide a manger's theft of assets -- i.e., embezzlement)

Allison Everhart, an employee in accounts payable, believes she can run a fictitious invoice through the accounts payable system and collect the money. She knows payments are subject to an audit. Which account would be the best place to hide the fraud?

A. Inventory

B. Wage expense

C. Consulting service expense

D. Property tax expense

C. Consulting service expense

(Expense accounts are often good places to hide fraud because accounts are closed at the end of the year. Consulting expense is a particularly good place to hide a fraud because it provides no actual product that may be counted or compared to the expense)

Which of these arrangements of duties could most likely lead to an embezzlement or theft?

A. The inventory warehouse manager has responsibility for making the physical inventory observation and reconciling discrepancies to the perpetual inventory records

B. The cashier prepared the bank deposit, endorsed the checks with a company stamp, and delivered the cash and checks to the bank for deposit (no other bookkeeping duties)

C. The accounts receivable clerk received a list of payments received by the cashier so he could make entries in the customers' accounts receivable subsidiary ledger

D. The financial VP received checks make out to suppliers and the supporting invoices, signed the checks, and mailed the checks

A. The inventory warehouse manager has responsibility for making the physical inventory observation and reconciling discrepancies to the perpetual inventory records

Which of the following would the auditor consider to be an incompatible operation if the cashier receives remittances?

A. The cashier prepares the daily deposit

B. The cashier makes the daily deposit at a local bank

C. The cashier posts the receipts to the accounts receivable subsidiary ledger cards

D. The cashier endorses the checks

C. The cashier posts the receipts to the accounts receivable subsidiary ledger cards

Which of the following is an effective audit procedure that an auditor might use to detect kiting between intercompany banks?

A. Review the composition of authenticated deposit slips

B. Review subsequent bank statements

C. Prepare a schedule of the bank transfers

D. Prepare a year-end bank reconciliation

C. Prepare a schedule of the bank transfers

(Kiting involves a mismatching of dates of recording cash transactions around year-end, and the schedule of bank transfers is designed to show all the relevant dates so the auditor can see that the entries were made in the proper periods)

Immediately upon receipt of cash, a responsible employee should

A. Record the amount in the cash receipts journal

B. Prepare a remittance listing

C. Update the subsidiary accounts receivable records

D. Prepare a deposit slip in triplicate

B. Prepare a remittance listing

(Effective control of cash requires that receipts be recorded promptly. For mail receipts, a listing of remittance advices by an employee not performing incompatible functions is a standard control activity. If the customer doesn't return the remittance advice, one should be prepared at the time the mail is opened. If remittance advices are not used, a list of receipts should still be made when the mail is opened)

Each morning the controller gets the prior day's list of remittances, a copy of the payment report, and a copy of the deposit slip returned from the bank. When comparing these items, the controller would be able to determine that

The cash received and remittance advice received were maintained in a single batch

(If the cash received was not deposited intact or remittances were not posted, the deposit slip amount would not match the remittances or the payments recorded)

Upon receipt of customers' checks in the mail room, a responsible employee should prepare a remittance list that is forwarded to the cashier. A copy of the list should be sent to the

Accounts receivable bookkeeper to update the subsidiary accounts receivable records

Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor?

A. Understating the sales journal

B. Overstating the accounts receivable control account

C. Overstating the accounts receivable subsidiary ledger

Overstating the sales journal

A. Understating the sales journal

(Not recording sales on account in the books of original entry is the most effective way to conceal a subsequent theft of cash receipts. The accounts will be incomplete but balanced, and procedures applied to the accounting records will not detect the defalcation)

Embezzlement is a type of fraud the involves

An employee misappropriating an employer's money or property entrusted to the employee's control in the employee's normal job

Which of the following control activities would best protect against the preparation of improper or inaccurate cash disbursements?

B. All signed checks must be reviewed and compared with supporting documentation by the treasurer before mailing

(A final review by the treasurer can catch mistakes made in the processing of the payment. This also involves a review of the supporting documentation, an important consideration as well)

During an audit of cash, the auditor is most concerned with the management assertion of

Existence

(The existence of cash is always a relevant assertion for cash because an overstatement of cash might indicate that fraudulent revenue was recorded)

In preparing for the audit of cash, the auditors perform analytical procedures concerning cash balances which of the following would be the best source of info for use in the estimate of cash?

A. Prior-years' balances

B. Management inquiry

C. Cash budgets

D. Aged accounts receivable reports

C. Cash budgets

(Budgets provided by management provide the best management estimates for the sources and uses of cash. Where cash receipts or cash expenditures vary from the budget by a material amount, a higher level of risk may be assessed)

Which of the following control activities could prevent a paid disbursement voucher from being presented for payment a second time?

D. The official signing the check should compare it with the voucher and should stamp "paid" on the voucher documents

Fraud risk factors are events or conditions that indicate which of the following

A. An opportunity to carry out a fraud

B. An attitude or rationalization that justifies a fraudulent action

C. An incentive or pressure to perpetrate fraud

D. All of these are correct

D. All of these are correct

If the auditor believes that a misstatement is or might be intentional and the effect on the financial statements could be material or cannot be readily determined, the auditor should do which of the following?

C. Perform procedures to obtain additional audit evidence to determine whether fraud has occurred or is likely to have occurred

In what way can audit procedures be modified to address assessed fraud risks?

A. Obtain more reliable info

B. Perform procedures close to year-end

C. Apply computer-assisted techniques to all items

D. All of these are valid modifications

D. All of these are valid modifications

Incorporating elements of unpredictability in the selection of audit procedures to be performed by auditors include all of the following EXCEPT

D. Sending attorney letters to every attorney listed under the legal expense account

(Sending attorney letters to every attorney listed under the legal expense account is common as it is important for auditors to inquire about any possible loss contingency. Since it is a customary procedure, this would not be an example of incorporating unpredictability into the selection of auditing procedures)

Revenues are normally considered to have been earned when:

The company has substantially accomplished what it must to be entities to the benefits

Sales are normally recorded on the date of the:

Sales invoice

When auditing the revenue and collection cycle, auditors normally select balances to confirm form the:

Accounts receivable listing

Which of the following accounts is not normally part of the revenue and collection cycle?

A. sales

B. Accounts receivable

C. Cash

D. Purchases Returns and Allowances

D. Purchases Returns and Allowances

The control procedure "credit sales approved by credit department" is directed toward which transaction assertion?

Accuracy

Which of the following would be the vest protection for a company that wishes to prevent the "lapping" of trade accounts receivable?

A. Separate duties of that the bookkeeper in charge of the general ledger has no access to incoming mail.

B. Separate duties so that no employee has access to both checks from customers and currency from daily cash receipts

C. Have customers send payments directly to the company's depository bank.

D. Request that customer's payment checks be made payable to the company and addressed to the treasurer.

C. Have customers send payments directly to the company's depository bank.

Which of the following internal control activities will most likely prevent the concealment of a cash shortage by improperly writing off a trade account receivable?

A. Write-offs must be approved by a responsible officer after review of credit department recommendations and supporting evidence

Auditors sometimes use comparisons of ratios as audit evidence. An unexplained decrease in the ratio of gross profit to sales may suggest which of the following possibilities?

B. Unrecorded sales

An audit team is auditing sales transactions. One step is to vouch a sample of debit entries from the accounts receivable subsidiary ledger back to the supporting sales invoices. The purpose of this audit procedure is to establish that

Entries in the accounts receivable subsidiary ledger were properly invoiced

An auditor noted that client sales increased 10% for the year. At the same time, COGS as a percentage had decreased from 45% to 40% and year-end accounts receivable had increased by 8%.

Based on this information, the auditor is most likely concerned about _________.

Fictitious sales

An auditor noted that client sales increased 10% for the year. At the same time, COGS as a percentage had decreased from 45% to 40% and year-end accounts receivable had increased by 8%.

Based on this information, the auditor interviewed the sales manager, who stated that the increase in sales without a corresponding increase in COGS was due to a price increase enacted by the company during the year. How would the auditor test the sales manager's representation?

Obtain copies of all price lists in use during the year and vouch the prices to sales invoices

To conceal a theft involving receivables, a dishonest bookkeeper might charge which of the following accounts?

D. Sales returns

Which of the following responses to an accounts receivable confirmation at December 31 would cause an audit team the most concern?

C. "These goods were returned for credit on November 15."

A client has a separate sales group for its largest "preferred" customers, a select group of customers who normally make purchases in excess of $250,000 and often have accounts receivable balances in excess of $1 million. Which of the following audit procedures would the auditor most likely perform?

D. Send out positive confirmations on a large sample of these customers

Audit documentation often included a client-prepared, aged trial balance of accounts receivable as of the balance sheet date. The audit team uses this aging primarily to

Estimate credit losses

Which of the following might be detected by auditors' cutoff review and examination of sales journal entries for several days prior to the balance sheet date?

B. Inflating sales for the year

Confirmation of individual accounts receivable balances directly with debtors will, of itself, normally provide the strongest evidence concerning the

Existence of the balances confirmed

Which of the following is the best reason for prenumbering in numerical sequence documents such as sales orders, shipping documents, and sales invoices?

C. Enables personnel to check the numerical sequence for missing documents and unrecorded transactions

When a sample of customer accounts receivable is selected for vouching debits, auditors will vouch them to

Sales invoices with shipping documents and customer sales invoices

In the audit of accounts receivable, the most important emphasis should be on the

Existence assertion

When accounts receivable are confirmed at an interim date, auditors need not be concerned with

Sending negative confirmations to all customers as of the year-end date

The negative request form of accounts receivable confirmation is useful particularly when the

Assessed level of risk of material misstatement relating to receivables is low, number of small

When an audit team traces a sample of shipping documents to the related sales invoice copies, they are trying to find relevant evidence that

Shipments to customers were invoiced

(This does not imply that the invoices were recorded in the sales journal)

Write-offs of doubtful accounts should be approved by

The treasurer

(Or another high-ranking manager)

When an audit team does not receive a response on a positive accounts receivable confirmation, auditors should do all of the following except

A. Send a second request

B. Do nothing for immaterial balances

C. Examine shipping documents

D. Examine client correspondence files

B. Do nothing for immaterial balances

(Because the confirmations are a sample of the account balance, even immaterial items should be followed up as they represent other balances in the universe of receivables)

Cash receipts from sales on account have been misappropriated. Thick of the following acts would conceal this devaluation and be LEAST LIKELY to be detected by an auditor?

A. Understating the sales journal

B. Overstating the accounts receivable control account

C. Overstating the accounts receivable subsidiary ledger

D. Understating the cash receipts journal

A. Understating the sales journal

(Not recording sales on account in the books of original entry is the most effective way to conceal a subsequent theft of cash receipts. The accounts will be incomplete but balanced, and procedures applied to the accounting records will not detect the defalcation)

Which of the following internal control activities most likely would deter lapping of collections from customers?

A. Independent internal verification of dates of entry in the cash receipts journal with dates of daily cash summaries

B. Authorization of write-offs of uncollectible accounts by supervisor independent of credit approval

C. Separation of duties between receiving cash and posting the accounts receivable ledger

D. Supervisory comparison of the daily cash summary with the sum of the cash receipts journal entries

C. Separation of duties between receiving cash and posting the accounts receivable ledger

(Lapping is the delayed recording of cash receipts to cover a cash shortage. Current receipts are posted to the accounts of customers who paid one or two days previously to avoid complaints (and discovery) when monthly statements are mailed. The best protection is for the customers to send payments directly to the company's depository bank. The next best procedure is to ensure that the accounts receivable clerk has no access to cash received by the mail room. Thus, the duties of receiving cash and posting the accounts receivable ledger are segregated)

The financial records of the Movitz Company show that R. Dennis owes $4,100 on an account receivable. An independent audit is being carried out, and the auditors send a positive confirmation to R. Dennis. What is the most likely reason as to why a positive confirmation rather than a negative confirmation was used here?

A. Control risk was particularly low for accounts receivable

B. Inherent risk was particularly high for accounts receivable

C. Dennis's account was not yet due

D. Dennis's account was not with a related party

B. Inherent risk was particularly high for accounts receivable

(Because detection risk is lower for positive confirmations than negative confirmations, a positive confirmation is more likely when inherent risk is high. A negative confirmation might be used if control risk is low)

An audit client sells 15 to 20 units of product annually. A large portion of the annual sales occur in the last month of the fiscal year. Annual sales have not materially changed over the past five years. Which of the following approaches would be most effective concerning the timing of audit procedures for revenue?

A. The auditor should perform analytical procedures at an interim date and discuss any changes in the level of sales with senior management

B. The auditor should inspect transactions occulting in the last month of the fiscal year and review the related sale contracts to determine that revenue was posted in the proper period

C. The auditor should perform tests of controls at an interim date to obtain audit evidence about the operational effectiveness of internal controls over sales

D. The auditor should review period-end compensation to determine whether bonuses were paid to meet earnings goals

B. The auditor should inspect transactions occulting in the last month of the fiscal year and review the related sale contracts to determine that revenue was posted in the proper period

(Since a large portion of the sales occur in the last month the auditor needs to test end of year sales, specifically the determination of the timing of sales is important to ensure sales were recorded in the proper period)

An auditor is required to confirm accounts receivable if the accounts receivable balances are

A. Older than the prior year

B. Material to the financial statements

C. Smaller than expected

D. Subject to valuation estimates

B. Material to the financial statements

( confirmation are generally reserved for accounts that are material to the black being examined, in this case, accounts receivable)

During the confirmation of accounts receivable, an auditor receives a confirmation via the client's fax machine. Thick of the following actions should the auditor take?

A. Not accept the confirmation and select another customer's balance to confirm

B. Not accept the confirmation and treat is as an exception

C. Accept the confirmation and file it in the working papers

D. Accept the confirmation but verify the source and content through a telephone call to the respondent

D. Accept the confirmation but verify the source and content through a telephone call to the respondent

(When a reply to a confirmation is received via fax the auditor must determine that the fax actually came from the appropriate person at the client. A phone call to an appropriate person at the audit client is an acceptable method for verifying the legitimacy of the response)