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INTERNAL CONTROL

1. Of the following statements about an internal control system, which one is not valid?
a. no one person should be responsible for the custodial responsibility and the recording responsibility for an asset
b. transactions must be properly authorized before such transactions are processed
c. because of the cost benefit relationship, a client may apply control procedures on a test basis
d. control procedures reasonably insure that collusion among employees can not occur

2. Which of the following is an invalid concept of internal control?

a. in cases where a person is responsible for all phases of a transaction there should be a clear designation of that person’s
responsibility
b. the recorded accountability for assets should be compared with the existing assets at reasonable intervals and appropriately
be applied on a test basis in some circumstances
c. accounting control procedures may appropriately be applied on a test basis in some circumstances
d. procedures designed to detect errors and irregularities should be performed by persons other than those who are in a position
to perpetrate them

3. Internal accounting control comprises the plan of organization and the procedures and records that are concerned with the
safeguarding of assets and the:
a. decision process of management
b. reliability of financial records
c. authorization of transactions
d. achievements of administrative objectives

4. Internal control can be generally subdivided into administrative controls and accounting controls. The scope of study and
evaluation of internal control contemplated by GAAS requires the consideration of:
a. both administrative controls and accounting controls
b. administrative controls
c. accounting controls
d. accounting controls in an audit engagement and administrative controls in a management-advisory-service engagement

5. Internal administrative controls includes the overall plan of organization and the procedures that are concerned with:
a. safeguarding the assets and providing reliable financial records
b. the decision process leading to management’s authorization of transactions
c. the execution of transactions in accordance with special or general authorization
d. providing for reasonable assurance that access to assets is permitted only in accordance with management authorization

6. Which of the following is not an element of an entity’s internal control structure?

a. control risk
b. control procedures
c. accounting system
d. control environment

7. Which of the following internal control features would an auditor be least likely to review?
a. segregation of the asset-handling and record-keeping functions
b. company policy regarding credit and collection efforts
c. sales and cost records classified by products
d. authorization of additions to plant and equipment

8. Which of the following best describes the inherent limitations should be recognized by an auditor when considering the potential
effectiveness of a system of internal accounting control?
a. procedures whose effectiveness depends on segregation of duties can be circumvented by collusion
b. the competence and integrity of client personnel provides an environment conducive to accounting control and provides
assurance that effective control will be achieved
c. procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are
effective against irregularities perpetrated by management
d. the benefits expected to be derived from effective internal accounting control usually do not exceed the costs of such controls

9. When considering the effectiveness of a system of internal accounting control, the auditor should recognize that inherent limitations
do exist. Which of the following is an example of an inherent limitation in a system of internal accounting control?
a. the effectiveness of procedures depends on the segregation of employee duties
b. procedures are designed to assure the execution and recording of transactions in accordance with management’s
authorization
c. in the performance of most control procedures, there are possibilities of errors arising from mistakes in judgment
d. procedures for handling large numbers of transactions are processed by EDP

10. Which of the following would not be considered an inherent limitation of the potential effectiveness of an entity’s internal control
structure?
a. incompatible duties
b. management override
c. mistakes in judgment
d. collusion among employees

11. When considering internal control, an auditor should be aware of the concept of reasonable assurance, which recognizes that the:
a. segregation of incompatible functions is necessary to ascertain that internal control is effective
b. employment of competent personnel provides assurance that the objectives of internal control will be achieved
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c. establishment and maintenance of a system of internal control is an important responsibility of the management and not of the
auditor
d. cost of internal control should not exceed the benefits expected to be derived from internal control

12. A system of internal accounting control normally would include procedures that are designed to provide reasonable assurance that:
a. employees act with integrity when performing their assigned tasks
b. transactions are executed in accordance with management’s general or specific authorization
c. decision processes leading to management’s authorization of transactions are sound
d. collusive activities would be detected by segregation of duties

13. An auditor would most likely be concerned with internal control structure policies and procedures that provide reasonable
assurance about the:
a. efficiency of management’s decision making process
b. appropriate prices the entity should charge for its products
c. methods of assigning production tasks to employees
d. entity’s ability to process and summarize financial data

14. Transaction authorization within an organization may be either specific or general. An example of specific transaction authorization
is the:
a. establishment of requirements to be met in determining the customer’s credit limits
b. setting of automatic re-order points for materials or merchandise
c. approval of a detailed construction budget for a warehouse
d. establishment of sales prices for products to be sold to any customer

15. Proper segregation of functional responsibilities in an effective system of internal accounting control calls for separation of the
functions of:
a. authorization, execution and payment
b. authorization, recording and custody
c. custody, execution and reporting
d. authorization, payment and recording

16. Proper segregation of functional responsibilities calls for the separation of the:
a. authorization, approval and execution functions
b. authorization, execution and payment functions
c. receiving, shipping and custodial functions
d. authorization, recording and custodial functions

17. Proper segregation of duties reduces the opportunities to allow persons to be in position to both:
a. journalize entries and prepare financial statements
b. record cash receipts and cash disbursements
c. establish internal controls and authorize transactions
d. perpetuate and conceal errors and irregularities

18. Effective internal control requires organizational independence of departments. Organizational independence would be impaired in
which of the following situations?
a. the internal auditors report to the audit committee of the board of directors
b. the controller reports to the vice president of production
c. the payroll accounting department reports to the chief accountant
d. the cashier reports to the treasurer

19. Which of the following is a responsibility that should not be assigned to only one employee?
a. access to securities in the company’s safe deposit box
b. custodianship of the cash working fund
c. reconciliation of bank statements
d. custodianship of tolls and small equipment

20. In general, a material internal accounting control weaknesses may be defined as a condition in which material errors and
irregularities may occur and not be detected within a timely period by:
a. an independent auditor during the compliance test phase of the study and evaluation of internal accounting control techniques
b. employees in the normal course of performing their assigned functions
c. management when reviewing interim financial statements and reconciling account balances
d. outside consultants who issue a special purpose report on internal control

21. In general, a material internal control weakness may be defined as a condition in which material errors or irregularities would
ordinarily not be detected within a timely period by:
a. an auditor during the normal study and evaluation of the system of internal control
b. a controller when reconciling accounts in the general ledger
c. employees in the normal course of performing their assigned functions
d. the chief financial officer when reviewing interim financial statements

22. A well-designed system of internal control that is functioning effectively is most likely to detect an irregularity arising from:
a. the fraudulent action of several employees
b. the fraudulent action of an individual employee
c. informal deviations from the official organization chart
d. management fraud

23. Which of the following is the least likely reason for the auditor’s study and evaluation of internal control?
a. to determine the extent of audit testing
b. to serve as a basis for reliance on the controls
c. to determine the nature of the transactions
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d. to serve as a basis for constructive service suggestions

24. A secondary objective of the auditor’s study and evaluation of internal accounting control is that the study and evaluation provides:
a. a basis for determining the nature, extent and timing of audit tests
b. assurance that management’s procedures to detect irregularities are properly functioning
c. a basis for constructive suggestions concerning improvements in internal accounting control
d. evidence that incompatible functions for accounting control purposes have been eliminated

25. A secondary objective of the auditor’s study and evaluation of internal control is that the study and evaluation provides:
a. a basis for constructive suggestions concerning improvements in internal control
b. a basis for reliance on the system of internal accounting control
c. an assurance that the records and documents have been maintained in accordance with existing company policies and
procedures
d. a basis for the determination of the resultant extent of the tests to which auditing procedures are to be restricted

26. The development of constructive suggestions to ma client in its internal control structure is:
a. addressed by the auditor only during a special engagement
b. as important as establishing a basis for reliance on the internal control structure
c. a requirement of the auditor’s consideration of the internal control structure
d. a desirable by-product of an audit engagement

27. The preliminary phase of the auditor’s review of internal control is designed to provide information on three matters. Which of the
following is not a purpose of the preliminary review?
a. determine the extent to which EDP is used in significant accounting applications
b. understand the flow of transactions in the system
c. comprehend the basic structure of accounting control
d. identify the controls on which reliance is planned

28. The auditor is least concerned with which of the following?

a. administrative controls
b. application controls
c. safeguarding of assets
d. access to assets

29. During the consideration of the internal control structure in a financial statement audit, an auditor is not obligated to:
a. search for significant deficiencies in the operation of the internal control structure
b. understand the internal control environment and the accounting system
c. determine whether the control procedures relevant to audit planning have been placed in operation
d. perform procedures to understand the design of the internal control structure policies

30. Which of the following would be inappropriate during a preliminary evaluation of the system of internal control?
a. completion of an internal control questionnaire
b. use of attribute sampling
c. oral inquiries
d. review of an accounting manual prepared by the client

31. The primary objective of procedures performed to obtain an understanding of the internal control structure is to provide an auditor
with:
a. evidential matter to use in reducing detection risk
b. knowledge necessary to plan the audit
c. a basis from which to modify test of controls
d. information necessary to prepare flowcharts

32. An auditor should obtain sufficient knowledge of an entity’s accounting system to understand the:
a. safeguards use to limit access to computer facilities
b. process used to prepare significant accounting estimates
c. procedures used to assure proper authorization of transactions
d. policies used to detect the concealment of irregularities

33. When obtaining an understanding of an entity’s internal control procedures, an auditor should concentrate on the substance of the
procedures rather than their form because:
a. the procedures nay be operating effectively but may not be documented
b. management may establish appropriate procedures but not enforce compliance with them
c. the procedures may not be so inappropriate that no reliance is contemplated by the auditor
d. management may implement procedures whose costs exceed their benefits

34. When obtaining an understanding of an entity’s internal 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 an auditor

35. An auditor’s primary consideration regarding an entity’s internal control structure policies and procedures is whether the policies
and procedures:
a. affect the financial statement assertions
b. prevent management override
c. relate to the control environment
d. reflect management’s philosophy and operating style
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36. In obtaining an understanding of an entity’s internal control structure, an auditor is required to obtain
knowledge about the:
A B C D
Operating effectiveness of policies and procedures Yes No Yes No
Design of policies and procedures Yes Yes No No

37. In obtaining an understanding of a manufacturing entity’s internal control structure concerning inventory balances, an auditor most
likely would:
a. review the entity’s descriptions of inventory policies and procedures
b. perform test counts of inventory during the entity’s physical count
c. analyze inventory turnover statistics to identify slow-moving and obsolete items
d. analyze monthly production reports to identify variances and unusual transactions

38. In obtaining an understanding of an entity’s internal control structure in a financial statement audit, an auditor is not obligated to:
a. determine whether the control procedures have been placed in operation
b. perform procedures to understand the design of the internal control policies
c. document the understanding of the entity’s internal control structure elements
d. search for significant deficiencies in the operation of the internal control structure

39. In a study of the system of internal control the completion of a questionnaire is most closely associated with which of the following?
a. separation of duties
b. review of the system
c. flowchart accuracy
d. tests of compliance

40. Which of the following questions would an auditor least likely include on an internal control questionnaire concerning the initiation
and execution of equipment transactions?
a. Are request for major repairs approved at a higher level that the department initiating the request?
b. Are pre-numbered purchase orders used for equipment and periodically accounted for?
c. Are requests for purchases of equipment reviewed for consideration of soliciting competitive bids?
d. Are procedures in lace to monitor and properly restrict access to equipment?

41. A flowchart is most frequent used by an auditor in connection with the:

a. preparation of generalized computer audit programs
b. review of the client’s internal accounting controls
c. use of statistical sampling in performing an audit
d. performance of analytical review procedures of account balances

42. During which phase of an audit examination is the preparation of flowcharts most appropriate?
a. review of the system of internal accounting control
b. tests of compliance with internal accounting control procedures
c. evaluation of the system of internal administrative control
d. analytical review of operations

43. An auditor’s flowchart of client’s accounting system is a diagrammatic representation that depicts the auditor’s?
a. assessment of control risk
b. identification of weaknesses in the system
c. assessment of the control environment’s effectiveness
d. understanding of the system

44. An auditor’s flowchart of a client’s accounting system is a diagrammatic representation that depicts the auditor’s:
a. program of test of controls
b. understanding of the system
c. understanding of the types of irregularities that are probable, given the present system
d. documentation of the study and evaluation of the system

45. Which of the following best describes the principal advantage of the use of flowcharts in reviewing internal control?
a. standard flowcharts are available and can be effectively used for describing most company internal controls
b. flowcharts aid in the understanding of the sequence and relationships of activities and documents
c. working papers are not complete unless they include flowcharts as well as memoranda on internal control
d. flowcharting is the most efficient means available for summarizing internal control

46. When preparing a record of a client’s system of internal accounting control, the independent auditor sometimes uses a systems
flowchart, which can best be described as:
a. a pictorial representation of the flow of instructions in a client’s internal computer system
b. a diagram which clearly indicates an organization’s internal reporting structure
c. graphic illustration of the flow of operations which is used to replace the auditor’s internal; control questionnaire
d. a symbolic representation of a system or series of sequential processes

47. Decision tables differ from program flowcharts in that decision tables emphasize:
a. ease of manageability for complex programs
b. logical relationships among conditions and actions
c. cost benefit justifying the program
d. the sequence in which operations are performed

48. In an audit of financial statements in accordance with GAAS, an auditor is required to:
a. identify specific internal control structure procedures relevant to management’s financial statement assertions
b. perform tests of controls to evaluate the effectiveness of the entity’s accounting system
c. determine whether procedures are suitably designed to prevent or detect material misstatements
d. document the auditor’s understanding of the entity’s internal control structure
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49. The auditor review of the client’s system of internal accounting control is documented in order to substantiate:
a. conformity of the accounting records with GAAP
b. compliance with GAAS
c. adherence to requirements of management
d. the fairness of the financial statement presentation

50. The auditor’s review of the client’s accounting system of internal control is documented in order to substantiate:
a. conformity of the accounting records with GAAP
b. representation as to adherence to requirements of management
c. representation as to compliance with GAAS
d. the fairness of the financial statement presentation

*****END OF EXERCISE*****
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