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Chapter 7 Audit Planning: Assessment of Control Risk 96

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.
97 Chapter 7 Audit Planning: Assessment of Control Risk

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
Chapter 7 Audit Planning: Assessment of Control Risk 98

"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.
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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
Chapter 7 Audit Planning: Assessment of Control Risk 100

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.
101 Chapter 7 Audit Planning: Assessment of Control Risk

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
Chapter 7 Audit Planning: Assessment of Control Risk 102

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.
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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.
Chapter 7 Audit Planning: Assessment of Control Risk 104

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.
105 Chapter 7 Audit Planning: Assessment of Control Risk

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.
Chapter 7 Audit Planning: Assessment of Control Risk 106

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.
107 Chapter 7 Audit Planning: Assessment of Control Risk

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 a lowering 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.
Chapter 7 Audit Planning: Assessment of Control Risk 108

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 item
materiality 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
109 Chapter 7 Audit Planning: Assessment of Control Risk

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
Chapter 7 Audit Planning: Assessment of Control Risk 110

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

COMPLETION:
111 Chapter 7 Audit Planning: Assessment of Control Risk

65. After assessing inherent risk, the auditor needs to assess control risk in order to complete
the phase of the audit.

ANSWER: PLANNING

66. Based on the initial understanding of internal control, the auditor may decide to assess
control risk at the maximum level for some assertions and below maximum for others. To
justify reducing the assessed level of control risk below maximum, the auditor must obtain
an understanding of the of the controls relating to those
assertions.

ANSWER: OPERATING EFFECTIVENESS

67. As an internal control documentation device, the internal control , by presenting a


pictorial overview of the processing steps, has the advantage of providing a clear and easy
review of existing internal control policies and procedures.

ANSWER: FLOWCHART

68. is an effective means for further testing of selected internal


control policies and procedures where an audit trail in the form of documentation exists.

ANSWER: DOCUMENT EXAMINATION AND TESTING

69. Whenever control risk is assessed below maximum, the auditor must document the
for such reduction.

ANSWER: BASIS

70. If, based on the study of the business and application of analytical procedures, the auditor
suspects earnings inflation, individual item materiality thresholds should be
.

ANSWER: LOWERED (DECREASED, REDUCED)

71. For transaction cycle subsets where internal control is weak and numerous errors are
expected, aggregate materiality thresholds should be set ____ relative to those
applicable to strong internal control subsets.

ANSWER: LOW

72. The nature and timing of substantive audit procedures requires a approach to
designing audit programs, whereas determining the extent of testing suggests a
approach.

ANSWER: QUALITATIVE, QUANTITATIVE


Chapter 7 Audit Planning: Assessment of Control Risk 112

MATCHING:

73. Indicate by letter how each of the listed controls can be most effectively tested.

a. Observation
b. Reprocessing
c. Document examination and testing

____1. Computer controls applicable to payroll processing

____2. Correctness of account distribution appearing on vendor


invoices

____3. Whether invoices exist for shipments to customers

____4. Evidence, appearing on the face of receiving reports,


that the goods were transferred from receiving to
stores

____5. Whether computer errors are reprocessed by the “control


group rather than the computer operator

____6. All documents must be attached in order to vouchers to


be approved for payment

SOLUTION:

1. b
2. c
3. c
4. c
5. a
6. c

74. Each of the listed scenarios represents conditions discovered by the auditor after analyzing
inherent risk and completing tests of financial reporting controls. Indicate by letter the impact on
materiality thresholds set previously by the auditor during the preliminary planning stages of the
audit. More than one answer may apply to a given scenario.

a. Increase the dollar amount of the individual item threshold


b. Lower the dollar amount of the individual item
threshold
c. Increase aggregate threshold as a percent of the
individual item threshold
d. Lower aggregate threshold as a percent of the
individual item threshold
e. No need to change initial thresholds
113 Chapter 7 Audit Planning: Assessment of Control Risk

____1. Although controls over sales processing appear to be


effective, analytical procedures indicate possible
management override of the controls in the form of
premature revenue recognition

____2. Originally considered weak, payroll controls now appear


to be effective, based on auditor testing of selected
controls

____3. Although controls over the processing of vendor invoices


were effective in past years and were thought to be
unchanged for the year under audit, tests of controls
revealed a significant deterioration

____4. Testing of sales processing controls caused the auditor


to increase the assessed level of control risk for the
revenue cycle; and the application of analytical
procedures indicates that sales revenue may be materially
overstated and that discounts and returns may have been
understated

____5. After testing controls related to payroll processing,


the auditor was able to reduce the assessed level of
control risk; but application of analytical procedures
suggests that salaries and wages expense may be materially
overstated

____6. The auditor decided not to test controls in the


expenditure cycle because they were considered ineffective in past
years and, in the auditor’s opinion,
have not improved

____7. In past audits, Sara Lindquest, CPA, lowered the


individual item threshold given the use of “liberal”
accounting practices by Lopez Industries, an audit
client (Proposed audit adjustments typically reduced unaudited net
income by 15% to 20%.) Application of
analytical procedures to the current year’s unaudited income, however, indicates
the use of more conservative accounting practices

SOLUTION:

1. b
2. c
3. d
4. b,d
5. a,c
6. e
Chapter 7 Audit Planning: Assessment of Control Risk 114

7. e

PROBLEM/ESSAY:

75. In studying her client’s existing internal control over cash receipts, the auditor
determined the following:
1. All sales are made on credit.
2. Customer checks are prelisted and restrictively
endorsed upon receipt.
3. The endorsed checks are then forwarded to data
processing where they are entered into the computer system.
4. The checks are transferred to the cashier who prepares the daily
deposit and delivers it to the bank.

Required:

a. Identify specific errors or fraud that might occur given the


above system for processing cash receipts.

b. The above description of cash receipts processing is unclear as to


whether certain controls that may prevent or detect errors and fraud are present in the
existing system.

1. Identify the controls that are clearly missing;


2. Identify other controls that may or may not be
present, but that are necessary to prevent or detect the errors and
fraud that you listed in part (a).

c. For the controls that are clearly missing, identify


possible compensating controls?

d. Assuming the auditor determines that the controls


which you listed in (b)(2) are present, how might she
test them? Be specific.

SOLUTION:

a.
1. Checks may be misappropriated by one or more persons in data
processing;
2. Recording errors might occur in processing the checks
a. Wrong customer credited;
b. Wrong amount entered;
c. Improper discount taken.
3. Checks may be misappropriated by cashier

b.
115 Chapter 7 Audit Planning: Assessment of Control Risk

1. The checks should not be forwarded to data


processing. Rather, the checks should be transferred directly to the
cashier after being endorsed for deposit only; and a copy of the
prelisting, together with any accompanying
remittance advices, should be sent to data processing for
recording.

2. Controls that should be present:

a. Someone not having access to the checks


should compare the total of the prelisting of cash receipts
with the receipted deposit ticket obtained from the bank, and
also with the debit to cash produced by computer
processing of the receipts;
b. Computer editing controls should check for
proper customer number and correctness of cash
discounts taken

c. A control total for cash receipts should be


compared by the computer with the total of cash
receipts processed to verify correctness of cash receipts entered into
the computer.

d. Monthly statements should be mailed to


customers and all exceptions cleared by
persons not having access to remittances.

c.
Comparing the prelisting of cash receipts with the
deposit ticket and clearing exceptions to monthly
statements should detect any missing checks.

d.
1. Select a sample of daily cash prelistings and compare
with general ledger debit to cash and to receipted deposit ticket.
2. Select a sample of customer statement copies and
check customer correspondence files for exceptions and how the exceptions were
resolved.
3. Either reprocess or observe reprocessing of
customer remittances to determine effectiveness of computer editing controls (be
particularly alert to errors in entering customer account numbers and
improper discounts)

76. a. What is the auditor’s documentation responsibility with regard to the


client’s system of internal control?
Chapter 7 Audit Planning: Assessment of Control Risk 116

b. Under what conditions might the auditor elect not to test


controls for operating effectiveness?

SOLUTION:

a.
1. Auditors must document their understanding of
clients’ internal control;
2. If control risk is assessed below maximum, the auditor must
document the basis for such reduction.

b.
1. The auditor considers the controls to be
ineffective;
2. The cost of testing the controls exceeds the cost savings
associated with reduced substantive testing.