CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 1: How long should working paper be kept?
Answer: After the engagement is completed, the working papers
should be kept for a specific period of time established by the
CAE. In setting this policy, the CAE should consult with legal
counsel to ensure that the document-retention time frame
conforms to all applicable laws and other contractual agreements.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 2: The effectiveness of analytic
procedures depends on what?
Answer: The effectiveness of analytical procedures depends on
the quality of the initial assertion about the relationship,
the predictability of the relationship between the two items, and
the certainty of that relationship. The more certain the relationship,
the better the evidence from analytical procedures.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 3: What are analytic procedures?
Answer: Analytic procedures examine the relationship between
two pieces of information to determine the extent to which that
relationship is “reasonable” (that is, if the actual relationship
between these two items is what is expected). The pieces of
information might be financial or nonfinancial, but it is important
that they are somehow related or potentially related for analytic
procedures to be a useful tool.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 4: What are asset management ratios?
Answer: Asset management ratios measure the firm’s use of
assets to generate revenue and income. Thus, they also relate to
liquidity.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 5: What are business risks?
Answer: These are risks that threaten the survival of the
company. Business risk includes the uncertainty about the
demand for the company’s products and services, the price that it
can charge, or the costs of producing and delivering its products
and services.

Two risks that are commonly thought of as being components of

business risk are strategic risk and reputation risk.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 6: What are checklists?
Answer: A checklist ensures that tasks, steps, or items that need
to be accomplished are completed. Checklists are generally
standardized; therefore, those items that need particular attention
during the engagement will not be omitted as may happen if the
checklist was created from nothing each time it was used.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 7: What are competitive benchmarks?
Answer: A company compares itself against its best competitors.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 8: What are complimentary opinions?
Answer: Standard 2410.A2 notes, “Internal auditors are
encouraged to acknowledge satisfactory performance in
engagement communications.” Auditors might issue a
complimentary opinion if an operation is found to be well
organized, well controlled, and functioning as it should.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 9: What are conclusions and opinions?
Answer: Conclusions and opinions are the internal auditor’s
evaluations of the observations and recommendations regarding
the activities that were under review. These may state if a function
is operating as intended, if control criteria are being met, if
objectives and goals are being met, and so forth. An opinion
should be clearly, concisely written and include only conclusions
that can be justified and adequately supported by the facts.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 10: What are direct and indirect questions?
Answer: Direct questions have a very narrow focus and seek
specific information about a specific situation.
Indirect questions are more broadly directed and will elicit more
open-ended answers.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 11: What are embedded audit modules?
Answer: Embedded audit modules are small programs, situated
within a larger application, that monitor transactions for anything
that meets a certain criteria: a certain dollar amount, the sale or
purchase of a particular item, transactions with related parties, and
so forth.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 12: What are financial risks?
Answer: These are risks related to the financial structure of the
company—in particular, the risk relating to the mix of equity and
debt. Financial risks are also present if the company has an
insufficient long-term capital base for the amount of trading it is
doing (that is, overtrading). Fraud and misuse of financial
resources are other types of financial risks.

Two components of financial risk are market risk and credit risk.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 13: What are functional benchmarks?
Answer: A company compares itself against organizations that
operate within the same technological area. This comparison
provides information on achievements and advances in the
company’s business.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 14: What are generic benchmarks?
Answer: A company compares one of its processes against those
that are virtually the same in other companies, regardless of the
industry or production of the other company. This type of
benchmarking is not as helpful as a benchmark that compares
similar processes.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 15: What are leverage ratios?
Answer: Leverage ratios measure a firm’s use of debt to finance
assets and operations. Leverage (that is, trading on the equity) is
advantageous when the company earns more on money that it has
borrowed than it costs to borrow that money.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 16: What are liquidity ratios?
Answer: Liquidity ratios measure a firm’s short-term viability,
meaning its ability to continue to operate in the short term by
paying its short-term obligations.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 17: What are observations?
Answer: Observations are the relevant statements of
fact discovered during the engagement, and they are made as a
result of comparing the difference between the current state of
affairs (where the company presently stands) with the ideal state
of affairs (where the company would like to be).

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 18: What are operational risks?
Answer: This refers to the potential for loss resulting from
inadequate or failed internal processes, people and systems, or
from external events. Examples include: technology failure, poor
management, lack of supervision, weak accountability and control,
errors in financial models and reports (financial and operational),
attempts to conceal losses or make personal gains (such as rogue
traders), and third party fraud.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 19: What are profitability ratios?
Answer: Profitability ratios measure earnings relative to some
base, such as productive assets, sales, or capital.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 20: What are questionnaires?
Answer: Questionnaires can be used in a variety of ways to
support the auditor’s information-gathering process. They may be
used to collect specific information or they may be used in a more
general sense to assess the current situation and determine any
work that remains to be done.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 21: What are reputation risks?
Answer: These are potential threats to the reputation of a
company. For example, a company might produce a product that
is found to be defective or dangerous to the public—and thus the
brand reputation suffers. Reputation risk is positively correlated to
other risks, since its magnitude is partially dependent on the
likelihood that other risk factors are present. In other words, if the
company manages to minimize all other risks, there is a
correspondingly less chance for reputational risk to occur because
there is less chance overall of something going wrong.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 22: What are strategic risks?
Answer: These are the potential volatilities of profits caused by
the nature and type of business operations. Some of the factors
that determine the level of strategic risk include: the state of the
economy, actions of competitors, the impact of new technology,
the fluctuating nature of industries within which the business
operates, and many others.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 23: What are surveys?
Answer: Surveys are questionnaires that are sent to people
outside of the organization. They are relatively low-cost to conduct
and can provide valuable information about external perceptions
about the organization.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 24: What are the classic sample selection
methods?
Answer: Judgmental (haphazard) sampling
Random number sampling
Stratified sampling
Systematic sampling
Block sampling

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 25: What are the classifications of benchmarks?
Answer: Benchmarks can be financial or nonfinancial.
Financial benchmarks: Financial benchmarks are comparisons
based on monetary, numerical factors, such as profitability and
cost of production per unit.
Nonfinancial benchmarks: Nonfinancial benchmarks are
comparisons based on other factors besides financial numbers,
such as the percentage of on-time deliveries or percentage of
satisfied customers.
Benchmarks can also be internal or external.
Internal benchmark: A company compares its objectives against
its own internal divisions, processes, functions, or departments.
External benchmark: A company compares its objectives against
another company’s, such as a competitor.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 26: What are the five key risks associated
with spreadsheets?
Answer: Unskilled users
Lack of guidelines for spreadsheet preparation
Data entry and recycling
Spreadsheet errors
Loss of data

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 27: What are the four attributes of observations
and recommendations?
Answer: Criteria: These are the standards, measures, or
expectations for making measurements (that is, what should
exist).
Condition: This is the factual information that the auditor found
during the engagement (that is, what does exist).
Cause: This is the reason that there is a difference between what
should exist and what does exists (that is, why the difference
exists).
Effect: This is the risk or exposure that the organization (or others)
faces as a result of actual conditions being different from ideal
conditions (that is, impact of the difference).

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 28: What are the four most common types of
CAAT?
Answer: Generalized Audit Software (GAS): These programs
(such as ACL and IDEA) perform automated functions and are
useful for testing both controls and balances.
Utility Software: This software performs routine jobs such as
sorting, merging, and managing data. Examples of utility software
include spreadsheets (such as Excel) and automated working
papers.
Application Software for Tracing and Mapping: This software
follows a trail of information from input to output.
Expert Systems Software: This system takes the knowledge and
logic that has been obtained by experts and assists the auditor
with decision-making and risk assessment.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 29: What are the four types of interviews?
Answer: Preliminary: This interview establishes a relationship
with interviewees, helps them feel comfortable with the auditor,
and set the groundwork for the importance of the process.
Fact-gathering: During this interview, facts are collected about a
specific situation.
Follow-up: After having had a chance to process the information
from fact-gathering interviews and any other work, the auditor
conducts follow-up interviews to gather additional information or to
clarify issues that were raised in previous interviews.
Exit: For this final stage, the auditor conducts final checks to verify
the accuracy of the information gathered.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 30: What are the four ways that companies
can respond to risk?
Answer: Transfer the risk
Accept the risk
Reduce the risk
Avoid the risk

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 31: What are the most common
methods of variable sampling?
Answer: Mean-per-unit sampling
Difference estimation
Ratio method
Probability-proportional-to-size sampling

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 32: What are the steps in the interview process?
Answer: Planning for the interview
Scheduling the interview
Opening the interview
Conducting the interview
Recording the interview
Assessing the interview

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 33: What are the three main costs associated
with statistical sampling?
Answer: The cost of training the auditors in the necessary
methods
The cost of designing the samples to meet the statistical
requirements
The cost of selecting the items to be tested

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 34: What are the three main ways to
test computer-processed transactions?
Answer: Test data approach
Integrated test facility (ITF)
Parallel simulation

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 35: What are the two categories of spreadsheets?
Answer: Modeling
Operational
When used for modeling, such as a merger or acquisition,
spreadsheets can act as a complex calculator to project any
number of “what if” scenarios. For operations, spreadsheets both
contain and manipulate transaction data. A common operational
spreadsheet application is the maintenance of business lists, such
as trade inventories, fixed assets, confidential customer
information, and so forth.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 36: What are the two main types of files of working
papers?
Answer: The current file contains all documents related to the
current year’s engagement.
The permanent file contains documents relevant to multiple
engagements across several years.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 37: What are the two unique characteristics of
PPS?
Answer: PPS automatically stratifies the population because the
largest items will have the most likelihood of being selected and
the smallest items the least chance. Therefore, it is a useful
method when working with a diverse population.
PPS is more effective in the detection of overstatements rather
than understatements because, through the process of PPS, the
smaller the item is the less likely it is to be tested. Furthermore, a
zero balance item (or an item that has not been recorded) has no
chance of being selected for testing. For this reason, PPS is a
better test for assets than for liabilities, since assets are more likely
to be overstated.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 38: What does it mean to accept the risk?
Answer: The company elects to tolerate the risk. By accepting the
risk, the company will not do anything to actively reduce or
eliminate the risk. For example, if a company believes that costs
of dealing with the risk do not outweigh its benefits, then it might
decide to accept the risk. However, under such circumstances the
company should still periodically review risk to be certain that
circumstances have not changed. If a given accepted risk is later
determined to become too uncertain, the company may wish to
adopt a different risk response strategy.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 39: What does it mean to assess control risk too
high?
Answer: Assessing control risk too high occurs when the auditor
concludes that the control system does not work, when in fact it is
working. This error causes unnecessary additional work and
testing during the audit. This happens because the auditor is not
relying on a system that works. They will do unnecessary testing
because they think that the information coming out of the system
is more likely to be incorrect than is really the case.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 40: What does it mean to assess control risk too
low?
Answer: Assessing control risk too low occurs when the auditor
concludes that the controls are working, when they are in fact not
working. As a result, an incorrect audit opinion is issued because
the auditor has incorrectly concluded that the controls work.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 41: What does it mean to avoid the risk?
Answer: The company decides that a given set of risks is too great
to bear, so it completely avoids the situation that creates that risk.
For example, a company that produces a highly controversial
product could decide to avoid the risk of lawsuits or damage to its
reputation by stopping production of the product. The company
can also avoid risk by not entering into a volatile or highly
competitive market.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 42: What does it mean to reduce the risk?
Answer: The company takes action to minimize the effect of the
risk. To reduce risk, the company puts in the necessary controls
to lessen or mitigate the risks to an acceptable level. Experience
has shown that the vast majority of risks can be reduced when
appropriate controls are enacted. For example, if a company has
a petty cash account and believes that the most at stake is $200,
the company could lessen the risk of theft by having an
independent verifier doing an occasional inspection of the
balance. An important fact to keep in mind is that risk can be
reduced but only in rare cases can it be entirely eliminated.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 43: What does it mean to transfer risk?
Answer: The company allows someone else to assume the risk.
Purchasing fire, flood, or theft insurance is an example of risk
transfer. Contracts can be written in such a way as to designate
specifically which party will bears responsibility in the case of a
specific risk event. Derivatives can be used to hedge against
possible changes (that is, risks) in commodity prices, changes in
interest rates, or changes in currency exchange rates.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 44: What factors influence sample size?
Answer: Population Size: The larger the population, the larger the
sample that is required.
Acceptable Risk of Error: Risk of acceptable error and sample size
are inversely proportional. That is, the lower the acceptable risk of
error, the larger the sample size will need to be.
Variability of Items within the Population: If there are very diverse
and different items within the population, the sample size will need
to be large enough to ensure that a representative proportion of
items are tested. This outcome can be achieved by stratifying the
sample.
Tolerable Deviation Rate in the Population: This figure reflects the
number of that can be found errors within the sample and still
conclude that it is correct. The lower the acceptable number, the
larger the sample will need to be.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 45: What is a flexible budget?
Answer: A flexible budget is one that projects what the budget
should have been if it had been prepared for the actual level of
sales. In a sense, a flexible budget is actually multiple budgets
created at the beginning of the year for different levels of sales.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 46: What is a learning curve?
Answer: The term “learning curve” refers to the idea that
efficiency increases the more experience a person has with a
given task. As a result, the time required for performing the task
decreases as increases occur in the number of times the task has
been performed.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 47: What is a pilot sample?
Answer: A pilot sample is sometimes done if no other information
is available to compute the needed values. For example, if the
population size is 1,000, an auditor may take a random sample of
50 items in order to get an idea as to the statistics needed to
compute the sample size (that is, confidence level, standard
deviation, and precision).

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 48: What is a questionnaire matrix?
Answer: A questionnaire matrix is similar to the yes/no
questionnaire, except that it includes spaces for additional
information. Any number of rows and columns can be created to
express interrelationships between individuals, tasks, or a variety
of other quantities.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 49: What is a risk and control matrix?
Answer: A risk and control matrix is an excellent tool that matches
controls to risks, assuring that every risk is covered by an
appropriate control. This matrix also shows where a particular
control might provide protection over more than one risk.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 50: What is a standard cost?
Answer: A standard cost is an estimate of the cost the company
expects to incur in the production process. It is the target against
which results will be measured. Without a standard cost, the
analysis of actual activities and results is difficult because there is
no standard against which to measure the performance.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 51: What is acceptance sampling?
Answer: This is a quality control tool that is used when something
can be classified as either acceptable or unacceptable.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 52: What is Alpha risk?
Answer: Alpha risk refers to mistakes that cause the auditor to do
additional and unnecessary work to arrive at the correct
conclusion. As a result, the audit is accurate but less efficient.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 53: What is an embedded audit routine?
Answer: An embedded audit routine is a process, built within a
regular production program, that conducts special auditing tasks.
Embedded audit data collection is one type of embedded audit
routine, and it uses specially programmed modules embedded as
inline-code within the regular program code. During the course of
regular data processing, the embedded routine selects and
records specific data for later analysis and evaluation by an
auditor.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 54: What is an Integrated Test Facility (ITF)?
Answer: An Integrated Test Facility (ITF) is used to audit large
computer systems that employ real-time processing. ITF uses test
data and fictitious test entities (such as imaginary vendors,
employees, products, or customers) that are actually included in
the system’s master files, and the test data is processed
concurrently with real transactions. Transactions are then
processed against live master files containing both legitimate
records as well as the fictitious records.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 55: What is asset liquidity risk?
Answer: This risk arises when there are insufficient participants
in the market. For example, there is an asset to sell but few or no
buyers.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 56: What is attribute sampling?
Answer: Attributes sampling refers to the testing of internal
controls, and it tests for the existence of a specific characteristic.
An example of attributes sampling is a test that assesses
authorization. In this case, the auditor is testing if an invoice,
purchase order, or other document is properly authorized. The
item is either authorized or it is not; there are no degrees of
authorization.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 57: What is benchmarking?
Answer: Benchmarking is the process whereby a company uses
the standards set by other companies as a target or model for its
own operations, a method also known as good practices.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 58: What is Beta risk?
Answer: Beta risk refers to mistakes that cause the audit opinion
to be wrong. As a result, the audit is less effective; in fact, the audit
opinion will be incorrect. Auditors must be most concerned about
avoiding Beta risk.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 59: What is block sampling?
Answer: With this method, the auditor chooses a block or group
of items within the population. Block sampling makes it easier to
locate the individual items to include in the sample. Furthermore,
it is best used to test the application of a new control or a control
over time.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 60: What is CAAT?
Answer: A Computer-Assisted Audit Technique (CAAT) is
systems-based or transactions-based software that automatically
extracts and analyzes data. CAATs are used in all of the phases
of the audit, from planning to reporting.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 61: What is competitive advantage?
Answer: Competitive advantage is an advantage that a company
has over its competitors, which it gains by offering consumers
greater value than they can get from its competitors.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 62: What is compliance risk?
Answer: This is the risk associated with not being in compliance
with federal laws and regulations, internal policies, or accounting
principles (for example, IFRS, US GAAP, UK GAAP, or some
other national GAAP).

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 63: What is controlled reprocessing?
Answer: In controlled reprocessing, the auditor receives a verified
copy of the processing program that the auditee is using and then
runs the information or transactions through the verified program.
The results of this test are compared to the actual results that have
been recorded.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 64: What is correlation analysis?
Answer: Correlation analysis measures the relationship between
two variables. Specifically, it determines the strength of the linear
relationship between x and the value y in order to ascertain
whether or not a given trend projection is meaningful. In other
words, this measurement shows the extent to which a change in
one variable will result in a change in the other. A high correlation
means that the two items are closely connected to each other.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 65: What is corroborative evidence?
Answer: Corroborative evidence supports other evidence. The
greater the amount of corroborating evidence, the more
persuasive it is.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 66: What is credit risk?
Answer: This refers to losses incurred from a debtor’s non-
payment of a loan or other line of credit (either principal or interest,
or both). Credit risk is only an issue when the position is an asset.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 67: What is difference estimation?
Answer: With this method, the auditor finds the average
difference between the book value (or recorded value) and the
audited amount of the items in the sample (verified by audit), and
then applies this average error to each item in the population. This
average error is then multiplied by the number of items in the
population to provide a plus/minus range for the population as a
whole. The auditor then determines if the account is reasonably
stated.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 68: What is discovery sampling?
Answer: This is used to test for fraud, and thus it is an
investigative technique. The auditor looks for any single
deviation on the assumption that there are no mistakes in the
population. To this end, the auditor determines the size that the
sample needs to be in order to achieve a certain level of
confidence that the error rate is sufficiently low.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 69: What is dual sampling and when is it used?
Answer: In dual-purpose sampling, the auditor conducts both
attribute sampling and variable sampling at the same time.
However, to do this the auditor must be confident that the
deviations found in the sample for control failures will be less than
the acceptable level of tolerable error for the substantive tests. In
other words, the auditor can only perform dual-purpose sampling
if he or she is confident that the control risk will be sufficiently low
enough to rely on the results of the sample that will be selected. If,
after conducting dual-purpose sampling, the auditor determines
that the internal controls cannot be relied upon, the substantive
testing will most likely need to be redone.
The total sample size of dual-purpose sampling is larger than the
sample size of a single test, but it is smaller than the combined
sample size of two individual tests.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 70: What is extended records?
Answer: Extended records is a term that refers to the technique
of modifying a program to tag specific transactions and then
saving all the processing steps in an “extended record,” thus
permitting an audit trail to be reconstructed from one file for those
transactions. Transactions might be selected randomly, or they
might be selected as exceptions to edit tests.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 71: What is external information?
Answer: This is information that the auditor receives directly from
a third party. With the exception of information obtained directly by
the auditor, this is the most reliable information because the client
has not had access to it.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 72: What is external-internal information?
Answer: This is information generated by a third party then
processed by the client. Because the client was the last party to
have the document, it could be altered without the knowledge of
the third party. As a result, external-internal information has low
reliability.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 73: What is funding liquidity risk?
Answer: This is the risk that the company will not have the funds
to pay its short-term obligations. This condition often occurs when
there is a mismatch between cash inflows and cash outflows.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 74: What is internal information?
Answer: This is information that is generated by and will remain
with the client. This form of information is least persuasive or
reliable because it remains in the possession and control of the
people being audited.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 75: What is internal-external information?
Answer: This is information generated by the client then
processed by a third party. Information of this type is both more
reliable and more persuasive than internal information because it
has been handled by an external party just prior to the auditor
receiving it.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 76: What is judgmental (haphazard) sampling?
Answer: With this method, the auditor uses professional judgment
to determine the size of the sample and then selects the items to
be tested without any bias or particular reason for excluding or
including an item. This method can be used only in nonstatistical
sampling. It cannot be used for statistical sampling because it
does not allow for the determination of the necessary statistics.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 77: What is judgmental sampling?
Answer: Because conclusions about a larger population are being
drawn from a smaller section of the whole, sampling
requires professional judgment. Using professional judgment, the
auditor determines the sufficiency of the evidence. In making this
determination, the auditor will take into account the size and the
design of the sample. Larger sample will provide more accurate
evidence; better-designed samples will provide more accurate
conclusions.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 78: What is mapping?
Answer: Mapping uses special software to monitor the execution
of a program. The software counts the number of times each
program statement in the program is executed. Mapping can help
determine if program application control statements that appear in
the source language listing of the program are actually executed
when the program runs and have not been bypassed. It can also
locate “dead” program codes and can flag codes that may be
being used fraudulently.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 79: What is market risk?
Answer: This is the risk that the value of an investment will
decrease due to market factors. There are four standard market
risk factors:
Equity price risks: The risk that stock price volatility will have a
negative impact.
Interest rate risk: The risk that interest rates will fluctuate
unfavorably.
Foreign exchange risk: The risk that foreign exchange rates will
change.
Commodity price risk: The risk that commodity prices will change.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 80: What is mean-per-unit sampling?
Answer: With this method, the auditor tests a sample of items,
obtains the audited value of these tested items (verified by audit),
and calculates an average amount per item. This average amount
per item is then applied to the number of items in the population
as a whole. The auditor does not need to know the book value (or
recorded value) of the sample items tested.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 81: What is multiple regression analysis?
Answer: Simple linear regression analysis involves only two
variables. Multiple regression analysis involves more than two
independent variables.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 82: What is net operating income to sales?
Answer: In net operating income to sales, the use of EBIT
(earnings before interest and taxes) emphasizes operating results
and more nearly approximates cash flows than other income
measures.

Net Operating Income to Sales = EBIT ÷ Net Sales

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 83: What is non-response bias?
Answer: Non-response bias occurs when the internal auditors
ignore non-responses when analyzing the survey results. When
the auditor ignores the surveys of the people who did not respond,
they assume that they would have responded the same way as
the people who did not respond. There may be, however, a
multitude of reasons for why these people did not respond, and so
it is a fallacy to presume knowledge of absent information.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 84: What is parallel simulation?
Answer: Parallel simulation uses real data (rather than simulated
data) and processes it through test or audit programs. The output
from the parallel simulation is then compared with the output from
the real processing. Parallel simulation is expensive and time-
consuming, and thus it is usually limited to sections of an audit that
are of major concern but that are important enough to require an
audit of all transactions.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 85: What is political and economic risk?
Answer: This represents the financial risk that a government
suddenly and unexpectedly changes its policies. Common
examples of political and economic risk are expropriation or
confiscation of company assets.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 86: What is probability-proportional-to-size
sampling (PPS)?
Answer: PPS is a form of variable sampling in which the auditor
uses the actual individual dollars within the population as the
population instead of the number of invoices or some other
identifier. This type of sampling is often used when the population
consists of very diverse values or amounts. In the case of PPS
being used to test accounts receivable, the population would be
made up of the number of dollars of receivables outstanding rather
than the number of invoices or number of customers.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 87: What is profit margin?
Answer: Profit margin measures the percentage of the company’s
sales that becomes income after interest and taxes.

Profit Margin = Net Income after Interest and Taxes ÷ Net Sales

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 88: What is random number sampling?
Answer: With this method, the auditor uses a random number
generator to select the items that are to be tested. Random
number sampling uses tables of digits that have been scientifically
randomized. This method is done without bias and each item has
an equal chance of being selected.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 89: What is regression analysis?
Answer: Regression analysis is a sophisticated version of trend
analysis that analyzes a relationship between two or more
variables (a dependent variable and one or more independent
variables) to identify if a relationship exists between them. If a
relationship exists, it can be used to predict future values for the
dependent variable based on estimates of the independent
variable or variables.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 90: What is relevant information?
Answer: The information supports engagement observations and
recommendations and is consistent with the objectives for the
engagement.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 91: What is reliable information?
Answer: The information is the best attainable through the use of
appropriate engagement techniques.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 92: What is risk of incorrect acceptance?
Answer: Risk of incorrect acceptance occurs when the auditor
concludes that the amount is correct because the sample is
correct, when in fact the whole amount is not correct. As a result,
the conclusion is incorrect. Unfortunately, there is no chance for
the auditor to correct this mistake because the auditor as
concluded that the amount is correct and no further tests will be
performed.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 93: What is risk of incorrect rejection?
Answer: Risk of incorrect rejection occurs when the auditor
concludes that the amount is incorrect be-cause the sample was
incorrect, when in fact the whole amount is correct.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 94: What is sampling risk?
Answer: Because the auditor is testing only a portion of the items
in a population, there is the possibility that the conclusion might be
incorrect, a condition known as sampling risk.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 95: What is sequential sampling?
Answer: This is used when the sample selected follows a number
of steps or includes a number of requirements, any of which would
lead to a deviation in the item if one of the steps or requirements
is not correct.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 96: What is statistical sampling?
Answer: With this objective approach to sampling, the auditor
determines the sample size and selects the items to be sampled
using formulas and calculations. The auditor will then
quantitatively evaluate the results.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 97: What is stop-or-go sampling?
Answer: This method is used to reduce the sample size by testing
only enough items to prove that the rate of deviation is less than
the acceptable rate of error. If an initial sample does not support
the estimation of the population, then the sample size is enlarged
until the auditor has proven that the sample deviation is less than
the tolerable deviation. This sampling technique minimizes the
sample size whenever a low rate of noncompliance is expected.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 98: What is stratified sampling?
Answer: With this method, the auditor breaks the population into
different levels based on the size of the items within the
population. Within each of these strata, the auditor determines a
separate testing method. The primary goal of stratified sampling is
to reduce the effect of variances within the population by making
more populations of more similar items and, as a result, this
method is most useful when the items within the population are
diversified (that is, very different from each other).

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 99: What is sufficient information?
Answer: The information is factual, adequate, and convincing so
that a prudent, informed person would reach the same conclusions
as the internal auditor.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 100: What is systematic sampling?
Answer: With this method, the auditor selects a starting point
within the population and then determines an interval. For
example, if the auditor determines that the interval is every
fifteenth item, he or she begins at the designated starting point and
then selects every fifteenth item for testing.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 101: What is tagging and tracing?
Answer: In tagging and tracing, certain transactions are identified
when they are input (tagged) and then followed through the
computer system until they are output (traced). This process
enables the auditor to confirm all of the procedures were applied
to a specific transaction.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 102: What is the accounts receivable turnover
ratio?
Answer: The accounts receivable turnover ratio is used to
measure the average time receivables are held and tracks the
efficiency of a firm’s accounts receivable collections.

Accounts Receivable Turnover Ratio = Net Credit Sales ÷ Average

Accounts Receivable

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 103: What is the cash cycle?
Answer: The cash cycle is the length of time it takes to convert an
investment of cash in inventory back into cash, while recognizing
that some purchases are made on credit. Therefore, the cash
cycle (also known as the net operating cycle) is also the number
of days in the operating cycle minus the number of days purchases
in payables.

Cash Cycle = Days Sales in Inventory + Days Sales in

Receivables – Days Purchases in Payables

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 104: What is the coefficient of correlation (r)?
Answer: The coefficient of correlation (r) is a numerical measure
that expresses both the direction (positive or negative) and the
strength of the linear association between two variables. This
amount of correlation is expressed as a number between −1 and
+1.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 105: What is the coefficient of determination (r2)?
Answer: The coefficient of determination (r2) is the percentage of
the total amount of change in the dependent variable (y) that can
be explained by changes in the independent variable (x). r2 is the
square of the coefficient of correlation and is expressed as a
number between 0 and 1.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 106: What is the confidence level?
Answer: The confidence level is a way of measuring the sampling
risk. If the risk of incorrect acceptance is 5%, then the confidence
level is 95%, meaning that the auditor is 95% confident that the
sample is representative of the population.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 107: What is the current ratio?
Answer: The current ratio is the most commonly used measure of
near-term solvency as it relates current assets to the claims of
short-term creditors. In other words, it measures the company’s
ability to pay its short-term obligations with short-term assets.

Current Ratio = Current Assets ÷ Current Liabilities

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 108: What is the debt ratio?
Answer: The debt ratio measures the percentage of funds
provided by creditors. It determines long-term debt payment ability
and the degree to which creditors are protected from the firm’s
insolvency.

Debt Ratio = Total Debt ÷ Total Assets

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 109: What is the debt-to-equity ratio?
Answer: The debt-to-equity ratio compares the resources
provided by creditors with resources provided by shareholders.
Like the debt ratio, the debt-to-equity ratio determines a firm’s
long-term debt payment ability.

Debt-to-Equity Ratio = Total Debt ÷ Shareholders' Equity

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 110: What is the defensive interval ratio?
Answer: The defensive interval ratio estimates the number of
days that the company can meet its basic operational costs. The
average daily cash expenditures can be approximated by reducing
total expenses for the year by noncash charges (for example,
depreciation, amortization of intangibles) and dividing this amount
by 365.

Defensive Interval Ratio = (Cash + Net Receivables + Marketable

Securities) ÷ Daily Operating Cash Outflow

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 CIA Part 1: Internal Audit Basics

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Engagements - Introduction
Study Note # 111: What is the DuPont equation?
Answer: The DuPont equation shows that return on investment
(ROI) may be explained in terms of both the efficiency of asset
management and profit margin. Using income before interest and
taxes and/or operating assets changes the ratio, depending on
which change is made to the formula. Income before interest and
taxes is obviously higher than after interest and taxes, and
operating assets will be less than total assets.

Multiplying the return on assets by the equity multiplier (also called

the leverage factor) gives the return on common (or total) equity.

Net Income after Net Income after

Net Sales
Interest and Taxes Interest and Taxes
x =
Average Total
Net Sales Average Total Assets
Assets

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 112: What is the fixed charge coverage ratio?
Answer: The fixed charge coverage ratio is an extension of the
times-interest-earned ratio; it includes all fixed charges in the
denominator.

Fixed Charge Coverage Ratio = (Earnings before Interest and

Taxes + Long-Term Lease Payments) ÷ (Interest + Long-Term
Lease Payments)

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 113: What is the formula to calculate sample
size for attribute sampling?
Answer:

C2 p
What is the formula to calculate sample size for attribute q
sampling?Sample Size (n) =
P2

Where:
C = confidence coefficient (from a table)
p = the expected deviation rate
q = 100% - p
P = the precision per item

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 114: What is the formula to calculate sample
size for variable sampling?
Answer:

What is the formula to calculate sample size for variable C2 σ2

sampling?Sample Size (n1) = P2

Where:
C = confidence coefficient (from a table)
n1 = the sample size using replacement in the sample selection
C = the number of standard deviations related to the required
confidence interval
σ = the standard deviation of the population
P = the precision or allowance for sampling risk

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 115: What is the inventory turnover ratio?
Answer: The inventory turnover ratio measures how many times
during the year the company sells the amount of inventory it holds.
An average inventory (that is, the average of beginning and ending
inventory) figure should be used. If annual inventory is highly
cyclical, a monthly average should be used.

Inventory Turnover Ratio = Cost of Sales ÷ Average Inventory

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 116: What is the leverage factor ratio?
Answer: The leverage factor can be combined with the DuPont
equation to measure the extent to which debt financing enhances
equity financing. The higher the ratio, the greater the leverage and
risk.

Leverage Factor Ratio = Average Total Assets ÷ Average

Common Shareholders' Equity

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 117 What is the main difference between test
data and ITF?
Answer: The main difference between the test data approach and
an ITF is that the test data in an ITF is processed alongside real
data. No one except the auditor knows which entries are fictitious.
Using the approach, the auditor can be sure that the programs
being checked are the same programs as those that are being
used to process real data.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 118: What is the mathematical formula for risk
exposure?
Answer: Exposure from an individual risk = Likelihood of loss
occurring x Potential impact if loss occurs

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 119: What is the number-of-days-inventory-is-held
ratio?
Answer: The number-of-days-inventory-is-held ratio measures
the average number of days that inventory is held before sale and
it reflects the efficiency of inventory management.

Number-of-Days-Inventory-Is-Held Ratio = 365, 360, or 300 ÷

Inventory Turnover

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 120: What is the number-of-days-receivables-held
ratio?
Answer: The number-of-days-receivables-held ratio indicates the
number of days it takes the company to collect their receivables.

Number-of-Days-Receivables-Held Ratio = 365, 360, or 300 ÷

Receivables Turnover

This ratio may also be computed using average daily sales,

because these are effectively net-credit sales divided by the
number of days in a year.

Average Accounts Receivable ÷ Average Daily Sales

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 121: What is the operating cycle?
Answer: The operating cycle is the length of time it takes to
convert an investment of cash in inventory back into cash (through
collections of sales).

Operating Cycle = Days Sales in Inventory + Days Sales in

Receivables

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 122: What is the purpose of a preliminary survey?
Answer: Internal auditors use preliminary surveys to become
familiar with the activities, risks, and controls of the area to be
audited. A preliminary survey is the first step in the audit process
and it is particularly useful if one is auditing an activity for the first
time and there is little detailed information about the activity.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 123: What is the quick ratio?
Answer: The quick ratio measures the firm’s ability to pay its
short-term debts from its most liquid assets. Liquidity is a tradeoff
for profitability, as liquid investments do not provide as high a
return as productive assets.

Quick Ratio = (Cash + Net Receivables + Marketable Securities)

÷ Current Liabilities

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 124: What is the ratio method?
Answer: With this method, the auditor determines a ratio between
the book amounts (or recorded value) of the sample and the
audited amounts of the sample (verified by audit), and then applies
this ratio to the population as a whole. This method is most
effective when the book and audited values are similar.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 125: What is the return on common equity ratio?
Answer: The return on common equity ratio measures the
company’s return on the book value of its equity. The average
common shareholders’ equity includes total equity minus the
preferred shareholders’ capital and any minority interest.

Return on Common Equity = (Net Income – Preferred Dividends)

÷ Average Book Value of Common Equity

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 126: What is the return on total assets (or return on
investment) ratio?
Answer: In the return on total assets (or return on investment)
ratio, the numerator may again be defined in various ways. One
possibility is to use the net income available to common
shareholders; another method is found in the basic earning power
ratio (EBIT ÷ Average Total Assets). This ratio enhances
comparability of firms with different capital structures and tax
planning strategies.

Return on Total Assets or Return on Investment = Net Income ÷

Average Total Assets

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 127: What is the return on total equity ratio?
Answer: The return on total equity ratio measures the return of
the company on all forms of equity, common and preferred.

Return on Total Equity = Net Income ÷ Average Total Equity

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 128: What is the snapshot technique?
Answer: The snapshot technique “takes a picture” of a transaction
as it is processed. Program code is added to the application,
instructing it to print out the contents of selected memory areas
when the snapshot code is executed. A snapshot is used
commonly as a debugging technique. As an audit tool, snapshot
code can be used only for transactions that exceed predetermined
limits.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 129: What is the test data approach?
Answer: The objective of the test data approach is to verify the
processing accuracy of programs and any programming changes
that are made. Test data is input prepared by an auditor that
contains both valid (correct) and invalid (incorrect) data. Next, the
input is processed manually to determine the correct look of the
output. Then the auditor tests the data processing on the client’s
computer, doing so under the auditor’s direct control. After
processing the test data electronically, the auditor compares the
manually-processed results with the electronically-processed
results to determine accuracy.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 130: What is the times-interest-earned ratio?
Answer: The times-interest-earned ratio, also known as the
interest coverage ratio, indicates the margin of safety over fixed
interest charges, so a consistently high ratio is desirable. This ratio
is an income statement approach to evaluating debt payment
ability.

Times-Interest-Earned Ratio = Earning before Interest and Taxes

÷ Interest Expense

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 131: What is trend analysis?
Answer: Trend analysis, also known as horizontal analysis, is a
specialized analytical procedure that analyzes changes over time
in account balances and many other different types of historical
data. It is a common quantitative (or numerical) method that can
be used for both substantive and compliance testing.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 132: What is useful information?
Answer: The information helps the organization meet its goals.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 133: What is variance analysis?
Answer: Variance analysis is an analytical procedure that
compares actual performance with the budgeted or anticipated
results and ascertains the reasons for any differences. This
procedure allows auditors to concentrate their efforts on the areas
of operations that are less efficient or effective.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 134: What is working capital?
Answer: Working capital is another measure of the ability of the
company to meet its liabilities as they come due.

Working Capital = Current Assets – Current Liabilities

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 135: What items are commonly kept in the
permanent file?
Answer: Communications and reports from previous
engagements
Results of reviews done after the engagement is completed
Chart of accounts
Updated organizational charts
Long-term contracts
Debt agreements
Share documentation
Historical financial information
Management reports
Corporate charter and other corporate documents
Significant correspondence related to the engagement

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 136: What parts of the engagement should
the working papers document?
Answer: Planning
The examination and evaluation of the internal control system
The procedures performed, the evidence obtained, and the
conclusions reached
The review process
Communications from the engagement client
Any necessary follow up

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 137: What security-related issues exist
with electronic working papers?
Answer: Data Protection: Electronically-stored information is
always at risk of being irretrievably lost.
Data Access: Sufficient identification checks and passwords
should restrict access to specific data only to those who are
authorized.
Changing Data: It is important that only authorized people have
the ability to change the files.

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 CIA Part 1: Internal Audit Basics

Section C: Conducting Internal Audit

Engagements - Introduction
Study Note # 138 When is variables sampling used?
Answer: Variables sampling is used when the auditor is testing
for the amount of a certain quantity. An example of variables
sampling is the analysis of a transaction or an account balance. In
this case, the auditor determines the dollar amount of a sample,
compares the actual amount to the recorded amount, and then,
extrapolating from the amount of discrepancy between the two
figures, draws a conclusion about the population as a whole.

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