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College of Accountancy and Finance
AUDITING AND ASSURANCE PRINCIPLES

Quizzer
RISK ASSESSMENT - PHASE III
INTERNAL CONTROL SYSTEM

Name: _________________________________ Section: __________

Multiple Choice Questions:

1. The primary purpose for obtaining an understanding of an audit client's internal control
structure is to:
a. provide a basis for making constructive suggestions in a management letter.
b. determine the nature, timing, and extent of tests to be performed in the audit.
c. obtain sufficient competent evidential matter to afford a reasonable basis for an Opinion
on the financial statements under examination.
d. provide information for a communication of internal control structure-related matters to
management.

2. Which of the following can an auditor observe as a general control procedure used by
companies?
a. Segregation of functional responsibilities.
b. Management philosophy and operating cycle.
c. Open lines of communication to the audit committee of the board of directors.
d. External influences such as bank examiner audits.

3. A client's control procedure is:

a. an action taken by auditors to obtain evidence.
b. an action taken by client personnel for the purpose of preventing, detecting, and
correcting errors and irregularities in transactions.
c. a method for recording, summarizing and reporting financial information
d. the functioning of the board of directors in support of its audit committee

4. The control objective designed to reduce the probability that fictitious transactions get
recorded in the accounts is:
a. completeness
b. authorization
c. proper period.
d. validity

5. The control objective designed to reduce the probability that a credit sale transaction will
get debited to cash instead of accounts receivable is:
a. validity.
b. classification
c. accuracy.
d. completeness.

6. In most audits of large companies, internal control risk assessment contributes to audit
efficiency, which means:
a. the cost of year-end audit work will exceed the cost of control evaluation work.
b. auditors will be able to reduce the cost of year-end audit work by an amount more than
the control evaluation costs.
c. the cost of control evaluation work will exceed the cost of year-end audit work.
 d. auditors will be able to reduce the cost of year-end audit work by an amount less than
the control evaluation costs.

7. Which of the following is a device designed to help the audit team obtain evidence about
the control environment and about the accounting and control procedures of an audit client?
a. A narrative memorandum describing the control system.
b. An internal control questionnaire.
c. A flowchart of the documents and procedures used by the company.
d. A well-indexed file of working papers.

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

9. The primary objective of procedures performed to obtain an understanding of the internal

control system is to provide an auditor with
a. evidential matter to use in reducing detection risk;
b. knowledge necessary to plan the audit.
c. a basis from which to modify tests of controls.
d. information necessary to prepare flowchart.

10. Which of the following is not a reason an auditor should obtain an understanding of the
elements of an entity's internal control system in planning an audit?
a. To identify types of potential misstatements that can occur.
b. To design substantive tests.
c. To consider the operating effectiveness of the internal controls.
d. To consider factors that affect the risk of material misstatements.

11. When control risk is assessed at the maximum level for all financial statement assertions,
an auditor should document the auditor's
Basis for
Understanding Conclusion that concluding that
of the entity's control risk control risk
internal control is at the is at the
elements maximum level maximum level
a. Yes No No
b. Yes Yes No
c. No Yes Yes
d. Yes Yes Yes

12. After obtaining an understanding of an entity's internal control system, an auditor may
assess control risk at the maximum level for some assertions because the auditor
a. believes the internal control policies and procedures are unlikely to be effective.
b. determines that the pertinent internal control system elements are not well documented.
c. performs tests of controls to restrict detection risk to an acceptable level.
d. identities internal control policies and procedures that are likely to prevent material
misstatements.

13. After obtaining an understanding of an entity's internal control system and assessing control
risk, an auditor next may
a. perform tests of controls to verify management's assertions that are embodied in the
financial statements.

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 b. consider whether evidential matter is available to support a further reduction in the
assessed level of control risk.
c. apply analytical procedures as substantive tests to validate the assessed level of control
risk.
d. evaluate whether the internal control system policies and procedures detected, material
misstatements in the financial statements.

14. The objective of tests of details of transactions pe formed as tests of controls is to

a. detect material misstatements in the account balances of the financial statements.
b. evaluate whether an internal control system policy or procedure operated effectively.
c. determine the nature, timing, and extent of substantive tests for financial statement
assertions.
d. reduce control risk, inherent risk; and detection risk to an acceptably low level.

15. An auditor uses the knowledge provided by the understanding of the internal control system
and the assessed level of control risk primarily to
a. determine whether procedures and records concerning the safeguarding of assets are
reliable.
b. ascertain-whether the opportunities to allow any person to both perpetrate and conceal
irregularities are minimized.
c. modify the initial assessments of inherent risk and preliminary judgments about
materiality levels.
d. determine the nature, timing, and extent of substantive tests for financial statement
assertions.

16. In a study and evaluation of the control system policies and procedures, the completion of
a questionnaire is most closely associated with which of the following?
a. Tests of controls.
b. Substantive tests.
c. Obtaining an initial understanding of the system.
d. Review of the system design.

17. A weakness in internal control over recording retirements of equipment may cause an
auditor to
a. trace additions to the "other assets" account to search of equipment that is still on hand
but no longer being used
b. select certain items of equipment from the accounting records and locate them In the
plant.
c. inspect certain items of equipment in the plant and trace those items to the accounting
records.
d. review the subsidiary ledger to ascertain whether depreciation was taken on each item
of equipment during the year.

18. Reportable conditions are matters that come to an auditor's attention that should be
communicated to an entity's audit committee because they represent
a. material irregularities or illegal acts perpetrated by high-level management.
b. significant deficiencies in the design or operation of the internal control system.
c. flagrant violations of the entity's documented conflict-of-interest policies.
d. intentional attempts by client personnel to limit the scope of the auditor's field work.

19. Miles Retailing, Inc., maintains a staff of three full-time internal auditors who report directly
to the controller. In planning to use the internal auditors to provide assistance in performing
the audit, the independent auditor most likely will
a. place limited reliance on the work performed by the internal auditors.
b. decrease the extent of the tests of controls needed to support the assessed level of
detection risk.

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 c. increase the extent of the procedures needed to reduce control risk to an acceptable
level.
d. avoid using the work performed by the internal auditors.

20. Indeveloping a preliminary audit strategy, an auditor should consider

a. whether the allowance for sampling risk exceeds the achieved upper a precision limit
b. findings from substantive tests performed at interim dates,
c. whether the inquiry of the client's attorney identifies any litigation, claims, or
assessments not disclosed in the financial statements.
d. the planned assessed level of control risk.

21. Which of the following statements describes why a properly designed and executed audit
may not detect a material irregularity?
a. Audit procedures that are effective for detecting an unintentional misstatement may be
ineffective for an intentional misstatement that is concealed through collusion.
b. An audit is designed to provide reasonable assurance of detecting material errors, but
there is no similar responsibility concerning material irregularities.
c. The factors considered in assessing control risk indicated an increased risk of intentional
misstatements, but only a low risk of unintentional errors in the financial statements.
d. The auditor did not consider the factors influencing audit risk for account balances that
have effects pervasive to the financial statements taken as a whole.

22. When an auditor increases the planned assessed level of control risk because certain control
procedures were determined to be ineffective, the auditor would most likely increase the
a. extent of tests of details.
b. level of inherent risk.
c. extent of tests of controls.
d. level of detection risk.

23. An auditor's primary consideration regarding an entity's internal control system policies and
procedures is whether the policies and procedures
a. affect the financial statement assertions.
b. prevent management override.
c. relate to the control environment.
d. reflect management's philosophy and operating style.

24. When there are numerous property and equipment transactions during the year, an auditor
who plans to assess control risk at a low level usually performs
a. analytical procedures for property and equipment balances at the end of the year.
b. tests of controls and extensive tests of property and equipment balances at the end of
the year.
c. analytical procedures for the current year property and equipment transactions
d. tests of controls and limited tests of current year property and equipment transactions.

25. When an auditor assesses control risk below the maximum level, the auditor is required to
document his or her

Basis for understanding that Understanding of the entity's

control risk is below the internal control system
maximum level elements
a. No No
b. Yes Yes
c. Yes No
d. No Yes

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 26. An auditor most likely would review an entity's periodic accounting for the numerical
sequence of shipping documents and invoices to support management's financial statement
assertion of
a. existence.
b. rights and obligations.
c. valuation.
d. completeness.

27. An advantage of using internal control flowcharts instead of internal control questionnaires
to document information about internal control is that flowcharts
a. identify internal control weaknesses more prominently.
b. provide a visual depiction of clients' activities.
c. indicate whether control procedures are operating effectively.
d. reduce the need to observe clients employees performing routine; tasks.

28. Which of the following audit techniques most likely would provide an auditor with the
greatest assurance about the effectiveness, of the operation of an internal control
procedure?
a. Confirmation with outside parties.
b. Inquiry of client personnel.
c. Recomputation of account balance amounts.
d. Observation of client personnel.

Case Analysis

Case 1 – 10 points
During the pre-audit conference for Quicky, Inc., the senior auditor described for the new staff
people assigned to this year's audit the essential characteristics of Quicky's internal control system.
In the payroll cycle, controls have been found to be severely lacking; however, the auditors have
been reasonably satisfied with the controls within the other cycles. In the past, the controls over
cash receipts have been evaluated as excellent.

Within the payroll area, material errors and irregularities can occur readily. Supervisors do not
review time cards prepared by employees; pay rates, hours, extensions, and withholdings are not
reviewed independently. Paychecks, after being signed, are returned to department supervisors for
distribution.

Requirements:
a. What alternatives are available to auditors for dealing with weak financial control subsets?
What possible effects might the absence of payroll controls have on the financial statements
in this case?

b. What steps should the auditor take if, based on the initial review, controls are thought to
be adequate?

c. Although the control procedures relating to cash receipts have been excellent in the past,
they should be reevaluated again this year
1. Why is it necessary for the auditors to study and evaluate internal control each year?

2. Why is a minimum audit necessary notwithstanding excellent controls?

Case 2 – 10 points
David Tuazon, CPA, has been engaged to audit the financial statements of the Islander Drug Store,
Inc. Islander is a Medium-Sized retail outlet that sells a wide variety of consumer goods. All sales
are for cash or check. Cashiers use cash registers to process these transactions. There are no
receipts by mail and there are no credit card or charge sales.
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Requirement:
Construct the “Processing Cash Collections” segment of the internal control questionnaire on “Cash
Receipts” to be used as a basis for understanding the internal control system for the Islander Drug
Store, Inc. Each question should elicit either a yes or no response. Do not discuss the internal
controls relating to cash sales.

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