18.1 Control Procedures Flashcards
A company’s accounts payable supervisor assigned a vendor code to a storage facility owned by the supervisor, then instructed the company’s accounting system to pay monthly rent for a storage unit allegedly leased from the storage facility. This situation is an example of a failure of controls due to the lack of
A. Commitment to competence in job skills and knowledge
B. An effective internal audit function
C. Appropriate segregation of duties
D. Appropriate physical controls
C. Appropriate segregation of duties
Internal controls may be preventive, detective, corrective, or directive. Which of the following is preventive?
A. Requiring two persons to open mail
B. Reconciling the accounts receivable subsidiary file with the control account
C. Using batch totals
D. Preparing reconciliation
A. Requiring two persons to open mail
Preventive controls are designed to prevent an error or an irregularity. Detective and corrective controls attempt to identify and correct errors or irregularities that have already occurred. Preventive controls are usually more cost beneficial than detective or corrective controls. Assigning two individuals to open mail is an attempt to prevent misstatement of cash receipts.
The procedure requiring preparation of a prelisting of incoming cash receipts, with copies of the prelist going to the cashier and to accounting, is an example of which type of control?
A. Preventive
B. Corrective
C. Detective
D. Directive
A. Preventive
A prelisting of cash receipts in the form of checks is a preventive control. It is intended to deter undesirable events from occurring. Because fraud involving cash is most likely to occur before receipts are recorded, either remittance advices or a prelisting of checks should be prepared in the mail room so as to establish recorded accountability for cash as soon as possible. A cash register tape is a form of prelisting for cash received over the counter. One copy of a prelisting will go to accounting for posting to the cash receipts journal, and another is sent to the cashier for reconciliation with checks and currency received.
In a well-designed internal control structure in which the cashier receives remittances from the mail room, the cashier should not
A. Endorse the checks
B. Prepare the bank deposit slips
C. Deposit remittances daily at a local bank
D. Post the receipts to the accounts receivable subsidiary ledger cards
D. Post the receipts to the accounts receivable subsidiary ledger cards
The cashier is an assistant to the treasurer and thus performs an asset custody function. Individuals with custodial functions should not have access to the accounting records. If the cashier were allowed to post the receipts to the accounts receivable subsidiary ledger, an opportunity for embezzlement would arise that could be concealed by falsifying the books.
Accounting controls are concerned with the safeguarding of assets and the reliability of financial records. Consequently, these controls are designed to provide reasonable assurance that all of the following take place except
A. Permitting access to assets in accordance with management’s authorization.
B. Executing transactions in accordance with management’s general or specific authorization.
C. Compliance with methods and procedures ensuring operational efficiency and adherence to managerial policies.
D. Comparing recorded assets with existing assets at periodic intervals and taking appropriate action with respect to differences.
C. Compliance with methods and procedures ensuring operational efficiency and adherence to managerial policies.
An accounting control is concerned with the safeguarding of assets and the reliability of financial records, whereas an operational or administrative control is concerned with operational efficiency and effectiveness. Thus, compliance with methods and procedures ensuring operational efficiency and adherence to managerial policies is an objective of an operational control.
Which one of the following situations represents an internal control weakness in the payroll department?
A. Payroll department personnel are rotated in their duties.
B. Paychecks are distributed by the employees’ immediate supervisor.
C. Payroll records are reconciled with quarterly tax reports.
D. The timekeeping function is independent of the payroll department.
B. Paychecks are distributed by the employees’ immediate supervisor.
Paychecks should not be distributed by supervisors because an unscrupulous person could terminate an employee and fail to report the termination. The supervisor could then clock in and out for the employee and keep the paycheck. A person unrelated to either payroll recordkeeping or the operating department should distribute checks.
Auditors document their understanding of internal control with questionnaires, flowcharts, and narrative descriptions. A questionnaire consists of a series of questions concerning controls that auditors consider necessary to prevent or detect errors and fraud. The most appropriate question designed to contribute to the auditors’ understanding of the completeness of the expenditure (purchases-payables) cycle concerns the
A. Internal verification of quantities, prices, and mathematical accuracy of sales invoices
B. Use and accountability of prenumbered checks
C. Disposition of cash receipts
D. Qualifications of accounting personnel
B. Use and accountability of prenumbered checks
A completeness assertion concerns whether all transactions and accounts that should be presented in the financial statements are so presented. The exclusive use of sequentially numbered documents facilitates control over expenditures. An unexplained gap in the sequence alerts the auditor to the possibility that not all transactions have been recorded. A failure to use prenumbered checks would therefore suggest a higher assessment of control risk. If a company uses prenumbered checks, it should be easy to determine exactly which checks were used during a period.
Which one of the following situations represents a strength of internal control for purchasing and accounts payable?
A. Prenumbered receiving reports are issued randomly.
B. Invoices are approved for payment by the purchasing department.
C. Unmatched receiving reports are reviewed on an annual basis.
D. Vendors’ invoices are matched against purchase orders and receiving reports before a liability is recorded.
D. Vendors’ invoices are matched against purchase orders and receiving reports before a liability is recorded.
A voucher should not be prepared for payment until the vendor’s invoice has been matched against the corresponding purchase order and receiving report. This procedure provides assurance that a valid transaction has occurred and that the parties have agreed on the terms, such as price and quantity.
________ controls alert the proper people after an unwanted event.
Detective controls. They are effective when detection occurs before material harm occurs.
The internal auditor recognizes that certain limitations are inherent in any internal control system. Which one of the following scenarios is the result of an inherent limitation of internal control?
A. A security guard allows one of the warehouse employees to remove company assets from the premises without authorization
B. The firm sells to customers on account, without credit approval
C. The comptroller both makes and records cash deposits
D. An employee, who is unable to read, is assigned custody of the firm’s computer tape library and run manuals that are used during the third shift.
A. A security guard allows one of the warehouse employees to remove company assets from the premises without authorization
Inherent limitations of internal control arise from faulty judgement in decision making, simple error or mistake, and the possibility of collusion and management override. Thus, a control (use of security guards) based on segregation of functions may be overcome by collusion among two or more employees.
Which one of the following duties assigned to the cashier exposes the organization to a control risk in terms of segregation of duties?
A. Signing the deposit slips
B. Comparing the check register with the bank statement
C. Depositing cash at the bank
D. Entering information in the accounts receivable subsidiary ledger
D. Entering information in the accounts receivable subsidiary ledger
Segregation of duties involves the separation of the functions of authorization, recordkeeping, and asset custody to minimize the opportunities for a person to be able to perpetrate and conceal errors or fraud in the normal course of his or her duties. A cashier who records information in the accounts receivable subsidiary ledger has both custody and recordkeeping duties, which violates segregation of duties.
Appropriate control over obsolete materials requires that they be
A. Carried at cost in the accounting records until the actual disposition takes place
B. Determined by an approved authority to be lacking in regular usability
C. Sorted, treated, and packaged before disposition takes place, in order to obtain the best selling price
D. Retained within the regular storage area
B. Determined by an approved authority to be lacking in regular usability
Since auditors, storekeepers, etc., may not have the requisite expertise to determine whether materials are usable, that decision must often be made by a designated independent authority. To provide effective control of materials, this determination, asset custody, and authorization for disposal are functions that should be segregated.
Internal control cannot be designed to provide reasonable assurance regarding the achievement of objectives related to
A. Elimination of all fraud
B. Reliability of financial reporting
C. Compliance with applicable laws and regulations
D. Effectiveness and efficiency of operations
A. Elimination of all fraud
Internal control is a process designed to provide reasonable assurance regarding the achievement of organizational objectives. Because of inherent limitations, however, no system can be designed to eliminate all fraud.
To test the adequacy of controls, a variety of methods may be used, including
A. Inspection and verification
B. Reperformance and observation
C. Comparison and confirmation
D. Inquiry and analytical procedures
B. Reperformance and observation
Inquiry should be done but is not sufficient by itself to test the adequacy of controls. A system of controls is only effective when properly designed and followed. Other testing methods performed in combination with inquiry may include inspection, recalculation, and reperformance of a relevant control.
Which of the following is most likely considered to determine whether internal controls are operating effectively?
A. Attorney’s responses to an auditor’s inquiries
B. A questionnaire completed by an employee in the receiving department about her duties and responsibilities
C. A management representation letter corroborating inventory pricing
D. Confirmations of receivables verifying account balances
B. A questionnaire completed by an employee in the receiving department about her duties and responsibilities
Test of controls are directed toward operating effectiveness. They include (1) inquiries of entity personnel (e.g., a questionnaire completed by an employee in the receiving department); (2) inspection of documents, reports, and electronic files indicating performance of the controls; (3) observation of the application of the controls; and (4) reperformance of the controls.
Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle?
A. Merchandise received is not promptly reconciled to the outstanding purchase order file
B. Obsolete items included in inventory balances are rarely reduced to the lower of cost or market value
C. Fictitious transactions are recorded that cause an understatement of revenue and overstatement of receivables
D. The write-off of receivables by personnel who receive cash permits the misappropriation of cash
D. The write-off of receivables by personnel who receive cash permits the misappropriation of cash
Authorization of transactions (write-offs of receivables) and custody of assets (cash) are incompatible duties.
Which of the following tests of accounts receivable is most likely to determine the effectiveness of related controls?
A. Inspecting an entity’s analysis of accounts receivable for unusual balances
B. Comparing an entity’s uncollectible accounts expense with actual uncollectible accounts receivable
C. Observing an entity’s employee prepare the schedule of past due accounts receivable
D. Sending requests to an entity’s principal customers to confirm the existence of accounts receivable
C. Observing an entity’s employee prepare the schedule of past due accounts receivable
To test the effectiveness of controls, common methods are inquiry, observation, inspection, recalculation, and reperformance of a control. Thus, observing an entity’s employee prepare the schedule of past due accounts receivable provides evidence of the effectiveness of certain controls over accounts receivable.
Which of the following controls most likely would help ensure that all credit sales transactions of an entity are recorded?
A. The accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences they report
B. The accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account monthly
C. The billing department supervisor matches prenumbered shipping documents with entries in the sales journal
D. The billing department supervisor sends copies of approved sales orders to the credit department for comparison to authorized credit limits and current customer account balances
C. The billing department supervisor matches prenumbered shipping documents with entries in the sales journal
The sequential numbering of documents provides a standard control over transactions. The numerical sequence should be accounted for by an independent party. A major objective is to detect unrecorded and unauthorized transactions. Moreover, comparing shipments with the sales journal also will detect unrecorded transactions.
Which control is not appropriate for property, plant, and equipment?
A. Proper authority for acquisition and retirement of assets
B. Written policies for capitalization and expenditure and review of application of depreciation methods
C. Disposal of fully depreciated assets
D. Detailed property records and physical controls over assets
C. Disposal of fully depreciated assets
No control should require disposal of fully depreciated assets. They may still be productive and used in the business and should remain on the books until disposal.
An entity’s internal control structure (ICS) consists of the policies and procedures established to provide reasonable assurance that specific entity objectives will be achieved. Only some of these objectives, policies, and procedures are relevant to a financial statement audit. Which one of the following would most likely be considered in such an audit?
A. Timely reporting and review of quality control results
B. Marketing analysis of sales generated by advertising projects
C. Maintenance of statistical production analyses
D. Maintenance of control over unused checks
D. Maintenance of control over unused checks
The policies and procedures most likely to be relevant to a financial statement audit pertain to the entity’s ability to record, process, summarize, and report financial data consistent with the assertions embodied in the financial statements. Maintenance of control over unused checks is an example of a relevant procedure because the objective is to safeguard cash. The auditor must understand the ICS policies and procedures relevant to the assertions about cash in the financial statements. (S)he must then assess control risk for those assertions; that is, (s)he must evaluate the effectiveness of the ICS in preventing or detecting material misstatements in the assertions.
A proper segregation of duties requires that an individual
A. Authorizing a transaction records it
B. Recording a transaction not compare the accounting record of the asset with the asset itself
C. Maintaining custody of an asset be entitled to access the accounting records for the asset
D. Authorizing a transaction maintain custody of the asset that resulted from the transaction
B. Recording a transaction not compare the accounting record of the asset with the asset itself
One person should not be responsible for all phases of a transaction, i.e., for authorization, recording, and custodianship of the related assets. These duties should be performed by separate individuals to reduce the opportunities for any person to be in a position of both perpetrating and concealing errors or fraud in the normal course of his or her duties. For instance, an employee who receives and lists cash receipts should not be responsible for comparing the recorded accountability for cash with existing amounts
Which of the following is the best way to compensate for the lack of adequate segregation of duties in a small organization?
A. Allowing for greater management oversight of incompatible activities
B. Requiring accountants to pass a yearly background check
C. Disclosing lack of segregation of duties to the external auditors during the annual review
D. Replacing personnel every 3 or 4 years
A. Allowing for greater management oversight of incompatible activities
Complete segregation may not be feasible due to cost-benefit restraints. Compensating controls most likely are established when segregation of duties is not feasible. Typical compensating controls may include more management oversight.
Auditors regularly evaluate controls. Which of the following best describes the concept of control as recognized by internal auditors?
A. Management takes action to enhance the likelihood that established goals and objectives will be achieved
B. Control procedures should be designed from the “bottom up” to ensure attention to detail
C. Control represents specific procedures that accountants and auditors design to ensure the correctness of processing
D. Management regularly discharges personnel who do not perform up to expectations
A. Management takes action to enhance the likelihood that established goals and objectives will be achieved.
A control is any action taken by management to enhance the likelihood that established goals and objectives will be achieved. Management plans, organizes, and directs the performance of sufficient actions to provide reasonable assurance that objectives and goals will be achieved. Thus, control is the result of proper planning, organizing, and directing by management.
An entity wishes to evaluate the design and perform tests of controls over its cash disbursements procedures. If the controls leave no trail of documentary evidence, the most likely testing methods are
A. Inquiry and analytical procedures
B. Observation and inquiry
C. Analytical procedures and confirmation
D. Confirmation and observation
B. Observation and inquiry
When documentary evidence does not exist, tests of the effectiveness of the operation of controls may involve such methods as observation, inquiry, or computer-assisted techniques. Inquiry alone, however, does not ordinarily provide sufficient appropriate evidence to support the conclusion that the control is operating effectively.
