Chapter 8: Internal Control and its Role in F/S Audits

Question 1

What is the role of internal control?

Answer 1

minimize risk of material misstatement and helping to plan audit tests

Question 2

What is the relationship between internal control and control risk?

Answer 2

when internal control is strong, control risk is low

Question 3

Evidence collecting strategies

Answer 3

Reliance and Substantive

Question 4

How is the choice between what evidence collecting strategy to use made?

Answer 4

Depends on the strength of IC and cost of strategy

Question 5

What strategy is used when controls are weak?

Answer 5

Substantive Strategy

Question 6

Reliance Strategy

Answer 6

auditor places some reliance on ICs to help ensure the assertions are accurate (CR < 100%)

Question 7

When is a reliance strategy acceptable?

Answer 7

when ICs are deemed to be adequate

Question 8

Substantive Strategy

Answer 8

auditor decides not to place any reliance on ICs to help ensure assertion is correct (CR = 100%)

Question 9

Reasons for employing a substantive strategy

Answer 9

1) CR is high, 2) Cheaper

Question 10

COSO

Answer 10

primary framework used in US to understand and evaluate IC

Question 11

Internal Control (COSO definition)

Answer 11

process effected by personnel that is designed to provide reasonable assurance regarding achievement of objectives

Question 12

Objectives of Internal Controls

Answer 12

1) reliability of financial reporting, 2) Compliance with laws and regulations, 3) Effectiveness and Efficiency of operations, 4) Safeguarding of Assets

Question 13

Internal Controls (Simple Definition)

Answer 13

processes, policies, devices, and organizational structures implemented by organization to mitigate threats

Question 14

What is the primary purpose of financial reporting process?

Answer 14

to accurately identify, record, classify, aggregate and report transaction information and supporting information in compliance with GAAP

Question 15

Four components of financial reporting system

Answer 15

1) Source documents, 2) Journals, 3) General and Subsidiary Ledgers, 4) Financial Statements

Question 16

Source Documents

Answer 16

documents generated when transaction takes place, byproduct of transaction that provide information about transaction

Question 17

Journals

Answer 17

where transactions are recorded and summarized

Question 18

General Journals

Answer 18

used to record any transaction

Question 19

Specialized Journals

Answer 19

used for specific types of transactions

Question 20

Ledgers

Answer 20

used to aggregate transaction information that was recorded in journals, made up of accounts which have balances at specific points in time

Question 21

General Ledger

Answer 21

summary of net activity for all accounts contained in chart of accounts at a particular point in time

Question 22

Subsidiary Ledger

Answer 22

contain more detailed information about specific accounts

Question 23

Trial Balance

Answer 23

list of general ledger accounts and their balances at specific point in time

Question 24

Financial statements

Answer 24

report the line items that summarize a company’s account balances

Question 25

Limitations for accounting ICs

Answer 25

1) Management Override, 2) Collusion, 3) Human misunderstanding/Error

Question 26

Management override

Answer 26

person who has ability to fire an employee can often coerce employee to by-pass controls

Question 27

Collusion

Answer 27

refers to two or more getting together to beat the system

Question 28

Human misunderstanding/Error

Answer 28

humans may misunderstand or goof up their IC assignment which can cause a control failure

Question 29

Segregation of Duties

Answer 29

no single individual is in a position where they can both perpetrate and cover-up fraudulent activity

Question 30

Segregation of Duties at the Macro-Level of the Organization

Answer 30

Segregation of the accounting function from the operating function

Question 31

Operating Function

Answer 31

enter into and complete transactions, have access to assets

Question 32

Accounting function

Answer 32

ability to manipulate accounting records

Question 33

Segregation of Duties at the Micro-Level of the Organization

Answer 33

At least three employees involved in processing a transaction: authorization, execution, and accounting

Question 34

Requirements for Adequate Documentation of Transactions

Answer 34

1) Transaction Trail should be left and be easy to follow, 2) Using pre-numbered documents, 3) Document transaction events in a timely fashion

Question 35

Physical Controls to Safeguard Assets

Answer 35

controls that impede the ability for someone to steal assets

Question 36

Reconciliations

Answer 36

check for agreement between two or more different information sources that provide information about the same event or account

Question 37

Types of Internal Controls

Answer 37

1) Company level controls, 2) System level controls, 3) Period-end controls

Question 38

Company level controls

Answer 38

create control climate/attitude for organization (ex. corporate governance structure)

Question 39

System Process Level Controls

Answer 39

day-to-day controls that ensure transactions occur correctly

Question 40

Period-end controls

Answer 40

refers to controls over period-end adjustment and closing process

Question 41

Forms of IT controls

Answer 41

general and application

Question 42

General controls

Answer 42

controls that affect all IT applications

Question 43

Application controls

Answer 43

controls that only impact specific IT application

Question 44

Echo Check

Answer 44

components of system send messages to each other to verify transmission of data between components

Question 45

Validity/Existence Check

Answer 45

computer compares input customer account number to internally stored list of valid account numbers to ensure account number correctly input

Question 46

Control Total

Answer 46

comparison of computer processed totals to manually computed totals of all daily sales to ensure all of the day's sales were accurately input and processed

Question 47

Limit (reasonableness) Check

Answer 47

test to ensure that numeric value of data input does not exceed certain prescribed value

Question 48

Parity check

Answer 48

computer adds a bit to each byte to make byte either positive or negative, done so computer can continuously verify internal accuracy of data transmission/processing

Question 49

Check Digit Verfication

Answer 49

numerically-computed number added to five-digit part number to ensure accuracy of part number input