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Internal Control Flashcards

1
Q

If Internal Control is poor and a company’s accounting practices are sloppy - which risk is higher?

A

Control risk increases with poor Internal Controls and sloppy accounting practices.

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2
Q

If Internal Control is poor - what is the effect on the audit?

A

Auditor will need to perform more testing and dig deeper into accounts in order to arrive at an opinion regarding the financial statements.

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3
Q

What does Internal Control provide reasonable assurance for?

A

Internal control provides reasonable assurance that

Material misstatements will be prevented

Reliability/integrity of financial statements will be preserved

Assets are protected against misuse

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4
Q

What is required in an examination of Internal Control under Sarbanes-Oxley?

A

CEO/CFO must disclose Internal Control deficiencies

Management must provide assessment of Internal Control

Management must certify Financial Statements

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5
Q

What is the relationship between Internal Control and Substantive Testing?

A

Inverse Relationship

Stronger Internal Controls - Less Testing Needed

Weaker Internal Controls - More Testing Needed

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6
Q

What are the 3 objectives of Internal Control?

A

Reliability of Financial Reporting

Operational Efficiency/Effectiveness

Compliance with Law and Regulations

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7
Q

What are the 5 components of Internal Control?

A

Control Environment

Risk Assessment

Information and Communication

Monitoring

Control Activities

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8
Q

What is the purpose for a Control Environment assessment?

A

Sets tone for the entire company

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9
Q

What are the components of the Control Environment?

A

Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resource Policies
Assignment of Authority/Responsibility
Management’s Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement

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10
Q

What does an auditor’s assessment of Detection Risk determine?

A

Detection Risk determines nature- timing- and extent of audit procedures.

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11
Q

What determines the acceptable level of Detection Risk?

A

Risk of material misstatement determines acceptable level of Detection Risk

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12
Q

What items could increase the risk of material misstatement?

A

Rapid growth in the company.

The methods management uses to identify risk- estimate its significance and assess the likelihood of occurrence

Major changes to operations- personnel- systems- IT- products- corporate organization- and foreign operations.

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13
Q

What happens when Control Risk is assessed to be at the maximum level?

A

No Internal Control testing is performed.

All audit procedures are increased in intensity to compensate for increased risk.

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14
Q

What happens when Control Risk is below the maximum level?

A

Auditor tests Internal Controls.

Auditor evaluates Control Risk based on tests

Auditor adjusts substantive tests accordingly

Weaker Internal Control - More substantive tests

Stronger Internal Control - Less substantive tests

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15
Q

Describe some common examples of Control Activities.

A

Performance Reviews

Information Processing

Physical Controls

Segregation of Duties

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16
Q

What should an auditor understand with respect to Information and Communication on an audit?

A

Understand Client’s

Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external reporting process

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17
Q

How must an auditor document understanding of Internal Control?

A

Through written documentation such as Internal Control memos- flowcharts- and questionnaires

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18
Q

What questions should be asked to determine the risk of material misstatement?

A

Were all transactions recorded?
Were they timely?
Measured appropriately?
Recorded in correct period?
Presented and disclosed properly?
Did Management communicate their responsibilities?

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19
Q

What is the purpose of testing Internal Controls?

A

Auditor needs reasonable assurance that controls are functioning as designed and effective

Internal Control Testing should be strong as (IRON) so that nothing gets past them

Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents

If results are as expected- substantive procedures do not need to be adjusted

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20
Q

When can controls tested by an auditor in a prior year be used in the current year’s audit assessment?

A

Controls tested by auditor in a prior year can be used in the current year’s audit assuming they are re-tested every third year

Exception If the control has changed since the last audit

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21
Q

What happens if Internal Controls are deficient?

A

Control Risk increases

Scope of substantive procedures increases

Detection Risk decreases

Material Weakness - Reasonable possibility that a material misstatement in Financial Statements would not be found- more than a remote chance of occurrence

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22
Q

What is a Material Weakness?

What type of opinion on Internal Controls?

A

Reasonable possibility exists that a material misstatement in Financial Statements would not be found- and has more than a remote chance of occurrence.

Adverse Opinion

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23
Q

What does Tracing test?

A

Tests Completeness

Starts with source document and traces forward to the journal entry.

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24
Q

What does Vouching test?

A

Tests Existence.

Starts with a journal entry and searches for a voucher or source document to support the entry.

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25
What activities represent Segregation of Duties?
Non-compatible duties performed by separate individuals- such as Authorization of asset disbursement vs. Recording of Assets vs. Custody of assets If supporting audit evidence doesn't exit - use Observation and Inquiry Accounting should be segregated from Production
26
With respect to signing checks - how are duties segregated?
Employees who prepare vouchers/invoices should not also have the authority to SIGN CHECKS Tip - Remember this as an underlying theme with Segregation of Duties. The authority to make a payment should not also lie in the hands of those creating invoices/vouchers. Why? People commit fraud by setting up fake companies and basically paying themselves
27
With respect to custody of assets - how should duties be segregated?
Employees who have custody of assets should not also RECORD those assets Someone in charge of petty cash should not also control the petty cash records Treasury Department (custodians) should NOT have record keeping duties They control assets and should not be able to adjust any recording of those assets
28
What are the limitations on Control Activities?
Controls can't stop collusion or bad judgment Management can override controls Cost vs. Benefit relationship of Internal Control
29
What is required if a Material Weakness is identified?
A written report to management is required. Report declaring that no material weaknesses were found is allowed Previous weaknesses reported that still exist should be reported again Should be reported no later than 60 days after audit report release date If one or more material weaknesses is uncorrected at year-end- an Adverse Opinion on Internal Control must be given
30
What is the effect of a Significant Deficiency? What is it?
A significant deficiency adversely affects a company's ability to report in the financial statements according to GAAP. A significant deficiency is a more than a remote likelihood of material misstatement by more than an inconsequential amount
31
What must occur if a Significant Deficiency is identified?
If a Significant Deficiency is identified- a written report to management required Report declaring that no significant deficiencies exist is not allowed Previous deficiencies reported that still exist should be reported again Should be reported no later than 60 days after the audit report release date
32
What is a Control Deficiency?
A control is not operating as intended.
33
What must an auditor ask if using the work of third parties?
Are they competent? Are they objective?
34
What must an auditor understand with respect to internal auditors?
Auditor needs to understand the role of Internal Auditors within the organization because their work affects the audit plan Responsibility for judgments about materiality or appropriateness of entries or estimates cannot be shared with third parties like Internal Auditors Internal Auditors should be asked to do some of the legwork like preparing schedules or running reports They should not be asked to make any decisions or judgments
35
What is required in an examination of Internal Control under Sarbanes-Oxley?
CEO/CFO must disclose deficiencies Management must provide assessment of Internal Controls Management must certify Financial Statements
36
What is the relationship between Internal Control and Substantive Testing?
Has inverse relationship Stronger Internal Control results in LESS substantive testing Weaker Internal Control leads to MORE substantive testing
37
What are the three objectives of Internal Control?
Reliability of Financial Reporting Operational Efficiency/Effectiveness Compliance with Law and Regulations
38
What are the five components of Internal Control?
Control Activities Risk Assessment Information and Communications Monitoring Control Environment
39
What are the components of the Control Environment?
Integrity/Ethics of Management Competence of Management Organizational Structure Human Resources Policies Assignment of Authority/Responsibility Management's Style (riskier with a dominant/aggressive individual) Board/Audit Committee involvement
40
What happens when Control Risk is below the maximum level?
Auditor tests Internal Controls. Auditor evaluates Control Risk based on tests Auditor adjusts substantive tests accordingly Weaker Internal Control - More substantive tests Stronger Internal Control - Less substantive tests
41
What should an auditor understand with respect to Information and Communication on an audit?
Understand Client's Major transaction classes Transaction initiation Support records/documents Transaction processing Financial Statement internal reporting process Financial Statement external communication process
42
How must an auditor document understanding of Internal Control?
Auditor must document understanding of Internal Control via Memos - Flowcharts - Questionnaires
43
What is the purpose of testing Internal Controls?
Auditor needs reasonable assurance that controls are functioning as designed and effective Internal Control Testing should be strong as (IRON) so that nothing gets past them Inquiry - Interview company personnel Re-performance - Can it be replicated? Observation - Watch the control be applied INspection - Dig into the details/documents If results are as expected - substantive procedures do not need to be adjusted
44
How to assess risk
Analytical procedures Inquiry Inspection of documents Observation
45
Characteristics of documents in "cycles" for IC
Pre-printed, Pre-numbered, numerically controlled
46
Order of components of IC
Control Environment, Risk Assessment, Control Activitites, Information & Communication, Monitoring
47
Financial Statement Audit (Non-Issuer) VS PCAOB (Issuer); | Which periods do you look at?
Entire Period As a point in time
48
Name examples of a company-level control Name an example of a control activity over a specific type of transaction
Monitoring, mgmt risk assessment process, controls over the drafting of financial statements Segregation of duties
49
Where do internal auditors report to?
They report to the audit committee instead of top management since it is more likely that the internal auditor will be able to objectively perform the function If not, RMM will increase
50
What is the responsibility of the payroll department?
The calculate the pay for employees NOT to distribute checks!!!
51
What is a bill of lading?
Supports the amoount received
52
What is a PO?
Evidence that the goods received were ordered
53
What does tracing test? What does vouching test?
Tests completeness, and detects understatements Test existence, and detects overstatements
54
What do you do as an independent auditor when a service auditor performs an audit?
Inquire about the service auditor's professional reputation DO NOT audit their work, or review their audit programs
55
Significance of inherent limitations for attestation engagement and PCAOB audit
May not prevent or detect misstatements Also may not project into future
56
How to date attestation engagement VS PCAOB audit
Period of time / Specific date Specific date
57
How can you measure an internal auditor's objectivity?
By looking at who they report to Reviewing recommedations made in their reports
58
How does scope, procedures, and purpose of the examination of Internal Control VS assessment of RMM differ
IC is more extensive because requires more tests on IC Same IC is to express an opinion; Assess RMM is to determine the nature, timing, and extent of sub testing
59
What are the distribution of internal controls are restricted to who?
Management, and those who are in charge of governance
60
Name the 3 types of Internal Control Reports
GAAS financial statement audit, AICPA attestation engagement, PCAOB audit
61
SIMS IC example a) if wrong account b) to check if posted in an account c) if customer checks are being misappropriated and before getting to cashier d) if customer check are being misappropriated and got to cashier
a) confirm b) compare amounts AR and amounts amounts of invoices c) confirm with customer because it will show overstatement d) compare AR with validated deposit slip
62
For internal control reports, who do you have to communicate control deficiencies too for an FS audit, Attestation Engagement, and a PCAOB audit? Pg. 4-23
Just management for all 3
63
If you report on Internal Control, what does it mean?
They hired you to give an opinion on internal control, therefore it is considered an attestation engagement or a PCAOB audit
64
What do you NOT do to assure that all billed sales are correctly posted to accounts receivable ledger
Dont reconcile to daily ledger Compare sales to daily postings of AR
65
A department that should be charge in writing off bad debt should be independent of?
Sales, credit, and recordkeeping
66
What is included in an internal control questionnaire? | Pg. 4-21
``` P Physical Control R Recording A Authorization I Independent checks S Segregation of duties E Evaluate performance ```
67
SIM IC: Segregation of Duties a) When a sales clerk prepares a sales order without shipping advice, is it appropriate? b) What role in ARCCs should the sales clerk be?
a) Yes because shipping advice should be made when goods are shipped b) Authorization
68
What is a good control for maintaining proper custody of a security? What is not a good control?
Investment ledger are periodically compared with the contents of a safety deposit box by independent auditor Access to sercurities in the safe deposit box limited to only ONE person; it should be 2
69
Does matters that must be communicated with those in charge of governance have to be written? (DISAPPROVE)
No, it can be oral or written
70
What is important with tracing and vouching?
Dont go from journal to ledger!!!
71
What is a good safeguard for marketable securities?
Two company officials would have joint controls of the securities, which would be kept in a bank safe-deposit box
72
If you obtain credit approval, which assertion does it cover?
Valuation
73
What is the cashier's responsibility?
Everything to do with cash receipts

AUD (8 decks)

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