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Flashcards in STUDY UNIT ONE CORPORATE GOVERNANCE Deck (26):
1

The chief executive officer (CEO) of a corporation is appointed by the common shareholders and is responsible for carrying out the entity’s day-to-day operations.

True.
False.

False.
Your answer is correct.
The CEO of a corporation is appointed by the board of directors, not the common shareholders, to carry out the entity’s day-to-day operations.

2

Internal control has three categories of objectives: effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations.

True.
False.

True.
Your answer is correct.
Internal control has three categories of objectives. Operations objectives relate to achieving the entity’s mission and safeguarding assets. Reporting objectives enable investors and creditors to have reliable and timely financial reports. Compliance objectives ensure that entities are acting in accordance with applicable laws and regulations.

3

Seymore was recently invited to become a director of Buckley Industries, Inc. If Seymore accepts and becomes a director, Seymore, along with the other directors, will not be personally liable for
A Honest errors of judgment.
B Declaration of a dividend that the directors know will impair legal capital.
C Diversion of corporate opportunities to themselves.
D Lack of reasonable care.

A Honest errors of judgment.
This answer is correct.
The directors of a corporation owe a fiduciary duty to the corporation and the shareholders. They also are expected to exercise reasonable business judgment. The law does recognize human fallibility and allows for directors to be safe from liability for honest mistakes of judgment.

4

In general, which of the following must be contained in articles of incorporation?
A Names of states in which the corporation will be doing business.
B Names of the initial officers and their terms of office.
C Name of the state in which the corporation will maintain its principal place of business.
D Number of shares of stock authorized to be issued by the corporation.

D Number of shares of stock authorized to be issued by the corporation.
This answer is correct.
Articles of incorporation must contain the name of the corporation, the number of authorized shares, the address of the initial registered office of the corporation, the name of its first registered agent at that address, and the names and addresses of the incorporators. The articles may also include names and addresses of the initial directors, purpose and duration of the corporation, and any provision that may be set forth in the bylaws.

5

A company’s new time clock process requires hourly employees to select an identification number and then choose the clock-in or clock-out button. A video camera captures an image of the employee using the system. Which of the following exposures can the new system be expected to change the least?
A Fraudulent reporting of employees’ own hours.
B Inaccurate accounting of employees’ hours.
C Errors in employees’ overtime computation.
D Recording of other employees’ hours.

C Errors in employees’ overtime computation.
This answer is correct.
This internal control process is responsible for verifying that the correct employee enters the proper amount of time (s)he worked. This function is not responsible for applying pay rates to the amount of hours worked and therefore would not change any errors in overtime computations.

6

Which of the following is necessary to be an audit committee financial expert according to the criteria specified in the Sarbanes-Oxley Act of 2002?
A Education and experience as a certified financial planner.
B Experience with internal accounting controls.
C Experience in the preparation of tax returns.
D A limited understanding of generally accepted auditing standards.

B Experience with internal accounting controls.
This answer is correct.
Under the Sarbanes-Oxley Act of 2002, an issuer’s audit committee should have at least one financial expert. One of the requirements to be considered a financial expert is that the person have an understanding of internal controls over financial reporting.
View Subunit 1.2 Outline

7

Which of the following best describes an inherent limitation that should be recognized by an auditor when considering the potential effectiveness of internal control?
A Controls, whether manual or automated, whose effectiveness depends on segregation of duties can be circumvented by collusion.
B The benefits expected to be derived from effective internal control usually do not exceed the costs of such control.
C The competence and integrity of client personnel provide an environment conducive to control and provides assurance that effective control will be achieved.
D Procedures designed to assure the execution and recording of transactions in accordance with proper authorizations are effective against fraud perpetrated by management.

A Controls, whether manual or automated, whose effectiveness depends on segregation of duties can be circumvented by collusion.
This answer is correct.
One of the inherent limitations of internal control is that it can be circumvented by collusion among persons both within and outside the entity. Thus, a control based on segregation of duties will be ineffective if a person in a position to commit fraud colludes with a person who can conceal it.
View Subunit 1.3 Outline

8

Company management completes event identification and analyzes the risks. The company wishes to assess its risk after management’s response to the risk. According to COSO, which of the following types of risk does this situation represent?
A Inherent risk.
B Residual risk.
C Event risk.
D Detection risk.

B Residual risk.
This answer is correct.
Risk that remains even after management’s initial response is residual risk
View Subunit 1.4 Outline

9

According to COSO, the use of ongoing and separate evaluations to identify and address changes in internal control effectiveness can best be accomplished in which of the following stages of the monitoring-for-change continuum?
A Change identification.
B Change management.
C Control baseline.
D Control revalidation/update.

A Change identification.
This answer is correct.
Of the four steps in the monitoring-for-change continuum described in the 2009 COSO document Guidance on Monitoring Internal Control Systems, change identification is the one in which separate and ongoing evaluations can best be accomplished.
View Subunit 1.3 Outline

10

Control activities constitute one of the five components of internal control described in the COSO model. Control activities do not encompass
A. An internal auditing function.
B. Information processing.
C. Physical controls.
D. Performance reviews.

A. An internal auditing function.
Answer (A) is correct.
The COSO model describes control activities as policies and procedures that help ensure that management directives are carried out. They are intended to ensure that necessary actions are taken to address risks to achieve the entity’s objectives. Control activities have various objectives and are applied at various organizational and functional levels. However, an internal auditing function is part of the monitoring component.
(1.3.52)

11

Which of the following are elements included in the control environment as described by the COSO model for internal control?
A. Organizational structure, management philosophy, and planning.
B. Competence of personnel, backup facilities, laws, and regulations.
C. Risk assessment, assignment of responsibility, and human resource practices.
D. Integrity and ethical values, assignment of authority, and human resource policies.

D. Integrity and ethical values, assignment of authority, and human resource policies.
Answer (D) is correct.
According to the COSO model, the control environment includes the attitude and actions of the board and management regarding the significance of control within the entity. The control environment provides the discipline and structure for the achievement of the primary objectives of the system of internal control. The control environment includes the following elements:

Human resource policies and practices
Integrity and ethical values
Organizational structure
Commitment to competence
Management’s philosophy and operating style
Board of directors or audit committee
Assignment of authority and responsibility
(1.3.47)

12

Under the reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (SOX), the CEO and CFO must include a statement in the annual report to the effect that
A. The issuer has used the COSO model to design and assess the effectiveness of its system of internal control.
B. The board of directors has taken responsibility for establishing and maintaining an adequate system of internal control over financial reporting.
C. The system of internal control has been assessed by an independent public accounting firm that is not currently the subject of any PCAOB investigation.
D. The system of internal control has been assessed by an independent public accounting firm that is registered with the PCAOB.

Answer (D) is correct.
The CEO and CFO must include a statement in the annual report to the effect that the system of internal control has been assessed by an independent public accounting firm that is registered with the PCAOB.
(1.2.29)

13

Internal controls are likely to fail for any of the following reasons, except
A. They are not designed and implemented properly at the outset.
B. They are designed and implemented properly, and their design changes as processes change.
C. They are designed and implemented properly as static controls, but the environment in which they operate changes.
D. They are designed and implemented properly, but their operation changes in some way.

B. They are designed and implemented properly, and their design changes as processes change.
Answer (B) is correct.
After the internal control is designed and implemented, the inherent design of the control will not change. Therefore, internal controls are not likely to fail because their design changes. However, internal controls may fail due to (1) established objectives not suitable for internal control, (2) failures due to human judgment and errors, (3) breakdowns and employee misunderstanding, (4) management override, (5) collusion, and (6) external events.
1.3.64)

14

Enterprise risk management (ERM) helps management achieve all of the following except
A. Preventing loss of reputation and resources.
B. Reaching objectives.
C. Complying with laws and regulations.
D. Reporting on a timely basis.

Answer (D) is correct.
Enterprise risk management (ERM) helps management

Reach objectives
Prevent loss of reputation and resources
Report effectively
Comply with laws and regulations

ERM allows management to report effectively, not necessarily on a timely basis
(1.4.70)

15

Which of the following corporate actions is subject to shareholder approval?

A. Declaration of cash dividends.
B. Election of officers.
C. Removal of directors.
D. Removal of officers.

C. Removal of directors.
Answer (C) is correct.
A corporation is governed by shareholders (owners) who elect the directors on the corporation’s board and who approve fundamental changes in the corporate structure. Directors establish corporate policies and elect or appoint corporate officers who carry out the policies in the day-to-day management of the organization. In most states, the shareholders may by a majority vote remove, with or without cause, any director or the entire board.
(1.1.7)

16

A corporate director commits a breach of duty if

A. A contract is awarded by the company to an organization owned by the director.
B. An interest in property is acquired by the director without prior approval of the board.
C. The director’s action, prompted by confidential information, results in an abuse of corporate opportunity.
D. The director’s exercise of care and skill is minimal.

C. The director’s action, prompted by confidential information, results in an abuse of corporate opportunity.
Answer (C) is correct.
Corporate directors have a fiduciary duty to provide the corporation with business opportunities that come to them in their positions as directors of the corporation. A director who personally takes such a business opportunity has breached his or her duty of loyalty
(1.1.11)

17

Generally, a corporation’s articles of incorporation must include all of the following except the

A. Quorum requirements.
B. Name of each incorporator.
C. Number of authorized shares.
D. Name of the corporation’s registered agent.

A. Quorum requirements.
Answer (A) is correct.
A corporation comes into being when the articles of incorporation are filed with the secretary of state of the relevant state. The articles ordinarily must include the following: the corporation’s name; number of authorized shares of stock; address of initial registered office; name of the registered agent at that office; and the name and address of each incorporator
(1.1.4)

18

According to COSO, an effective approach to monitoring internal control involves each of the following steps, except

A. Establishing a foundation for monitoring.
B. Assessing and reporting the results, including following up on corrective action where necessary.
C. Increasing the reliability of financial reporting and compliance with applicable laws and regulations.
D. Designing and executing monitoring procedures that are prioritized based on risks to achieve organizational objectives.

C. Increasing the reliability of financial reporting and compliance with applicable laws and regulations.
Answer (C) is correct.
Increasing the reliability of financial reporting and compliance with applicable laws is a reporting and a compliance objective, not a part of the three-component model for monitoring.
(1.3.56)

19

Knox, president of Quick Corp., contracted with Tine Office Supplies, Inc., to supply Quick’s stationery on customary terms and at a cost less than that charged by any other supplier. Knox later informed Quick’s board of directors that Knox was a majority shareholder in Tine. Quick’s contract with Tine is

A. Void because of Knox’s self-dealing.
B. Void because the disclosure was made after execution of the contract.
C. Valid because the contract is fair to Quick.
D. Valid because of Knox’s full disclosure.

C. Valid because the contract is fair to Quick.
Answer (C) is correct.
An officer, like a director, owes fiduciary duties of care and loyalty to the corporation and its shareholders. Knox was required to disclose fully the financial interest in the transaction to which the corporation was a party. But a transaction approved by a majority of informed, disinterested directors or shareholders or that is fair to the corporation is valid, notwithstanding a conflict of interest.
(1.1.12)

20

Inherent risk is

A. A potential event that will adversely affect the organization.
B. Risk response risk.
C. The risk after management takes action to reduce the impact or likelihood of an adverse event.
D. The risk when management has not taken action to reduce the impact or likelihood of an adverse event.

D. The risk when management has not taken action to reduce the impact or likelihood of an adverse event.
Answer (D) is correct.
Inherent risk is the risk when management has not taken action to reduce the impact or likelihood of an adverse event. Thus, it is risk in the absence of a risk response.
(1.4.77)

21

According to COSO, the four categories of entity objectives in the enterprise risk management framework include each of the following, except

A. Effective and efficient use of the entity’s resources.
B. Reliability of reporting.
C. Implementation of internal controls.
D. Compliance with applicable laws and regulations.

C. Implementation of internal controls.
Answer (C) is correct.
Implementation of internal control is not an objective of enterprise risk management
(1.4.87)

22

A recent inventory shortage at XYZ Corp., an unaffiliated supplier, contributed to production failures at OPS Corp. in the current period. To avoid future production failures because of supplier inventory shortages, the most appropriate method is for OPS to

A. Establish an inventory control framework at XYZ.
B. Inform XYZ about its risk appetite regarding supply failures.
C. Increase the size of orders.
D. Produce the inventory items instead of purchasing from suppliers.

B. Inform XYZ about its risk appetite regarding supply failures.
Answer (B) is correct.
The risk appetite is the level of risk that an organization is willing to accept. In an enterprise risk management (ERM) system, the risk appetite is considered in (1) evaluating strategic options, (2) setting objectives, and (3) developing risk management techniques. Thus, communicating about the risk appetite with external parties is an important aspect of risk management. It allows the organization to develop strategies to work with suppliers who may have different objectives.
(1.4.81)

23

According to COSO, the proper tone at the top helps a company to do each of the following, except

A. Create a compliance-supporting culture that is committed to enterprise risk management.
B. Navigate gray areas where no specific compliance rules or guidelines exist.
C. Adhere to fiscal budgets and goals as outlined by the internal audit committee and board of directors.
D. Promote a willingness to seek assistance and report problems before it is too late for corrective action.

C. Adhere to fiscal budgets and goals as outlined by the internal audit committee and board of directors.
Answer (C) is correct.
Through words and actions, those at the top (the board of directors and management) communicate their attitudes toward integrity and ethical values. Tone at the top does not help a company adhere to fiscal budgets and goals as outlined by the internal audit committee and board of directors. Adherence to the budget is more closely linked to control activities.
(1.3.65)

24

The policies and procedures helping to ensure that management directives are executed and actions are taken to address risks to achievement of objectives are best described as
A Control activities.
B Monitoring activities.
C Control environments.
D Risk assessments.

A Control activities.
This answer is correct.
The COSO model for internal control describes control activities as the policies and procedures helping to ensure that management directives are executed and actions are taken to address risks to achievement of objectives.
View Subunit 1.3 Outline

25


According to COSO, the use of ongoing and separate evaluations to identify and address changes in internal control effectiveness can best be accomplished in which of the following stages of the monitoring-for-change continuum?
A Control baseline.
B Control revalidation/update.
C Change identification.
D Change management.

C Change identification.
This answer is correct.
Of the four steps in the monitoring-for-change continuum described in the 2009 COSO document Guidance on Monitoring Internal Control Systems, change identification is the one in which separate and ongoing evaluations can best be accomplished.
View Subunit 1.3 Outline

26

Of the following reasons to establish internal control, which is the most comprehensive?
A Provide reasonable assurance that the objectives of the organization are achieved.
B Safeguard the resources of the organization.
C Ensure the accuracy, reliability, and timeliness of information.
D Encourage compliance with organizational objectives.

A Provide reasonable assurance that the objectives of the organization are achieved.
This answer is correct.
The COSO model broadly defines internal control as a “process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: (1) effectiveness and efficiency of operations, (2) reliability of financial reporting, and (3) compliance with applicable laws and regulations.”
View Subunit 1.3 Outline