Auditing and Assurance Services, 16e (Arens/Elder/Beasley)
Chapter 11 Internal Control and COSO Framework
11.1 Learning Objective 11-1
1) Which of the following is not one of the three primary objectives of effective internal control?
A) reliability of financial reporting
B) efficiency and effectiveness of operations
C) compliance with laws and regulations
D) assurance of elimination of business risk
2) With which of management’s assertions with respect to implementing internal controls is the
auditor primarily concerned?
A) efficiency of operations
B) reliability of financial reporting
C) effectiveness of operations
D) compliance with applicable laws and regulations
3) Internal controls
A) are implemented by and are the responsibility of the auditors.
B) consist of policies and procedures designed to provide reasonable assurance that the company
achieves its objectives and goals.
C) guarantee that the company complies with all laws and regulations.
D) only apply to SEC companies.
4) Internal controls are not designed to provide reasonable assurance that
A) all frauds will be detected.
B) transactions are executed in accordance with management’s authorization.
C) the company’s resources are used efficiently and effectively.
D) company personnel comply with applicable rules and regulations.
5) Describe each of the three broad objectives management typically has for internal control.
With which of these objectives is the auditor primarily concerned?
6) Section 404 of the Sarbanes-Oxley Act requires that both private and public companies issue
an internal control report.
7) Management has a legal and professional responsibility to be sure that the financial statements
are prepared in accordance with reporting requirements of applicable accounting frameworks.
11.2 Learning Objective 11-2
1) Who is responsible for establishing a private company’s internal control?
A) senior management
B) internal auditors
C) FASB
D) audit committee
2) Two key concepts that underlie management’s design and implementation of internal control
are
A) costs and materiality.
B) absolute assurance and costs.
C) inherent limitations and reasonable assurance.
D) collusion and materiality.
3) The PCAOB places responsibility for the reliability of internal controls over the financial
reporting process on
A) the company’s board of directors.
B) the audit committee of the board of directors.
C) management.
D) the CFO and the independent auditors.
4) Which of the following parties provides an assessment of the effectiveness of internal control
over financial reporting for public companies?
A)
Management
Financial statement auditors
Yes
Yes
B)
Management
Financial statement auditors
No
No
C)
Management
Financial statement auditors
Yes
No
D)
Management
Financial statement auditors
No
Yes
5) An act of two or more employees to steal assets and cover their theft by misstating the
accounting records would be referred to as
A) collusion.
B) a material weakness.
C) a control deficiency.
D) a significant deficiency.
6) Sarbanes-Oxley requires management to issue an internal control report that includes two
specific items. Which of the following is one of these two requirements?
A) a statement that management is responsible for establishing and maintaining an adequate
internal control structure and procedures for financial reporting
B) a statement that management and the board of directors are jointly responsible for establishing
and maintaining an adequate internal control structure and procedures for financial reporting
C) a statement that management, the board of directors, and the external auditors are jointly
responsible for establishing and maintaining an adequate internal control structure and
procedures for financial reporting
D) a statement that the external auditors are solely responsible for establishing and maintaining
an adequate system of internal control
7) When management is evaluating the design of internal control, management evaluates
whether the control can do which of the following?
A)
Detect material
misstatements
Correct material
misstatements
Yes
Yes
B)
Detect material
misstatements
Correct material
misstatements
No
No
C)
Detect material
misstatements
Correct material
misstatements
Yes
No
D)
Detect material
misstatements
Correct material
misstatements
No
Yes
8) When one material weakness is present at the end of the year, management of a public
company must conclude that internal control over financial reporting is
A) insufficient.
B) inadequate.
C) ineffective.
D) inefficient.
9) The auditors primary purpose in auditing the client’s system of internal control over financial
reporting is
A) to prevent fraudulent financial statements from being issued to the public.
B) to evaluate the effectiveness of the company’s internal controls over all relevant assertions in
the financial statements.
C) to report to management that the internal controls are effective in preventing misstatements
from appearing on the financial statements.
D) to efficiently conduct the Audit of Financial Statements.
10) The internal control framework used by most U.S. companies is the ________ framework.
A) FASB
B) PCAOB
C) COSO
D) SEC
11) In performing the audit of internal control over financial reporting, the auditor emphasizes
internal control over classes of transactions because
A) the accuracy of accounting system outputs depends heavily on the accuracy of inputs and
processing.
B) the class of transaction is where most fraud schemes occur.
C) account balances are less important to the auditor then the changes in the account balances.
D) classes of transactions tests are the most efficient manner to compensate for inherent risk.
12) Internal controls can never be regarded as completely effective. Even if company personnel
could design an ideal system, its effectiveness depends on the
A) adequacy of the computer system.
B) proper implementation by management.
C) ability of the internal audit staff to maintain it.
D) competency and dependability of the people using it.
13) When considering internal controls,
A) auditors can ignore controls affecting internal management information.
B) auditors are concerned with the client’s internal controls over the safeguarding of assets if
they affect the financial statements.
C) management is responsible for understanding and testing internal control over financial
reporting.
D) companies must use the COSO framework to establish internal controls.
14) Of the following statements about internal controls, which one is least likely to be correct?
A) No one person should be responsible for the custodial responsibility and the recording
responsibility for an asset.
B) Transactions must be properly authorized before such transactions are processed.
C) Because of the cost-benefit relationship, a client may apply controls on a test basis.
D) Control procedures reasonably ensure that collusion among employees cannot occur.
15) The Sarbanes-Oxley Act requires
A) all public companies to issue reports on internal controls.
B) all public companies to define adequate internal controls.
C) the auditor of public companies to design effective internal controls.
D) the auditor of public companies to withdraw from an engagement if internal controls are
weak.
16) Which of the following is an accurate statement regarding the auditor’s responsibility for
understanding internal control?
A) Transaction-related audit objectives typically have no impact on the rights and obligations
objectives.
B) Transaction-related audit objectives typically have a significant impact on the balance-related
audit objective of realizable value.
C) Auditors generally emphasize internal control over account balances rather than classes of
transactions.
D) Auditors and management are both equally concerned about controls that affect the efficiency
and effectiveness of company operations.
17) The primary emphasis by auditors is on controls over
A) classes of transactions.
B) account balances.
C) both A and B, because they are equally important.
D) both A and B, because they vary from client to client.
18) An auditor should consider two key issues when obtaining an understanding of a client’s
internal controls. These issues are
A) the effectiveness and efficiency of the controls.
B) the frequency and effectiveness of the controls.
C) the design and operating effectiveness of the controls.
D) the implementation and operating effectiveness of the controls.
19) Reasonable assurance allows for
A) low likelihood that material misstatements will not be prevented or detected by internal
controls.
B) no likelihood that material misstatements will not be prevented or detected by internal
control.
C) moderate likelihood that material misstatements will not be prevented or detected by internal
control.
D) high likelihood that material misstatements will not be prevented or detected by internal
control.
20) Which of the following is most correct regarding the requirements under Section 404 of the
Sarbanes-Oxley Act?
A) The audits of internal control and the financial statements provide reasonable assurance as to
misstatements.
B) The audit of internal control provides absolute assurance of misstatement.
C) The audit of financial statements provides absolute assurance of misstatement.
D) The audits of internal control and the financial statements provide absolute assurance as to
misstatements.
21) Under the Dodd-Frank federal financial reform legislation, all public companies are required
to obtain an audit report on internal control over financial reporting.
22) When a company designs and implements internal controls, cost of the controls is not a valid
consideration.
11.3 Learning Objective 11-3
1) Which of the following activities would be least likely to strengthen a company’s internal
control?
A) separating accounting from other financial operations
B) maintaining insurance for fire and theft
C) fixing responsibility for the performance of employee duties
D) carefully selecting and training employees
2) Which of the following components of the control environment define the existing lines of
responsibility and authority?
A) organizational structure
B) management philosophy and operating style
C) human resource policies and practices
D) management integrity and ethical values
3) Which of the following factors may increase risks to an organization?
A)
Geographic dispersion of
company operations
Presence of new information
technologies
Yes
Yes
B)
Geographic dispersion of
company operations
Presence of new information
technologies
No
No
C)
Geographic dispersion of
company operations
Presence of new information
technologies
Yes
No
D)
Geographic dispersion of
company operations
Presence of new information
technologies
No
Yes
4) Which of the following statements is most correct with respect to separation of duties?
A) A person who has temporary or permanent custody of an asset should account for that asset.
B) Employees who authorize transactions should not have custody of related assets.
C) Employees who open cash receipts should record the amounts in the subsidiary ledgers.
D) Employees who authorize transactions should have recording responsibility for these
transactions.
5) Authorizations can be either general or specific. Which of the following is not an example of
a general authorization?
A) automatic reorder points for raw materials inventory
B) a sales manager’s authorization for a sales return
C) credit limits for various classes of customers
D) a sales price list for merchandise
6) Which of the following is correct with respect to the design and use of business documents?
A) The documents should be in paper format.
B) Documents should be designed for a single purpose to avoid confusion in their use.
C) Documents should be designed to be understandable only by those who use them.
D) Documents should be prenumbered consecutively to facilitate control over missing
documents.
7) Which of the following best describes the purpose of control activities?
A) the actions, policies and procedures that reflect the overall attitudes of management
B) the identification and analysis of risks relevant to the preparation of financial statements
C) the policies and procedures that help ensure that necessary actions are taken to address risks
to the achievement of the entity’s objectives
D) activities that deal with the ongoing assessment of the quality of internal control by
management
8) Which of the following deals with ongoing or periodic assessment of the quality of internal
control by management?
A) verifying activities
B) monitoring activities
C) oversight activities
D) management activities
9) Which of the following best describes an entity’s accounting information and communication
system?
A)
Monitor
transactions
Record and
process
transactions
Initiate transactions
Yes
Yes
Yes
B)
Monitor
transactions
Record and
process
transactions
Initiate transactions
No
No
No
C)
Monitor
transactions
Record and
process
transactions
Initiate transactions
Yes
No
No
D)
Monitor
transactions
Record and
process
transactions
Initiate transactions
No
Yes
Yes
10) Which of the following is a risk assessment principle?
A) accountability
B) use relevant, quality information to support the functioning of internal controls
C) consider the potential for fraud
D) develop general controls over technology
11) Which of the following is not an underlying principle related to risk assessment?
A) The organization should have clear objectives in order to be able to identify and assess the
risks relating to the objectives.
B) The auditors should determine how the company’s risks should be managed.
C) The organization should consider the potential for fraudulent behavior.
D) The organization should monitor changes that could impact internal controls.
12) Which of the following is not one of the subcomponents of the control environment?
A) management’s philosophy and operating style
B) organizational structure
C) adequate separation of duties
D) commitment to competence
13) It is important for the CPA to consider the competence of the clients’ personnel because their
competence has a direct impact upon the
A) cost/benefit relationship of the system of internal control.
B) achievement of the objectives of internal control.
C) comparison of recorded accountability with assets.
D) timing of the tests to be performed.
14) Proper segregation of functional responsibilities calls for separation of
A) authorization, execution, and payment.
B) authorization, recording, and custody.
C) custody, execution, and reporting.
D) authorization, payment, and recording.
15) Without an effective ________, the other components of the COSO framework are unlikely
to result in effective internal control, regardless of their quality.
A) risk assessment policy
B) monitoring policy
C) control environment
D) system of control activities
16) Which of the following is an accurate statement regarding control activities?
A) As the level of complexity of IT systems increases, the separation of duties often becomes
blurred.
B) Segregation of duties would be violated if the same person authorizes the payment of a
vendor’s invoice and also approves the disbursement of funds to pay the bill.
C) The most important type of protective measure for safeguarding assets and records is the us of
physical precautions.
D) all of the above
17) If a company has an effective internal audit department,
A) the internal auditors can express an opinion on the fairness of the financial statements.
B) their work cannot be used by the external auditors per PCAOB Standard 5.
C) it can reduce external audit costs by providing direct assistance to the external auditors.
D) the internal auditors must be CPAs in order for the external auditors to rely on their work.
18) To promote operational efficiency, the internal audit department would ideally report to
A) line management.
B) the PCAOB.
C) the Chief Accounting Officer.
D) the audit committee.
19) Hanlon Corp. maintains a large internal audit staff that reports directly to the accounting
department. Audit reports prepared by the internal auditors indicate that the system is functioning
as it should and that the accounting records are reliable. An independent auditor will probably
A) eliminate tests of controls.
B) increase the depth of the study and evaluation of administrative controls.
C) avoid duplicating the work performed by the internal audit staff.
D) place limited reliance on the work performed by the internal audit staff.
20) External financial statement auditors must obtain evidence regarding what attributes of an
internal audit (IA) department if the external auditors intend to rely on IA’s work?
A) integrity
B) objectivity
C) competence
D) all of the above
21) To obtain an understanding of an entity’s control environment, an auditor should concentrate
on the substance of management’s policies and procedures rather than their form because
A) management may establish appropriate policies and procedures but not act on them.
B) the board of directors may not be aware of management’s attitude toward the control
environment.
C) the auditor may believe that the policies and procedures are inappropriate for that particular
entity.
D) the policies and procedures may be so weak that no reliance is contemplated by the auditor.
22) The ________ is helpful in preventing classification errors if it accurately describes which
type of transaction should be in each account.
A) general ledger
B) general journal
C) trial balance
D) chart of accounts
23) Control activities help assure that the necessary actions are taken to address risks to the
achievement of the company’s objectives. List the five types of control activities.
24) Certain principles dictate the proper design and use of documents and records. Briefly
describe several of these principles.
25) Management’s identification and analysis of risk is an ongoing process and is a critical
component of effective internal control. An important first step is for management to identify
factors that may increase risk. Identify at least five factors, observable by management, which
may lead to increased risk in a typical business organization.
26) Separation of duties is essential in preventing errors and intentional misstatements on the
financial statements. List below the four general guidelines.
27) The internal control framework developed by COSO includes five so-called “components” of
internal control. Discuss each of these five components.
28) Discuss what is meant by the term “control environment” and identify four control
environment subcomponents that the auditor should consider.
29) List the four underlying principles of risk assessment per the COSO framework