53.

The director of internal auditing for a large retail

organization reports to the controller and is
responsible for designing and installing computer
applications relating to inventory control. Which of
the following is the major limitation of this
arrangement?
a. It prevents the audit organization from devoting
full time to auditing.
b. Auditors generally do not have the required
expertise to design and implement such systems.
c. It potentially affects the director's independence
and thereby lessens the value of audit services.
d. Such arrangements are unlawful because the
director participates in incompatible functions.
ANSWER: C
54. An internal auditor is examining inventory
control in a merchandising division with annual
sales of $3,000,000 and a 40 percent gross profit
rate. Tests show that 2 percent of the dollar amount
of purchases do not get into inventory due to
breakage and employee theft. Adding certain
controls costing $35,000 annually could reduce
these losses to .5 percent of purchases. Should the
control be recommended?
a. Yes, because the projected savings exceed the
cost of the added controls.
b. No, because the cost of the added controls
exceeds the projected savings.
c. Yes, because the ideal system of internal control
is the most extensive one.
d. Yes, regardless of cost-benefit considerations,
because the situation involves employee theft.
ANSWER: B
COMPLETION:

55. An overriding factor contributing to internal

control effectiveness is toward internal control.
ANSWER: MANAGEMENT ATTITUDE
56. A chart of accounts, accounting manuals, and
standard journal entries promote proper of
transactions.
ANSWER: RECORDING

57. Evidence of proper approval, review, and

recording of transactions is provided by a welldocumented .
ANSWER: AUDIT TRAIL
58. Limited access controls and accountability
controls are subsets of .
ANSWER: SAFEGUARD CONTROLS
59. The independent auditor is interested only in
those aspects of control that affect the .
ANSWER: FINANCIAL STATEMENTS
60. An effective system of budgeting, standard
costs, and performance reporting should highlight
significant variances caused by failure to record
transactions. This set of controls, therefore, assists
in detecting material errors of.
ANSWER: OMISSION
61. To the extent the assertion of is met, errors of
omission are minimized.
ANSWER: COMPLETENESS
61. To assure proper control in a small business, the
necessary approval and review procedures should
be performed by the.
ANSWER: OWNER/MANAGER

MATCHING:
63. Indicate by letter the internal control that best
describes each of the listed control procedures.
a. Accuracy control--prevention
b. Accuracy control--detection
c. Safeguard control--prevention
d. Safeguard control--detection
____1. All incoming checks are restrictively
endorsed immediately upon receipt
____2. Accounting manuals are used to determine
debit and credit accounts for nonrecurring
transactions
____3. Bank accounts are reconciled monthly by
persons not having access to either financial assets
or accounting records

____4. Newly-hired accounting personnel undergo

rigorous training before assuming responsibility for
transaction processing
____5. Members of the internal audit staff perform
a monthly review of all non routine journal entries
____6. All cash receipts are prelisted and deposited
intact daily
____7. A member of the controllers staff compares
the receipted bank deposit ticket with the cash
prelisting
____8. A set of standard journal entries is used to
record such monthly journal entries as depreciation,
amortization, accrued payroll, accrued interest, and
bad debts expense
____9. All revenue and expense budget variances in
excess of predetermined levels are investigated for
cause on a monthly basis
____10. Before signing checks, the treasurer
reviews all documentation
SOLUTION:
1. c
2. a
3. d
4. a
5. b
6. c
7. d
8. a
9. b
10. b

PROBLEM/ESSAY:
64. An important component of internal control
monitoring is the periodic examination of substance
and comparison with its recorded accountability.
Give three examples of this form of monitoring and,
for each example, identify the account and the
underlying substance.

Account: general ledger cash account

3. Agree accounts receivable subsidiary ledger with
control, mail statements to customers, and clear all
exceptions reported by customers
Substance: customer responses to statements
Account: accounts receivable subsidiary ledger and
control account
4. Count cash in cash register (substance) and
compare with locked-in tape (account)
5. Compare brokers monthly statement (substance)
with investment ledger (account)
6. Compare vendors statements (substance) with
accounts payable ledger (account)
7. Compare receipted bank deposit slip (substance)
with cash receipts entry and prelisting (account)
8. Inspect plant assets (substance) and compare
with plant assets ledger (account)
65. Asset safeguard controls may be classified as
access controls and accountability controls. Give
two examples of each.

SOLUTION:
Access controls:
1. Secure areas for merchandise, small tools,
supplies, securities, etc.
2. Cash registers with locked-in tapes
3. Limited access to unused documents
4. Daily intact deposits of cash receipts
5. System of passwords to limit access to computer
data bases
6. Dual access to negotiable securities
Accountability controls:

SOLUTION:
1. Compare inventories (substance) with perpetual
inventory records (account)
2. Reconcile bank accounts
Substance: bank statements

1. Fixing responsibility over prenumbered

documents
2. Periodic accounting for numeric sequence of
used documents

3. Establishing imprest funds for petty cash and

fixing responsibility for custodianship
4. Bonding of employees in positions of trust

66. For each of the cases described below, identify

the principal control activities that would have
prevented or detected the misstatement.
1. The shipping clerk of Duvinski Enterprises was
able to remove goods from the companys
warehouse by fabricating shipping orders and bills
of lading. An accomplice with a trucking company
was able to pick up the goods during normal
business hours and transport them to warehouse
space rented by the duo. The fraud was detected
when the one of the trucking company dispatchers
discovered that the truck was being used for
unscheduled runs. Further investigation by the firm
revealed the delivery destination, whereupon the
driver confessed to the thefts.

2. In conducting the annual audit for Bevis Rod and

Reel, Inc., the auditors noted that several monthly
and year-end adjustments had not been recorded
by the company. Among the omissions were
depreciation, interest accruals, and employer
payroll taxes.

3. Although the auditors, by drafting the necessary

audit adjustments, provide reasonable assurance as
to the fairness of the annual financial statements,
Comptronix Exploration and Development
Companys monthly statements frequently
contained material errors due to improper
recording of unique and often complex
transactions.

4. Unrecorded customer remittances were

misappropriated by an accounts receivable clerk.
The affected accounts were reduced by a
combination of fictitious sales returns, inflated sales
discounts, and write-off of the overstated balances
to the allowance for doubtful accounts.
SOLUTION:

1. Use of prenumbered documents, restricted

access to unused documents, fixing of responsibility
over document custody, and periodic accounting
for, and cancellation of, used documents would
have prevented the clerk from gaining access to the
documents and using them to effect the fraudulent
transfer. Also, as part of the accounting for used
documents, shipping orders and bills of lading
should be matched with sales invoices to determine
that all shipments have been billed to customers. In
the present case, the shipments were never billed.
2. A set of standard journal entries for all recurring
adjustments would have ensured proper recording
of monthly depreciation, interest, and payroll taxes.
Monthly review of the general ledger trial balance
by responsible accounting personnel provides
further assurance that both recurring and
nonrecurring adjustments are not overlooked.

3. A detailed chart of accounts and accounting

manuals describing the various accounts and
related transactions, together with adequate hiring
and training policies for accounting personnel,
should provide reasonable assurance of correct
recording of non routine transactions.
4. Proper separation of duties should have
prevented the accounts receivable clerk from
having access to customer remittances. Customer
accounts should be posted from cash prelistings and
remittance advices--not from the checks
themselves. Also, effective internal control should
require proper approval of all accounts receivable
write-offs. Finally, sales returns should be
supported by proper documentation, including
receiving reports evidencing receipt of the returned
goods.