Chapter 5

33. The most important fundamental component of an entity's internal control is

A. Reliability of financial reporting.
B. Effectiveness and efficiency of operations.
C. Compliance with applicable laws and regulations.
D. People who operate the control system

34. The primary purpose for obtaining an understanding of a nonpublic audit client's internal control is to
A. Provide the rational for the inherent risk assessment at the financial statement assertion level.
B. Determine the nature, timing, and extent of tests to be performed in the audit.
C. Provide information for a communication of internal control-related matters to management.
D. Provide a basis for making constructive suggestions in a management letter

35. Effectiveness of audit procedures would be reduced by

A. Deciding to obtain external evidence instead of internal evidence.
B. Performing procedures during the interim period as opposed to at the fiscal year-end date.
C. Selecting larger sample sizes for audit.
D. Performing audit procedures at the fiscal year-end date as opposed to the interim period

36. According to the PCAOB, during the audit of internal controls for an issuer, the ultimate objective of
testing the design effectiveness of internal controls is to
A. Determine whether the company' controls are processing company data effectively
B. Determine that the company's controls will satisfy the company's control objectives and can
effectively prevent or detect errors or fraud that could result in material misstatements, if they
operate as prescribed
C. Determine that the company's employees are processing the controls according to the policy and
procedures manuals at the company
D. None of the above

37. To test the operating effectiveness of a control, an audit team might use a combination of each of the
following tests except for:
A. Inquiry of client personnel.
B. Confirmation of balances.
C. Observation of company operations.
D. Inspection of documentation

38. Which of the following is a preventive control?

A. Detailed fluctuation analysis completed by the CFO for revenue.
B. Reconciliation of a bank account.
C. Recalculation of a sample of payroll entries by internal auditors.
D. Separation of duties between the payroll and personnel departments

39. In most audits of large entities, control risk assessment contributes to audit efficiency, which means that:
A. Auditors will be able to reduce the cost of substantive procedures by an amount more than the
control evaluation costs.
B. Auditors will be able to reduce the cost of substantive procedures by an amount less than the cost
of tests of controls.
C. The cost of control evaluation work will exceed the cost of substantive procedures.
D. The cost of substantive procedures will exceed the cost of control evaluation work.
40. Which of the following is a device designed to help the audit team obtain evidence about the accounting
and control activities of an audit client?
A. A narrative memorandum describing the control system.
B. An internal control questionnaire.
C. A flowchart of the documents and procedures used by the company.
D. All of the above.

41. Tests of controls in a GAAS audit are required for:

A. Obtaining evidence about the operating effectiveness of client control activities.
B. Obtaining evidence about the financial statement assertions.
C. Accomplishing control over the occurrence of recorded transactions.
D. Applying analytical procedures to financial statement balances.

42. A transaction-level internal control activity is best described as:

A. An action taken by auditors to obtain evidence.
B. An action taken by client personnel for the purpose of preventing, detecting, and correcting
errors and frauds in transactions to eliminate or mitigate risks identified by the company.
C. A method for recording, summarizing, and reporting financial information.
D. The functioning of the board of directors in support of its audit committee.

43. When planning the audit of internal controls for an issuer, the audit team should:
A. Identify significant accounts, locations, and assertions.
B. Conduct a walkthrough of the internal control process.
C. Make inquiries of employees regarding the existence of control activities.
D. Reperform control activities performed by client employees to determine their effectiveness.

44. A material weakness is a situation in which:

A. It is reasonably possible that an immaterial misstatement would not be detected on a timely basis.
B. It is reasonably possible that a material misstatement would not be detected on a timely basis.
C. It is probable that an immaterial financial statement misstatement would not be detected on a
timely basis.
D. There is a remote likelihood that a material misstatement would be detected on a timely basis.

45. When completing the audit of internal controls for an issuer, the severity of an internal control
deficiency depends on:
A. Whether there is a reasonable possibility that the company's controls will fail to prevent or detect
a misstatement of an account balance or disclosure.
B. Whether the account has a history of errors.
C. The magnitude of the potential misstatement resulting from the deficiency or the deficiencies.
D. Both A & C
E. All of these are correct.

46. Which of the following does not accurately summarize auditors' requirements regarding internal
control?
Public Entity Nonpublic Entity
A. Evaluating control risk: Yes Yes
B. Understanding: Yes Yes
C. Test controls: Yes Yes
D. Documenting: Yes Yes
47. When completing the audit of internal controls for a public company, the PCAOB requires auditors to
audit internal controls over
A. Operations
B. Compliance with Regulations
C. Financial reporting
D. All of the above

48. When completing the audit of internal controls for a public company, AS 5 requires auditors to report
on
Management's Report on Internal Control An Audit of Internal Control
A. Yes Yes
B. No No
C. No Yes
D. Yes No

49. When completing the audit of internal controls for a public company, AS 5 requires auditors to test:
A. Operating effectiveness only.
B. Design effectiveness only.
C. Both operating and design effectiveness.
D. Neither operating nor design effectiveness

50. Which of the following would probably not be considered an indication of a material weakness?
A. Immaterial fraud committed by senior management.
B. Overproduction by the manufacturing plant.
C. Ineffective oversight by the audit committee.
D. Evidence of a material misstatement.

51. Which report would not be appropriate for a public accounting firm to provide on financial reporting
controls?
A. Unqualified—no material weaknesses found.
B. Disclaimer of opinion—unable to perform all necessary procedures.
C. Disclaimer of opinion—significant deficiencies exist.
D. Adverse—material weaknesses exist.

52. The purpose of separating the duties of hiring personnel and distributing payroll checks is to separate
the:
A. Authorization of transactions from the custody of related assets.
B. Operational responsibility from the record-keeping responsibility.
C. Human resources function from the controllership function.
D. Administrative controls from the internal accounting controls.

53. Which of the following statements is not true with respect to the auditors' report on internal control over
financial reporting?
A. The report will be dated as of the date of the financial statements.
B. The report will express an opinion on the effectiveness of internal control over financial
reporting.
C. The auditor will issue an adverse opinion if one or more material weaknesses exist.
D. The report may be presented with the report on the entity's financial statements as a combined
report.
54. If the auditors encounter a significant scope limitation in evaluating a public company's internal control
over financial reporting, which of the following types of opinions on the effectiveness of the company's
internal control over financial reporting would be appropriate?
A. Unqualified opinion or adverse opinion.
B. Qualified opinion or adverse opinion.
C. Unqualified opinion or disclaimer of opinion.
D. Disclaimer of opinion.

55. Which of the following information would be included in the introductory paragraph of the auditors'
report on internal control over financial reporting if the report is presented separately from the auditors'
report on the entity's financial statements?
A. A reference to the auditors' report and opinion on the entity's financial statements.
B. The fact that the auditors conducted an audit of the entity's financial statements.
C. Statements identifying the responsibility of the auditors and management for internal control
over financial reporting.
D. The definition of a material weakness in internal control over financial reporting.

56. If the auditor plans to assess control risk at less than the maximum and rely on controls, and the nature,
timing, and extent of further audit procedures are based on that lower assessment, the auditor must
A. Obtain evidence that the controls selected for testing are designed effectively and operated
effectively during the entire period of reliance.
B. Assess control risk at less than the maximum for all relevant assertions.
C. Perform only substantive procedures.
D. Provide additional examples of responses to assessed fraud risks relating to fraudulent financial
reporting.

57. When testing a control activity's operating effectiveness, procedures the auditor performs to test
operating effectiveness would likely include
A. Inquiry of appropriate personnel
B. Reading over the company's code of conduct
C. Reperformance of the control activity
D. Both A and C are correct

58. Matters that could affect the necessary extent of testing for a control activity as it related to the degree of
auditor reliance on a control activity would not include the following:
A. The frequency of the performance of the control by the company during the period being audited.
B. The length of time that the auditor is planning to rely on the operating efficiency of the control
activity.
C. The expected rate of deviation for a control activity.
D. The relevance and reliability of the audit evidence to be obtained to test the operating
effectiveness of a control activity

59. The auditor should assess control risk for each relevant assertion by evaluating the evidence obtained
from all sources, including:
A. The auditor's testing of controls for the audit of internal control on a public company.
B. Misstatements detected during the financial statement audit.
C. Any control deficiencies identified during the audit.
D. All of the above.
60. Once the auditor detects a control deficiency, which of the following steps must he or she take first?
A. Test the deficient control, assuming a maximum level of risk.
B. Evaluate the severity of the deficiency on the auditor's control risk assessment for that assertion.
C. Modify the planned substantive procedures as a result of the deficiency.
D. Perform tests of other controls related to the same assertion as the control deemed ineffective.