Roque Quick Auditing Theory Chapter 5 PDF

251
CHAPTER 5
Risk Assessments
and Internal Control
1. PSA 315 (Identifying and Assessing the Risks of Material

Misstatement through Understanding the Entity and its Envi-
ronment) requires the auditor to perform risk assessment
procedures at
A. The financial statement level only.
B. The assertion level only.
C. "fl1e financial statement level and the assertion level for
classes of transactions, account balances and disclo-
sures.
D. Either the financial statement or assertion level.
Risk assessment procedures are performed to obtain an un-

derstanding c;>f the entity and its envjronment, including the
entity's internal control, to identify and assess the risks of
material misstatement, whether due to fraud or error, at the
financial statement and assertion levels.
252 CPA EXAMINATION REVIEWER: AUDITING THEORY
2. The auditor's risk assessment procedures should always in-

clude the following, except . . .
A. Inquiries of management and of others within the entity.
B. Analytical procedures.
c. Observation and inspection.
o. Substantive test procedures
.
and tests of.controls.
The auditor's risk assessment procedures shall include:

1. Inquiries of management and of others within the
entity who, in the auditor's judgment, may have in-
formation that is likely to assist in identifying risks of
material misstatement due to fraud or error.
2. Analytical procedures.
3. Observation and inspection.
Substantive test procedures are audit procedures de-

signed to detect material misstatements at the assertion
level. Tests of controls are audit procedures designed to
evaluate the effectiveness of controls in preventing, or de-
tecting and correcting,' material misstatements at the asser-
tion level.
3. The auditor's risk assessment procedures

A. By th~mselves, do not provide sufficient appropriate au-
dit evidence on which to base the audit opinion.
B. Should n~t consider information obtained from the audi-
tor's pn~v1ous experience with the entity. .
C. Are .designed to detect material misstatements at the as-
sertio~ level for classes of transactions/ account balances
and disclosures.
D. Are designed to test th " . , n-
t roIs. e e. •ectiveness of the entity s c0
CHAPTER 5 Risk Assessments and Internal Control 253
4. The auditor should obtain an understanding of the entity's

objectives and strategies, and those business risks that may
result in risks of material misstatement. Which of the follow-
ing statements concerning the entity's business risk is incor-
rect?
A. Business risk is broader than the risk of material mis-
statement of the financial statements, though it includes
the latter.
B. An understanding of the business risks facing the entity
increases the likelihood of identifying risks of material
misstatement.
C. The auditor has a responsibility to identify or assess all
business risks.
D. Business risk may arise from the development of new
products or services that may fail.
As defined in PSA 315. business risk is "a risk resulting

from significant conditions, events, circumstances, actions
or inactions that could adversely affect an entity's ability to
achieve its objectives and execute its strategies, or from the
setting of inappropriate objectives and strategies."
The auditor does not have a responsibility to identiiy or as-

sess all business risks facing the entity because not all busi-
ness risks give rise to risks of 1!1aterial misstatement.
S. The risk that the auditor may give an inappropriate opinion

when the financial statements are materially misstated is
called
A. Detection risk
B. Business risk
C. Audit risk
D. Inherent risk
6. Audit risk has three components: inherent risk, control risk,

and detection risk. Which is correct?
A. Detection risk is a function of the efficiency of an audit-
ing procedure.
B. Cash is more susceptible to theft than an inventory of
coal because it has a greater inherent risk.
C. The risk that material misstatements will not be prevent-
ed or detected on a timely basis by internal control can .
be reduced to zero by effective controls.
D. The existing levels of inherent risk, control risk, and de- l
tection risk can be changed at the discretion of the audi- r
~~ ~
The three components of audit risk are:
1. "Inherent risk" is the susceptibility of an account

balance or class of transactions to misstatement that
could be material, individually or when aggregated ·
with misstatements in other balances or classes, as-
suming that there were no related internal controls. t
1.
2. "Control risk" is the risk that a misstatement that !

c.ould occur in an account balance or class of transac- . ·
t1ons that could be material individually or when ·
I . I I
aggregated with other misstatements in other ba - r
ances or classes, will not be prevented, or detec~ed f ·
and corrected, on a timely basis, by the accounting
and internal control systems.
r.
r
3. "Detection risk" is the risk that an auditor's sub- r.
stantive procedures will not detect a misstatement~
t~at exists in an account balance or class of transac- ~
tions that could be material, individually or when r·
f
i
CHAPTER 5 Risk Asses~ments and Internal Control 2ss·
aggregated with misstatements in other balances or

classes.
Cash has a greater inherent risk than an inventory of coal.
Answer A is incorrect because detection risk is a function of

the effectiveness of an auditing procedure, not its efficiency.
Answer C is incorrect because even the most effective inter-

nal control has inherent limitations. Thus, control risk can-
not be reduced to zero.
Answer D is incorrect because inherent risk and control risk

exist independently of the audit and, therefore, cannot be
changed at the discretion of the auditor.
The acceptable level of detection risk is a function of the de-

sired level of overall audit risk and the assessed levels of in-
herent risk and control risk. Hence, detection risk can be
changed at the discretion of the auditor. However, it·should
be emphasized that the auditor's preliminary assessments
of inherent risk and control risk may change as the audit
work continues.
7. The risk that an auditor's substantive procedures will lead to

the conclusion that a material misstatement does not exist in
an account balance or transaction class when, in fact, such
misstatement does exist is
A. Control risk
B. Inherent risk
C. Audit risk
D. Detection risk
8. The existence of audit risk is recognized by the statement in

the auditor's report that the
A. Financial statements are presented fairly, in all material
respects, in accordance with Philippine Financial Report-
ing Standards.
B. Audit includes examining, on a test basis, evidence sup-
porting the amounts and disclosures in the financial
statements.
C. Auditor obtains reasonable assurance about whether the
financial statements are free of material misstatement.
D. Auditor is responsible for expressing an opinion on the
financial statements, which are management's responsi·
bility.
An audit conducted in accordance with PSAs provides only

reasonable, not absolute, assurance that the financial state·
ments are free of material misstatement, whether caused by
error or fraud.
9. Which of the following audit risk components may be as·

sessed in quantitative terms?
Inherent Risk Control Risk Detection Ri£s
A. Yes No Yes
B. Yes Yes Yes
c. No No No
D. No No Yes
Audit risk and its components may be assessed in quantita·

tive or non-quantitative terms.
10. Some account balances, such as those for retirement ~:~:.

~ts and finance leases, are the results of complex .ca h~
t1ons. The susceptibility to material misstatements rn t
types of accounts is referred to as
A. Audit risk
B. Detection risk
C. Inherent risk
D. Control risk
Inherent risk, which is the susceptibility of an assertion to

material misstatement in the absence of related controls, ex-
ists independently of the audit. Some assertions and related
account balances and classes of transactions have greater
level of inherent risk than others. For example, account bal-
ances resulting from complex calculations such as those for
retirement benefits and finance leases have a higher risk of
misstatement.
11. There is an inverse relationship that exists between the ac-

ceptable level of detection risk and the
A. Risk of failing to discover material misstatements.
B. Assurance provided by substantive tests.
C. Preliminary judgments about materiality levels.
D. Risk of misapplying audit procedures.
An auditor assesses control risk by considering internal con-

trol. There exists a.n inverse relationship between control
risk and detection ri.s k-that is, the greater (lower) the as-
sessed level of control risk, the lower (greater) the accepta-
ble level of detection risk.
The acceptable level of detection risk affects substantive

testing. As the acceptable level of detection risk decreases,
the auditor changes the nature, timing, and extent of sub-
stantive tests to increase tbe assurance they provide.
Therefore, there is an inverse relationship between the ac-
ceptable level of detection risk and substantive testing.
.258 CPA EXAMINATION REVIEWER: AUDITING THEO.RY
12. Which of the following statements concerning audit risk and

its components is incorrect?
A. Regardless of the assessed levels of inherent and control
risks, the auditor should always perform some substan-
tive procedures for material account balances and clas-
ses of transactions.
B. The higher the assessment of inherent and control risks,
the more evidence the auditor should obtain from the
performance of substantive procedures.
C. The assessed level of inherent risk need not be consid-
ered in determining the nature, timing, and extent of
substantive procedures required to reduce audit risk to
an acceptably low level. .
D. After obtaining .an understanding of the accounting and
internal control systems, the auditor should make a pre-
liminary assessment of control risk, at the assertion lev·
el, for each material account balance or class of transac·
tions.
According to the standard, the auditor should consider the

assessed levels of inherent and control risks in determi11ing
the nature, timing, and extent of substantive procedures re·
quired to reduce audit risk to an acceptable level.
13. Because the concepts of audit risk and materiality are i~~~~~
related, they must be considered together by the audi
Which of the following statements is correct? . all
A. The P.hrase in the. auditor's report "pres~nt. fairly, ~dal
1
material respects, m accordance with Philippine ~na that

Reporting Standards" indicates the auditor's belief ate·
the financial statements taken as a whole are not Jl'I
rially misstated. t are
B. If misstatements are not individually material, bU we
material when aggregated with other misstatements,
concept of materiality does not apply.
· CHAPTER 5 Risk Assessments and Internal Control
259
C. Audit risk is the risk that an auditor may unknowingly

modify his/her opinion when, in fact, the financial state-
ments are fairly presented.
D. Only material errors cause financial statements to be ma-
terially misstated.
· The opinion paragraph of the auditor's report explicitly re-

fers to materiality. By stating that the financial statements
are presented fairly, in all material respects, in accordance
with an applicable financial reporting framework, the audi-
tor is of the opinion that the financial statements are not
materially misstated.
Answer B is incorrect be·cause the concept of materiality

recognizes that some misstatements, either ind.ividually or
when aggregated with other misstatements, are important
for 't he fair presentation of financial statements.
Answer C is incorrec~ because audit risk is the probability

that an auditor may give an inappropriate opinion when the
financial statements are materially misstated.
Answer D is incorrect because material misstatements can

result from errors or fraud.
14. The statements below describe the interrelationship of audit

risk components. Which is false?
A. There is an inverse relationship between detection risk
and the combined level of inherent and control risks.
B. When inherent and control risks are high, the acceptable
level of detection risk needs to be low to reduce audit
risk to an acceptably low level.
C. When inherent and control risks are low, an auditor can

accept a higher detection risk and still reduce audit risk
to an acceptably low level.
D. The assessed level of inherent and control risks can be
sufficiently low to eliminate the need for the auditor to
perform any substantive procedures.
The standard states that regardless of the assessed levels of

inherent and control risks, the auditor should perform some
substantive procedures for material account balances and
classes of transactions.
15. Based on audit evidence gathered and evaluated, an auditor

decides to increase the assessed level of control risk from
that originally planned. To achieve an overall audit risk level
that is substantially the same as the planned audit risk level,
the auditor would
A) Increase materiality levels.
B) Decrease detection risk.
C) Decrease substantive testing.
D) Increase inherent risk.
16. A basic premise underlying analytical procedures is that

A. Plausible relationships among data may reasonably be
expected to exist and continue in the absence of known
conditions to the contrary. · . of
B. These procedures cannot replace tests of details
transactions and balances. ttie
C. Statistical tests of financial information may lead to ·al
detection of material misstatements in the financt
statements. ..,e
· atJ'
D. The st~dy o~ financial ratios is an acceptable alterfl
to the investigation of unusual fluctuations.
,
"Analytical procedures" as defined in the standard means

evaluations of financial information made by a study of
plausible relationships among both financial and nonfinan-
cial data.
A basic premise underlying the application of analytical pro-

cedures is that plausible relationships among data may rea-
sonably be expet>ted to exist in the absence of known condi-
tions to the contrary.
Answer B is incorrect because for some assertions, the ap-

plication of analytical procedures alone may provide the au-
ditor with the level of assurance he/she desires.
Answer C is incorrect because the use of analytical proce-

dures (e.g., simple comparisons) does not necessarily re-
quire statistical testing.
Answer D is incorrect because analytical procedures, such

as ratio analysis, enable an auditor to identify significant dif-
ferences that should be evaluated and investigated.
17. For all audits of financial statements conducted in accord-

ance with PSAs, the use of analytical procedures is required
to some extent
8 ~ ~ D
As a risk assessment procedur.e
in the planning phase Yes Yes Yes No
As a substantive test procedure Yes No No Yes
In the overall review of the
financial statements Yes Yes No Yes
Analytical procedures are used/or the following purposes:
1. As risk assessment procedures to obtain an under-

standing of the entity and its environment.
2. As substantive tes~ procedures when their applica-

tion is, based on the auditor's judgment, more effec-
tive and efficient tha'n tests of details in reducing the
risk of material misstatement.
3. As an overall review of the financial statements at

the completion stage of the audit engagement.
18. Which of the following statements concerning analytical pro-

cedures is true?
A. Analytical procedures are more efficient, but not more
effective, than tests of details of transactions.
B. Analytical procedures used as risk assessment proce-
dures use data aggregated at a high level. .
C. Analytical procedures can replace tests of controls in
gathering audit evidence to support the assessed level of
control risk.
D. Analytical procedures usually involve comparisons of ra·
tios developed from recorded amounts with ratios devel·
oped by management.
Analytical ~rocedures . applied as risk assessment pr~:s

dures focus on enhancing the understanding of the en~J .
~us.iness, identifying unusual transactions and ~ve~ts, id::d
t1fymg areas that may represent specific audit risks,
most often use data aggregated at a high level.
Answer A is incorrect be.c ause for many assertions, tests of

details are still more effective or efficient in providing the
level of assurance desired by the auditor.
Answer C is incorrect because analytical procedures can be

used as substantive tests, not as tests of controls.
Answer D is incorrect because analytical procedures involve

comparisons of recorded amounts or ratios developed from
recorded amounts with expectations developed by the audi-
tor-not with assertion's developed by management.
19. Analytical procedures used in planning an audit should focus

on
A. Enhancing the auditor's understanding of the client's
business. '
B. Evaluating the adequacy of evidence gathered concern-
ing unusual balances.
C. Identifying significant deficiencies in internal control.
D. Testing individual account balances that depend on ac-
counting estimates.
20. An.alytical procedures performed in the

A. Planning s~age of the audit should assist in assessing the
validity of the conclusions reached.
B. Planning stage of the audit should address the risk of
material misstatement of revenue due to fraudulent fi-
nancial reporting.
C. Final review stage of the audit should achieve audit ob-
jectives related to specific assertions in the financial
statements.
D. Final review stage of the audit should focus on identify-
ing specific risks.
264 CPA EXAMINATION REVIEWER: AUDITING THl;'.ORY
21. An auditor obtains an unde~tanding of the nature of the

entity to
A. Make constructive suggestions concerning improvements
in the client's internal control.
B. Understand the account balances, transactions, and dis-
closures in the financial statements.
C. Devefop an attitude of professional skepticism concern-
ing management's financial statement assertions.
D. Evaluate whether the aggregation of known misstate-
ments causes the financial statements taken as a whole
to be materially misstated.
22. It is the process designed, implemented and maintained by '

those charged with governance, management, and other j
personnel to provide reasonable assurance about the

achievement of the entity's objectives. \
A. Internal auditing
B. Internal control
C. Business strategy
D. Accounting process
PSA 315 states that internal control is d~igned and imple-

mented to achieve the entity's objectives with regard ·to:
• Reliability of financial reporting;
• Effectiveness and efficiency of operations; and
• Compliance with applicable laws and regulations.
23. Which of the following statements concerning internal con·

trol is incorrect?
A. Internal control is effected by people. asstW
B. Internal control is expected to provide absolute
anee.
C. Internal control is a process.
cHAPTER 5 Risk Assessments and ln~emal Control 265
o. Internal control is geared to achieving objectives in the

overlapping categories of financial reporting, compliance
and operations.
24 . Tue inherent limitations in an entity's internal control system

include
I. Collusion among individuals
II. Breakdowns in established controls.
III. Mistakes in judgment.
A. I and III only C. II and III only
B. I and II only D. I, II and III
25. The procedures performed to obtain an understanding of the

internal control system provide an auditor with
A. Sufficient appropriate evidence to use in forming an
overall opinion on the entity's financial statements.
B. Enough understanding to design procedures to gather
sufficient appropriate audit evidence.
c. Enough understanding to express an opinion on the ef-
fectiveness of the ~ntity's internal control system.
D. Audit evidence to use in formjng an overall opinion on
the entity.
26. Some inherent limitations in an entity's internal control sys-

tem include
I. The possibility of management overriding the internal
control in place for illegitimate purposes.
II. Collusion among employees to conceal fraud.
III. Mistakes in judgment as the ·result of .inadequate infor- .
mation or time pressure_s.
A. I and II only C. II and III only
B. I and III only D. I, II and III
27. When considering an entity's internal control system, an au-

ditor is not required to
A. Search for significant deficiencies in the operation of the
internal control system .
.B. Understand the components of the entity's internal con-
trol system.
C. Determine whether relevant controls have been placed in 1
operation.
D. Perform procedures to understand the design of the in·
ternal control system policies.
28. The following are components of internc.11 control, except

A. Control activities
B. The entity's risk assessment process
C. Control environment
D. Business risk
The five components of internal control are:

1. The control environment.
2. The entity's risk assessment process. .
3. The information system, including the related bus~
ness processes relevant to financial reporting, an
communication.
4. Control activities.
5. Monitoring of controls.
29. An entity's internal control system contains manual elerne~~

and often contains automated elements. Manual elerne le·
in internal control may be less reliable than automated e
ments because _,,ti
aSSC"''
A. Manual control elements can be more easily bYP e to
·1~nored , or overridden and they are also more pron
simple errors and mistakes.
CHAPTER 5 Risk Assessments and Internal Control
267
B. Manual control elements facilitate the additional analysis

of information.
C. Consistency of application of manual control elements
can always be assumed.
D. Manual control elements include reliance on systems or
programs that are inaccurately processing data, pro-
cessing·inaccurate data, or both.
30. IT benefits an entity's internal control by enabling an entity

to
A. Reduce the risk that controls will be circumvented.
B. Process large, unusual or non-recurring transactions.
C. R~ly on systems or programs that are inaccurately pro-
cessing data.
D. Allow unauthorized changes to data in master files.
The use of IT allows an entity to:

• Consistently apply predefined business rules and
perform complex calculations in processing large
volumes of transactions and data;
• Enhance the timeliness, availability, and accuracy of
information;
• Facilitate the additional analysis of information;

• Enhance the ability to monitor the performance of
the entity's activities and its polici~s and procedures;
• Reduce the risk that control will be circumvented;

and
• Enhance the ability to achieve effective segregation
of duties by implementing security controls in appli-
cations, databases, and operating systems.
31. When obtaining an understanding of controls that are rele-

vant to the audit, the auditor is required to
A. Evaluate the design of those controls.
B. Determine whether those controls have been imple-
mented.
C. Evaluate the design of those controls and determine
whether they have been implemented.
D. Evaluate the design of those controls and determine
whether they have been implemented by performing
tests of controls.
PSA 315 states that when obtaining an understanding of

controls that are relevant to the audit, the auditor shall
evaluate the design of those controls and determine wheth·
er they have been implemented.
Evaluating the design of a control involves consideri~g

whether the control, individually or in combination with
other controls, is capable of effectively preventing, or de-
tecting and correcting, material misstatements. Jmple01en·
tation of a control means that the control exists and that
the entity is using it.
Risk assessment procedures to obtain an understan d'ing of

controls relevant to the audit include the following:
• Inquiring of entity personnel.
• Observing the application of specific controls.
• Inspecting documents and reports. . n syste
!Tl
• Tracing transactions through the informat io
to financial reporting.
. dit pfO'
As defined in the standard tests of controls are au 55 of
' . ene
cedures designed to evaluate the operating effectiv
controls in preventing, or ~etecting and correcting, material

misstatements at the assertion level.
32. This internal control component is the foundation for all oth-
er components. It sets the tone of the organization, pro-
vides discipline and structure, and influences the control
consciousness of employees.
B. Monitoring of controls
O. The entity's risk assessment process
PSA 315 states that the control environment includes the

governance and management functions and the attitudes,
awareness, and actions of those charged with governance
and management concerning the entity's internal control
and its importance in the entity. The control environment
sets the tone of the .. organization, influencing the control
consdousness of its people.
33. Which of the following are considered control environment

elements?
Commitment Detection Organizational
to Competence Risk Structure
A. No Yes No
B. Yes Yes Yes
C. Yes No Yes
D. No No Yes
The control environment component of internal control en-

compasses the following elements:
a) Communication and enforcement of integrity and
ethical values.
b) Commitment to competence.
~ --! ' ... ~··_...::"._..~_.. _
2'?2 CPA EXAMINATION REVIEWER: AUDITING THEORY
38.. The following are subcomponents of the control environ·

ment, except
A. Management's philosophy and operating style.
B. Adequate separation of duties.
C. · Organizational structure.
D. f:ommitment to competence.
39. The pt:Jrpose of an entity's accounting information and com·

municati0n system. is to
Record and
Monitor process Initiate
· transactions transactions transactions
A. No No No
B. Yes Yes Yes
c. Yes No No
D. No Yes Yes
40. Which of the following statements concerning physical con·

trols is incorrect? ,
A. Access to computer hardware should not be limited to
authorized personnel.
B. Physical controls limit access to assets and important
records. . av
C. In systems with online entry of data, many users m
have access through remote input devices. es to
D. Acc~ss .often extends beyond the entity's employe
qJstom~rs and .suppliers through remote terminals.
risk and
41. Inherent risk is related to detection
_,____ _ re)~~ed to tbe amount of a,u dit evidence.
A) Q!rectlyi in1vcrs~~Y ·
,BJ pirectly,.dir~ctly
q .Inve~ely,, i(l~ersely
D) Inversely, directly
A. All controls are ordinarily relevant to a financial state-

ment audit.
B. Controls over safeguarding of assets and liabilities are of
primary importance, while controls over the reliability of
financial reporting may also be relevant.
C. Controls over the reliability of financial reporting are or-
dinarily most directly relevant to a financial statement
audit, but other controls may also be relevant.
D. An auditor may ordinarily ignore a consideration of con-
trols when a substantive audit approach is taken.
Controls that are relevant to a financial statement audit per-

tain to the entity's objective of preparing financial state-
ments for external purposes and the management of risk
that may give rise to a material misstatement in those finan-
cial statements.
37. Which of the following internal control components relates to

an entity's process for identify'ing and responding to busi-
ness risks?
B. Information and communication
C. Risk assessment
D. Monitoring of controls
PSA 315 states that the entity's risk assessment process

forms the basis for how management determines the risks
to be managed.
For financial reporting purposes, an entity's risk assessment

process includes how management identifies ri~ks releva~t
to the preparation of financial statements, estimates their
significance, assesses the likelihood oLtheir occurre_nce, and
decides upon actions to manage them.
J
c) Participation by those charged with governance.

d) Management's philosophy and operating style.
e) Organizational structure.
t) Assignment of authority and responsibility.
g) Human resource policies and practices.
Detection risk is a component of audit risk.
34. Which of the following elements are included in an entity's

control environment?
Integrity and Assignment of
Ethical Values Authority and Responsibility
A. Yes Yes
B. Yes No
c. No Yes
D. No No
35. Which of the following components of an entity's int~~al

control includes development and use of training policies
that communicate prospective ·roles and responsibilities to
employees?
A. Monitoring of controls
B. Control activities
D. Information and communication
.
The control environment component of internal contr re·
~w
eludes human resource policies and practices relative to,. o.

.t . . nse inti'
crm ment~ orientation, training, evaluating, cou
promoting, compensating, and remedial actions.
ce
36. Which of the following statements concerning the relevda·11t iS
1
·
of vanous types of controls to a financial statement au
correct?
c~PTCR 5 Risk Assessments and Internal Control 273
42. An auditor's flowchart of an entity1s information system is a

diagrammatic representation that depicts the auditor's
A. Documentation of the study and evaluation of the inter-
nal control system.
B. Understanding of the system.
C. Understanding of the types <... •raud that are probable,
given the present system.
D. A program for tests of controls.
43. Which of the following statements about auditor documenta-

tion of the client's internal controls is correct?
A. Documentation must include flowcharts.
B. Documentation must include procedural write-ups.
C. Documentation is desirable but not necessary.
D. No one particular form of documentation is necessary.
44. Which of the following are the two key issues that an auditor
considers when obtaining. an understanding of a client's in-
ternal controls?
A. The effectiveness and efficiency of the controls.
B. The implementation and efficiency of the controls.
C. The design and utilization of the controls.
D. The frequency and effectiveness of the controls.
45. The auditor documents his· or her understanding of the in-

ternal control system to substantiate
A. The fairness of presentation of the financial statements.
B. Adherence to· the requirements of management.
C. Compliance with PSAs.
D. Conformity of the accounting records with the applicable
financial reporting framework.
46. Which of the following is not an advantage of an IT system

used as part of the entity1s internal control system?
- - J
A. A reduced amount of information is required to be re-

viewed manually.
B. Detection of potential problems only if the computer is
programmed to do so.
C. The delivery, timeliness and accuracy of information are
maintained as the volume of transactions increases.
D. Potentially fewer errors as individual calculation discrep-
ancies are reduced.
47. The best way for an auditor to obtain evidence about segre-
gation .of duties is to
A. Observe personnel performing their duties.
B. Reperform the task.
C. Inspect documents and records to ensure an independ-
ent check has been performed. .
D. Discuss the performance of duties within the company
with the internal auditor.
48. An auditor must assess control risk as high when he/has

A. Decided not to test the internal control system.
B. Decided on a high lev~I of detection risk.
c. Assessed inherent risk to be high. . trol
D. Found no significant deficiencies in the internal con
system.
?"
49. Which of the following describes "narrative memoran~a is in·
A. A schematic diagram that uses standardized symrt ~y' the
terconnecting flow lines and annotations to po rthe in·
steps involved in processing information through
formation system. policieS
1
B. Series of questions about accounting and contro ssarY to
and procedures that an auditor considers nec~al state·
, prevent material misstatements in the financt
ments.
C. A form of documentation that summarizes the auditor's

overall understanding of the information system or spe-
cific ·Control policies or procedures.
D. A written report on the effectiveness of the entity's in-
ternal control system.
50. are groups of related business ac-

tivities such as the acquisition' of merchandise and payment
of vendors.
A. Transactions
B. Transaction cycles
C. Economic cycles
D. Business events
51. The following are transaction cycles, except

A. General ledger and reporting
B. Human resources
C. Expenditure/Disbursement
D. Revenue/Receipt
52. The collection of job time tickets or time sheets is part of

which of the following transaction cycles?
A. Revenue/Receipt
B. Human resources
C. Production
D. Expenditure/Disbursement
53. Which of the following best explains why many modern ac-
counting software packages offer separate transaction cycle
modules?
A. A properly designed Accounting Information System does
not use the concept of separate business transaction ·cy-
cles to process transactions.
B. The nature of a given transaction cycle is the same irre-
spective of the type of organization.
-- .
276 CPA EXAfv1fNA TION REVIEWER: AUDITING THEORY
C. Most businesses do not need the revenue cycle module

as part of their Accounting Information System.
D. Every organization does not need to implement all of the
available transaction cycle modules.
54. One apvantage of pre-numbering source documents is that it

helps to verify that
A. All cash has been collected. .
B. No inventory has been misplaced.
C. All transactions have been recorded since the numerical
sequence serves as a control.
D. Documents have been used in order.
Use the following flowchart symbols to answer the

questions below:
#1
/# I G2
#4 #5
u
V0
u
CHAPTER 5 Risk ~sses&ments and Internal Control 277
55. Which symbol would be used to represent a computer pro-

cess?
A. #1 #4 c.
B. #2 D. #12
56. Which symbol would be used to represent a decision?

A. #9 C. #8
B. #11 D. #5
- 57. Which symbol would be used to represent an invoice sent to

a customer?
A. #2 C. #1
B. #5 D. #9
58. Which symbol would be used to represent a general ledger?

A. #2 C. #3
B. #1 D. #4
59. Which symbol would be used to represent a manual pro-

cess?
A. #4 C. #9
B. #5 D. #10
60. Which symbol would be used to represent a connection to

another part of the flowchart on the same page?
A. #4 C. #10
B. #9 D. #11
61. Which symbol would be used to represent a connection to

another part of the flowchart on a different page?
A. #4 C. #10
B. #9 D. #11
62. Which symbol would be used to represent a file of paper

documents?
A. #6 c. #8
B. #7 D. #10
63. Which symbol would be used to represent the display of a

report on a computer screen?
A. #1 C. .#3
B. #2 D. #10
64. Which symbol would be used to represent a beginning, an .

ending, or a cormection to another procedure?
A. #8 C. #11
B. #10 D. #12
65. Duplicate checking of calculations is an example of a correc·

tive control.
Adherence to appropriate procedures to resubmit rejected

transactions is an example of a detective control.
A. True; False C. False; True

B. True; True D. False; False
elate to
66. General IT controls are policies and procedures th.at. r . of
many applications and support the effective functto~infude
application controls. General IT controls commonly inc
controls over the following, except
A. Data center and network operations
B. Manual follow-up of exception reports
C. Access security
D. Program change
le of aP-
Manual follow-up of exception reports is an exainP cedures
plication controls. 1hese controls relate to protions.or
used to initiate, record, process and report transac
other financial data.
67. Application controls are

A. Manual or automated procedures that typically operate
at a business process level and apply to the processing
of transactions by individual applications.
B. Policies and procedures that relate to many applications.
C. Controls that maintain the integrity of information and
security of data such as controls over system software
acquisition, change and maintenance.
D. Controls· that relate to many applications and support the
effective functioning of general controls.
68. Under PSA 315, monitoring of controls is an internal control

component that involves a process of assessing the qua]ity
of internal control performance over time. It involves as-
sessing the design and operation of controls on a timely ba-
sis and taking necessary corrective actions. Monitoring of
controls is accomplished through ongoing monitoring activi-
ties, ,separate evaluations, or a combination of the two. An
entity's ongoing monitoring activities often include
A. Periodic reporting by the entity's internal auditors about
the functioning of internal control.
B. Reviewing the purchasing function.
C. Periodic audits by the audit committee.
D. The audit of the annual financial statements.
According to the standard, ongoing monitoring activities are

built into the normal recurring activities of an ~ntity and in-
clude regular management supervisory activities, such as
reviewing the purchasing function.
Answer A is incorrect because regularly providing infor-

mation about the functioning of internal control is monitor-
ing of controls by the entity's internal auditors through sep-
arate evaluations.
Answer C is incorrect because the audit committee (a sub-

committee of the board of directors that is composed of
board members who are not officers of the entity) does not
ordinarily perform periodic audits.
Answer D is incorrect because the annual audit of financial

statements is not a monitoring activity.
I
69. Control activities relate to the following, except
A. Segregation of duties
B. Performance reviews
C. An internal audit function
D. Authorization
Control activities are the 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 that threaten the achievements of th~ entity'~
objectives. Control activities have various objectives a~
are applied at various organizational and functional !eves.
Specific control activities include those that relate to:
• Authorization
• Performance reviews
• Information processing
• Physical controls
• Segregation of duties
An internal audit function is part of the monitoring cornpo·

nent of internal control.
· "fes el<cept
70. The following are examples of monitoring act1v1 1 ' 1 rlY gen·
A. Information Technology (IT) management re~un~ or vol·
erates exception reports for unusual transactio
cHAPTER 5 Risk Assessments and Internal Control 281
umes of transactions and follows up with investigation as

to causes.
B. Management has asked internal auditing to perform reg-
ular audits of the controls over cash processing.
C. Management regularly compares divisional performance
with budgets for the division.
D. IT management regularly reconciles batch control totals
for items processed with batch controls for items submit-
ted.
Reconciling batch· control totals being a processing control

is not part of the internal control's monitoring component.
71. Which of the following is a reason to establish internal con-

trol?
A: To provide reasonable assurance that the entity's objec-
tives are achieved.
B. To safeguard the resources of the organization.
C. To encourage compliance with organizational objectives.
D. To ~nsure the accuracy, reliability, and timeliness of in-
formation.
According to PSA 315, "Internal control is tbe process de-

signed, implemented and maintained by those charged with
governance, management, and other personnel to provide
reasonable assurance about the achievement of the entity's
objectives with regard to reliability of financial reporting, ef-
fectiveness and efficiency of operations, and compliance
with applicable laws and regulations."
Answers B, C, and D are incorrect because they are sub-

sumed under the overall purpose of providing reasonable
assurance that the entity's objectives are achieved.
72. · Aninternal control system that is working effectively

A. Eliminates risk and potential loss to the entity.
B. Cannot be circumvented by management.
C.Reduces the need for management to review exception
reports on a day-to-day basis.
D. Is unaffected by changing circumstances and conditions
encountered by the entity.
An effective internal control system reduces the need for

management to spend time reviewing exception reports on
a day-to-day basis. An entity's internal control system, if
working effectively, should prevent as well as detect and
correct exceptions.
Answer A is incorrect becawse some risks are unavoidable

and others are too costly to eliminate.
Answer B is incorrect because a basic limita tion of internal

control is the potential for management override .
.I
I
Answer Dis incorrect because changes in circumstances and
conditions may require modifica tion of internal control.
73. Because of inherent limitations, internal control cannot be

designed to provide reasonable assurance regarding the
achievem~nt of objectives concerning
A. Effectiveness and efficiency of operations.
B. Elimination of all fraud.
C. Reliab~lity of financial reporting.
D. Complrance with applicable laws and regulations.
74. When considering an entity's system of internal control, o.n:
of the auditor's majo~ concerns is to ascertain whethern';e
ternal control is designed to provide reasonable assura
that
A. Financial stateme·nts are fairly presented.
CHAPTER S Risk As~sments and Internal Control 283
B_. The accounting manager reviews all accounting transac-

tions.
C. Profit margins are maximized, and operational efficiency
is optimized.
D. Corporate .morale problems are addressed immediately
and effectively.
Controls.t hat are relevant to an audit pertain to the entity's

objective of preparing financial statements for external pur-
poses that are fairly presented in accordance with an appli-
cable financial reporting framework.
75. When an entity's internal control is functioning effectively,

management can expect various benefits. The benefit least
likely to occur is
A. Some assurance of compliance with laws and regula-
tions.
B. Availability of reliable data for decision-making purposes.
C. Reduced cost of an external audit.
D. Elimination of employee fraud .
Because of inherent limitations of any system of internal

control, even the most effective internal control cannot
guarantee the elimination of employee fraud.
76. Internal controls should be designed to provide reasonable

assurance that
A. Management's planning, organizing, and directing pro-
ce5ses are properly evaluated.
B. Management's plans have not been circumvented by
employee collusion.
C. Material errors or fraud will. be prevented, or detected
and corrected, within a timely period by employees in
the course of performing their assigned duties.
----
284 CPA EXAMINATION REVIEWER; IAlJIJllll'ING THEO~~
D. The internal auditing department's ~danc~ ·aod ~

sight of management's performance is _a<!<;Omp&ished
economically and efficie!ltly.
Internal controls should be designed to prevent, 'Or cit~

and correct, material errors or fraud within a timely period
by employees in the normal course of their assigned duties.
Answer A is incorrect because it is the entity's internal au·

diting department that evaluates management processes.
Answer Bis incorrect because collusion is an inherent li'mi-

tation of internal control.
Answer D is incorrect because those charged with govern-

ance are responsible for the guidance and over~ight of mah·
agement.
77. Which of the following is a correct statement about internal

control? _ . t
A. The cost-benefit relationship is a primary cntenon tha
should be considered in designing internal control. t
B. The auditor can eliminate substa11tive tests on significa~.
account balances and classes of transactions for an en
ty that has exceptionally strong internal control. bl'Sh
1
C. The internal auditor has the responsibility to esta
and maintain internal control. res
D. Properly maintained internal control reasonably ensu
that collusion among employees cannot occur.
. ·1 de·
The cost-benefit relationship is a primary criterion ~00 1d
5
signing internal control-that is, the cost of a control ciselY
not exceed its benefits. Because it is impossible to pr~ bot~
0
me;;i.sure the costs and benefits of internal contr '
quantitative and qualitative estimates and judgments are

used by management to evaluate the relationship.
78. When obtaining knowledge about an entity's internal control,

it is important for the auditor to consider the competence of
its employees, because their competence bears directly and
importantly upon the
A. Cost-benefit relationship of internal control.
B. Comparison of recorded accountability with assets.
C. Achievement of the objectives of internal control.
D. Timing of substantive tests to be performed.
An important element of the control environment compo-

nent of internal control is human resource policies and prac-
tices. Human resource policies and practices concern hiring,
orientation, training, evaluatfog, counseling, compensating,
promoting, and remedial actions. The objectives of internal
control cannot be achieved without sufficient competent
personnel who will operate the system.
I
Answer A is· incor~ect

I
because the cost-benefit relationship
is a basic concept of internal control.
Answer B is incorrect because although comparison of rec-

orded accountability with assets is an important character-
istic of internal control, it is not directly related to the com-
petence of employees.
Answer D is incorrect because the timing of substantive

tests to be performed depends on a number of factors such
as the assessed level of risk of material misstatement.
79. Control activities are the policies and procedures that help
ensure that management directives are carried out. These
'
include activities relating to authorization, performance re-

views, information processing, physical controls, and segre-
gation of duties. There is proper segregation of duties when
an individual who
A. Records a transaction does not compare the accounting
record of the asset with the asset itself.
B. Authorizes a transaction records it.
C. Authorizes a transaction maintains custody of the asset
that resulted from the transaction.
D. Maintains custody of an asset has access to the account-
ing records for the asset.
A proper segregation of duties requires that one person

should not be responsible for all phases of a transaction: au·
thorizatien, recording, and custodianship of the related a:·
sets. Separate individuals should perform these incompatl·
ble duties to reduce the opportunities for any person to be
in a position to both perpetrate and conceal errors or fraud
in the normal course of his/her duties.
80. Proper segregation of duties reduces the opportunities for

persons to be in positions to both
A. Establish internal control and authorize transactions.
B. Perpetrate and conceal errors or fraud.
C. Record cash receipts and cash disbursements.
D. Record transactions and prepare financial statements·
Bl. Control activities include those that relate to physical c~~

trols over access to and use of assets and records. A deP
ture from the purpose of physical controls is that re-
A. T~e mail room clerk compiles a list of the checl<S
ce1ved in the incoming mail.
B. Access to safe-deposit box requires two officers. rviSors
C. Only warehouse personnel and production supe
have access to raw materials storeroom.
D. Only sales personnel use sales department vehicles.
82. Which of the following most likely would not be considered

an inherent limitation of internal control?
A. Management .override
B. Incompatible functions
C. Mistakes in judgment
D. Collusion among employees
The performance of incompatible functions is not an inher-

ent limitation of internal control but a failure to segregate
functional responsibilities properly.
Answers A, C, and Dare inherent limitations of inte rnal con-

trol.
83. A basic concept of internal control is the concept of reason-

able assurance, which recognizes that
A. Establishing and maintaining internal control is an Im-
portant responsibility of management.
B. Internal control may be ineffective due to collusion
among employees.
C. The cost of an entity's internal control should not exceed
the benefits expected to be derived.
D. Adequate safeguards over access to assets and records
should permit an entity to maintain proper accountabil.:
ity.
84. An auditor should obtain sufficient knowledge of an entity's

information system, including the related business processes
relevant to financial reporting, to understand the
A. Policies used to detect the concealment of fraud.
B. Process used to prepare significant accounting estimates.
C. Safeguards used to limit access to computer facilities.
288 CPA EXAMINATION REVIEWER: AUDITING Tftt::ORY
D. Procedur~s used to assure proper authorization of.trans·

actions.
The auditor should obtain an understanding of the infor·

mation system relevant to financial reporting to under·
stand:
a) The classes of transactions wnich are significant to

the financial statements.
b) The procedures-within ·both IT (Information Tech-
nology) and manual systems-by which those trans-
actions are initiated, recorded, processed, and re·
ported in 't he financial statements.
c) The accounting records and supporting documents
for those transactions.
d) How the information system captures events and
conditions, other than transactions, that are signifi·
cant to the financial statements.
e) The financial reporting proc~ss used to prepare th~
entity's financial statements, including significantac
counting estimates and disclosures._
. 'be ac·
Answers A, C, and D are incorrect because they descn jal
tivities outside the accounting system relevant to financ
reporting.
btain an
85. The primary objective of procedures perforrn~d to auditor
0
understanding of internal control is to provide an
with
A. Knowledge necessary to plan the audit.
B. A basis for modifying tests of controls.
C. Information necessary to prepare flowcharts.
D. Evidence to use in reducing detection risk.
Understanding the entity's internal control system is a mat-

ter that should be considered by an auditor in developing
the overall audit strategy.
Answer B is incorrect because the auditor's understanding

of internal control is the basis for determining the nature,
timing, and extent of both substantive tests and tests of con-
trols.
Answer C is incorrect because flowcharts are but one form
of internal control documentation.
Answer D is incorrect because substantive tests are per-

formed to gather evidence in order to reduce detection risk
to an acceptable level.
86. In a financial statement audit, the auditor is required to ob-

tain an understanding of the entity's internal control to as-
sess the risks of material misstatement in the financial
statements. The results of the understanding
A. Bear no relationship to the nature, timing, and extent of
further audit procedures to be performed.
B. Must be reported to the stockholders and the SEC
C. Are not reported to client management.
D. May be used as the basis for withdrawing from an audit
engagement.
PSA 315 states that the auditor's understanding of internal

control may raise doubts about the auditability of an entity's
financial statements.
Concerns about the integrity of the entity's management

may be so serious as to cause the auditor to conclude that
the risk of management representation in the financial
statements is such that an audit cannot be conducted.
Also, concerns about the condition and reliability of an enti-

ty's records may cause the auditor to conclude that it is un-
l
likely that sufficient appropriate audit evidence will be
available to support an unmodified opinion on the financial
I
statements. In such circumstances, the auditor considers a
qualification or disclaimer of opinion, but in some cases, the
auditor's only recourse may be to withdraw from the en·-
gagement.
87. In obtaining an understanding of internal control relevant to

the audit, an auditor is required to obtain knowledge about
I
the · I
A. Effectiveness of controls that have been implemented.
B. Consistency with which controls are currently being ap-
plied.
C. Design of the controls pertaining to internal control com-
ponents.
D. Controls related to each class of transactions and ac·
count balance.
According to PSA 315, obta ining an understanding of inter·

nal control involves evaluating the design of a control and
determining whether it has been implemented.
Evaluating the design of a control means determini.ng

whether the control-individually or in combination with
other controls-is capable of effectively preventing, or de·
tecting and correcting, material misstatements.
Implementation of a control means that the control exists

and that the entity is using it.
Answers A rind B are incorrect because in some cases. ~h:

. . b tant1V
au d 1tor may determine that performing only su 5 ·
CHAPTER 5 Risk Assessments and Internal Conllol 291
procedures is appropriate for specific assertions and, there-

fore, may choose not to obtain information about the oper-
ating effectiveness of controls and their consistency of ap-
plication.
Answer D is incorrect because the standard does not explic-

itly require obtaining knowledge about controls related to
each transaction class and account balance.
88. The auditor uses the understanding of internal control to

I. Identify types of potential misstatements.
II. Consider factors that affect the risks of material mis-
statement.
III. Design the nature, timing, and extent of further audit
procedures.
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III
89. In obtaining an understanding of internal control relevant to

the audit, the auditor may trace several transactions through
the system, inc[uding how the transactions interface with
any service organizations whose services are part of the en-
tity's information system. The primary objectiye of this pro-
cedure is to
A. Evaluate the design of internal control and determine
whether it has been implemented.
B. Determine the effectiveness of internal control.
C. Detect fraud.
D. Replace substantive tests.
90. Information about segregation of duties ordinarily is best

obtained by
-.....::.
. _: ....... ..
...........-.-... · ·.;..
- ··;;,,,; .. -~......,--
- .... . _--.-:_ -
. . .
.... .oe... ---"'~ · ~,_~L~·..,:...~..,:.. ~·:..:..r;A~ -~;;,;;
' ~-~~:t,ltioil~.W.,Oilblil. . . . ._~~llllilll~~--
292 CPA EXAMINAT/OpJ. REVIEWER: AUOlilNG THEORY
A. Performing tests of transa~ions r~t cort-oborate m~m-

. agement's financial statement assertions.
B. Devefoping audit objectives that reduce control risk.
C. Observing employees as they apply specific co.ntrols .
D. Obtaining a flowchart of activities performed by entity
personnel.
.j
According to PSA 315, risk assessment procedures to obtain
l. audit evidence about the design and implementation of rel·
evant controls may include:
1 • Inquiring of entity personnel.

1 • Observing the application of specific controls.
• Inspecting documents and reports.
• Tracing transactions through the information system
relevant to financial reporting.
91. In obtaining an understanding of an entity's internal control

in a financial statement audit, an auditor is not required tod
A. Determine whether the controls have been implemente ·
B. Perform procedures to evalua~t~design of controls.
C. Document the ungerstanding of the entity's internal con·
trol components. .
D. Search for significant deficiencies in the operafion of in·
ternal control.
The auditor should obtain a sufficient understanding of innt·

. · teme ·
ter.nal control to assess the risks of material m1ssta . 1 of
The understanding includes knowledge about the desigited.
relevant controls and whether they have been i~ple~~:ugli
i.e., whether they have been placed in operation. ses in
the auditor may become aware of material weakn:sr 5ucli
internal control, he/she is not required to. search fionancial
1
internal control weaknesses or deficiencies. A
statement audit is not designed to determine the adequacy

of internal control for management purposes.
92. In a financial statement audit, the auditor is required to per-

form tests of controls when
I. The auditor's risk assessment includes an expectation of
the operating effectiveness of controls.
II. When substantive procedures alone do not provide suffi-
cient appropriate audit evidence at the assertion level.
A. I only
B. II only
C. Either I or II
D. Neither I nor II
Under PSA 330 (The Auditor's Responses to Assessed

Risks), the auditor should perform tests of controls when
his/her assessment of risks of material misstatement at the
assertion level includes an expectation that controls are op-
erating effectively or when substantive procedures alone do
not provide sufficient appropriate evidence to reduce the
risks of material misstatement at the assertion level.
93. Which of the following determines the extent of the auditor's

tests of control?
A. Auditor's knowledge
B. Auditor's initial/planned assessment of control risk.
C. Resources available to the auditor. ,
D. Management's desire to help the auditor.
94. After obtaining an understanding of internal control relevant

to the audit, the at."1ditor may attempt to assess control risk
at below the maximum level. In turn, the auditor will (1)
identify specific controls that are likely to prevent or detect
material misstatements in the relevant financial statement
-
294 CPA EXAMINATION REVIEWER: AUDITING THEORY ·
assertion~ and (2) perform tests of controls. The purpose of

performing tests of controls is to
A. Evaluate inherent risk.
B. Assure that the auditor has a sufficient understanding of
internal control.
C. Evaluate the effectiveness of such controls.
D. Provide recommendations to management to ililllprove in·
ternal control.
The auditor performs tests of controls to obtain assurance

about the operating effectiveness of controls.
95. Tests of controls are concerned primarily with each of the

following questions, except
A. By whom were the controls applied?
B. Were the necessary controls consistent'ly performed?
C. How were the controls applied?
D. Why were the controls applied?
Testing t he ope rating effectiveness of controls includes ?b-

taining audit evidence about (1) how controls were applied
at relevant tim es during the period under audi t, (2) the con-
sistency with which they were applied, and (3) by whom ~
0
. . why con
by what mean s they were applied. Determmmg d-
trols were a pplied rela tes more to obtaining an undersftan11 _
ing of internal control than testing the effectiveness 0 co ·
trols.
'th pSA51
96. In an audit of financial statements. in accordance WI
an auditor is required to erit's fi·
A. Identify specific controls relevant to managem
nancial statement assertions. . ned to
B. Determine whether controls are suitably desig
prevent or detect material misstatement.
C. Perform tests of controls to evaluate the operating effec-

tiveness of controls.
D. Document the auditor's understi3nding of the entity's in-
ternal control.
The auditor is required to document in the audit working

papers the understanding obtained of the entity's internal
control and the assessment of control risk. When control
risk is assessed at less than the maximum, the auditor
should also document the basis for the conclusion.
Answers A, B, and Care incorrect because these procedures

are to be performed only when the auditor wishes to assess
control risk at less than the maximum.
97. In performing a walk-through test, the

A. Auditor traces one or several transactions within each
major class through the transaction trail to confirm his or
her understanding of the information system and control
procedures.
B. Auditor performs a physical review of the entity's proper-
ty, plant and equipment to confirm the physical location
of major assets. ·
<:. Senior auditor "walks-through" the processing of the en-
tity's transactions with other members of the audit team
focusing on the control processes which aim to prevent
misstatements in the financial statements.
D. Auditor traces one or several transactions within each
major class through the transaction trail to confirm the
cut-off period.
98. In evaluating the effectiveness of the design of an entity's

internal control system in order to make a preliminary as-
sessment of control risk for an assertion the auditor has to
I. Identify potential misstatements that could occur in the

entity's assertion.
II. Identify the necessary controls that would be likely to
prevent or detect the material misstatements.
III. Evaluate the evidence and makes the assessment.
A. I and II only C. II and III only
B. I and III only D. I, II and III
99. The ultimate purpose of assessing control risk is to contrib-

ute to the auditor's evaluation of the risk that
A. Material misstatements may exist in the financial state-
ments.
B. Specified controls requiring segregation of duties may be
circumvented by collusion.
C. Entity's control may be overridden by management.
D. Tests of controls may fail to identify procedures relevant
to assertions.
The ultimate purpose of assessing control risk at the asser-

tion level for each material account balance or class of
transactions is to contribute to the auditor's evaluation of
the risk that material misstatements exist in the financial
statements.
100. An auditor may decide to assess control risk at a high level

for some or all assertions because the auditor believes
A. The entity's internal control system is not effective. ve
B. More emphasis on tests of controls than substanti
tests is warranted. s-
C. Sufficient appropriate audit evidence to support the a
sertions is likely to be available. ed
D. The entity's internal control components are interrelat ·
The auditor ordinarily assesses control risk at a high level

for some or all assertions when:
a) the entity's internal control system is not effective;
or
b) evaluating the operating effectiveness of the entity's
controls would not be efficient.
101. An auditor assesses control risk in terms of

A. Types of potential fraud.
B. Financial statement assertions.
C. Specific control activities.
D. Control environment elements.
The assessment of control risk is the process of evaluating

the effectiveness of an entity's internal control in preventing
or detecting and correcting material misstatemen~. Control
risk is assessed in terms of financial statement assertions.
102. The preliminary assessment of control risk for a financial

statement assertion should be h'igtl unless the auditor
I. Is able to identify controls relevant to the assertion
which are likely to prevent, :>r detect and correct, mate-
rial misstatements.
II. Plans to perform tests of controls to support the ~sess-
ment. ·
A. I only
B. II only
C. Both I and II
D. Neither 'I nor II
103. In performing tests of the operating effectiveness of an enti-

ty's controls, an auditor selects from a variety of techniques,
including
-
298 CPA EXAM/NATION REVIEWER: AUDITING THEORY
A. Reperformance and observation.

B. Inq,u iry and analytical procedures.
C. Comparison and confirmation.
D. Inspection and verification.
Tests of controls ordinarily include inquiry, observation, in-

spec;tion, and reperformance of a policy or procedure that
pertains to an assertion.
Answers B, C, and D are incorrect because they include pro·

cedures which are more closely associated with substanti¥e
testing-namely, analytical procedures, comparison, con·
firmation, and verification.
104. An auditor intends t~ perform tests of control on a client's

cash disbursements procedures. If the control procedures
leave no audit trail of documentary evidence, the auditor
most likely will test the procedures by
A. Inquiry and analytical procedures.
B. Inquiry and observation.
c. Analytical procedures and confirmation.
D. Confirmation and observation.
. f con·
According to PSA 330, documentation of operation ° . on·
. for some factors m
trols may ·not exist · t h e con trol .envir
·i·cy or
. d pons1b1 1 1
ment, such as assignment of authority an res ~ rrned
for some types of control activities, such as those per ~erat·
by a computer. In such cases•.audit evidenc.e ab~uti~ com·
ing effectiveness may be obtained through 1 ~qu ~ the use
bination with other procedures like observatwn an
of computer-assisted audit techniques (CAATs).
re·
. accounts d't1
105. Which . of the following procedures concernrng 0
btain au
ceivable would an auditor most likely perform to
CHAPTER 5 Risk Assessments and Internal Control
299
evidence in support of an assessed level of control risk·that

is less than high?
A. Comparing an entity's bad debt expense to actual bad
debt losses. ·
B. Inspecting an entity's analysis of accounts receivable for
unusual balances.
C. Observing an entity's staff prepare the schedule of past
due accounts receivable.
D. Sending confirmation requests to an entity's principal
customers to verify the existence of accounts receivable.
An auditor who wishes to assess control· risk at less than

high should perform tests of operating effectiveness of rele-
vant controls. Tests of controls include inquiry, observation,
inspection, and reperformance of a control by the auditor.
106. The following statements relate to an auditor's assessment

of control risk. Which is true?
A. The lower the assessed level of control risk, the less as-
surance the audit evidence must provide about the oper-
ating effectiveness of controls.
B. The basis for an auditor's conclusions about the assessed
level of control risk need not be documented unless con-
trol risk is assessed at the maximum level.
C. Assessing control risk and obtaining an understanding of
an entity's internal control may be performed concur-
rently.
D. When assessing control risk, an auditor should not con-
sider evidence obtained in prior audits about the opera-
tion of controls.
For efficiency reasons, an auditor may plan to perform tests

of controls when evaluating the design of controls and ob-
taining evidence of their implementation.
_ _.._..··.· ........w_~·.""'."'""···-.-.....:- ~
_.c..
_,...,....
1,'11.....
. ..- -~·.l!l!I.'· .•.• 11.gj•hil.· .-.lliilll!••.-.~...........•i..• .-.····::·=·:f!!!!;~~n!·::
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.-.
107. The following statements relate to the use of audit evidence

when testing the operating effectiveness of relevant controls.
!I Which is false?
iJ A. An auditor who obtains sufficient appropriate audit evi-
dence about the operating effectiveness of controls dur-
f ing the interim period should no longer obtain additional
evidence of operating effectiveness for tl)e remaining pe-
riod. ·
B. An auditor may plan to use audit evidence about the op-
erating effectiveness of controls obtained in prior audits.
C. If an auditor plans to rely on controls that have changed
since they were last tested, the auditor should test the
operating effectiveness of such controls in the current
audit.
D. Audit evidence pertaining only to a point in time may be
sufficient for the auditor's purpose, for example, when
testing controls over an entity's physical count of inven-
tories at year-end.
PSA 330 states that when the auditor obtains audit evidence
about the operating effectiveness of controls during an in·
terim period, the auditor should determine what additional
audit evidence should be obtained for the remaining period.
In addition, the auditor is required to obtain audit evide~ce
about the n-ature and extent of any sig11ificant changes in in·
ternal control, including changes in the information systern.
· rer·
processes, and personnel that occur subsequent to the in
im period.
30 states
Answers B and C are correct statements. PSA 3 op·
that if the auditor plans to use audit evidence about t~e rhe
erating effectiveness of controls obtained in prior audt~· 0g-
auditor should obtain audit evidence about whether c ~ co
es in those specific controls have occurred subseque; ill'
the prior audit. In this regard, the auditor may perfor
cffAPTER 5 Risk Assessments and Internal Control 301
quiry in combination with observation or inspection. If the

auditor plans to rely on contr_ols that have changed since
they were last tested, the auditor is required to test the op-
erating effectiveness of such controls in the current audit.
Answer Dis a correct statement. According to PSA 330, the

timing of tests of controls depends on the auditor's objective
and determines the period ofreliance on those controls.
Tests of controls at a particular time provide evidence of

operating effectiveness at that time, while tests of controls
throughout a period provide evidence of operating effec-
tiveness for that period.
Audit evidence of operating effectiveness at a point in time

may be sufficient for the auditor's purpose, such as tests of
controls over physical inventory count at year-end.
108. According to PSA 330, an auditor who plans to rely on con-

trols that have not changed since they were last tested
should test the operating effectiveness of such controls at
least once in every
A. Second audit
B. Third audit
C. Fourth audit
D. Fi~h audit
An auditor may plan to rely on controls that have not

changed since they were last tested. The length. of time pe-
riod between retesting such controls is a matter of profes-
sional judgment but cannot exceed two years. Therefore,
the operating effectiveness of such controls should be tested
at least once in every third audit.
~~-------------~------~!
•
109. Which of the following procedures~re performed by an audi·

tor who wants to detect material misstatements at the as·
sertion level?
A. Compliance .tests
B. Tests of controls
C. Substantive tests
D. Dual"purpose tests
Substantive tests are procedures performed in order to de-

tect material misstatements at the assertion level, including
tests Of details of account balances, classes of transactions,
and disclosures, and substantive analytical procedures.
110. A~er gaining an understanding of internal control arid as·

sessing the risks of material misstatement, an auditor decid·
ed to perform tests of controls. The auditor most likely de-
cided that
A. Additional evidence to support a further reduction in con·
trol risk is not available.
B. It is not possible or practicable to reduce the risks of ma·
terial misstatement at the assertion level to an accepta·
bly low level with audit evidence obtained only from sub-
stantive test procedures.
C. There were ma·ny internal control weaknesses that could
allo~ misstat:ements to enter the accounting syst~m'. ti·
D. An increase in the assessed level of control risk is JUS
fied for certain financial statement assertions.
An auditor shall perform tests of controls when:
1. The auditor's risk assessment includes an expecta·

ti on of the operating effectiveness of controls; or
2. Substantive procedures alone do riot provide suffi-

cient appropriate audit evidence at the assertion
level.
Answer A is incorrect because tests of controls are per-

formed to obtain sufficient appropriate audit evidence to
support a further reduction in control risk.
Answer C is incorrect because the auditor should · not per-

form tests of controls when, as a result of his/her risk as-
sessment, there is no expectation of the operating effective-
ness of controls, i.e., if there are many internal control
weaknesses.
Answer Dis incorrect because tests of controls are designed

to decrease the auditor's preliminary assessment of control
risk, not increase it.
111. In conducting an audit in accordance with PSAs, the auditor

is required to identify and assess the risks of material mis-
statement at the financial statement level, and at the asser-
tion level for classes of transactions, account balances, and
disclosures. Some of these risks, in the auditor's judgment,
require special audit consideration, such as ·those that in-
volve fraud or complex transactions. Such risks are called
A. Business risks
B. Audit risks
C. Significant risks
D. Material risks
112. As a result of obtaining an understanding of an entity's in-

ternal control system, the auditor may become aware of ma-
terial weaknesses in the design or implementation of internal
control. The auditor is required to communicate this matter

to
A. Those charged with governance or management.
B. Chief executive officer.
C. Securities and Exchange Commission.
1
• 1 D. Board of Accountancy.
, \I
PSA 315 states, "The auditor shall communicate material
weaknesses in internal control identified during the audit
on a timely basis to management ·a t an appropriate level of
responsibilify, and, as required by PSA 260, (Communica·
tion with Those Charged with Governance), with those i
charged with governance (unless all of those charged with

governance are involved in ·m anaging the entity.)"
113. The auditor's final assessment of control risk for financial

statement assertions is based on
A. Evaluating the evidence obtained from the entity's man·
agement.
8. Evaluating the evidence obtained from third parties. d·ng
C. Evaluating the evidence obtained from an understa~ ~
of relevant internal control system components an
lated tests of controls. din9
D. Evaluating the evidence obtained from an understan
of relevant internal control system components. ·
REVENUE/RECEIPT CYCLE
for the
114. Which of the following is not a source document
revenue cycle?
A. Sales order
· 8. Receiving report
C. Credit memo
D. Delivery receipt
115. Which of the following activities is not part of.the revenue

cycle?
A. Sales order entry
B. Receiving
C. Billing
D. Shipping
116. In the revenue cycle, a customer ~laces an order for a cer-

tain product. What step should be taken before the order is
checked for inventory availability?
A. A packing list should be generated for the warehouse.
B. The customer's credit should be checked for a sale on
account.
C. The sales order should be created and written to a file.
D. The shipping department should be notified of an order
in process.
117. is the maximum allowable account balance

for a given customer.
A. Credit limit
B. Reorder point
C. Credit checkpoint
D. Backorder point
118. An essential part of the revenue cycle is filling customer or-

. ders and shipping goods to customers. Automating ware-
house systems cut costs, improve efficiency, and en·able
more customer-responsive shipments. Which of the follow-
ing elements is required for an automated perpetual invento-
ry system?
A. Forklifts
B. Conveyor belts
C. Bar-code scanners
Q. VAN
-
306 CPA EXAM/NAT/ON REVIEWER: AUDITING THEORY
119. The basic document created in the billing process is the

A. Bill of lading
B. Purchase or.der
C. Sales invoice.
D. Packing list I
120. To ensure proper segregation of duties, who should make ,
decisions concerning issuance of credit memos? •
A. Warehouse manager
B. Credit manager
C. Cashier
D. Accounts receivable supervisor
121. Which of the following is not an objective of the reve·

nue/receipt cycle?
A. · Received goods are counted and inspected for quality..
B. Custody over assets resulting from the revenue/receipt
cycle is properly maintained.
C. Transactions related to the revenue/receipt cycle are
properly authorized, e~ecuted, and recorded. . d
D. Approved sales orders are shipped on a timely basis.an
in accordance with customer specifications.
The revenue/receipt cycle encompasses the activitie~ perf

0
taining to the sale of goods or services and the collection.
. d 1n·
cash for the goods or services provided. Counting an .
specting received goods for quality is an objective of the~
penditure/disbursement cycle and is only indirectly rela
to the revenue/receipt cycle.
eceipt
122. The following are directly involved ln ttie revenueI r
cycle, except
A. Treasurer and controller
B. Receiving department clerk
C. Billing clerk
i. \
\
'•
D. Sales manager and the credit manager
The receiving department clerk count~ and inspects the

goods received from suppliers and prepares receiving re-
ports which serve as partial authorization for invoice pay-
ment. This activity relates more directly to expendi-
ture/disbursement cycle.
Answer A is incorrect because the treasurer has custody of

cash receipts from customers and the controller maintains
records such as those relating to sales and cash receipts.
Answer C is incorrect because the billing clerk is responsible

for the billing process, including the preparation of sales in-
voices.
Answer D is incorrect because the sales manager executes

sales transactions and the credit manager is responsible for
authorizing sales.
123. Which of the following controls most likely would provide

reasonable assurance that all credit sales transactions of an
entity are recorded?
A. The accounting department supervisor controls the mail-
ing of monthly statements to customers and investigates
any differences reported by customers.
B. The accounting department supervisor independently
reconciles, on a monthly basis, the accounts receivable
subsidiary ledger to the accounts receivable control ac-
count.
C. The billing department supervisor matches prenumbered
shipping documents with entries in the sales journal.
D. The billing department supervicor sends copies of ap-
proved sales orders to the credit department for compar-
ison to authorized credit limits and current customer ac-

count balances.
,I Comparing prenumbered shipping documents with entries

in the sales journal will detect unrecorded sales transac-
tions.
·~ Answer A is· incorrect because unrecorded credit sales

transactions result to understatement of receivables. Cus-
tomers are unlikely to report understatement of their ac- · US.
counb. ·
Answer B is incorrect because the reconciliation will not de-

tect unrecorded sales transactions.
Answer D is incorrect because credit approval does not pro·

vide assurance that all sales transactions have been record·
ed.
124. For effective internal control, employees maintaining the ac-

counts receivable subsidiary ledger should not also approve
A. Cash disbursements.
B. Write-offs of customer accounts.
C. Granting of credit to customers.
D'. Employee overtime wages.
Segregating the functions of authorization, record-keeP~!t

and custody of assets provides reasonable assurance e
perpetration and concealment of fraud or error by the sa~0
employee will be mi_nimized. Therefore, the authoriza~~e
00
function of approving write-offs of receivables should ·ng
done by the same employee who performs a record-ke.~~rY
function of maintaining the accounts receivable subsI
ledger.
\ \·
'
Answers A and D are incorrect because authorizing cash

disbu~sements and employee overtime wages are not relat-
ed to receivables.
Answer C is incorrect because although granting of credit

authorizes a debit to receivable, combining this function
with maintaining the accounts receivable subsidiary ledger
is less likely to result in fraud.
125. A sound internal control procedure should require that de-

fective merchandise returned by customers be presented ini-
tially to the
A. Receiving clerk.
B. Accounts receivable supervisor.
C. Billing clerk.
D. Shipping department supervisor.
Sound internal control procedures dictate .that all receipts of

merchandise should be initially handled by receiving de-
partment personnel. Receiving reports must be prepared
for all goods received.
126. An employee misappropriates cash receipts from sales on

account. Which of the following acts would conceal this de-
falcation and be least likely to be detected by an auditor?
A. Understating the cash receipts journal.
B. Overstating the accounts receivable subsidiary ledger.
C. Overstating the accounts receivable control account.
D. Understating the sales journal.
The most effective way of concealing theft of cash receiµts is

by not recording sales on account. The procedures that will
be applied to the accounting records will not detect the de-
falcation because the accounts remain balanced, yet incom-
....
3i0 CPA EXAM1NATION REVIEWER: AUDITING THEORY
plete. In addition, customers are unlikely to report their-

regularity to the auditor because unrecorded sales will not
be billed and unrecorded receivables will not be confirmed.
Ii Questions 127 through 130 are based on the following in·

.1' formation:
.j In connection with your audit of the financial statements of

Tanya Company, you gathered the following information
about its sales procedures:
Customer orders are received by the sales-order depart·

ment. A clerk computes the peso amount of the order and
sends it to the credit department for approval. Credit ap-
proval is stamped on the order and returned to the sales·
order department. A sales invoice is prepared, and the sales
order is filed in the customer order file.
The customer copy of the sales invoice is sent to the bill~n9

department and held in the pending file awaiting notification
that the order has been shipped.
The shipping copy of the sales invoice is routed th:out:

warehouse and the shipping .department as authontv or
respective departments to release and ship the goo~·
Shipping department personnel pack the order and prepare

a three-copy bill of lading:
Original copy - mailed to the customer
Second copy - sent with the shipment . dinQ file
Third copy filed in sequ~nce in the bill of 1a
he billin9
The shipping copy of the sales invoice is sent to t
department.
.oHAP
TER 5 Risk Assessments and Internal .Control 311
The billing clerk matches the received shipping copy of the

sales invoice with the customer copy from the pending file.
Both copies of the invoice are priced, extended, and footed.
The customer copy is then mailed to the customer, and the
shipping copy is sent to the accounts receivable clerk.
The accounts receivable clerk enters the sales invoice data in

the sales journal, posts the customer's account in the ac-
counts receivable subsidiary ledger, and files the shipping
copy in the sales invoice file. The sales invoices are num-
bered and filed in sequence.
127. To obtain evidence concerning the proper credit approval of

sales, the auditor would select a sample of transaction doc-
uments from the population represented by the
A. Bill of lading file . .
B. Accounts receivable subsidiary ledger.
C. Sales invoice file.
D. Customer order file.
As described, the entity's procedure is to send the customer

order to the credit department for approval. Approval is
stamped on the customer order which is then returned to
the sales department. and filed. Thus, the only documenta-
tion for credit approvals is the customer order file.
128. In determining whether the internal control operated effec-

tively to minimize errors of failure to post sales invoices to
the accounts receivable subsidiary 'ledger, the auditor should
select a sample of transactions from the population repre-
sented by the
A. Sales invoice file.
B. Accounts receivable subsidiary ledger.
C. Customer order file.
D. ~ill of lading file.
--
A sample of sales invoices should be traced to the accounts

receivable subsidiary ledger. Sales invoices without corre-
sponding entries in the accounts receivable subsidiary ledg-
er represent transactions not posted.
129. To effectively determine whether the entity's control actiVi-

ties minimize errors of failure to invoice goods that have
been shipped, the auditor should select a sample of transac-
tions from the population represented by the
A. Sales invoice file.
B. Bill of lading file.
C. Accounts receivable subsidiary ledger.
D. Customer order file.
To determine if goods that have been shipped were not in-

voiced, an effective audit procedure is to match a· sample
from the bill of lading file to sales invoices.
130. To obtain evidence that uncollected items in customers' ac-

counts represented valid trade receivables, the auditor
should select a sample of items from the population repre-
sented by the
A. Bill of lciding file.
B. Customer order file.
C. Accounts receivable subsidiary ledger.
D. Sales invoice file.
Confirmation directly with customers of a sample of odpg:.~

accounts from the accounts receivable subs1 1a
.d. ry le bJeS
·
3
would provide an audito; with evidence.that the reeeiV
are valid assets.
It of lff·
131. Which of the following most likely would be the resu
effective controls in the revenue/receipt cycle?
I'
I
I
1
1 A. Omission of shipping documents could go undetected,
~ causing an understatement of inventories.
B. Irregularities in recording transactions in the subsidiary
accounts could result in a delay in goods shipped.
c. Final authorization of credit memos by sales department
personnel could permit an employee defalcation scheme.
Q; Fictitious transactions could be recorded causing ari un-
derstatement of revenues and an overstatement of re-
ceivables.
'\
Final approval of credit memos in the sales department may
I allow sales department personnel to commit irregularities.
i
Answer A is incorrect because if shipping documents are
omitted, shipped goods may not be credited to inventory,
causing the account to be overstated, not understated.
l Answer B is incorrect because posting in the subsidiary ac-

,l counts takes place only after shipment of goods.
Answer D is incorrect because recording fictitious sales

would overstate revenues.
132. At which point in an ordinary sales transaction of a wholesal-

ing business is a lack of specific authorization of least con-
cern to the auditor in performing. risk assessment proce-
dures?
A. Granting of credit
B. Determination of discounts
C. Selling of goods for cash
D. Shipment of goods
Selling of goods for cash would likely be covered by a gen- ·
l eral authorization.
l
I
l I
i
:
Answers·A, B, and Dare incorrect because granting of credit

determination of discounts, and shipment of goods may re:
quire specific authorization.
'I
133. Samantha Company uses its sales invoices for posting per-
petual inventory records. Inadequate internal control over
J the invoicing function allows goods to be shipped but not in·
voiced. The inadequate controls could cause what type of .
misstatement in each of the following accounts?
Revenues Receivables Inventories
A. Understatement Understatement Understatement
B. Overstatement Overstatement Understatement
c. Understatement Understatement Overstatement
D. Overstatement Overstatement Overstatement
If goods are shipped but are not invoiced, there will be no

documentation for sales, thus 1,mderstating revenues .an:
receivables. Moreover, inventory will not be credite '
thereby overstating the account.
134. Which of the following controls is often lacking in a retail

cash sales environment?
A. Segregation of functions
B. Competent personnel
c. Monitoring
D. Access to assets limited to authorized personnel
rdinarilY
In ~ retail cash sales environment, the sales clerk 0 todY of
authorizes and records the transactions and ha~. cusoffunc·
assets. But the apparent lack of proper segregation ervision
tions is compensated by controls such as close s~~ers tha1
of t.he cash receipts function, the use. of ~ash reyi ;ecording
limits access to assets, and an effective mterna
fun ction that maintains control over cash receipts.
CHAPTER 5 Rlsk Assessments and Internal Control 315
135. An auditor's risk assessment procedures disclosed that the

accounts receivable clerk approves credit memos and has
access to cash. Which of the following controls would be
most effective in offsetting this weakness?
A. The controller reconciles accounts to the amount shown
in the ledger.
B. The owner reviews credit memos after they are record-
ed.
C. The controller receives the monthly bank statement di-
rectly and reconciles the cash accounts.
D. The owner reviews errors in billings to customers and
postings to the subsidiary ledger.
The clerk is holding incompatible duties and thus, is in a po-

sition to both perpetrate and conceal a fraud in the normal
course of his/her duties.
The clerk has custody of cash, authorizes credit memos, and

performs the record-keeping function for accounts receiva-
ble. Hence, the clerk can easily misappropriate cash re-
ceived from customers and conceal such defalcation by re-
cording fictitious sales returns.
In a small ·business, it may not be practicable to institute

formal control activities. In this situation, the active in-
volvement of the owner may compensate for the absence of
some control activities such as proper segregation of duties.
The owner may conside'r reviewing credit memos for au-
thenticity.
Answer A is incorrect because there will be no discrepancy

between the subsidiary ledger and the control account even
if improper credits to accounts receivable are pos~ed.
Answer C is incorrect because reconciliation of cash ac-

counts will not reveal misappropriation of cash collected
from customers concealed by recording improper credit
memos.
Answer D is incorrect because the absence of errors in

billings and postings to the subsidiary ledger would not pre·
elude the clerk from defalcating cash collected from custom·
ers.
136. The following controls are ordinaril'f found in an entity's reJ·

enue/receipt cycle. Which control most likely would be ef·
fective in offsetting the tendency of sales personnel to max·
imize sales volume at the expense of high bad debt write-
offs?
A. Employees responsible for authorizing sales and bad
debt write-offs are denied access to cash.
B. Subsidiary account receivable ledgers are reconciled to
the control account by an employee independent of the
authorization of credit.
C. Employees involved in . the credit-granting function are
se~ar~ted from the sales function. b
D. Shipping documents and sales invoices are matched Y
an employee who does not authorize write-offs of cus·
tomers' accounts.
The sales department's. function should be confined to ~

generation of sales and provision of services to customedi~
The credit approval process should be handled by the ere
department.
!he pro_blem is t?e incompatibility of the sales .and t h:erscred·A,

1t-grantmg functions. The controls described in ans
B, and D do not address the i~sue.
137. Which of the following control activities in an entity's reve-

nue/receipt cycle would provide reasonable assurance that
all billed sales are correctly posted to the accounts receiva-
ble ledger?
A. Each shipment of goods on credit is supported by a pre-
numbered sales invoice.
B. The accounts receivabl'e subsidiary ledger is reconciled
daily to the accounts receivable control account in the
general ledger.
C. Daily sales summaries are compared to daily postings to
the accounts receivable ledger.
D. Each sales invoice is supported by a prenumbered ship-
ping document.
Daily sales summaries include information about billed

sales. Reconciliation of these summaries to the accounts re-
ceivable ledger would provide reasonable assurance that all
billed sales were posted.
Answer A is incorrect because matching shipments with

sales invoices would provide reasonable assurance that
goods shipped were billed.
Answer B is incorrect because reconciling the subsidiary

ledger with the control account would only prove that the
aggregate amount debited to the subsidiary ledger agrees
with the amount debited to the control account in the gen-
eral ledger.
Answer D is incorrect because if sales invoices are support-

ed by shipping documents, it WOJlld assure -that billed sales
were actually shipped. ·
.......
138. Which of the following tests of controls would most likely be

performed by an auditor to obtain evidence about manage-
ment's assertion concerning the completeness of sales
transactions?
A. Inquiries about the entity's credit granting policies and
whether credit checks are consistently applied.
B. Inspect the entity's reports of prenumbered shipping
documents that have not been recorded in the sales
journal.
C. Compare prices on prenumbered sales invoices to the
entity's authorized price list.
D. Verify that extensions and footings on sales invoices and
monthly statements of customers' accounts have been
checked.
Inspecting shipping documents that have not been recorded

in the sales journal will possibly disclose items that have
been sold as evidenced by the shipping documents but were
not recorded as sales.
139. An online sales order processing system most likely would

have an advantage over a batch sales order processing sys·
tern by ,
A. Enabling shipment of customer orders .to be initiated as
the orders are received. .a
B. Maintaining more accurate records of accounts receiv ·
ble and inventories.
C. Maintaining backup copies of the database. of
D. .Detecting errors in the data entry process by the use
edit checks.
. . t 1oca·
In an onlme system, terminals installed in d1fferen k that
tions are directly connected to the computer networ en·
makes it possible to process transactions as theY. a~t~ated
tered. Hence, shipments of customer orders can be 101
..
instantaneously as they are received. On the other hand,

batch processing involves processing of transactions in
batches, on a delayed basis.
L40. When an office supply company is unable to fill an order

completely, it marks the out-of-stock items a~ back ordered ·
on the customer's order form and enters these items in a
back order file that can be viewed or printed by manage-
ment. Customers are becoming dissatisfied with the compa-
IJY because of its failure to keep track of and ship out-of-
stock items as soon as they are available. Which of the fol-
lowing is the best approach to ensure prompt delivery of
out-of-stock item~?
A. Increase inventory levels to minimize the occurrence of
stock outs.
B. Match the back order file to goods received daily.
C. Reconcile the sum of filled and back orders with the total
of all orders placed daily.
D. Implement electronic data interchange (EDI) with supply
vendors to decrease the time to replenish inventory.
The inability to keep track of and ship out-of-stock items as

soon as they become·available may be addressed by match-
ing the back order file to goods received daily. Once identi-
fied, appropriate action on unfilled orders could then be
made.
Answers A, C, and D are incorrect because the approaches

described do not ensure prompt delivery of items that are
out of stock.
EXPENDITURE/DISBURSEMENT CYCLE
141. Which of the following is a source document that would be

found in the expenditure cycle?-
A. Journal voucher
B. Purchase order
C. Time card
D. Delivery receipt
142. is a standing order to purchase specified

items at a de.signated price, from a particular supplier for a
set period of time. ·
A. Set order
B. Blanket purchase order
C. Purchase order
D. Commodity order
143. Which of the following is probably the most effective control

for the prevention of kickbacks to purchasing agents?
A. Review of vendor performance.
B. A corporate policy to prohibit purchasing agents from ac·
cepting kickbacks.
C. Purchasing from approved vendors.
D. Good supervision in the purchasing area.
144. The easiest way to prevent the acceptance of unordered

goods is to . re
A. Always require that a valid purchase order exists befo
goods can be accepted at the time of delivery.
B. Order only from approved vendors.
C. Have an appropriate conflict of interest policy in plac~en·
D. Require receiving department personnel to call the
dor before accepting any goods.
rstand·
145. The auditor's primary objective in obtaining an un~e .5 to
ing of the .client's controls over the purchasing fU~ctio~~ard·
A. Investigate the recording of unusual transactions
ing raw materials.
B. Determine the reliability of

financial reporting by the pur-
chasing function. ·
c. Observe the annual physical count.
D. Ascertain that raw materials paid for are on hand.
Controls that are relevant to the audit are those that relate
to the reliability of financial reporting.
Answer A is incorrect because investigation of the recording

of unusual transactions is an audit procedure, not an audit
objective.
Answer C is incorrect because observation of the annual

physical count of inventories relates more to the production
cycle of the entity.
Answer D is incorrect because materials paid for need not

be on hand-materials may have been sold or used in pro-
duction.
146. In a well-designed internal control system, employees in the

same department most likely would approve purchase orders
and also
A. Negotiate terms with vendors.
B. Authorize requisitions of goods.
C. Inspect and count goods upon receipt.
D. Reconcile the open invoice file.
In a well-designed internal control system, the entity's pur-

chasing department approves purchase orders and·negoti-
ates terms with vendors as part of the authorization pro-
cess.
-
Answers B, C, and D are incorrect because authorizing the

requisition of goods, inspecting and counting goods re-
ceived, and reconciling the open invoice file are functions
incompatible with the authorization performed by the pur-
chasing department.
147. Effective controls relevant to purchasing of raw materials

should usually include all of the following, except
A. Determining the need for the raw materials prior to pre·
paring the purchase order.
B. Systematic reporting of product changes that will affect
raw materials.
C. Obtaining financial approval prior to making a commit·
ment.
D. Obtaining third-party written quality and qua~tity reports
prior to payment for the raw materials.
Third-party written quality and quantity reports are not-0r·

dinarily sought before making the payment. The ent1·cy's. re·
ceiving department personnel usually have suffi~I~~~
knowledge about the purchased goods. Only_in excepao
cases when an outside advice may be considered.
Answer A is incorrect because determining the need f~~ :n~

raw materials before preparing the purchase order WI
sure that only needed materials will be ordered. ·
Answer B is incorrect because reporting of product ~h:sn~:i

affecting raw materials ensures that obsolete matena
not be ordered.
roval
Answer C is incorrect because obtaining financial ap{e tJiat
before making a commitment is important to cnsu
sufficient funds will be available on payment date.
c:;HAPTER 5 Risk Assessments and Internal Control 323
148. As part of its purchasing system, an entity's receiving de-

partment receives copies of purchase orders for use in iden-
tifying and recording goods received. The purchase orders
list the name of the v~ndor and the quantities of the materi-
als ordered. A possible error that this system could allow is
A. Payment for unauthorized purchases~
B. Payment to unauthorized vendors.
C. Overpayment of partial deliveries.
D. Delay in recording purchases.
lfthe quantities of the materials ordered are included in the

purchase order copy that is sent to the receiving depart-
ment, receiving department personnel may be tempted to
just copy the quantities ordered from the purchase order
when they prepare receiving reports. Hence, a possible er-
ror that this system could allow is overpayment for partial
deliveries.
From the standpoint of a good internal control, a "blind

copy" of the purchase order-that is, no indication of the
quantities ordered-should be sent to the receiving de-
partment. This will ensure that its personnel will conduct
an actual count and inspection of goods received.
149. Which of the following controls is not usually performed in

the accounts payable department?
A. Indicating on the voucher the affected asset and ex-
pense accounts to be debited.
B. Approving vouchers for payment by having an authorized
employee sign the vouchers.
C. Accounting for unused prenumbered purchase orders
and receiving reports.
D. · Matching the vendor's invoice with the related purchase
requisition, purchase order, and receiving reoort. ·
......
..., '
324 CPA EXAM/NATION REVIEWER: AUDITING THEORY
The accounts payable department processes vendor invoic·

es for payment. Employees in this department should not
perform functions related to purchasing and receiving
goods.
Accounting for unused prenumbered purchase orders and

rec.eiving reports should be performed by employees in the
purchasing and receiving departments, respectively.
Answers A, B, and Dare incorrect because the responsibili·

ties described are all functions of the accounts payable de-
partment.
150. Which of the following procedures would best discourage the

resubmission of vendor invoices after they have been paid?
A. The mailing of payments directly to payees by accounts
payable department personnel.
B. A requirement for double endorsement of checks.
C. The cancellation of vouchers by accounl:ing personnel.
D. The cancellation of vouchers by treasurer personnel.
. d pporting
Cancelmg the voucher package-voucher an su t of
documents-upon payment prevents duplicate payrn~n to
a voucher. This should be done in the treasurer's 0 ~~;ate
ensure that the documents will not be recycled for duP
payments.
d. ctlY to
Answer A is incorrect because mailing payments irecrupu·
payees does not prevent recycling of invoices by uns
lous individuals.
. not a
, rnent is
Answer Bis incorrect because a single endorse . g docu·
control weakness provided that proper supportin
ments are required before the check is signed and the signa-
tory does not have incompatible duties.
Answer C is incorrect because the voucher package should

not be canceled before payment.
151. A university does not have a centralized receiving function

for departmental purchases of books, supplies, and eqL;Jip-
ment. Which of the following controls would most effective-
ly prevent payment for goods not received, if performed pri-
or to invoice payment?
A. Vendor invoices should be approved by a departmental
supervisor other than the employee ordering the goods.
B. Invoices over a specified amount should be approved by
the vice president of finance.
C. Names and addresses on vendor invoices should be
compared to a list of department-authorized vendors.
D. Vendor invoices should be matched with department
purchase orders.
The departmental supervisors would most likely be aware

of all goods received by their departments. Thus, approval
of vendor invoices by departmental supervisors would most
effectively prevent payment for goods not received.
Answer 8 is incorrect because the vice president of finance

does not receive incoming goods ..
Answers C and D are incorrect because comparing invoices

with lists. of authorized vendors and matching invoices with
purchase orders do not provide evidence that goods were
actually received.
....
326 CPA EXAMINATION REVIEWER: AUDITING ·THEORY
152. To minimize the risk that purchasing agents will use their
positions for personal gain, an entity should
A. Direct the purchasing department to maintain records on
p·urchase prices paid, to be reviewed every 6 months.
B. Request internal auditors to send confirmation requests
to selected venqors.
C. Require competitive bidding.
D. Specify that all items purchased must pass quality con·
trol tests.
The purchase of goods through competitive bidding will re-

duce costs and the possibility that purchasing agents will
have side agreements with vendors.
The controls described in answers A, B, and D are detective,

not preventive, controls.
153. The following are appropriate questions on an internal con·

trol questionnaire concerning purchase transactions, except
A. Are all goods received in a centralized receiving depart·
ment counted, inspected, and compared with purchase
orders on receipt?
B. Are intact cash receipts deposited daily in the bank?
C. Are prenumbered purchase orders and receiving reports
used and accounted for? r·
D. Are an approved purchase requisition and a signed pu
chase order required for each purchase?
The question about the daily deposit of intact cash recei~

relates to the revenue/receipt cycle not the expen
ture/disbursement cycle. '
154 Th i 0 II · · . al con·
. · e O\~mg ~uest1ons ordinarily appear in an intern
trol quest1onna1re on cash disbursements except
A. Are prelistings made of all cash recei~ts?
B. Is each check supported by an approved voucher?

c. Are imprinted and prenumbered checks used and is a
check protection device used in printing the check
amount?
o. Are all disbursements except for petty cash made by
check?
Prelisting of cash receipts is part of the revenue/receipt cy-

cle.
155. In a well-designed internal control, the same employee may
be permitted to
A. Prepare receiving reports and also approve purchase or-
ders.
B. Approve vouchers for payment and also have access to
unused purchase orders.
C. Mail signed checks and also cancel supporting docu-
ments.
p. Mail signed checks and also prepare bank reconciliations.
In a typical cash disbursements system, approved check
vouchers and supporting documents are forwarded to the
cash disbursements department. This department, having a
custodial function, is responsible for sigriing checks, cancel-
ing supporting documents, and mailing signed checks.
Answer A is incorrect because approving purchase orders is

a function of the purchasing department. The receiving de-
partment, responsible for the prepa:raflon of receiving re-
ports, should not know the quqntity ordered.
Answer B is incorrect because vouchers are approved in the

accounts payable department, and only the purchasing de-
partment should be allowed access to unused purchase or·

de rs.
Answer D is incorrect because the bank reconciliation

should be performed by an employee who does not have a
custodial responsibility.
156. Which of the following is of least concern to an auditor in

assessing the risks of material misstatement?
A. Signed checks are distributed by the controller to ap-
proved payees.
B. Checks are signed by one person.
C. Cash receipts are not deposited intact daily.
D. Treasurer does not verify the names and addresses of
check payees.
The fact that checks are signed by only one person does not
necessarily signal a weakness in the entity's internal control
. 'ble
system as long as the signatory does not have mcompati
functions and proper verification of supporting documenta·
tion is done before signing. •
rfonll5
Answer A is inco·r rect because the controller, who pe . ned
a record-keeping function, should not have access to sig
checks.
. f ·ntact cash
Answer C is incorrect because daily deposit o . i
receipts should be required to minimize defalcation.
hould sigII
Answer D is incorrect because the treasurer s entatioJl
checks only after verification of supporting docurn
has been performed.
157. Under which of the following circumstances would an auditor

be most likely to intensify an audit of a P20,000 petty cash
fund?
A. Petty cash :vouchers are not prenumbered.
B. The custodian endorses reimbursement checks.
C. Reimbursement occurs twice each week.
D. The custodian occasionally uses the petty cash fund to
cash employee checks.
Frequent reimbursement of petty cash fund (for example,

twice each week) suggests that the fund is not functioning
as intended. In this case, the auditor may need to intensify
the audit of the petty cash fund.
Answers A and D are incorrect because although failure to

prenumber vouchers and occasional use of the fund to cash
employee checks are not preferable practices, they do not
necessarily lead to commission of errors or fraud.
Answer B is incorrect because the custodian's endorsement

is required to cash a replenishment check.
15.8. In Jervs Company's accounting system, the quantities

counted by the receiving department and entered at a ter-
minal are transmitted to the computer, which immediately
transmits the amounts back to the terminal for display to
enable the operator to
A. Verify that the amount was entered accurately.
B. Establish the validity of the account number.
C. Verify the authorization of the disbursement.
D. Prevent the overpayment of the account.
The display of the amounts entered is called doseu-loop

verification-an effective contr~I to verify the accuracy of
data input.
PRODUCTION CYCLE
159. What document is prepared to authorize the removal of the

necessary quantity of raw materials from storeroom to facto-
ry?
A. Production order
B. Materials requisition
C. Move ticket
D. Purchase invoice
160. Which of the following is an essential control procedure to

ensure the accuracy of the recorded inventory quantities?
A. Calculating unit costs and valuing obsolete or damaged
inventory items in accordance with inventory polic.y.
B. Testing inventory extensions.
C. Performing a gross profit test.
D. Establishing a cutoff for goods received and shipped.
Establishing a cutoff for goods received and shipped wou~d

ensure.that only goods owned by the entity are included in
inventory.
cedures
Answers A, B, and C are incorrect because the P~0 thef
described relate more directly to inventory valuation ra
than inventory quantities.
161. The following questions are appropriate for an internal con·

trol questionnaire concerning inventory, except
A. Are goods stored in locked storage areas? . eel per·
B. Is access to the storage area limited to authonz
sonnel? rnent?
C. Are disbursement vouchers approved be~ore pa~ invento·
0
D. Are there independent, periodic comparisons
ry records w!th goods on hand?
Vouchers for all disbursements (not only for inventory pur-

chases) must be approved before payment. Therefore, a
question on voucher approval would be more appropriately
included in the expenditure/disbursement cycle question-
naire.
162. Effective internal controls over inventories are designed and

implemented for the following reasons, except
A. Inventories typically represent a large component of an
entity's current assets.
B. Inventories are the most liquid asset.
C. Inventories directly affect the financial performance of
an entity.
D. Inventorie~ typically represent a large portion of an enti-
ty's total assets.
Cash, not inventories, is the most liquid asset and has the
greatest inherent risk.
Answers A and D are incorrect because inventories typically

represent a material component of an entity's current assets
and total assets.
Answer C is incorrect because once sold, inventories be-

come cost of goods sold and is a determinant of an entity's
financial performance for a given period.
163. Leonor Manufacturing Corporation mass produces ten differ-

ent products. The company's controller is interested in
strengthening internal control over the accounting for mate-
rials used in production. He/She would most likely design
and implement
A. An economic order quantity (EOQ) system. ·
B. A perpetual inventory system.
C. A separation of duties among production personnel.
--
D. A job-order cost accounting system.
The entity can easily keep track of materials usage by main·

taining perpetual inventory records.
Answer A is incorrect because EOQ system will ensure cost.

effective reordering of materials but will not strengthen the
control over accounting for materials usage .
.Answer C is incorrect because s"egregation of duties among

production personnel does not strengthen control over ac·
counting for materials used in production unless the author·
ization, custodial, and record-keeping functions are likewise
separated.
Answer D is incorrect because a process-cost system, not a

job-order cost system, is appropriate for goods that are
mass produced.
164. Your client, a merchandising concern has annual sales of

P30,000,000 and a 40% gross p~ofit rate.
I
Tests reve~I tha_t
2% of the peso amount of purchases do not get into inven.
tory because of breakage and inventory pilferage by em
ployees. The company estimates that these losses could be
.
~ed uced ~o 0.5% of purchases by designing and 1mplemeuld
nt·
ing certain controls costing approximately P350,000. ShO
the controls be designed and implemented? use
A. Yes, regardless of cost-benefit considerations, beca
the situation involves employee theft. . oie
8· Yes, because the ideal system of internal contr01 '5
most expensive one. t11e
C. No, because the cost of designing and implementing
added controls exceeds the projected savings. eed
D. Yes, because the expected benefits to be derived exc
the cost of the added controls.
CHAPTER 5 Risk Assessments and lnte111al Control 333
A basic concept of internal control IS the concept of reason~

able assurance,· which recognizes that the cost of internal
contrql should not exceed the benefits expected to be de-
rivec:l.
The additional controls should not be considered because

the cost. is P350,000, but the estimated saving is only
P270,000 [(2% - 0.5%) x (P30 million sales x 60% cost of
sales ratio)].
165. The objectives of internal control for a production cyde are

to provide assurance that transactions are properly executed
and recorded, and that
A. Production orders are prenumbered and signed by a su-
pervisor. .
B. Custody of work-in-process and of finished goods is
properly maintained.
C. Independent internal verification of activity reports is es-
tablished.
D. Transfers to finished goods are documented by a com-
pleted· production report and a quality control report.
A primary objective of internal control in the production cy-

cle is to safeguard inventories from misuse and theft. The
inventories should be in the custody of a storekeeper, and
inventory movements should be properly documented and
recorded to establish accountability.
Answers A, C, and D are incorrect because the use of pre- ·

numbered production orders signed by a supervisor, inde-
pendent internal verification of activity reports, and docu-
menting inventory transfers are control activities-an in-
ternal control component, not control .objectives.
166. Which of the following controls most likely would ~ imple-

mented to achieve the production cycle control objective of
maintaining accurate inventory records?
A. Periodic inventory counts are used to adjust the perpet·
ual inventory records.
B. A just-in-time inventory ordering system keeps inventory
levels to a desired minimum.
C. Perpetual inventory records are periodically compared
with the net realizable value of individual inventory
items.
D. Purchase requisitions, receiving reports, purchase orders,
and vendor invoices are independently matched before
payment is approved.
A well-designed internal control system should require

comparison of the recorded accountability for assets with
existing assets at reasonable i~tervals.
In the produ~tion cycle, periodic inventory counts should b~

reconciled to the perpetual inventory records. This cont~o
will provide reasonable assurance about the accuracy of in·
ventory records.
Answer B is incorrect because a just-in-time ordering sy:~

tern provides assurance that desired inventory levels arf
maintained but does not ensure that accurate invento
records are maintained.
f er·
°
Answer C is incorrect because periodic comparison J~teS
petual inventory records with net realizable value r:f io·
more to inventory valuation rather than the accuracy
ventory records.
Answer D is incorrect because matching of purchase docu~

ments provides assurance that payments are made only for
goods authorized and received but does not ensure the ac-
curacy of perpetual inventory records.
167. Which of the following questions would an auditor most like-

ly include in the production cycle internal control question-
naire?
A. Are details of individual disbursements for raw materials
compared to the total for posting to the general ledger?
B. Are vendor invoices for raw materials approved before
payment?
C. Are all issuances of raw materials to production based on
approved requisition forms?
D. Are signed checks for the purchase of raw materials sent
directly to intended payees after signing, without being
returned to the p,erson who authorized the invoice pro-
cessing?
Answers A, B, and D are incorrect because comparing indi-

vidual disbursements for raw materials to totals, approving
vendor invoices before payment, and sendihg checks direct- .
ly to payees after signing pertain more directly to the ex-
penditure/disbursement cycle.
168. Which of the following is the most likely procedure an audi-

tor would perform in obtaining ah understanding of a manu-
facturing entity's internal control for inventory balances?
A. Perform test counts of inventory when observing the en-
tity's physical count.
B. Perform analytical procedures designed to identify signif-
icant cost variances.
C. Analyze the liquidity and turnover ratio of the inventory.
D. Review the entity's description of inventory policies and
procedures.
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:; ·iii;;
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~---------------- -_-]
The auditor will review the entity's description of inventory

policies and procedures to evaluate the design of controls
and determine whether they have been implemented.
169. A properly designed internal control should require that de-

fective merchandise returned by customers be presented ini·
tially to the
A. Receiving clerk.
B. Purchasing clerk.
c.
Billing clerk.
D. Inventory control clerk.
Al! incoming goods, including defective merchandise re·

turned by customers, should be received by the receiving
clerk.
INVESTING CYCLE
170. The following controls are appropriate for property, plan~

and equipment (PPE), except d
A. Written policies for capitalization and expenditure an
review of application of depreciation methods.
B. Disposal of fully depreciated PPE items. . ppE
C. Proper authority for acquisition and retirement of
items. ppf
D. Detailed PPE records and physical controls over
items.
. . d of be-
Fully depreciated PPE items need not be dispose assets
cause they may still be useful in the business. These
should remain on the books until disposal.
policies
Answers A, C, and D are incorrect because writte~ preci3'
for capitalization and expenditure and review of e
tion methods, proper authority for acquisition and retire-

ment, and detailed PPE records and physical controls are
proper controls over PPE.
111. The question that an auditor would least likely include on an

internal control questionnaire concerning the initiation and
execution of equipment transactions is
A. Are requests for purchases of equipment reviewed for
consideration of soliciting competitive bids?
B. Are requests for major repairs approved at a ·higher level
than the department initiating the request?
C. Are procedures in place to monitor and properly restrict
access to equipment?
D. Are prenumbered purchase orders used for equipment
and periodically accounted for?
The issue is the initiation and execution of equipment trans-

actions. Restricting- access to equipment to authorized per-
sonnel only does not address the issue because it deals more
with proper custody of assets.
Answers A, B, and Dare incorrect because competitive bid-

ding, approval of major repairs, and use of prenumbered
purchase orders are related to the issue concerning initia-
tion and execution of equipment transactions.
172. Which of the following controls would most li~ely detect

equipment acquisitions that are misclassified as maintenance
expense?
A. Segregation of duties of employees in the accounts pay-
able department.
B. Authorization by the board of directors of significant
equipment acquisitions.
C. Independent verification of invoices for disbursements
recorded as equipment acquisitions.
:,j
~I
I
I
D. Investigation of variances within a formal budgeting sys-
\ tem.
If equipment acquisitions are misclassified as maintenance

expense, an entity's formal budgeting system that includes
estimates of maintenance expense will report a significant
. variance. The misclassification may be detected by investi-
gating the variance.
Answer A is incorrect because the accounts payable .de-

partment that processes payment transactions is unlikely to
question the classification of expenditures that are based on
pr.o per documentation.
J Answer B is incorrect because the misclassification occurs

l subsequent to authorization.
I Answer C is incorrect because verification of invoices from

i
the population of recorded equipment acquisitions will not
disclose items misclassified as maintenance expense.
173. Which of the following control activities is most likely to pre-

vent the improper disposition of equipment? _ d
A. A periodic analysis of the scrap sales and the repairs an
maintenance accounts. _ thor·
B. Periodic comparison of removal work orders with au
izing documentation. _ tha1
C. The use of serial numbers to identify equipment
could be sold. dis·
D. A separation of duties between those authorized toe re-
pose of equipment and those authorized to approv
moval work orders.
. / .•
CHAPTER 5 Risk Assessments ~nd Internal Control 339
There should be proper segregation of duties to reduce the

opportunity for an individual to both perpetrate and conceal
errors or fraud.
The functions of authorization, recording, and asset custody

should be separated. Accordingly, the authorization to dis-
pose of equipment by approving removal work orders (au-
thorization) and the disposal of equipment (asset custody)
snould not be assigned to the same person.
Answers A, B, and Care incorrect because the control activi-

ties described are detective, not preventive, in nature.
. 174. Which of the following control activities most likely would

justify a reduced level of control risk concerning property,
plant, and equipment (PPE) acquisitions?
A. Periodic physical inspection of PPE by the internal audit
staff.
B. Approval of periodic depreciation entries by a supervisor
independent of the accounting department.
C. The review of pre,numbered purchase orders to detect
unrecorded trade-ins.
D. Comparison of current-year PPE account balances with
prior-year figures.
A periodic physical inspection by an objective and compe-

tent internal audit staff is the best way to verify the exist-
ence of PPE. This will reduce the possibility of recording fic-
titious PPE acquisitions and other fraudulent acts. The im-
plementation of this control activity would justify a lower
assessed level of control risk
-
-,
Answer B is incoq:;e ct because depreciation is computed

based on recorded amounts of PPE. Depreciation will be
misstated if the basis used in calculating it is also misstated,
Answer C is incorrect because reviewing purchase orders to

detect unrecorded trade-ins is not as effective as directly in·
specting the assets.
Answer D is incorrect because comparing recorded PPE ac·

count balances may not be effective for detecting nonexist·
ent PPE.
175. An internal control objective concerning property, plant, and

equipment (PPE) acquisitions is that they be recorded at the
correct amounts and in the proper period, and properly d.as·
sified. In which of the following conditions would an auditor
most likely assess a high level of risk of material misstate-
ment?
A. All material acquisitions of PPE are required to be ap·
proved by the board of directors.
B. Most additions are self-constructed by the entity. lude
C. Recently acquired loans include covenants that prec
further plant acquisitions for 5 years. .
D. Gross PPE increased 30% during the current penod.
. . ·ects. Ja·
If an entity has on-going in-house construction pro) 'ts in·
1
bor and overhead costs should be allocated between over.
.
ven t ones an d m-
. house construction . pro1ec
. ts · Moremple~
capitalization of borrowing costs would invol~e c~erneot
calculations. Therefore, the inherent risk of missta
for self-constructed assets is high.
Answer A is incorrect because the required approval of the

entity's board of directors for all material PPE additions re-
lates to authorization, not recording.
Answer C is incorrect because the loan covenant that pre-

cludes further plant additions for 5 years is most likely to
decrease risk.
Answer D is ·incorrect because the significant increase in

PPE does not necessarily increase the risk of misstatement.
For example, the significant increase may be due to material
acquisitions of PPE from outside vendors. In this case, the
cost of PPE can easily be determined by just referring to
amounts on vendor invoices.
176. Why is property, plant, and equipment (PPE) typically con-

sidered to be one of the accounts least susceptible to fraud?
A. Internal control on this account is inherently effective.
~· The depreciated values are always smaller than cost.
C. The inherent risk of PPE is usually low.
D. For most companies, the recorded amounts of PPE are
immaterial.
PPE is one of the accounts that is least susceptible to mis-

statement in the absence of related controls-that is, its in-
herent risk is low. This is because of the infrequency of
transactions in the account and the relative ease in verifying
its existence. ·
Answer A is incorrect because inherent risk, not control risk,

pertains to the susceptibility of an account to misstatement.
Answer B is incorrect because not all PPE items are depre-

ciable, for example, land.
·-
Answer D is incorrect because although transactions affect.

ing PPE are infrequent, the amounts involved arr: usually
large.
177. Which of the following misstatements or questionable prac·

tices niay be uncovered if an auditor tours an entity's pro-
duction facility?
A. Insurance coverage on the facility has lapsed.
B. Overhead has been overapplied.
C. Depreciation expense on fully depreciated machinery has
been recognized.
D. Necessary facility maintenance has not been performed.
The auditor's tour of an entity's production facility woul~

involve direct observation of the asset condition. Hence, 11
is likely that the auditor will discover that necessary facility
maintenance has not been performed during the year.
Answer A is incorrect because inspection of insurance c~n·

tracts, not a tour of the plant facility, will detect lapsed in·
surance coverage.
Answer B is incorrect because comparison of the a.ctu~~

overhead incurred with applied overhead will determine
~verhead has been overapplied.
xamine
Answer C is incorrect because the auditor should e beeO
depreciation records to determine if depreciation has
provided on fully depreciated machinery.
. . ~~
178. Wh1~h of the fol_lowing c;ontrols would an _e ntity 01 .tieS?
use in safeguarding against the loss of trading secun
cHAPTER 5 Risk Assessments and Internal Control . 343
A. The independent auditor traces all purchases and sales

of trading securities through the subsidiary ledgers to
the general ledger.
B. An independent trust company that has no direct contact
with the employees who have record-keeping responsi-
bilities has possession of the securities.
C. The internal auditor inspects the trading securities in the
entity's safe each year on the balance sheet date.
D. A designated member of the board of directors controls
the securities in a bank safe-deposit box.
Engaging an independent trust company for the custody of

an entity's trading securities may be considered the best
way to safeguard such securities against loss. Such an insti-
tution normally has very strict controls over assets under its
custody, including access to its vaults.
Answer A is incorrect because an independent auditor's

tracing of trading securities transactions is an audit test, not
a control.
Answer C is incorrect because the internal auditor's inspec-

tion of trading securities in the entity's safe each year on the
balance sheet date does not assur~ that no securities have
been removed between inspection dates.
Answer D is incorrect because a better control is to require

the presence of two authorized persons to access a safe-
deposit box.
179. Which of the following controls wouid a company most likely

use to safeguard marketable securities when such securities
are not in the custody of an independent trust agent?
A. The chairman of the board of directors verifies the mar-

ketable securities, which are kept in a bank safe-deposit
box, each year~on the balance sheet date.
B. The internal auditor and the controller independently
trace all purchases and sales of marketable securities
from the subsidiary ledgers to the general ledger.
C. Two company officials have joint control of marketable
securities, which are kept in a bank safe-deposit box.
D. The investment committee of the board of directors peri-
odically reviews the investment decisions delegated to
the treasurer.
A physical control to safeguard an entity's assets such as

marketable securities is to keep them in a bank safe-deposit
box requiring two signatures to gain access. ·
Answer A is incorrect because verification of marketable se·

curities once a year is unlikely to provide adequate control.
Answer B is incorrect because tracing of marketable securi·

ties transactions to the accounting records assures proper
recording but does not physically safeguard the asset.
Answer D .is incorrect because periodic review of the in;

vestment decisions delegated to the treasurer does no
physically safeguard the asset.
180. Which of the following internal control activities would :.

entity most likely implement to assist in satisfying the co
pleteness assertion related to noncurrent investm~nts? bank.
A. The internal auditor compares the securities in the
safe-deposit box with recorded investments. . h bank
B. Senior management verifies that securities in t e
safe-deposit box are registered in the entity's narne.
c. The controller compares the current market prices of

recorded investments with the brokers' advices on file.
D. The treasurer vouches the acquisition of securities by
comparing brokers' advices with canceled checks.
Comparison of securities in the bank safe-deposit box with

the accounting records assures that the investment balance
is complete, that is, all investment se.curities have been re-
flected in the account.
Answer B is incorrect because senior management's verifi-

q1tion that securities are registered in the entity's name re-
lates to the rights assertion.
Answer C is incorrect because comparing market prices

with brokers' advices pertains to the valuation assertion.
Answer D is incorrect because vouching securities pur-

chased by comparing brokers' advices with canceled checks
relates to the rights assertion.
181. Which of the following is not a proper control over invest-

ment securities?
A. Separation of custodial and treasury functions.
B. Employing an independent trust agent.
C. Proper authorization of transactions.
D. Storage in a safe-deposit box.
An entity's treasury .function should includ.e custody of cash

and securities.
Answers B, C, and D are incorrect because employing an in-

dependent trust agent, proper authorization of transactions,
and storage of investment securities in a safe-deposit box

are proper controls over investment securities.
182. The following controls are designed to protect investment

securities, except
A. Investment securities should be properly controlled phys·
ically in order to prevent unauthorized usage.
B.. Custody over ,investment securities should be limited to
personnel having record-keeping responsibility over the
securities. .
C. Securities should be registered in the entity's name.
D. Access to securities should be vested in two individuals.
As with other assets, the custody of investment securities

should be delegated to individuals who do not have record·
ing responsibility over securities.
FINANCING CYCLE
183. Which of the following questions is most likely to be includt~

by an auditor on an internal control questionnaire for no
payable? . eel by the
A. Are direct borrowings on notes payable authonz
board of directors? riticallY
B. Are assets that collateralize notes payable c
needed for the entity's continued existence? ·red on
C. Are two or more authorized signatures requi
checks that repay notes payable? . the pur·
D. Are the proceeds from notes payable used for
chase of noncurrent assets? ·
. rrowillgs
Most companies ordinarily require that direct ~odirectof'S·
0
on notes payable be authorized by the board
': '
Accordingly, an auditor should verify if such control has

been properly implemented.
184. The audit program for long-term debt should include steps
that require the
A. Verification of the existence of the bondholders.
B. Examination of any bond trust indenture.
C. Inspection of the accounts payable master file.
D. Investigation of credits to the bond interest income ac-
count.
185. During the year under audit, a company has completed a

private placement of a substantial amount of bonds. Which
of the following is the most important step in the auditor's
program for the audit of bonds payable?
A. Confirming the amount issued with the bond trustee.
B. Tracing the cash received from the issue to the account-
ing records.
C. Examining the bond records maintained by the transfer
agent.
D. Recomputing the annual interest cost and the effective
yield.
186. Several years ago, Consuelo, Inc., secured a conventional

real estate mortgage loan. Which of the following audit pro-
cedures would be least likely to be performed by an auditor
auditing the mortgage balance?
A. Examine the current year's cancelled checks.
B. Review the mortgage amortization schedule.
C. Inspect public records of lien balances.
D. Recompute mortgage interest expense.
187. During an audit of a publicly held company, the auditor

should obtain written confirmation regarding debenture
transactions from the
A. Debenture holders
B. Client's attorney
C. Internal auditors
D. Trustee
188. An audit program for the audit of the retained earnings ac-
count should include a step that requires verification of
A. Market value used to charge retained earnings to ac- 1
count for a 2-for-1 stock split.

B. Approval of the adjustment to the beginning balance as
a result of a write-down of an account receivable.
C. Authorization for both cash and stock dividends.
D. Gain or loss resulting from disposition of treasury shares.
189. Where no independent stock transfer agents are employed

and the corporation issues its own stocks and maintains
stock records, cancelled stock certificates should .
A. Be defaced to prevent reissuance and attached to their
corresponding stubs. ·n
B. Not be .defaced, but segregated from other stock certi ·
cates and retained in a car.celled certificates file.
c.Be destroyed to prevent fraudulent reissuance. rtment
D. Be defaced and sent to the Secretary of the Depa
of Finance.
HUMAN RESOURCES CYCLE

or
. · ·ty is theft
190. A potential threat to the payroll processrng actlVI trol that
fraudulent distribution of payroll checks. one ~~~g issued
can be implemented to help prevent paycheckS er
to "ghost" employees is
A. Use of a payroll clearing account. . . b sol'fleone
B. Paychecks should be physically distributed Y
who does not authorize or record payroll.
c. Periodic reconciliation of the payroll bank account.

o. The cashier should sign all payroll checks.
!91. Effective controls over the payroll function may include

A. Custody of rate authorization records by the supervisor
of the payroll department.
B. Preparation of payroll transaction journal entries by an
employee who reports to the supervisor of the personnel
department.
c. Verification of agreement of job time tickets with em-
ployee clock card hours by a payroll department employ-
ee.
D. Reconciliation of totals on job time tickets with job re-
ports. by employees responsible for those specific jobs.
Comparison of the job time tickets, which show the total

time spent on jobs, and time cards will provide an inde-
pendent check of the accuracy of time indicated on time
cards.
Answer A is incorrect because the pay rates used in the cal-

culation of payroll should be authorized by the personnel
department.
Answer B is incorrect because the payroll department, not

the personnel department, prepares the payroll transaction
journal entries. This is to segregate the authorization and
record-keeping functions.
Answer D is incorrect because an independent party, not the

employees involved, should reconcile totals on job time
tickets with job reports.
Ill
192. Employees of a manufacturing entity are often required to

, use time cards and job time tickets. Which of the following
statements concerning the use of these documents is incor-
rect?
A. Time reported on job time tickets should be reconciled to
time cards.
B. Payroll should be calculated based on job time tickets.
C. Each employee should have only one time card.
D. An employee may have one or many job time tickets in a
day.
Time cards are the official records of time worked by em·

ployees and should be the basis for payroll preparation.
193. Organiza~ional independence in the processing of payroll can

be achieved by segregating the functions of authorization,
record-keeping, and custody of assets. Which ·one of the
following functional separations is not required for internal
control purposes?
A. Separation of payroll preparation and paycheck distribU·
tion.
B. Separation of personnel function from payroll prepara·
tion.
C. Separati~n of timekeeping from payroll preparation. of
D. Separation of payroll preparation and maintenance
year-to-date records.
. f Jll'
The du~ies of payroll preparation and maintenance 0 ~ g.
ployees year-to-date records both involve recordkeeP
0
Hence, they need not be separated for control purposes.
· Which of the following controls is most effective in pro~~~

194
reason?ble assurance that salary, wage, and benefit e><
es are incurred only for work performed?
R 5 Risk Assessments and Internal Control 351
cHAPTE
A. The payroll register is used as the source document for

posting employee benefit costs to the general ledger. .
B. All time cards and reports are reviewed and approved in
writing by immediate line supervisors who do not have
responsibilities for paycheck distribution.
c. Actual payroll amounts are regularly compared against
budgeted amounts by management, with all material
budget variances being investigated.
o. The accuracy of extensions of hours worked and pay
rates is rechecked by an independent party, and pay rate
and other key payroll information is changed only upon
the receipt of a written authorization from the personnel
department.
An· appropriate control is the review and appr6val of time

cards and reports by line supervisors because they have di-
rect knowledge about whether work has been performed.
And because they have no responsibilities for paycheck dis-
tribution, they are not in a position to misappropriate
paychecks.
Answer A is incorrect because using the payroll register as

the source document for posting to the general ledger con-
trols recording of employee benefit costs, not the propriety
of the reported time worked.
Answer C is incorrect because investigating material vari-

ances between actual payroll and budgeted amounts may
probably not reveal specific improprieties. It is, therefore,
less effective than the review of time cards and reports by
line supervisors.
.
Answer D is incorrect because although an arithmetic check
of payroll calculations and personnel authorization of pay
rate changes are effective controls over payroll processing,

they do not assure that employee benefit costs are incurred
only for work performed.
195. The purpose of segregating 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 re-
sponsibility.
C. Human resource function from the controllership func·
tion.
D. Administrative controls from the internal accounting con·
trols.
A well-designed internal control provides for proper segre·

gation of authorization, recording, and asset custody func·
tions.
An entity's personnel department provides authoriz'1tion

for hiring, pay rates, and deductions; the production de·
partment provides authorization for hours worked. In turn.
the payroll department calculates and records the payroll
based on these authorizations. Based on these calculations,
the treasurer signs and distributes paychecks to employ·
ees-an asset custody function.
196. Which of_ the following departments most likely appr~

changes m pay rates and deductions from employee
ries?
A. Payroll
B. Personnel
C. Controller
D. Treasurer
An entity's personnel department provides authorization

for hiring, termination, deductions, and .changes in pay
rates.
197. Which of the following situations represents an internal con-

trol weakness in the payroll department?
A. The timekeeping function is independent of the payroll
depa~ment.
B. Payroll records are periodically reconciled with tax re-
ports.
C. Paychecks are distributed by the employees' Immediate
supervisor.
D. Payroll department personnel are rotated in their duties.
A sound internal control dictates that there should be prop-

er segregation of functional responsibilities to minimize the
risk that errors or fraud will be committed and concealed by
the same person.
The functions of authorization, recording, and asset custody

should be separated. if the employees' immediate supervi-
sor also distributes paychecks, paychecks of fictitious em-
ployees can be diverted if that supervisor also has access to
personnel records.
198. Which of the following personnel department procedures

reduces the risk of payroll fraud and represents an appropri-
ate responsibility for the department?
A. Authorizing the addition or deletion of employees from
the payroll.
B. Authorizing overtime hours.
C. Collection and retention of unclaimed paychecks.
D. Distributing paychecks.
The personnel department has the responsibility of author-

izing employee transactions such as hiring, terminating, and
changes in pay rates and deductions.
199. Each Saturday afternoon, paychecks are distributed by the

production department's shift supervisor. The company's
production department is so large and the turnover of facto-
ry workers is so great that the supervisor does not know
many of the workers. Unclaimed paychecks are returned to
the payroll clerk, from whom the factory workers ·can claim
them at some later time. The payroll clerk routinely contin·
ues the payroll record for workers one week after their de-
parture from the co.mpany and ultimately diverts the un·
claimed paychecks. Which of the following controls would
most likely prevent this misappropriation?
A. Require the treasurer's office to prepare checks only on
the basis of supporting documentation from both the
timekeeper and payroll accounting.
B. Periodically rotate the shift supervisor.
C. Require the timekeeper to compute weekly pay of each
factory worker and to make distribution of the checkS re-
ceive? from th~ treasurer's office. bY
D. · Require the shift supervisor to know all the workers
name.
The payroll accounting should calculate and record the pa:~

roll based on authorized pay rates and deductions and eaed
employee's timecard. Paychecks should be prepared ~asg a
. d . t hav1n
on t his ocumentat10n. The payroll departmen ' dY of
record-keeping responsibility, should not have custo
unclaimed paychecks.
. . shift su·
Answer B is incorrect because the identity of the
pervisor is not an element of the payroll clerk's fraud.
I.
I
Answer C is incorrect because the calculation of payroll and

distribution of paychecks are incompatible functions and
should not be performed by the timekeeper.
Answer D is incorrect because it would be very difficult to

implement the control of knowing all factory workers by
name.
200. Proper internal control over the cash payroll function man-
dates which of the following?
A. A separate checking account for payroll should be main-
tained.
B. Each employee should be asked to sign a receipt.
C. The payroll clerk should fill the envelopes with cash and
a computation of the net pay.
D. Unclaimed pay envelopes should be retained by the
paymaster.
In a cash payroll system, employees must be required to

sign a 1eceipt that will serve as documentation for the pay-
ment.
Answer A is incorrect because a separate checking account

need not be maintained.
Answer C is incorrect because the payroll clerk who has a

recording responsibility should not be assigned to fill the
envelopes with cash.
Answer D is incorrect because unclaimed cash payroll

should be deposited in the bank for proper custody.
TRUE OR FALSE
1. As the risk of material misstatement increases, detection risk

should decrease.
2. If planned detection risk is reduced, the amount of evidence

the auditor accumulates will decrease.
3. Inherent risk and control risk are inversely related to each

other.
4. The risk of material misstatement refers to the combination

of inherent risk and control risk.
5. In a financial statement audit, inherent risk is evaluated to

help an auditor assess the susceptibility of a financial state-
ment assertion to a material misstatement assuming there
are no related controls.
6. Inherent risk is inversely related to the amount of audit :~

dence whereas detection risk is directly related to
amount of audit evidence required.
f evidence
7. Inherent risk is directly related to the amount 0 unt of
whereas detection risk is inversely related to the amo
audit evidence required.
: he audito<
8. Inherent risk and control risk are assessed by t t aud~·
and function independently of the financial statemen
udi·
9. As the acceptable level of detection risk increaseslsa~/
per·
tor may change the timing of the tests on controne tiJ11e·
0
forming them throughout the year rather than at
10. As the acceptable level of detection risk increases, an audi-

tor may change the timing of substan~ive tests by perform-
ing them at an interim date rather than year end.
11. The risk that an auditor will conclude, based on substantive

tests, that a material misstatement does not exist in an ac-
count balance when, in fact, such misstatement does exist is
referred to as detection risk.
12. When an auditor increases the assessed level of risk of ma-

terial misstatement because certain controi' procede1res were
determined to be ineffective, the auditor would most likely
increase the level of detection risk.
13. The risk of material misstatement includes nonsampling risk.
14. As the acceptable level of detection risk decreases, an audi-

tor may change the nature of substantive procedures from
less effective to more effective procedures.
15. As the acceptable level of detection risk decreases, the as-

surance directly provided from substantive procedures
should increase.
16. Materiality judgments are made in light of surrounding cir-

cumstances and necessarily involve both quantitative and
qualitative judgments.
17. The documentation of an auditor's understanding of internal

controls must include flowcharts.
18.- To obtain evidential matter about control risk, an auditor

selects tests from a variety of techniques including confirma-
tion.
~--------------------~,,.,,,,,
J
. 358 CPA EXAMINATION REVIEWER: AUDITING THEORY
19. Reports on service organizations typically provide.reasonable

assurance that their financial statements are free of material
misstatements.
20. Where computer processing is used in significant accounting

applications, internal control activities may be defined by
classifying control activities into two types: general and ap-
plication.
21. In evaluating internal control, the auditor is basically con·

cerned that the system provides reasonable assurance that
operational efficiency has been achieved in accordance with
management plans.
22. The maintenance of the system of internal .control is an im·

portant responsibility of the internal auditor.
23. Because of the cost/benefit relationship, tests of controls

may be applied on a test basis in some circumstances.
24. The concept of reasonable assurance in the context 0~ ~

entity's internal controls recognizes that auditors may fail
detect material misstatements.
ntrols
25. An effective control environment guarantees that aII co
are followed as prescribed.
fers to
26. The risk assessment component of internal controls re
the auditor's assessment of control risk.
'
·nvoive
27. Assessing control risk at below the maximum would ~fie as·
identifying specific internal controls relevant to speci
sertions.
cHAPTER 5 Risk AsseS-qments and Internal Control 359
zs. In the audit of financial statemen~, an auditor's prirnary

consideration regarding an .internal control policy or proce-
dure is whether the policy or procedure affects manage-
ment's financial statement assertions.
29. As part of gaining an initial understanding of internal control,

an auditor is required to obtain knowledge about the operat-
ing effectiveness of the internal control.
30. Assessing control risk below maximum involves concluding

that controls are ineffective.
31. After the auditor has preJ?ared a flowchart of the internal

controls surrounding sales and evaluated the design· of the
system, the auditor would perform tests of controls on all
control activities documented in the-flowchart.
32. Observation is a procedure that would most likely be used

by an auditor in performing tests of control activities that in..,
valve segregation of functions and that leave no transaction
trail.
33. Tracing bills of lading to sales invoices provides evidence

that billed sales were shipped.
34. Tracing copies of sales invoices to shipping documents will

provide evidence that all shipments to customers were
billed.
35. The accounts payable department receives the purchase or-

der form to ensure that the goods had been received by the
party requesting the goods.
36. The authority to accept incoming goods in receiving should

be based on an approved purchase order.
,,
I
.,• '
'I
· 11
37. For effective internal control purposes, the vouchers payable

department generally should stamp, perforate, or otherwise
cancel supporting documentation after payment is mailed.
38. Vendors' statements and vendors' invokes are both relative-

ly reliable evidence because they originate from a third par·
ty.
39. Credit memos are normally issued to adjust the customers

balance to the amount owed to the company.
40. The document that the accounting staff will use as the pri·
mary basis for recording sales transactions and updating the
customers accounts receivable subsidiary ledger is the sales
invoice.
KEY ANSWERS
1. c 21. B 41. D 61. D 81. c

2. D 22. B 42. B 62. c 82. B
3. A 23. B 43. D 63. c 83. c

4. c 24. D 44. c 64. D 84. B
5. c 25. B 45. c 65. D 85. A
6. B 26. D 46. B 66. B 86. D
7. D 27. A 47. A 67. A 87. c

8. c 28. D 48. A 68. B 88. D
.9. B 29. A 49. c 69. c 89. A
10. c 30. A 50. B 70. D 90. c

11. B 31. c 51. A 71. A 91. D
12. c 32. c 52. B 72. c 92. c

13. A 33. c 53. D 73. B 93. B
14. D 34. A 54. c 74. A 94. c

15. B 35. c 55. c 75. D 95. D
16. A 36. c 56. A 76. c 96. D
17. B 37. c 57. c 77. A 97. A
18. B 38. B 58. A 78. c 98. D
39. D 59. B 79. A 99. A

19. A '
20. B 40. A 60. c 80. B 100. A
-~
101. B 121. A 141. B 161. c 181. A

102. c 122. B 142. B 162. B 182. B
103. A 123. c 143. B 163. B 183. A
104. B 124. B 144. A 164. c 184. B
105. c 125. A 145. B 165. B 185. A
106. c 126. D 146. A 166. A 186. c
107. A 127. D 147. D 167. c 187. D
108. B 128. A 148. c 168. D 188. c
109. c 129. B 149. c 169. A 189. A
110. B 130. c 150. D 170. B 190. B
111. c 131. c 151. A 171. c 191. c
112. A 132. c 152. c 172. D 192. B
113. c 133. c 153. B 173. D 193. D
114. B 134. A 154. A 174. A 194. B
115. B 135. B 155. c 175. B 195. A
116. B 136. c 156. B 176. c 196. B
117. A 137. c 157. c 177. D 197. c
118. c 138. B 158. A 178. B 198. A
119. c 139. A 159. B 179. c 199. A
120. B 140. B 160. D 180. A 200. s
TRUE OR FALSE
1. True 9. False 17. False 25. False 33. False
2. False 10. True 18. False 26. False 34. False
3. False 11. True 19. False 27. True 35. False
4. True 12. False 20. True 28. True 36. True
5. True 13. False 21. False 29. False 37. False
6. False 14. True 22. False 30. False 38. True
7. True 15. True 23. True 31. False 39. True
8. True 16. True 24. False 32. True 40. True
'
'.
'
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251

1. PSA 315 (Identifying and Assessing the Risks of Material

Risk assessment procedures are performed to obtain an un-

2. The auditor's risk assessment procedures should always in-

The auditor's risk assessment procedures shall include:

Substantive test procedures are audit procedures de-

3. The auditor's risk assessment procedures

4. The auditor should obtain an understanding of the entity's

As defined in PSA 315. business risk is "a risk resulting

The auditor does not have a responsibility to identiiy or as-

S. The risk that the auditor may give an inappropriate opinion

6. Audit risk has three components: inherent risk, control risk,

1. "Inherent risk" is the susceptibility of an account

2. "Control risk" is the risk that a misstatement that !

aggregated with misstatements in other balances or

Cash has a greater inherent risk than an inventory of coal.

Answer A is incorrect because detection risk is a function of

Answer C is incorrect because even the most effective inter-

Answer D is incorrect because inherent risk and control risk

The acceptable level of detection risk is a function of the de-

7. The risk that an auditor's substantive procedures will lead to

8. The existence of audit risk is recognized by the statement in

An audit conducted in accordance with PSAs provides only

9. Which of the following audit risk components may be as·

Audit risk and its components may be assessed in quantita·

10. Some account balances, such as those for retirement ~:~:.

Inherent risk, which is the susceptibility of an assertion to

11. There is an inverse relationship that exists between the ac-

An auditor assesses control risk by considering internal con-

The acceptable level of detection risk affects substantive

12. Which of the following statements concerning audit risk and

According to the standard, the auditor should consider the

material respects, m accordance with Philippine ~na that

C. Audit risk is the risk that an auditor may unknowingly

· The opinion paragraph of the auditor's report explicitly re-

Answer B is incorrect be·cause the concept of materiality

Answer C is incorrec~ because audit risk is the probability

Answer D is incorrect because material misstatements can

14. The statements below describe the interrelationship of audit

C. When inherent and control risks are low, an auditor can

The standard states that regardless of the assessed levels of

15. Based on audit evidence gathered and evaluated, an auditor

16. A basic premise underlying analytical procedures is that

"Analytical procedures" as defined in the standard means

A basic premise underlying the application of analytical pro-

Answer B is incorrect because for some assertions, the ap-

Answer C is incorrect because the use of analytical proce-

Answer D is incorrect because analytical procedures, such

17. For all audits of financial statements conducted in accord-

Analytical procedures are used/or the following purposes:

1. As risk assessment procedures to obtain an under-

2. As substantive tes~ procedures when their applica-

3. As an overall review of the financial statements at

18. Which of the following statements concerning analytical pro-

Analytical ~rocedures . applied as risk assessment pr~:s

Answer A is incorrect be.c ause for many assertions, tests of

Answer C is incorrect because analytical procedures can be

Answer D is incorrect because analytical procedures involve

19. Analytical procedures used in planning an audit should focus

20. An.alytical procedures performed in the

21. An auditor obtains an unde~tanding of the nature of the

22. It is the process designed, implemented and maintained by '

personnel to provide reasonable assurance about the