In obtaining an understanding of a manufacturing entity's internal control concerning inventory balances, an auditor most likely would:
Answer(s): C
Choice "c" is correct. This question asks about internal control. Review of descriptions of controls would typically be performed while gaining an understanding of an entity's internal control (for any system or cycle, not just inventory).Choice "a" is incorrect. Analysis of inventory ratios is an analytical procedure, which is not used to gain an understanding of internal control.Choice "b" is incorrect. Analytical procedures are used in planning the audit, as a substantive test, or for final overall review; they are not used to gain an understanding of internal control. Choice "d" is incorrect. Observation of physical inventory counts is a substantive test, not a procedure used to gain an understanding of internal control.
The overall attitude and awareness of those charged with governance (i.e., an entity's board of directors) concerning the importance of internal control usually is reflected in its:
Choice "c" is correct. The control environment reflects the overall attitude, awareness and actions of those charged with governance (i.e., the board of directors, management, owners, and others) concerning the importance of control and its emphasis in the entity. Choice "a" is incorrect. Computer-based controls are a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "b" is incorrect. A system of segregation of duties is a control activity. The overall attitude and awareness of those charged with governance is not a control activity. Choice "d" is incorrect. Safeguards over access to assets is a control activity. The overall attitude and awareness of those charged with governance is not a control activity.
In an audit of financial statements, an auditor's primary consideration regarding internal control is whether the control:
Answer(s): B
Choice "b" is correct. Assessing control risk is the process of evaluating the effectiveness of an entity's internal control in preventing or detecting material misstatements in the financial statements.Choice "a" is incorrect. Management's philosophy and operating style are considered a part of the control environment. They are not the primary consideration in evaluating internal control. Choice "c" is incorrect. Providing adequate safeguards over access to assets is a type of control activity, but it is not the auditor's primary consideration regarding internal control. Choice "d" is incorrect. Policies and procedures concerning the effectiveness, economy, and efficiency of certain management decision-making processes are not relevant to the auditor's consideration of internal control.
The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that:
Choice "b" is correct. The ultimate purpose of assessing control risk is to contribute to the auditor's evaluation of the risk that material misstatements exist in the financial statements. Choice "a" is incorrect. Tests of controls are used to assess control risk, not to identify procedures relevant to assertions.Choice "c" is incorrect. Collusion represents an inherent limitation in the effectiveness of internal control.The auditor does not assess control risk to evaluate such limitations. Choice "d" is incorrect. Management override of policies represents an inherent limitation in the effectiveness of internal control. The auditor does not assess control risk to evaluate such limitations.
Management's attitude toward aggressive financial reporting and its emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when:
Choice "c" is correct. When management is dominated by one individual who is also a shareholder, there may not be any factors to moderate management's aggressive style. In such situations, management's style is likely to have a strong impact on the control environment. Choice "a" is incorrect. An active audit committee tends to moderate management's aggressive reporting style.Choice "b" is incorrect. External policies established by outside parties would tend to moderate management's aggressive reporting style.Choice "d" is incorrect. An effective internal audit function would tend to moderate management's aggressive reporting style.
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