When obtaining an understanding of an entity's internal controls, an auditor should concentrate on the substance of the controls rather than their form because:
Answer(s): B
Choice "b" is correct. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. When obtaining an understanding of a client's internal controls, an auditor should concentrate on the substance of controls rather than the form because even when appropriate procedures are established, management may not enforce compliance.Choice "a" is incorrect. "Substance over form" concerns relate to controls that appear on the surface to exist but in reality are not operating effectively. Procedures that are operating effectively, even if they are not documented, do not illustrate this situation. Choice "c" is incorrect. The auditor should first obtain an understanding of the controls in order to determine whether the controls are appropriate or inappropriate. The auditor would not focus at all on controls deemed to be inappropriate.Choice "d" is incorrect. While the cost-benefit of internal control is of concern to management in the design of the system, it plays no role in the auditor's attempt to gain an understanding of internal controls.
When an auditor is to conduct an audit of a service organization, what considerations should the auditor make in the planning stages regarding internal controls of the organization?
Answer(s): C
Choice "c" is correct. In some situations, the controls at a service organization are designed under the assumption that there will be certain complementary controls implemented by user organizations. These complementary controls should be included in the description of controls. The service auditor should obtain an understanding of such situations, in order to evaluate whether the complementary controls are necessary to achieve stated control objectives. Choice "a" is incorrect. The auditor would need to understand controls before assessing their operating effectiveness.Choice "b" is incorrect. Substantive procedures are not performed by a service auditor, who is either reporting on controls placed in operation, or on controls placed in operation and their operating effectiveness. Remember that a service auditor's engagement is not the same as an audit of financial statements.Choice "d" is incorrect. Although a service auditor's engagement differs from an audit of financial statements, it is performed in accordance with the general standards as well as the relevant fieldwork and reporting standards. It is not considered to be an agreed-upon procedures engagement, as the auditor has not been engaged by the service organization to issue a report of findings based on specific, agreedupon procedures.
Proper segregation of duties reduces the opportunities to allow any employee to be in a position to both:
Answer(s): D
Choice "d" is correct. Proper segregation of duties reduces the opportunities for any individual to both perpetrate and conceal errors or fraud.Choice "a" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since journalizing cash receipts and disbursements and preparing the financial statements are both recordkeeping functions, this would not be a violation of proper segregation of duties.Choice "b" is incorrect. Monitoring internal controls and evaluating whether those controls are operating as intended would properly be performed by one person. Combining these functions does not violate the concept of proper segregation of duties, since it does not encompass an inappropriate combination of authorization, recordkeeping, and custodial functions. Choice "c" is incorrect. Proper segregation of duties typically involves assigning different people the responsibilities of authorizing transactions, recording transactions, and maintaining custody of the related assets. Since adopting new accounting pronouncements and authorizing the recording of transactions are both authorization functions, this would not be a violation of proper segregation of duties.
Management's emphasis on meeting projected profit goals most likely would significantly influence an entity's control environment when:
Choice "b" is correct. Management's emphasis on meeting projected profit goals would significantly influence an entity's control environment when a significant portion of management compensation is represented by stock options, because management would then have a personal interest that might be at odds with accurate financial reporting.Choice "a" is incorrect. An effective internal audit function would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.Choice "c" is incorrect. External policies established by outside parties would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.Choice "d" is incorrect. Active participation of those charged with governance would tend to moderate management's emphasis on meeting projected profit goals, and would therefore tend to dampen the effect on the control environment.
Which of the following factors would most likely be considered an inherent limitation to an entity's internal control?
Choice "b" is correct. Human error is an inherent limitation in internal control, because even a properly designed and operating internal control system cannot prevent errors in the use of information provided by the system.Choice "a" is incorrect. The complexity of the information processing system is not an inherent limitation of internal control, because controls can be adequately designed to take such complexity into account.Choice "c" is incorrect. An ineffective board of directors is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control. Choice "d" is incorrect. Lack of appropriate incentives to improve the control environment is a weakness in internal control, but it is one that could and should be corrected. It is not an inherent limitation of internal control.
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