AUDITING.docx

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

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

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

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

 ____4. Newly-hired accounting personnel undergo rigorous training before assuming responsibility for transaction processing  ____5. Members of the internal audit staff perform a monthly review of all non routine journal entries  ____6. All cash receipts are prelisted and deposited intact daily  ____7. A member of the controller’s staff compares

the receipted bank deposit ticket with the cash prelisting  ____8. A set of standard journal entries is used to record such monthly journal entries as depreciation, amortization, accrued payroll, accrued interest, and bad debts expense  ____9. All revenue and expense budget variances in excess of predetermined levels are investigated for cause on a monthly basis  ____10. Before signing checks, the treasurer reviews all documentation SOLUTION: 1. c 2. a 3. d 4. a 5. b 6. c 7. d 8. a 9. b 10. b

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

Account: general ledger cash account 3. Agree accounts receivable subsidiary ledger with control, mail statements to customers, and clear all exceptions reported by customers Substance: customer responses to statements Account: accounts receivable subsidiary ledger and control account 4. Count cash in cash register (substance) and compare with locked-in tape (account) 5. Compare brokers’ monthly statement (substance)

with investment ledger (account) 6. Compare vendors’ statements (substance) with accounts payable ledger (account) 7. Compare receipted bank deposit slip (substance) with cash receipts entry and prelisting (account) 8. Inspect plant assets (substance) and compare with plant assets ledger (account) 65. Asset safeguard controls may be classified as access controls and accountability controls. Give two examples of each.

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

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

1. Fixing responsibility over prenumbered documents 2. Periodic accounting for numeric sequence of used documents

3. Establishing imprest funds for petty cash and fixing responsibility for custodianship 4. Bonding of employees in positions of trust

66. For each of the cases described below, identify the principal control activities that would have prevented or detected the misstatement. 1. The shipping clerk of Duvinski Enterprises was able to remove goods from the company’s

warehouse by fabricating shipping orders and bills of lading. An accomplice with a trucking company was able to pick up the goods during normal business hours and transport them to warehouse space rented by the duo. The fraud was detected when the one of the trucking company dispatchers discovered that the truck was being used for unscheduled runs. Further investigation by the firm revealed the delivery destination, whereupon the driver confessed to the thefts.

2. In conducting the annual audit for Bevis Rod and Reel, Inc., the auditors noted that several monthly and year-end adjustments had not been recorded by the company. Among the omissions were depreciation, interest accruals, and employer payroll taxes.

3. Although the auditors, by drafting the necessary audit adjustments, provide reasonable assurance as to the fairness of the annual financial statements, Comptronix Exploration and Development Company’s monthly statements frequently

contained material errors due to improper recording of unique and often complex transactions.

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

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

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