Which of the following controls would most likely allow for a reduction in the scope of the auditors tests of depreciation expense?

Which of the following is an essential element of the audit trail in an electronic data interchange (EDI) system?

Activity logs that indicate failed transactions.

Because an audit trail allows for the tracing of a transaction from initiation to its disposition, an activity log provides a key link in the process. Such a log provides information about users who have accessed the system, the files accessed, the processing accomplished, the time of access, and the amount of time the processing required.

Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity’s financial statements?

Significant differences between the physical inventory count and the accounting records are not investigated.

If a significant amount of inventory is missing, the inventory and the statements are materially misstated. If the physical inventory is significantly greater than the accounting records indicate, the entity may not have sold as much inventory as it claimed. The result is overstated revenues, financial statements that are materially misstated, and an increased risk of fraud.

Which of the following controls will most likely allow for a reduction in the scope of the auditor’s tests of depreciation expense?

Review and approval of the periodic equipment depreciation entry by a supervisor who does not actively participate in its preparation.

A reduction in control risk and the consequent increase in the acceptable level of detection risk may permit the auditor to alter the nature, timing, or extent of substantive tests. An independent check on the validity and accuracy of depreciation expense clearly enhances the effectiveness of internal control and is thus likely to reduce the external auditor’s assessment of control risk.

Fraudulent use of corporate credit cards will be minimized by which of the following controls?

Subjecting credit card charges to the same expense controls as those used on regular company expense forms.

Credit card charges should be controlled in much the same manner as expense accounts and other expense reports, including use of limitations on specific kinds of expenditures. These charges should be compared with supporting documentation, such as receiving reports and invoices.

A client’s program that recorded receiving report information entered directly by the receiving department on vendor shipment receipt included a reasonableness or limit test. Which of the following errors would this test likely detect?

The receiving department clerk entered the quantity of the product received as 0.

Reasonableness or limit tests are used to test quantities received to determine if they are within acceptable limits. Entry of a product number with 0 received is identified as probable error.

Which control is most likely to give the greatest assurance that securities held as investments are safeguarded?

Access to securities requires the signatures and presence of two designated officials.

The presence of two authorized individuals is usually required for access to securities, especially those held in safe-deposit boxes. This precaution provides supervisory control.

Which of the following observations made during the preliminary survey of a local department store’s disbursement cycle reflects a control strength?

The CFO’s office prepares checks for suppliers based on vouchers prepared by the accounts payable department.

Accounting for payables is a recording function. The matching of the supplier’s invoice, the purchase order, and the receiving report (and usually the purchase requisition) should be the responsibility of the accounting department. These are the primary supporting documents for the payment voucher prepared by the accounts payable section that will be relied upon by the CFO in making payment.

An auditor notes year-to-year increases of over $200,000 for small tool expense at a manufacturing facility that has produced the same amount of identical product for the last 3 years. Production inventory is kept in a controlled staging area adjacent to the receiving dock, but the supply of small tools is kept in an unsupervised area near the exit to the plant employees’ parking lot. After determining that all of the following alternatives are equal in cost and are also feasible for local management, the auditor can best address the security issue by recommending that plant management

Move the small tools inventory to the custody of the production inventory staging superintendent and implement the use of a special requisition to issue small tools.

Physical control of assets is a preventive control that reduces the likelihood of theft or other loss. Giving responsibility for custody of small tools to one individual establishes accountability. Requiring that requisitions be submitted ensures that tool use is properly authorized.

Which of the following organizational controls related to the processing of scrap would you recommend?

Segregate the responsibility for processing scrap materials from the operational activities that produce the scrap materials.

Organizational controls address the segregation of functional responsibilities: custodianship, recordkeeping, authorization, and execution. Thus, those who generate the scrap should not subsequently process it.

When an entity uses a trust company as custodian of its trading securities, the possibility of concealing fraud most likely will be reduced if the

Trust company has no direct contact with the entity employees responsible for maintaining investment accounting records.

To conceal fraud related to trading securities, collusion between those responsible for record keeping and custody is required. The possibility of collusion is reduced if no direct contact between responsible parties exists.

To strengthen internal control over the custody of heavy mobile equipment, the client would most likely institute a policy requiring a periodic

Inspection of equipment and reconciliation with accounting records.

To strengthen control over the custody of equipment, the client should conduct periodic physical inventories (inspections) and compare them with the equipment subsidiary ledgers. A basic control is to compare the recorded accountability with existing assets at reasonable intervals. This physical inspection is especially appropriate when the client is, for example, a construction firm that owns expensive mobile equipment and permits field supervisors to authorize disposals.

Which of the following activities performed by a department supervisor most likely would help in the prevention or detection of a payroll fraud?

Approving a summary of hours each employee worked during the pay period.

The department supervisor is in the best position to determine that employees are present and performing the assigned functions.

What information would the auditor expect to find in the data dictionary that would assist in a payroll application audit?

Programs that access the data.

The data dictionary is a file (possibly manual but usually computerized) in which the records relate to specified data items. It contains definitions of data records and files and the list of programs used to process them. Only certain persons or entities are permitted to retrieve data or to modify data items. Accordingly, these access limitations are also found in the data dictionary.

In the accounting system of Apogee Company, the quantities counted by the receiving department and entered at a terminal are transmitted to the computer, which immediately transmits the amounts back to the terminal for display on the terminal screen. This display enables the operator to

Verify that the amount was entered accurately.

The display of the amounts entered is an input control that permits visual verification of the accuracy of the input by the operator. This is termed closed-loop verification.

Each Friday afternoon, payroll checks are distributed by the shift superintendent. The plant is so large and the turnover is so great that the superintendent does not know many of the workers. Undelivered checks are returned to the payroll clerk, from whom the workers can obtain them at some later time. The payroll clerk routinely continues the payroll record for workers one week after their departure from the firm, ultimately cashes the unclaimed checks, and keeps the money. Which of the following is a control designed to prevent this misappropriation?

Require the CFO’s office to prepare checks only on the basis of supporting documentation from both the timekeeper and payroll office.

The payroll should be prepared from the time cards, which are the official records of time worked, and the authorized pay rates and deductions. After the payroll is prepared, it should be independently verified. Also, the payroll department has a recording function and should not be charged with custody of related assets (undelivered paychecks) even temporarily. Undelivered checks should be sent to the CFO for deposit in a bank account after a reasonable period of time.

To avoid potential errors and fraud, well-designed internal control in the accounts payable area should include a segregation of which of the following functions?

Cash disbursements and vendor invoice verification.

The functions of cash disbursements (custody of assets) and invoice verification (recordkeeping) should be segregated for effective internal control. Invoice verification should be done by an employee outside the CFO’s department.

To minimize the risk that agents in the purchasing department will use their positions for personal gain, the organization should

Require competitive bidding.

The primary function of a purchasing department is to ensure the authorized acquisition of goods of a specified quality on a timely basis at an economical price. Competitive bidding procedures should reduce both costs and the likelihood that a purchasing agent will show favoritism to a vendor.

A company employs three accounts payable clerks and one treasurer. Their responsibilities are as follows:

Clerk 1: Reviews vendor invoices for proper signature approval.
Clerk 2; Enters vendor invoices into the accounting system and verifies payment terms.
Clerk 3: Posts entered vendor invoices to the accounts payable ledger for payment and mails checks.
Treasurer: Reviews the vendor invoices and signs each check.

Which of the following would indicate a weakness in the company’s internal control?

Clerk 3 mails the checks and remittances after they have been signed.

Certain duties should be segregated so that an individual cannot perpetrate and conceal fraud or error. The ideal structure segregates authorization of the transaction, recording of the transaction, and custody of the assets from the transaction. Clerk 3 should not both post the invoices to accounts payable (recording the transaction) and mail the checks after they have been signed (custody of the assets).

Which of the following controls is most effective in providing reasonable assurance that salary, wage, and benefit expenses are incurred only for work performed?

All time cards and reports are reviewed and approved in writing by immediate line supervisors having no responsibilities for paycheck distribution.

Review and approval of time cards by line supervisors is appropriate because these supervisors should know whether work has been performed. Also, they do not distribute paychecks, so they are not able to divert falsely authorized checks.

The sampling unit in a test of controls pertaining to the occurrence of payroll transactions ordinarily is a(n)

Payroll register entry.

Determining whether payroll transactions occurred is an internal control objective of the human resources and payroll cycle. The payroll register records each payroll transaction for each employee. Thus, an entry in the payroll register is reconciled to time cards to test whether the recorded transaction actually occurred.

In the audit of which of the following types of profit-oriented enterprises is the auditor most likely to place special emphasis on testing the controls over proper classification of payroll transactions?

A manufacturing organization.

A manufacturer is characteristically labor intensive with a high frequency and volume of payroll transactions requiring classification into direct labor and overhead. Payroll information is important in the costing of work-in-process, finished goods inventory, and cost of goods sold.

In a review of an EDI application using a third-party service provider, the auditor should

I. Ensure encryption keys meet ISO standards
II. Determine whether an independent review of the service provider’s operation has been conducted
III. Verify that only public-switched data networks are used by the service provider
IV. Verify that the service provider’s contracts include necessary clauses, such as the right to audit

II & IV.

An auditor should review trading partner agreements and contracts with third-party service providers. These documents should contain necessary clauses and appropriately limit liabilities. Moreover, legal counsel should have reviewed the agreements or contracts. An auditor should also determine whether the third-party service provider’s operations and controls have been independently reviewed (e.g., by public accountants).

If a payroll system continues to pay employees who have been terminated, control weaknesses most likely exist because

There were inadequate manual controls maintained outside the computer system.

The authorization to pay employees comes from outside the computer department. Thus, ineffective controls external to the computer processing department are most likely the cause of allowing the payments to terminated employees to continue without detection.

Organizational independence in the processing of payroll is achieved by functional segregations that are built into the system. Which one of the following functional segregations is not required for internal control purposes?

Segregation of payroll preparation and maintenance of year-to-date records.

Most companies have their payrolls prepared by the same individuals who maintain the year-to-date records. A functional segregation is not needed because both duties involve recordkeeping.

Which of the following questions should not appear in an internal control questionnaire relating to cash disbursements?

Are prelistings made of all cash receipts?

Prelisting of cash receipts is performed in the mail room as part of the sales-receivables-cash receipts cycle. This question is inappropriate in a questionnaire relating to cash disbursements. The questionnaire should list inquiries as to whether (1) supporting documentation is mutilated upon signing, (2) issuing a check to cash or bearer is prohibited, (3) signing blank checks is prohibited, (4) unused checks are controlled, (5) voided checks are retained and accounted for, and (6) the check signer is responsible for mailing signed checks.

In assessing risks of material misstatement for purchases, an auditor vouches a sample of entries in the voucher register to the supporting documents. Which assertion would this test of controls most likely support?

Occurrence.

A voucher signifies a liability. Its issuance is recorded in the voucher register after comparison of the vendor’s invoice with the purchase requisition, purchase order, and receiving report. The direction of testing is an important consideration in determining the relevant assertion. Selecting a sample of recorded entries in the voucher register and vouching them to the supporting documentation provides evidence that the transactions occurred.