Professional Documents
Culture Documents
Internal Audit Sample Problems
Internal Audit Sample Problems
Multiple-Choice Questions
8. Which of the following parties provides an assessment of the effectiveness of internal control over
1. Which of the following is responsible for establishing a private company’s internal control? financial reporting for public companies?
a. Management. Management Financial statement auditors
b. Auditors. a. Yes Yes
c. Management and auditors. b. No No
d. Committee of Sponsoring Organizations. c. Yes Yes
d. No No
2. Which of the following is not one of the three primary objectives of effective internal control?
a. Reliability of financial reporting 9. An act of two or more employees to steal assets or misstate records is frequently referred to as:
b. Efficiency and effectiveness of operations a. collusion.
c. Compliance with laws and regulations b. a material weakness.
d. Assurance of elimination of business risk. c. a control deficiency.
d. a significant deficiency.
3. The Public Company Accounting Oversight Board states that reasonable assurance allows a:
a. small likelihood of ineffective internal controls. 10. When the auditor attempts to understand the operation of the accounting system by tracing a few
b. remote likelihood that material misstatements will not be prevented or detected by transactions through the accounting system, the auditor is said to be:
internal control. a. tracing.
c. likelihood that material misstatements will not be prevented or detected by b. vouching.
internal control. c. performing a walk-through.
d. high likelihood that material misstatements will not be prevented or detected by d. testing controls.
internal control.
11. Which section of the Sarbanes-Oxley Act requires management to issue an internal control report?
4. Two key concepts that underlie management’s design and implementation of internal control are: a. 202
a. costs and materiality. b. 203
b. absolute assurance and costs. c. 404
c. inherent limitations and reasonable assurance. d. 408
d. collusion and materiality.
12. Sarbanes-Oxley requires management to issue an internal control report that includes two specific
5. Internal controls can never be considered as absolutely effective because: items. Which of the following is one of these two requirements?
a. their effectiveness is limited by the competency and dependability of employees. a. A statement that management is responsible for establishing and maintaining an
b. not all organizations have internal audit departments. adequate internal control structure and procedures for financial reporting.
c. controls are designed to prevent and detect only material misstatements. b. A statement that management and the board of directors are jointly responsible for
d. internal controls prevent separation of duties. establishing and maintaining an adequate internal control structure and procedures
for financial reporting.
6. A major control available in a small company, which might not be feasible in a big company, is: c. A statement that management, the board of directors, and the external auditors are
a. a wider segregation of duties. jointly responsible for establishing and maintaining an adequate internal control
b. a voucher system. structure and procedures for financial reporting.
c. fewer transactions to process. d. A statement that the external auditors are solely responsible.
d. the owner-manager’s personal interest and close relationship with personnel.
13. When management is evaluating the design of internal control, management evaluates whether the
7. Which of the following is responsible for establishing internal controls for a public company? control can do which of the following?
a. Management. Detect material misstatements Correct material misstatements
b. The PCAOB. a. Yes Yes
c. Management and auditors. b. No No
c. Yes No 20. When auditing a private company, the auditor should obtain an understanding of internal control
d. No Yes sufficient to:
a. provide reasonable protection against client fraud and defalcations by client
14. Internal control reports issued by public companies must identify the framework used to evaluate employees.
the effectiveness of internal control. Which of the following is the most common framework in the b. assess control risk.
U.S.? c. provide a basis for suggestions to the client for improving the accounting system.
a. Effective Internal Control Framework - AICPA d. provide a method for safeguarding assets, checking the accuracy and reliability of
b. Internal Control - Integrated Framework - COSO accounting data, promoting operational efficiency, and encouraging adherence to
c. Enterprise Internal Control - COSO prescribed managerial policies.
d. Enterprise Internal Control - AICPA
21. The initial presumption in the audit of a public company is that control risk is:
15. When one material weakness is present at the end of the year, management of a public company a. low.
must conclude that internal control over financial reporting is: b. moderate.
a. insufficient. c. high.
b. inadequate. d. low or moderate, but not high.
c. ineffective.
d. inefficient. 22. In the audit of a private company, the auditor will test controls when control risk is initially
assessed at:
16. The auditor’s tests to understand the client’s internal controls might include which of the following Low Moderate High
types of procedures? a. Yes No Yes
Observation of employees Inquiries of personnel b. No No Yes
a. Yes Yes c. Yes Yes No
b. No No d. No Yes No
c. Yes No
d. No Yes 23. The auditor’s study of a public company’s internal control is:
a. required by GAAS.
17. Which of management’s concerns with respect to implementing internal controls is the auditor b. required by the AICPA.
primarily concerned? c. required by the Sarbanes-Oxley Act.
a. Efficiency of operations. d. recommended by the AICPA.
b. Reliability of financial reporting.
c. Effectiveness of operations. 24. The auditor’s consideration of a private company’s internal control is:
d. Compliance with applicable laws and regulations. a. required by GAAP.
b. required by GAAS.
18. Which of the following activities would be least likely to strengthen a company’s internal control? c. required by the IRS.
a. Separating accounting from other financial operations. d. recommended by the SEC.
b. Maintaining insurance for fire and theft.
c. Fixing responsibility for the performance of employee duties. 25. Internal controls can never be regarded as completely effective. Even if company personnel could
d. Carefully selecting and training employees. design an ideal system, its effectiveness depends on the:
a. adequacy of the computer system.
19. Management must disclose material weaknesses in internal control: b. proper implementation by management.
a. whenever the weakness is deemed significant to a single class of transactions. c. ability of the internal audit staff to maintain it.
b. whenever the weakness is significant to overall financial reporting objectives. d. competency and dependability of the people using it.
c. if the weakness exists at the end of the year.
d. only if the auditor identifies the weakness as significant. 26. Even with the most effectively designed internal control, the auditor must obtain audit evidence,
beyond testing the controls, for every:
a. transaction.
b. financial statement account. d. A sales price list for merchandise.
c. material financial statement account.
d. financial statement account that will be relied upon by third parties. 33. The most important type of protective measure for safeguarding assets is:
a. adequate separation of duties among personnel.
27. The essence of an effectively controlled organization lies in the: b. proper authorization of transactions.
a. effectiveness of its independent auditor. c. the use of physical precautions.
b. effectiveness of its internal auditor. d. adequate documentation.
c. attitude of its employees.
d. attitude of its management. 34. Which of the following is correct with respect to the design and use of business documents?
a. Not all documents used for internal purposes need to be prenumbered.
28. To issue a report on internal control over financial reporting for a public company, an auditor must: b. Documents should be designed for single purposes only to avoid confusion in their
a. evaluate management’s assessment process. use.
b. independently assess the design and operating effectiveness of internal control. c. Documents should be designed to be understandable only by those who use them.
c. evaluate management’s assessment process and independently assess the design and d. Documents designed for external use must be prenumbered.
operating effectiveness of internal control.
d. test controls over significant account balances. 35. PCAOB Standard 2 requires auditors to evaluate the effectiveness of the audit committee’s
oversight of the company’s:
29. Which of the stock exchanges require listed companies to have an audit committee composed External financial reporting Efficiency of operations Internal control over
entirely of independent directors? financial reporting
NYSE NASDAQ a. Yes No Yes
a. Yes Yes b. No No Yes
b. No No c. Yes Yes No
c. Yes No d. No Yes No
d. No Yes
36. Which of the following is correct?
30. Which of the following factors may increase risks to an organization? a. Approval is a policy decision implemented by employees.
Geographic dispersion Presence of new information b. Approval occurs as a matter of general policy and includes significant transactions
of company operations technologies only.
a. Yes Yes c. Authorization is a policy decision for either a general class of transactions or specific
b. No No transactions.
c. Yes No d. Approval should be given by the employee responsible for recording the transaction.
d. No Yes
37. Which of the following principles is not necessary for the proper design and use of documents and
31. Which of the following statements is correct with respect to separation of duties? records?
a. Employees should not have temporary and permanent custody of assets. a. Designed for a single use to increase efficiency of operations.
b. Employees who authorize transactions should not have custody of related assets. b. Constructed in a manner that encourages correct preparation.
c. It is permissible to allow an employee to open cash receipts and record those c. Prepared at the time a transaction takes place.
receipts. d. Designed for multiple uses to increase efficiency of operations.
d. Employees who authorize transactions should have recording responsibility for these
transactions. 38. Narratives, flowcharts, and internal control questionnaires are three common methods of:
a. testing the internal controls.
32. Authorizations can be either general or specific. Which of the following is not an example of a b. documenting the auditor’s understanding of internal controls.
general authorization? c. designing the audit manual and procedures.
a. Automatic reorder points for raw materials inventory. d. documenting the auditor’s understanding of a client’s organizational structure.
b. A sales manager’s authorization for a sales return.
c. Credit limits for various classes of customers. 39. _____ deal with ongoing or periodic assessment of the quality of internal control by management.
a. Quality monitoring activities d. No Yes Yes
b. Monitoring activities
c. Oversight activities 46. A procedure that would most likely be used by an auditor in performing tests of control procedures
d. Management activities that involve segregation of functions and that leave no transaction trail is:
a. inspection.
40. Smaller public companies face challenges implementing effective internal control due to ______. b. observation.
a. a lack of expertise c. reperformance.
b. reduced importance d. reconciliation.
c. limited resources
d. limited available guidance 47. If the results of tests of controls support the design and operations of controls as expected, the
auditor uses ____ control risk as the preliminary assessment.
41. Which of the following is not one of the levels of an absence of internal controls? a. a lower
a. Major deficiency. b. the same
b. Material weakness. c. a higher
c. Significant deficiency. d. either a lower or higher
d. Control deficiency.
48. Internal controls normally include procedures designed to provide reasonable assurance that:
42. Which of the following is the correct definition of “control deficiency?” a. employees act with integrity when performing their assigned tasks.
a. A control deficiency exists if the design or operation of controls does not permit b. transactions are executed in accordance with management’s authorization.
company personnel to prevent or detect misstatements on a timely basis. c. decision processes leading to management’s authorization of transactions are sound.
b. A control deficiency exists if one or more deficiencies exist that adversely affect a d. collusive activities would be detected by segregation of employee duties.
company’s ability to prepare external financial statements reliably.
c. A control deficiency exists if the design or operation of controls results in a more 49. Which of the following is correct?
than remote likelihood that controls will not prevent or detect misstatements. a. A significant deficiency is always a material weakness.
d. A control deficiency exists if the design or operation of controls results in a more b. A control deficiency is always a material weakness.
than probable likelihood that controls will prevent or detect misstatements. c. A material weakness is less significant that a control deficiency.
d. A material weakness is always a significant deficiency.
43. A(n) _______ deficiency exists if a necessary control is missing or not properly formulated.
a. control 50. Which of the following is not a likely procedure to support the operating effectiveness of internal
b. significant controls?
c. design a. Inquiry of client personnel.
d. operating b. Observation of control-related activities.
c. Reperformance of client procedures.
44. To determine if significant internal control deficiencies are material weaknesses, they must be d. Completing an internal control questionnaire.
evaluated on their:
Likelihood Significance 51. Before making the final assessment of internal control at the end of an integrated audit, the auditor
a. Yes Yes must:
b. No No Test controls Perform substantive tests of details
c. Yes No a. Yes Yes
d. No Yes b. No No
c. Yes No
45. The purpose of an entity’s accounting information and communication system is to ______. d. No Yes
Monitor transactions Record and process transactions Initiate transactions
a. Yes Yes Yes 52. Significant deficiencies and material weaknesses in internal control of a public company must be
b. No No No reported to which of the following?
c. Yes No No a. The Public Company Accounting Oversight Board.
b. Members of management who are responsible for the related area of the company. c. custody, execution, and reporting.
c. Audit committee of the company’s board of directors. d. authorization, payment, and recording.
d. The AICPA.
59. Internal controls are not designed to provide reasonable assurance that:
53. Of the following statements about internal controls, which one is not valid? a. all frauds will be eliminated.
a. No one person should be responsible for the custodial responsibility and the b. transactions are executed in accordance with management’s authorization.
recording responsibility for an asset. c. access to assets is permitted only in accordance with management’s authorization.
b. Transactions must be properly authorized before such transactions are processed. d. company personnel comply with applicable rules and regulations.
c. Because of the cost-benefit relationship, a client may apply controls on a test basis.
d. Control procedures reasonably ensure that collusion among employees cannot occur. 60. Which of the following statements about auditor documentation of the client’s internal controls is
correct?
54. Which of the following best describes the inherent limitations that should be recognized by an a. Documentation must include flow charts.
auditor when considering the potential effectiveness of internal control? b. Documentation must include procedural write-ups.
a. Procedures that depend on segregation of duties can be circumvented by collusion. c. No documentation is necessary although it is desirable.
b. Competent and honest client personnel provide an environment conducive to d. No one particular form of documentation is necessary.
accounting control and provide absolute assurance that effective control will be
achieved. 61. Significant deficiencies are matters that come to an auditor’s attention and should be
c. Procedures designed to assure the execution and recording of transactions in communicated to an entity’s audit committee because they represent:
accordance with proper authorizations are effective against irregularities perpetrated a. material frauds perpetrated by high-level management.
by management. b. internal control deficiencies that could adversely affect a company’s ability to
d. The benefits expected to be derived from effective internal accounting control initiate, record, process, or report external financial statements reliably.
usually do not exceed the costs of such control. c. flagrant violations of the entity’s documented conflict-of-interest policies.
d. intentional attempts by client personnel to limit the scope of the auditor’s field work.
55. Which of the following is not one of the subcomponents of the control environment?
a. Management’s philosophy and operating style. 62. How must significant deficiencies and material weaknesses be communicated to those charged
b. Organizational structure. with governance?
c. Adequate separation of duties. a. Either oral or written communication is acceptable.
d. Commitment to competence. b. Oral communication is required.
c. Written communication is required.
56. It is important for the CPA to consider the competence of the clients’ personnel because their d. Written communication is required for material weaknesses, but oral communication
competence bears directly and importantly upon the: is allowed for significant deficiencies.
a. cost/benefit relationship of the system of internal control.
b. achievement of the objectives of internal control. 63. Which of the following statements, if any, is correct?
c. comparison of recorded accountability with assets. a. The NASDAQ market requires listed companies to have audit committees that have
d. timing of the tests to be performed. only independent directors.
b. The NASDAQ market requires listed companies to have audit committees that have
57. Audit evidence concerning proper segregation of duties normally is best obtained by: a minority of the positions held by independent directors.
a. direct personal observation of the employee who applies control procedures. c. The NASDAQ market recommends, but does not require, listed companies to have
b. making inquiries of co-workers about the employee who applies control procedures. audit committees.
c. preparation of a flowchart of duties performed and available personnel. d. The NASDAQ market recommends, but does not require, listed companies to have
d. inspection of third-party documents containing the initials of who applied control audit committees that have a minority of the positions held by independent directors.
procedures.
64. The Sarbanes-Oxley Act requires:
58. Proper segregation of functional responsibilities calls for separation of: a. all public companies to issue reports on internal controls.
a. authorization, execution, and payment. b. all public companies to define adequate internal controls.
b. authorization, recording, and custody. c. the auditor of public companies to design effective ICFR.
d. the auditor of public companies to provide recommendations to correct material c. work performed by internal auditors may be a factor in determining the nature,
weaknesses. timing, and extent of the independent auditor’s procedures.
d. understanding of the internal audit function is an important substantive test to be
65. When considering internal control, an auditor should be aware of the concept of reasonable performed by the independent auditor.
assurance, which recognizes that the:
a. segregation of incompatible functions is necessary to ascertain that internal control is 71. To be effective, an internal audit department must be independent of:
effective. a. operating departments.
b. employment of competent personnel provides assurance that the objectives of b. the accounting department.
internal control will be achieved. c. both a and b.
c. establishment and maintenance of internal control is an important responsibility of d. either a or b, but not both.
the management and not of the auditor.
d. costs of internal control should not exceed the benefits expected to be derived from 72. Hanlon Corp. maintains a large internal audit staff that reports directly to the chief financial officer.
internal control. Audit reports prepared by the internal auditors indicate that the system is functioning as it should and
that the accounting records are reliable. An independent auditor will probably:
66. The financial statements are not likely to correctly reflect GAAP if the: a. eliminate tests of controls.
a. controls affecting the reliability of financial reporting are inadequate. b. increase the depth of the study and evaluation of administrative controls.
b. company’s controls do not promote efficiency. c. avoid duplicating the work performed by the internal audit staff.
c. company’s controls do not promote effectiveness. d. place limited reliance on the work performed by the internal audit staff.
d. company’s control do not promote compliance with applicable rules and regulations.
73. External financial statement auditors must obtain evidence regarding what attributes of an internal
67. The primary emphasis by auditors is on controls over: audit (IA) department if the external auditors intend to rely on IA’s work?
a. classes of transactions. a. Integrity
b. account balances. b. Objectivity
c. both a and b, because they are equally important. c. Competence
d. both a and b, because they vary from client to client. d. All of the above
68. Compared to a public company, the most important difference in a nonpublic company in assessing 74. When planning an audit, the auditor’s assessed level of control risk is:
control risk is the ability to assess control risk at _______ for any or all control-related objectives. a. determined by using actuarial tables.
a. low b. calculated by using the audit risk model.
b. moderately low c. an economic issue, trading off the costs of testing controls against the cost of testing
c. medium balances.
d. high d. calculated by using the formulas provided in the AICPA’s auditing standards.
69. An auditor should consider two key issues when obtaining an understanding of a client’s internal 75. When a compensating control exists, the absence of a key control:
controls. These issues are: a. is no longer a concern because there is no longer a significant deficiency or material
a. the effectiveness and efficiency of the controls. weakness.
b. the frequency and effectiveness of the controls. b. is still a major concern to the auditor.
c. the design and utilization of the controls. c. could cause a material loss, so it must be tested using substantive procedures.
d. The implementation and efficiency of the controls. d. is magnified and must be removed from the sampling process and examined in its
entirety.
70. The independent auditor should acquire an understanding of the internal audit function as it relates
to the independent auditor’s study and evaluation of internal control because the: 76. After considering a client’s internal controls, an auditor has concluded that it is well designed and
a. audit programs, working papers, and reports of internal auditors can often be used as is functioning as intended. Under these circumstances the auditor would most likely:
a substitute for the work of the independent auditor’s staff. a. perform tests of controls to the extent outlined in the audit program.
b. procedures performed by the internal audit staff may eliminate the independent b. determine the control procedures that should prevent or detect errors and
auditor’s need for an extensive study and evaluation of internal control. irregularities.
c. not increase the extent of predetermined substantive tests. 80. There are four steps in the auditor’s process of understanding internal control and assessing control
d. determine whether transactions are recorded to permit preparation of financial risk for a public company. Step one is obtain and document an understanding of internal control:
statements in conformity with generally accepted accounting principles. design and operation. What are the remaining three steps?
77. To obtain an understanding of an entity’s control environment, an auditor should concentrate on the Answer:
substance of management’s policies and procedures rather than their form because: The remaining three steps are:
a. management may establish appropriate policies and procedures but not act on them. Assess control risk.
b. the board of directors may not be aware of management’s attitude toward the control Design, perform, and evaluate tests of controls.
environment. Decide planned detection risk and substantive tests.
c. the auditor may believe that the policies and procedures are inappropriate for that
particular entity. 81. Certain principles dictate the proper design and use of documents and records. Briefly describe
d. the policies and procedures may be so weak that no reliance is contemplated by the several of these principles.
auditor.
Answer:
Essay Questions Documents should be prenumbered consecutively to facilitate control over missing documents
and as an aid in locating documents when they are needed at a later date.
78. Describe each of the three broad objectives management typically has for internal control. With Documents and records should be prepared at the time a transaction takes place, or as soon as
which of these objectives is the auditor primarily concerned? possible thereafter, to minimize timing errors.
Documents and records should be designed for multiple uses, when possible, to minimize the
Answer: number of different forms. For example, a properly designed and used shipping document can
The three objectives are: be the basis for releasing goods from storage to the shipping department, informing billing of
Reliability of financial reporting. Management has both a legal and professional responsibility the quantity of goods to bill to the customer and the appropriate billing date, and updating the
to be sure that the information is fairly presented in according with reporting requirements perpetual inventory records.
such as GAAP. Documents and records constructed in a manner that encourages correct preparation. This can
Efficiency and effectiveness of operations. Controls within an organization are meant to be done by providing internal checks within the form or record. For example, a document
encourage efficient and effective use of its resources to optimize the company’s goals. might include instructions for proper routing, blank spaces for authorizations and approvals,
Compliance with laws and regulations. Public and non-public organizations are required to and designated column spaces for numerical data.
follow many laws and regulations. Some relate to accounting only indirectly, such as
environmental protection and civil rights laws. Others are closely related to accounting, such 82. Management’s identification and analysis of risk is an ongoing process and is a critical component
as income tax regulations and fraud. of effective internal control. An important first step is for management to identify factors that may
increase risk. Identify at least five factors, observable by management, which may lead to increased
The auditor is primarily concerned with the objective of reliable financial reporting. risk in a typical business organization.
79. Briefly describe the responsibilities of management and external auditors for internal controls. Answer:
There are many factors that may lead to increased risk in an organization. Some examples include:
Answer: failure to meet prior objectives,
Management is responsible for establishing and maintaining the entity’s internal controls. For decreasing quality of personnel,
public companies, management is also required by Section 404 to publicly report on the
increasing geographic dispersion of company operations,
operating effectiveness of those controls. In contrast, the auditor’s responsibilities include
increasing significance and complexity of core business processes,
understanding and testing internal control over financial reporting. For public company
introduction of new information technologies, and
clients, the auditor is also required by Section 404 to issue an audit report on management’s
assessment of its internal controls, including the auditor’s opinion on the operating entrance of new competitors.
effectiveness of those controls.
83. During a financial statement audit of a private company, three steps must be completed by the
auditor before concluding that control risk is low. What are these steps?
Answer:
The three steps that must be completed by the auditor before concluding that control risk is low are: Risk assessment. This is management’s identification and analysis of risks relevant to the
1. obtaining an understanding of the control environment, risk assessment procedures, preparation of financial statements in accordance with GAAP.
accounting information and communication system, and monitoring methods at a fairly Information and communication. This is the set of manual and/or computerized procedures
detailed level; that identifies, assembles, classifies, analyzes, records, and reports a company’s transactions
2. identify specific controls that will reduce control risk and make an assessment of control risk; and maintains accountability for the related assets.
and Control activities. These are the policies and procedures that help ensure necessary actions are
3. test the effectiveness of controls. taken to address risks in the achievement of the company’s objectives.
Monitoring. This is management’s ongoing and periodic assessment of the quality of internal
84. What are the two primary factors that auditors consider in determining if an entity is auditable? control performance to determine that controls are operating as intended and modified when
needed.
Answer:
The two primary factors are the integrity of management and the adequacy of accounting 88. Discuss what is meant by the term “control environment” and identify four control environment
records. subcomponents that the auditor should consider.
Answer:
85. Define the following terms: control deficiency, significant deficiency, and material weakness. The control environment consists of the actions, policies, and procedures that reflect the
overall attitudes of top management, directors, and owners of an entity about control and its
Answer: importance to the entity. Subcomponents include integrity and ethical values, commitment to
A control deficiency exists if the design or operation of controls does not permit company competence, board of directors or audit committee participation, management’s philosophy
personnel to prevent or detect misstatements on a timely basis. and operating style, organizational structure, assignment of authority and responsibility and
A significant deficiency exists if one or more control deficiencies exist that results in more human resource policies and practices.
than a remote likelihood that a misstatement that is more than inconsequential will not be
prevented or detected. 89. Describe the auditor’s responsibilities related to communications regarding internal control matters.
A material weakness exists if a significant deficiency, by itself, or in combination with other
significant deficiencies, results in a more than remote likelihood that internal control will not Answer:
prevent or detect material financial statement misstatements. The auditor must communicate significant deficiencies and material weaknesses in writing to
those charged with governance as soon as they become aware of their existence. The
communication is usually addressed to the audit committee and to management. Timely
86. Describe three inherent limitations of internal control. communications may provide management an opportunity to address control deficiencies
before management’s report on internal control must be issued. In some instances,
Answer: deficiencies can be corrected sufficiently early such that both management and the auditor can
The effectiveness of internal controls depends on the competency and dependability of the people conclude that controls are operating effectively as of the balance sheet date.
using it. Inherent limitations of internal control include:
employee carelessness, 90. The text suggested a five-step approach to identify deficiencies, significant deficiencies, and
lack of understanding, material weaknesses. Describe this approach.
management override, and
collusion. Answer:
1. Identify existing controls. Because deficiencies and material weaknesses are the absence of
87. The internal control framework developed by COSO includes five so-called “components” of adequate controls, the auditor must first know which controls exist.
internal control. Discuss each of these five components. 2. Identify the absence of key controls. Internal control questionnaires, flowcharts, and
walkthroughs are useful tools to identify where controls are lacking and the likelihood of
Answer: misstatement is therefore increased.
Five components of internal control are: 3. Consider the possibility of compensating controls. A compensating control is one
The control environment. The control environment consists of the actions, policies, and elsewhere in the system that offsets the absence of a key control. When a compensating
procedures that reflect the overall attitudes of top management about control and its control exists, there is no longer a significant deficiency or material weakness.
importance to the company.
4. Decide whether there is a significant deficiency or material weakness. The likelihood of g 2. Company-wide policies for the approval of all transactions within stated limits.
misstatements and their materiality are used to evaluate if there are significant deficiencies or
material weaknesses. a 3. The actions, policies, and procedures that reflect the overall attitudes of top
5. Determine potential misstatements that could result. This step is intended to identify management, directors, and owners of an entity about control and its importance to
specific misstatements that are likely to result because of the significant deficiency or material the entity.
weakness. The importance of a significant deficiency or material weakness is directly related
to the likelihood and materiality of potential misstatements. f 4. Segregation of the following activities in an organization: custody of assets,
accounting, authorization, and operational responsibility.
91. Auditing standards related to the audits of private companies specify the extent to which auditors
can rely on evidence about internal controls obtained in prior years. Briefly describe this guidance.