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Which of the following factors should an auditor consider in making a judgment about whether a control deficiency is a significant deficiency?

I.

The likelihood that a control will fail to prevent or detect a misstatement.

II.

The magnitude of the misstatement that could result from the deficiency.

a.

Both I and II.

b.

II only.

c.

I only.

d.

Neither I nor II.

Explanation

Choice "a" is correct. When evaluating whether a control deficiency is a significant deficiency or a material weakness, the auditor should consider both the likelihood and magnitude of any potential misstatement.

Choices "c", "b", and "d" are incorrect, based on the explanation above.

Which of the following statements is correct concerning significant deficiencies in internal control with respect to an audit of a nonissuer?

a.

An auditor may report that no significant deficiencies were noted during an audit.

b.

All significant deficiencies are also considered to be material weaknesses.

c.

An auditor is required to search for significant deficiencies during an audit.

d.

An auditor may communicate significant deficiencies during an audit or after the audit's completion.

Explanation

Choice "d" is correct. Because timely communication may be important, the auditor may choose to communicate significant deficiencies during the course of the audit rather than after the audit is concluded.

Choice "c" is incorrect. The auditor is not obligated to search for significant deficiencies.

Choice "b" is incorrect. All material weaknesses are significant deficiencies, but not all significant deficiencies are material weaknesses.

Choice "a" is incorrect. Because of the potential for misinterpretation, the auditor should not issue a written report representing that no significant deficiencies were noted during the audit.

An auditor's letter issued on significant deficiencies relating to a nonissuer's internal control observed during a financial statement audit should:

a.

Indicate that the significant deficiencies should be disclosed in the annual report to the entity'sshareholders.

b.

Indicate that the audit's purpose was to report on the financial statements and not to provide an opinion on internal control.

c.

Include a brief description of the tests of controls performed in searching for significant deficiencies and material weaknesses.

d.

Include a paragraph describing management's assertion concerning the effectiveness of internalcontrol.

Explanation

Choice "b" is correct. Conditions noted by the auditor that are significant deficiencies or material weaknesses should be reported in writing. Any report issued on such conditions should (1) indicate that the purpose of the audit was to report on the financial statements and not to provide an opinion on internal control; (2) include the definition of a material weakness and, if applicable, significant deficiency; (3) include a restriction on use (i.e., the report is intended solely for the information and use of management, those charged with governance, etc.).

Choice "c" is incorrect. During an audit, the auditor is not required to design tests specifically to detect significant deficiencies or material weaknesses in internal control.

Choice "a" is incorrect. Significant deficiencies in internal control are not generally disclosed in the annual report, and the auditor's letter on internal control matters observed during a financial statement audit is intended solely for the information and use of management, those charged with governance, and others within the organization.

Choice "d" is incorrect. Management does not provide an assertion concerning the effectiveness of internal control as part of a financial statement audit of a nonissuer (but would provide such an assertion in a separate engagement related to internal control).

In reporting on a nonissuer's internal control over financial reporting in an attest engagement, a practitioner should include a paragraph that describes the:

a.

Potential benefits from the practitioner's suggested improvements.

b.

Inherent limitations of any internal control.

c.

Documentary evidence regarding the control environment factors.

d.

Changes in internal control since the prior report.

Explanation

Choice "b" is correct. In reporting on a nonissuer's internal control over financial reporting in an attest engagement (not an audit), the practitioner's report should include a paragraph stating that, because of inherent limitations of any internal control, errors or fraud may occur and not be detected.

Choice "c" is incorrect. Documentary evidence need not be provided in the practitioner's report.

Choice "d" is incorrect. The practitioner need not mention any changes in internal control since the last report.

Choice "a" is incorrect. The practitioner should not describe any potential benefits that might result from the practitioner's suggested improvements.

Which of the following conditions is necessary for a practitioner to accept an attest engagement to examine and report on a nonissuer's internal control over financial reporting?

a.

Management agrees not to present the practitioner's report in a general-use document to stockholders.

b.

The practitioner is a continuing auditor who previously has audited the entity's financial statements.

c.

The practitioner anticipates relying on the entity's internal control in a financial statement audit.

d.

Management presents its written assertion about the effectiveness of internal control.

Explanation

Choice "d" is correct. In order for a practitioner to examine and report on management's assertion about the effectiveness of an entity's internal control, management must present its written assertion about the effectiveness of internal control.

Choice "c" is incorrect. There is no requirement that the practitioner rely on internal control.

Choice "b" is incorrect. No requirement for previous engagement experience exists in order to report on a client's internal control. However, the attestation examination must be integrated with an audit of the entity's financial statements.

Choice "a" is incorrect. The practitioner's report is considered appropriate for general distribution.

Which of the following statements is correct concerning an auditor's required communication of significant deficiencies in internal control noted during a financial statement audit of a nonissuer?

a.

A significant deficiency previously communicated during the prior year's audit that remains uncorrected causes a scope limitation.

b.

An auditor should perform tests of controls on significant deficiencies before communicating them to the client.

c.

An auditor should communicate significant deficiencies after tests of controls, but before commencing substantive tests.

d.

An auditor's report on significant deficiencies should include a restriction on the distribution of the report.

Explanation

Choice "d" is correct. The report should state that the communication is intended solely for the use of management, those charged with governance, and others within the organization.

Choice "a" is incorrect. Significant deficiencies may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. The auditor may elect to use a primarily substantive approach to test balances, so internal control deficiencies do not necessarily constitute a scope limitation.

Choice "b" is incorrect. No requirement to perform tests of controls exists. Significant deficiencies may be identified through the consideration of internal control, the application of audit procedures to balances or transactions, or otherwise during the course of the audit.

Choice "c" is incorrect. Significant deficiencies may be communicated during or after the audit.

Snow, CPA, was engaged by Master Co., a nonissuer, to examine and report on management's written assertion about the effectiveness of Master's internal control over financial reporting. Snow's report should state that:

a.

Management's assertion is based on criteria established by the American Institute of Certified Public Accountants.

b.

Because of its inherent limitations, internal control may not prevent, or detect and correct misstatements.

c.

The purpose of the engagement is to enable Snow to plan an audit and determine the nature, timing, and extent of tests to be performed.

d.

The results of Snow's tests of controls will form the basis for Snow's opinion on the fairness of Master's financial statements in conformity with GAAP.

Explanation

Choice "b" is correct. The practitioner's report should include a paragraph stating that because of its inherent limitations, internal control may not prevent, or detect and correct misstatements.

Choice "a" is incorrect. The examination is performed in accordance with standards established by the AICPA, but management's assertion may be based on criteria established by some other recognized body.

Choice "d" is incorrect. Tests of controls do not provide a sufficient basis for an opinion on the fairness of the financial statements.

Choice "c" is incorrect. An examination of management's assertion on the effectiveness of an entity's internal control over financial reporting is performed solely to report on that assertion, and not to plan an audit.

Which of the following best describes a CPA's engagement to report on a nonissuer's internal control over financial reporting?

a.

A prospective engagement to project, for a period of time not to exceed one year, and report on the expected benefits of the entity's internal control.

b.

An attestation engagement to examine and report on management's written assertion about the effectiveness of its internal control.

c.

A consulting engagement to provide constructive advice to the entity on its internal control.

d.

A review engagement to render limited assurance on the entity's internal control.

Explanation

Choice "b" is correct. An engagement to report on an entity's internal control is best described as an attestation engagement to examine and report on management's written assertion about the effectiveness of its internal control.

Choice "d" is incorrect. Attestation standards do not permit a review engagement to be performed on a nonissuer's internal controls.

Choice "a" is incorrect. A prospective engagement is not appropriate for a report on internal control. In fact, the CPA's report includes an "inherent limitations" paragraph stating that projections of the internal control evaluation to the future are risky, since conditions or the degree of compliance may change.

Choice "c" is incorrect. In a consulting engagement, the practitioner develops findings, conclusions, and recommendations, but does not report on an assertion that is the responsibility of another party. When a CPA reports on an entity's internal control, he or she is in effect reporting on management's assertion.

When communicating internal control related matters noted in an audit of a nonissuer, an auditor's report issued on significant deficiencies should indicate that:

a.

The purpose of the audit was to report on the financial statements and not to provide assurance on internal control.

b.

Errors or fraud may occur and not be detected because there are inherent limitations in any internal control.

c.

A material weakness exists when the deficiencies noted were not detected within a timely period by employees in the normal course of performing their assigned functions.

d.

The issuance of an unmodified opinion on the financial statements may be dependent on corrective follow-up action.

Explanation

Choice "a" is correct. Any report issued on significant deficiencies should indicate that the purpose of the audit was to report on the financial statements and not to provide assurance on internal control.

Choice "b" is incorrect. A statement that errors or irregularities may occur and not be detected due to inherent limitations in internal control is included in the report when an auditor is engaged to express an opinion on internal control, not when the auditor is reporting as part of an audit.

Choice "d" is incorrect. The issuance of an unmodified opinion on the financial statements is never dependent on corrective follow-up action.

Choice "c" is incorrect. A control deficiency (and not necessarily a material weakness) exists when deficiencies are not detected within a timely period by employees in the normal course of performing their assigned functions.

A letter issued on significant deficiencies relating to an entity's internal control observed during an audit of the financial statements of a nonissuer should include a:

a.

Restriction on the use of the report.

b.

Statement of compliance with applicable laws and regulations.

c.

Paragraph describing management's evaluation of the effectiveness of internal control.

d.

Description of tests performed to search for material weaknesses.

Explanation

Choice "a" is correct. Any report issued on significant deficiencies noted during an audit should (1) indicate that the purpose of the audit was to report on the financial statements and not to provide assurance on internal control, (2) include the definition of significant deficiencies, and (3) include a restriction on the use of the report.

Choice "d" is incorrect. Because the auditor does not search for material weaknesses, a description of tests performed in this regard would not be included in a written report.

Choice "b" is incorrect. There is no required statement of compliance with applicable laws and regulations in a letter issued on significant deficiencies.

Choice "c" is incorrect. There is no paragraph describing management's evaluation in a letter issued on significant deficiencies.

Hannah, CPA, has been engaged to perform financial statement audits for three different clients. The first two clients, McCormick Surf Shop and Kleinpeter Technologies, are both nonissuers, while the third client, Bender Industries, is an issuer. Hannah is required to follow PCAOB standards in her audit of Bender Industries. She has also been asked to conduct the Kleinpeter audit in accordance with both generally accepted auditing standards and the auditing standards of the PCAOB. Regarding the McCormick engagement, Hannah has decided to follow only generally accepted auditing standards, and not the standards of the PCAOB. Which of the following best describes the scope of Hannah's work related to internal control in these three engagements?

a.

Hannah must express an opinion on the effectiveness of internal control in both the Bender and Kleinpeter engagements, but is not required to express such an opinion in the McCormick engagement.

b.

Hannah must express an opinion on the effectiveness of internal control in the Bender engagement, but is not required to express such an opinion in the Kleinpeter and McCormick engagements.

c.

Hannah is not required to express an opinion on the effectiveness of internal control in any of the three engagements, since she was hired to perform a financial statement audit and not to report on internal control.

d.

Hannah must express an opinion on the effectiveness of internal control in all three engagements.

Explanation

Choice "b" is correct. While it is true that Hannah is following PCAOB standards in both the Bender and Kleinpeter engagements, PCAOB standards do not require expanded testing and reporting on internal control for nonissuers. Therefore, only in the Bender engagement would Hannah be required to express an opinion on the effectiveness of internal control.

Choice "d" is incorrect. Hannah is not required to express an opinion on internal control in either the Kleinpeter engagement (because PCAOB standards do not require such an opinion for financial statement audits of nonissuers) or the McCormick engagement (because generally accepted auditing standards do not require such an opinion for financial statement audits).

Choice "a" is incorrect. Hannah is not required to express an opinion on internal control in the Kleinpeter engagement because PCAOB standards do not require such an opinion for financial statement audits of nonissuers.

Choice "c" is incorrect. Hannah is required to express an opinion on internal control in the Bender engagement. PCAOB standards require the auditor to express such an opinion, in conjunction with financial statement audits of issuers.

Which of the following is true regarding significant deficiencies in internal control?

a.

They must be included in the financial statements.

b.

Auditors must communicate them to management and to those charged with governance.

c.

They must be disclosed in footnotes.

d.

Auditors must search for them.

Explanation

Choice "b" is correct. The auditor is required to communicate to management and to those charged with governance (the audit committee) any significant deficiencies in internal control that the auditor observes.

Choice "d" is incorrect. The auditor is not obligated to search specifically for significant deficiencies in internal control.

Choice "a" is incorrect. Significant deficiencies in internal control are not typically included in the financial statements, as they relate to controls and not to the presentation and disclosure of financial information.

Choice "c" is incorrect. Significant deficiencies in internal control are not typically included in the footnotes to the financial statements, as they relate to controls and not to the presentation and disclosure of financial information.

Management of Eva Industries, an issuer as defined under the Sarbanes-Oxley Act, believes it has eliminated a material weakness previously noted in its assessment of internal control, and has hired Henna and Company, CPAs, to attest to the improvements in internal control. Which of the following is true of this engagement?

a.

It is required by generally accepted auditing standards.

b.

It is only required if Eva Industries elects to have an audit in accordance with PCAOB standards.

c.

Eva's management must provide a written report to accompany Henna and Company's report.

d.

It is required by PCAOB standards.

Explanation

Choice "c" is correct. Eva's management must provide a written report to accompany Henna and Company's report.

Choices "d" and "a" are incorrect. An engagement to report on whether a previously reported internal control weakness continues to exist is a voluntary engagement, not required by professional standards.

Choice "b" is incorrect. An engagement to report on whether a previously reported internal control weakness continues to exist is a voluntary engagement, not required by professional standards. In addition, as an issuer, Eva must have an audit in accordance with PCAOB standards.

A control deficiency would be considered a material weakness when the likelihood that potential financial statement misstatements will not be prevented, or detected/corrected, and the magnitude of such misstatements are at a minimum:

Likelihood

Magnitude

a.

Reasonable

Material

b.

Probable

More than inconsequential

c.

Reasonable

More than inconsequential

d.

Probable

Material

Explanation

Choice "a" is correct. A material weakness is a deficiency, or combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented or detected/corrected.

Choices "d", "c", and "b" are incorrect, based on the explanation above.

In an audit of an issuer, the auditor must provide an opinion on which of the following?

I.

The financial statements.

II.

The audit committee's oversight of financial reporting and internal control.

III.

The effectiveness of internal control.

a.

I and II only.

b.

I only.

c.

I, II, and III.

d.

I and III only.

Explanation

Choice "d" is correct. The auditor provides an opinion on the entity's financial statements and on the effectiveness of internal control. The auditor is not required to provide an opinion on the audit committee's oversight (but is required to report to the board when such oversight is ineffective).

Choices "c", "a", and "b" are incorrect, based on the explanation above.

Which of the following best describes the responsibility of the auditor to report significant deficiencies and material weaknesses in an audit of a nonissuer?

a.

Neither significant deficiencies nor material weaknesses are required to be communicated.

b.

The auditor must communicate significant deficiencies, but need not separately identify material weaknesses.

c.

The auditor must communicate material weaknesses, but need not disclose significant deficiencies.

d.

The auditor must communicate both significant deficiencies and material weaknesses.

Explanation

Choice "d" is correct. In an audit of a nonissuer, the auditor is required to communicate both significant deficiencies and material weaknesses to management and those charged with governance.

Choice "c" is incorrect. The auditor is required to communicate significant deficiencies.

Choice "b" is incorrect. The auditor's report includes the definition of significant deficiencies and a list of such deficiencies noted, as well as the definition of material weaknesses and a list of such weaknesses noted.

Choice "a" is incorrect. Both significant deficiencies and material weaknesses are required to be communicated to management and those charged with governance.

Which of the following best describes the responsibility of the auditor with respect to significant deficiencies and material weaknesses in an audit of an issuer?

Must be Communicated to Managementand the Audit Committee

Results in an Adverse Opinion of theEffectiveness of Internal Control

a.

Both significant deficiencies andmaterial weaknesses

Both significant deficiencies andmaterial weaknesses

b.

Both significant deficiencies andmaterial weaknesses

Material weaknesses but not significant deficiencies

c.

Material weaknesses but notsignificant deficiencies

Both significant deficiencies andmaterial weaknesses

d.

Material weaknesses but notsignificant deficiencies

Material weaknesses but notsignificant deficiencies

Explanation

Choice "b" is correct. In an audit of an issuer, the auditor is required to communicate both significant deficiencies and material weaknesses to management and the audit committee, but only material weaknesses result in an adverse opinion on the effectiveness of internal control.

Choice "a" is incorrect. In an audit of an issuer, significant deficiencies (that do not rise to the level of being material weaknesses) do not result in an adverse opinion on the effectiveness of internal control.

Choice "c" is incorrect. In an audit of an issuer, both significant deficiencies and material weaknesses must be communicated, in writing, to management and the audit committee. In addition, significant deficiencies (that do not rise to the level of being material weaknesses) do not result in an adverse opinion on the effectiveness of internal control.

Choice "d" is incorrect. In an audit of an issuer, the auditor is required to communicate both significant deficiencies and material weaknesses to management and the audit committee.

Which of the following best describes the responsibility of the auditor to report significant deficiencies and material weaknesses in an attest engagement to examine the effectiveness of a nonissuer's internal control?

a.

The auditor must communicate material weaknesses, but need not disclose significant deficiencies.

b.

The auditor must communicate both significant deficiencies and material weaknesses.

c.

The auditor must communicate significant deficiencies, but need not separately identify material weaknesses.

d.

Neither significant deficiencies nor material weaknesses are required to be communicated.

Explanation

Choice "b" is correct. In an attest engagement to examine the effectiveness of an entity's internal control, the auditor must communicate both significant deficiencies and material weaknesses to management and those charged with governance.

Choice "a" is incorrect. The auditor is required to communicate significant deficiencies.

Choices "c" and "d" are incorrect. Both significant deficiencies and material weaknesses are required to be communicated to management and those charged with governance.

In a financial statement audit of a nonissuer, a previously communicated significant deficiency that has not been corrected, ordinarily should be communicated again:

a.

Only if the deficiency is considered a material weakness.

b.

Only if the deficiency has a material effect on the auditor's assessment of control risk.

c.

Unless the entity accepts that degree of risk because of cost-benefit considerations.

d.

In writing, during the current audit.

Explanation

Choice "d" is correct. A previously communicated significant deficiency that has not been corrected ordinarily should be communicated again in writing, during the current audit.

Choices "b" and "a" are incorrect. The auditor is required to communicate significant deficiencies each year, regardless of whether the deficiency has a material effect on the auditor's assessment of control risk or the deficiency is considered a material weakness.

Choice "c" is incorrect. The auditor is required to communicate significant deficiencies each year, even if the entity accepts that degree of risk because of cost-benefit considerations.

Which of the following statements describes an auditor's obligation to identify deficiencies in the design or operation of internal control in a financial statement audit of a nonissuer?

a.

The auditor need not search for significant deficiencies in internal control but should document and communicate any such deficiencies that are discovered.

b.

The auditor should design and apply tests of controls to discover significant deficiencies in internal control that could result in material misstatements.

c.

The auditor need not search for significant deficiencies in internal control unless management requests an attestation that "no significant deficiencies in internal control were noted in the audit."

d.

The auditor should search for significant deficiencies in internal control if the auditor expects that controls are operating effectively (i.e., if the auditor plans to rely on controls).

Explanation

Choice "a" is correct. The auditor need not search for significant deficiencies in internal control, but should document and communicate any such deficiencies that are discovered.

Choice "b" is incorrect. Tests of controls are designed and applied to evaluate the risk of financial statement misstatement, and to determine the nature, timing, and extent of substantive tests to be performed. They are not designed to discover significant deficiencies in internal control.

Choice "c" is incorrect. Searching for significant deficiencies in internal control is not part of an audit, and it would be inappropriate for the auditor to state that no significant deficiencies in internal control were noted (even if management requested such a statement).

Choice "d" is incorrect. Searching for significant deficiencies in internal control is not part of an audit even if the auditor expects that controls are operating effectively (i.e., expects to rely on controls).

Jackson is auditing the financial statements of Saffer Company, an issuer. Which of the following is true?

a.

Jackson is not required to audit internal control, but should report any significant deficiencies or material weaknesses noted.

b.

Jackson is required to audit and report on Saffers internal control.

c.

Saffer is required to obtain an audit of its internal control, but a professional other than Jackson may be hired for this purpose.

d.

If Jackson provides an adverse opinion on the financial statements, an audit of Saffers internal control is not permitted.

Explanation

Choice "b" is correct. PCAOB Auditing Standard No. 5 requires Jackson to perform an integrated audit, auditing both the financial statements and management's assessment of the effectiveness of internal control.

Choice "a" is incorrect. Jackson is required to perform an integrated audit, which includes an audit of internal control.

Choice "c" is incorrect. PCAOB Auditing Standard No. 5 requires Saffer to have an audit of internal control. Because the objectives and the work involved in an audit of internal control and in a financial statement audit are so closely related, the two audits must be performed together. Each of these two audits provides information that is relevant to the other.

Choice "d" is incorrect. An audit of internal control is required, regardless of the type of opinion rendered on the financial statements.

Which of the following best describes an auditors responsibility with respect to communicating internal control deficiencies of issuers?

a.

The auditor is required to communicate all deficiencies in internal control to management, and deficiencies that constitute a significant deficiency or a material weakness to management and the audit committee.

b.

The auditor is not required to communicate control deficiencies to management or the audit committee unless they constitute a significant deficiency or a material weakness.

c.

The auditor is required to communicate all deficiencies in internal control to management, deficiencies that constitute a significant deficiency to the audit committee, and deficiencies that constitute a material weakness to the full board of directors.

d.

The auditor is not required to communicate control deficiencies or significant deficiencies to management or the audit committee, but must communicate material weaknesses to both management and the audit committee.

Explanation

Choice "a" is correct. The auditor is required to communicate all deficiencies in internal control to management, and deficiencies that constitute a significant deficiency or a material weakness to management and the audit committee.

Choice "c" is incorrect. There is no requirement that material weaknesses be communicated to the full board of directors.

Choice "b" is incorrect. The auditor is required to communicate all deficiencies in internal control to management.

Choice "d" is incorrect. The auditor is also required to communicate significant deficiencies to management and the audit committee.

In which case might an auditor of an issuer render a qualified opinion on internal control?

I.

When there is a scope limitation.

II.

When there is a material weakness in internal control.

a.

Both I and II.

b.

II only.

c.

I only.

d.

Neither I nor II.

Explanation

Choice "d" is correct. A scope limitation requires the auditor to disclaim an opinion or withdraw from the engagement, and a material weakness in internal control requires the auditor to issue an adverse opinion. Neither situation would result in a qualified opinion.

Choice "c" is incorrect. A scope limitation requires the auditor to disclaim an opinion or withdraw from the engagement.

Choice "b" is incorrect. A material weakness in internal control requires the auditor to issue an adverse opinion.

Choice "a" is incorrect. A scope limitation requires the auditor to disclaim an opinion or withdraw from the engagement, and a material weakness in internal control requires the auditor to issue an adverse opinion. Neither situation would result in a qualified opinion.

Gail is auditing the financial statements of Hoefener Home Improvements, a publicly held company. Gail notes several deficiencies in internal control, and is trying to determine whether each deficiency constitutes a significant deficiency or a material weakness. Which best describes the framework Gail should use in making this evaluation?

a.

A significant deficiency exists for weaknesses that are important enough to merit the attention of those responsible for financial reporting, and a material weakness exists when there is more than a remote chance of a material misstatement.

b.

A significant deficiency exists when there is more than a remote chance of a more than inconsequential misstatement, and a material weakness exists when there is more than a remote chance of a material misstatement.

c.

A significant deficiency exists for weaknesses that are important enough to merit the attention of those responsible for financial reporting, and a material weakness exists when there is a reasonable possibility of material misstatement.

d.

A significant deficiency exists when there is more than a remote chance of a more than inconsequential misstatement, and a material weakness exists when there is a reasonable possibility of material misstatement.

Explanation

Choice "c" is correct. A significant deficiency exists for weaknesses that are important enough to merit the attention of those responsible for financial reporting, and a material weakness exists when there is a reasonable possibility of material misstatement.

Choice "b" is incorrect. A significant deficiency exists for weaknesses that are important enough to merit the attention of those responsible for financial reporting, and a material weakness exists when there is a reasonable possibility of material misstatement.

Choice "d" is incorrect. A significant deficiency exists for weaknesses that are important enough to merit the attention of those responsible for financial reporting.

Choice "a" is incorrect. A material weakness exists when there is a reasonable possibility of material misstatement.

Which of the following actions should the auditor take in response to discovering a deviation from the prescribed control procedure?

a.

Make inquiries to understand the potential consequence of the deviation.

b.

Increase sample size of tests of controls.

c.

Assume that the deviation is an isolated occurrence without audit significance.

d.

Report the matter to the next higher level of authority within the entity.

Explanation

Choice "a" is correct. In response to discovering a deviation from a prescribed control procedure, the auditor should make inquiries to understand the potential consequence of the deviation.

Choice "c" is incorrect. The auditor should not simply assume that a deviation is an isolated occurrence without audit significance.

Choice "d" is incorrect. There is no requirement that the auditor report all deviations to the next higher level of authority within the entity. Note that a single deviation does not necessarily represent a control deficiency.

Choice "b" is incorrect. The auditor would not increase the sample size in tests of controls just because he or she discovers a single deviation. Instead, the auditor would estimate the population deviation rate based on the number of deviations in the sample.

Which of the following statements is correct regarding internal control?

a.

An inherent limitation to internal control is the fact that controls can be circumvented by management override.

b.

Internal control is a necessary business function and should be designed and operated to detect all errors and fraud.

c.

A well-designed internal control environment ensures the achievement of an entity's control objectives.

d.

A well-designed and operated internal control environment should detect collusion perpetrated by two people.

Explanation

Choice "a" is correct. Since management generally has the authority to implement and assign responsibilities under the internal controls, they will generally also have the ability to circumvent those internal controls. This is an inherent limitation of internal control.

Choice "c" is incorrect. Although the design of an internal control system is important, it needs to be paired with the proper implementation and monitoring, and even then cannot ensure that the entity's internal control objectives will be met.

Choice "d" is incorrect. Internal control structures generally rely in some manner on segregation of duties. Because of this, collusion by two or more people can generally destroy this segregation of duties and thus potentially cause circumvention of the internal controls that may not be immediately detected.

Choice "b" is incorrect. No internal control system can guarantee the detection of all errors and fraud. The purpose of an internal control system is to significantly reduce the likelihood that errors or fraud will be committed and go undetected.

During consideration of internal control in a financial statement audit, an auditor is not obligated to:

a.

Determine whether the control activities relevant to audit planning have been implemented.

b.

Perform procedures to understand the design of internal control.

c.

Search for all significant deficiencies in the operation of internal control.

d.

Understand the internal control environment and the accounting system.

Explanation

Choice "c" is correct. During consideration of internal control in a financial statement audit, an auditor is not obligated to search for all significant deficiencies in the operation of internal control, but should communicate any such situations noted to management and those charged with governance.

Choice "d" is incorrect. The auditor is required to obtain an understanding of each of the five components of internal control, including the control environment and the (accounting) information system.

Choices "a" and "b" are incorrect. As part of planning, the auditor is required to obtain an understanding of the design of relevant controls and to determine whether they have been implemented.

With respect to the audit of a nonissuer, significant deficiencies are matters that come to an auditor's attention that should be communicated to an entity's management and those charged with governance because they represent:

a.

Deficiencies in the design or operation of internal control that are important enough to merit attention by those responsible for oversight of the company's financial reporting.

b.

Material irregularities or illegal acts perpetrated by high-level management.

c.

Manipulation or falsification of accounting records or documents from which financial statements are prepared.

d.

Disclosures of information that significantly contradict the auditor's going concern assumption.

Explanation

Choice "a" is correct. Significant deficiencies in the design or operation of internal control should be communicated to management and those charged with governance because they are important enough to merit attention by those responsible for oversight of the company's financial reporting.

Choice "c" is incorrect. Manipulation or falsification of accounting records may not represent an internal control deficiency (e.g., if such fraud occurs through collusion).

Choice "d" is incorrect. Information indicative of a going concern problem is not an internal control deficiency.

Choice "b" is incorrect. Irregularities or illegal acts may not represent deficiencies in internal control (e.g., if such acts occur through collusion).

With respect to the audit of a nonissuer, significant deficiencies are matters that come to an auditor's attention, which should be communicated to an entity's management and those charged with governance because they represent:

a.

Material irregularities or illegal acts perpetrated by high-level management.

b.

Deficiencies in the design or operation of internal control that are important enough to merit attention by those responsible for oversight of the company's financial reporting.

c.

Intentional attempts by client personnel to limit the scope of the auditor's fieldwork.

d.

Flagrant violations of the entity's documented conflict-of-interest policies.

Explanation

Choice "b" is correct. Significant deficiencies in the design or operation of internal control should be communicated to management and those charged with governance because they are important enough to merit attention by those responsible for oversight of the company's financial reporting.

Choice "a" is incorrect. Irregularities or illegal acts may not represent deficiencies in internal control (e.g., if such acts occur through collusion).

Choice "d" is incorrect. Significant deficiencies do not necessarily involve violations of an entity's conflict-of-interest policies.

Choice "c" is incorrect. Interfering with the auditor's procedures would not constitute a significant deficiency, since such interference would not affect the financial statements.

When engaged to express an opinion on a nonissuer's internal control, an accountant should:

a.

Qualify any opinion concerning management's assertion that the cost of correcting any weaknesses exceeds the benefits.

b.

Obtain management's written assertions regarding whether the company has maintained effective internal control.

c.

Disclaim an opinion on whether the system taken as a whole is sufficient to prevent or detect material errors or irregularities.

d.

Keep informed of events subsequent to the date of the report that might have affected the accountant's opinion.

Explanation

Choice "b" is correct. An auditor should obtain management's written assertion about the effectiveness of the entity's internal control.

Choice "a" is incorrect. The accountant should disclaim (not qualify) an opinion on management's assertions that the cost of correcting weaknesses exceeds the benefits.

Choice "d" is incorrect. The accountant has no responsibility to evaluate the effect of subsequent events. In fact, the report on an entity's internal control specifically states that projections of the internal control evaluation to future periods is inappropriate.

Choice "c" is incorrect. The accountant provides an opinion (and not a disclaimer) on the effective operation of internal control.

Which of the following statements concerning material weaknesses and significant deficiencies is correct with respect to an audit of a nonissuer?

a.

An auditor should report immediately material weaknesses and significant deficiencies discovered during an audit.

b.

An auditor need not identify and communicate material weaknesses separately from significant deficiencies.

c.

All significant deficiencies are material weaknesses.

d.

All material weaknesses are significant deficiencies.

Explanation

Choice "d" is correct. Since a material weakness in internal control is important enough to merit attention by those charged with governance, it would also be considered a significant deficiency.

Choice "b" is incorrect. The auditor is required to separately identify and communicate significant deficiencies and material weaknesses.

Choice "a" is incorrect. Significant deficiencies and material weaknesses are generally communicated to the appropriate parties after the audit is complete. They may, at the auditor's discretion, be communicated during the audit, but there is no requirement for immediate communication.

Choice "c" is incorrect. A material weakness is a significant deficiency that results in a reasonable likelihood that a material misstatement in the financial statements will not be prevented or detected/corrected. Not all significant deficiencies will be material weaknesses.

The management of Cain Company, a nonissuer, engaged Bell, CPA, to express an opinion on Cain's internal control. Bell's report described several material weaknesses and potential errors and irregularities that could occur. Subsequently, management included Bell's report in its annual report to the Board of Directors with a statement that the cost of correcting the weaknesses would exceed the benefits. Bell should:

a.

Advise both management and the Board that Bell was withdrawing the opinion.

b.

Disclaim an opinion as to management's cost-benefit statement.

c.

Advise management that Bell's report was restricted for use only by management.

d.

Advise the Board that Bell either agrees or disagrees with management's statement.

Explanation

Choice "b" is correct. The auditor should disclaim an opinion as to management's cost-benefit statement (i.e., "We do not express an opinion or any other form of assurance on management's cost-benefit statement.").

Choice "d" is incorrect. The CPA should disclaim an opinion regarding management's representation.

Choice "c" is incorrect. The CPA's report on internal control is not restricted as to use.

Choice "a" is incorrect. The CPA does not need to withdraw the opinion as long as a disclaimer on management's cost-benefit statement is presented.

An auditor's communication of internal control related matters noted in an audit usually should be addressed to:

a.

Management and those charged with governance.

b.

The chief financial officer.

c.

The chief accounting officer.

d.

The director of internal auditing.

Explanation

Choice "a" is correct. An auditor's communication of internal control related matters noted in an audit usually should be addressed to management and those charged with governance.

Choices "d", "b", and "c" are incorrect. The director of internal auditing, the chief financial officer, and the chief accounting officer all would have access to the letter; however, it would not be addressed to them since they do not have the same level of authority and responsibility to the shareholders as management and those charged with governance.

When reporting on conditions relating to an entity's internal control observed during an audit of the financial statements of a nonissuer, the auditor should include a:

a.

Statement of positive assurance on internal control.

b.

Paragraph describing the inherent limitations of internal control.

c.

Restriction on the use of the report.

d.

Description of tests performed to search for material weaknesses.

Explanation

Choice "c" is correct. When reporting on conditions relating to an entity's internal control observed during an audit of the financial statements, the auditor should include a restriction on the use of the report.

Choice "d" is incorrect. The auditor would not include a description of tests performed to search for material weaknesses since the auditor is not in fact obligated to search for them.

Choices "a" and "b" are incorrect. An auditor would make a statement of positive assurance on internal control and include a paragraph describing the inherent limitations of internal control in conjunction with an engagement to report on internal control. These comments would not be made when reporting on an entity's internal control in conjunction with an audit of the financial statements of a nonissuer.

An engagement to express an opinion on the internal control of a nonissuer will generally:

a.

Be more extensive in scope than the assessment of control risk made during a financial statement audit.

b.

Increase the reliability of the financial statements that are being audited.

c.

Be more limited in scope than the assessment of control risk made during a financial statement audit.

d.

Require procedures that duplicate those already applied in assessing control risk during a financial statement audit.

Explanation

Choice "a" is correct. An engagement to express an opinion on internal control will generally be more extensive in scope than the assessment of control risk made during a financial statement audit of a nonissuer. This occurs because assessing control risk is the primary purpose of an engagement to express an opinion on internal control, whereas it is an incidental result of an audit of a nonissuer.

Choice "d" is incorrect. Since examination of internal control should be integrated with the financial statement audit, it is unlikely that the auditor would duplicate procedures that were already applied.

Choice "b" is incorrect. It is unlikely that the reliability of the financial statements would be increased if an engagement to express an opinion on internal control is performed; however, the audit might be more efficient due to the integration of the two audits.

Choice "c" is incorrect. An engagement to express an opinion on internal control is more extensive in scope than the control risk assessment performed during an audit of a nonissuer.

Which of the following statements is correct concerning significant deficiencies noted in an audit of a nonissuer?

a.

The auditor should separately identify those significant deficiencies that are considered to be material weaknesses.

b.

The auditor is obligated to search for significant deficiencies that could adversely affect the entity's ability to record and report financial data.

c.

Significant deficiencies should not be re-communicated each year if management has acknowledged its understanding of such deficiencies.

d.

Significant deficiencies are material weaknesses in the design or operation of specific internal control components.

Explanation

Choice "a" is correct. The auditor should separately identify significant deficiencies and material weaknesses.

Choice "d" is incorrect. Not all significant deficiencies are material weaknesses.

Choice "b" is incorrect. The auditor is not obligated to search for significant deficiencies. The auditor is obligated to communicate to the client any significant deficiencies identified while auditing the financial statements.

Choice "c" is incorrect. The auditor is obligated to re-communicate significant deficiencies each year, even if management has acknowledged its understanding of such deficiencies.

Which of the following statements concerning an auditor's communication of significant deficiencies identified during the audit of a nonissuer is correct?

a.

The auditor should request a meeting with management one level above the source of the significant deficiencies to discuss suggestions for remedial action.

b.

Suggestions concerning administration efficiencies and business strategies should not be communicated in the same report with significant deficiencies.

c.

Significant deficiencies discovered and communicated at an interim date should be reexamined with tests of controls before completing the engagement.

d.

Any report issued on significant deficiencies should indicate that providing assurance on internal control was not the purpose of the audit.

Explanation

Choice "d" is correct. Any report issued on significant deficiencies should indicate that providing assurance on internal control was not the purpose of the audit.

Choice "a" is incorrect. The auditor should communicate significant deficiencies to management and those charged with governance, but is not required to request a meeting with management one level above the source of the significant deficiencies, to discuss suggestions for remedial action.

Choice "c" is incorrect. Significant deficiencies discovered and communicated at an interim date do not need to be reexamined with tests of controls before completing the engagement.

Choice "b" is incorrect. Suggestions concerning administration efficiencies and business strategies may be communicated in the same report with significant deficiencies (the significant deficiencies must be separately identified, however).

Which of the following representations should not be included in a report on internal control related matters noted in an audit of a nonissuer?

a.

There are no significant deficiencies in the design or operation of internal control.

b.

The auditor's consideration of internal control would not necessarily disclose all significant deficiencies that exist.

c.

Corrective follow-up action is recommended due to the relative significance of material weaknesses discovered during the audit.

d.

Significant deficiencies related to internal control design exist, but there are no material weaknesses.

Explanation

Choice "a" is correct. A report on internal control related matters noted in an audit should not state that there are no significant deficiencies in internal control, since this statement might erroneously imply that the auditor searched for such conditions.

Choice "d" is incorrect. The auditor is permitted to state that no material weaknesses were identified during the audit. Typically this occurs in reports submitted to governmental authorities.

Choice "c" is incorrect. The auditor may suggest that corrective follow-up action should be taken due to the relative significance of material weakness discovered.

Choice "b" is incorrect. The auditor's report may state that his or her consideration of internal control would not necessarily disclose all significant deficiencies that exist.

Which is true regarding PCAOB standards surrounding internal control?

a.

All auditors must follow PCAOB standards surrounding internal control.

b.

PCAOB standards surrounding internal control apply only to audits of issuers.

c.

PCAOB standards surrounding internal control apply only to audits of nonissuers.

d.

The PCAOB has not issued standards surrounding internal control.

Explanation

Choice "b" is correct. PCAOB standards surrounding internal control apply only to audits of issuers.

Choices "a" and "c" are incorrect. PCAOB standards surrounding internal control apply only to audits of issuers, not to audits of nonissuers.

Choice "d" is incorrect. The PCAOB has issued Auditing Standards No. 5, requiring auditors of issuers to report on internal control.

An auditor has been hired to report on a nonissuer's internal control over financial reporting. Which of the following best describes a reporting option in this scenario?

a.

If management fails to provide a written representation letter acknowledging its responsibility for the effectiveness of internal control, the auditor may issue either a qualified opinion or an adverse opinion.

b.

When a significant deficiency exists, the auditor may issue either a qualified or adverse opinion.

c.

When a material weakness exists, the auditor should issue an adverse opinion.

d.

If management fails to provide a written representation letter acknowledging its responsibility for the effectiveness of internal control, the auditor will generally issue an unmodified opinion with additional explanatory language.

Explanation

Choice "c" is correct. When a material weakness exists, the auditor should issue an adverse opinion.

Choices "d" and "a" are incorrect. Failure of management to provide a written representation letter acknowledging its responsibility for the effectiveness of internal control generally will result in a disclaimer of opinion or withdrawal from the engagement.

Choice "b" is incorrect. While the auditor is required to communicate significant deficiencies to management and those charged with governance, the opinion on internal control need not be modified unless a material weakness is noted.

In obtaining an understanding of an entity's internal control in a financial statement audit, an auditor is not obligated to:

a.

Perform procedures to understand the design of internal control.

b.

Determine whether the control activities have been implemented.

c.

Document the understanding of the entity's internal control components.

d.

Search for significant deficiencies in the operation of internal control.

Explanation

Choice "d" is correct. When obtaining an understanding of an entity's internal control in a financial statement audit, an auditor is not obligated to search for significant deficiencies in the operation of internal control.

Choice "b" is incorrect. In order to determine the nature, timing and extent of tests to be performed, an auditor must determine whether the control activities have been implemented.

Choice "a" is incorrect. An auditor is required to perform procedures to confirm his/her understanding of the internal control systems' design, and to determine whether relevant controls have been implemented.

Choice "c" is incorrect. An auditor is required to document his or her understanding of the entity's internal control components, even if he or she intends to use a substantive approach.

Which of the following is not true about significant deficiencies in internal control?

a.

The auditor is required to communicate to management and those charged with governance all significant deficiencies in internal control that he or she observes during the audit.

b.

All material weaknesses in internal control are also significant deficiencies.

c.

The auditor is required to search for significant deficiencies in internal control.

d.

The auditor should not indicate to management that no significant deficiencies in internal control were noted during the audit.

Explanation

Choice "c" is correct. The auditor is not required to search for significant deficiencies (but any that are identified should be reported).

Choice "b" is incorrect. Material weaknesses are deficiencies in internal control such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented or detected/corrected on a timely basis. Material weaknesses are important enough to merit attention by those charged with governance, and therefore all material weaknesses are in fact significant deficiencies.

Choice "a" is incorrect. The auditor is required to communicate to those charged with governance all significant deficiencies that he or she observes during the audit.

Choice "d" is incorrect. The auditor should not indicate to management that no significant deficiencies were noted during the audit, as this might cause misinterpretation of the auditor's responsibility in such cases.

Which of the following matters would an auditor most likely consider to be a significant deficiency in internal control to be communicated to management and those charged with governance?

a.

Management's failure to renegotiate unfavorable long-term purchase commitments.

b.

Management's current plans to reduce its ownership equity in the entity.

c.

Recurring operating losses that may indicate going concern problems.

d.

Evidence of a lack of objectivity by those responsible for accounting decisions.

Explanation

Choice "d" is correct. A lack of objectivity by those responsible for accounting decisions represents a significant internal control deficiency because it may result in financial statements that are biased rather than being presented fairly. This is a matter that would merit attention by those charged with governance.

Choice "a" is incorrect. Management's failure to renegotiate unfavorable long-term purchase commitments does not represent a significant deficiency in internal control.

Choice "c" is incorrect. Going concern problems do not represent a significant deficiency in internal control.

Choice "b" is incorrect. Management's plan to reduce its ownership equity in the entity does not represent a significant deficiency in internal control.

In reporting on a nonissuer's internal control over financial reporting in an attest engagement, a practitioner should include a paragraph that describes the:

a.

Potential benefits from the practitioner's suggested improvements.

b.

Inherent limitations of any internal control.

c.

Documentary evidence regarding the control environment factors.

d.

Changes in internal control since the prior report.

Explanation

Choice "b" is correct. In reporting on a nonissuer's internal control over financial reporting in an attest engagement (not an audit), the practitioner's report should include a paragraph stating that, because of inherent limitations of any internal control, errors or fraud may occur and not be detected.

Choice "c" is incorrect. Documentary evidence need not be provided in the practitioner's report.

Choice "d" is incorrect. The practitioner need not mention any changes in internal control since the last report.

Choice "a" is incorrect. The practitioner should not describe any potential benefits that might result from the practitioner's suggested improvements.

In an audit of an issuer:

I.

Management must assess and report on internal control.

II.

The auditor must assess and report on internal control.

a.

Both I and II.

b.

Either I or II.

c.

I only.

d.

II only.

Explanation

Choice "a" is correct. It is management's responsibility to assess and report on internal control, but the auditor is also required to assess and report on internal control.

Choices "c", "d", and "b" are incorrect, based on the explanation above.

How do the scope, procedures, and purpose of tests of controls in an examination of the internal control of a nonissuer compare to those for obtaining an understanding of internal control and assessing control risk as part of a financial statement audit of a nonissuer?

Scope

Procedures

Purpose

a.

Similar

Different

Similar

b.

Different

Similar

Similar

c.

Different

Similar

Different

d.

Different

Different

Different

Explanation

Choice "d" is correct. In an engagement to express a separate opinion on an entity's internal control, the scope and procedures are more extensive, and the purpose is directed primarily toward the internal control report. In an audit, the scope is less extensive, and the purpose is to determine the nature, timing, and extent of auditing procedures. Audit procedures (testing) is more extensive when rendering an opinion on internal controls because the auditor should obtain evidence on selected controls over all relevant assertions, whereas in a financial statement audit the auditor is not required to test controls over all relevant assertions.

Choices "a", "b", and "c" are incorrect, based on the above explanation.

Which of the following circumstances would be inappropriate for the auditor to communicate to those charged with governance?

a.

Management has consulted with other accountants about accounting and auditing matters during the period under audit.

b.

A material misstatement was noted by the auditor and corrected by management.

c.

The auditor is requesting representations regarding the financial statements from management.

d.

No significant deficiencies in internal control exist that would affect the financial statements.

Explanation

Choice "d" is correct. The auditor may not report the absence of significant deficiencies to those charged with governance or management.

Choice "b" is incorrect. It is appropriate for the auditor to communicate to those charged with governance a material misstatement noted by the auditor and corrected by management.

Choice "c" is incorrect. The auditor's request that management provide representations regarding the financial statements is an appropriate communication from the auditor to those charged with governance.

Choice "a" is incorrect. Management's consultation with other accountants about accounting and auditing matters during the period under audit is an appropriate communication for the auditor to make to those charged with governance.