Chapter 21 Internal, Operational, and Compliance Auditing

True/False Questions

1. The work of internal auditors is primarily for the benefit of management and the board
of directors.

Answer: True Difficulty: Easy

2. The first internal auditors were primarily concerned with operational auditing.

Answer: False Difficulty: Medium

3. The passage of the Foreign Corrupt Practices Act increased the demand for internal
auditing.

Answer: True Difficulty: Easy

4. Evaluation of internal control is one of the general sections of the IIA's Standards of
the Professional Practice of Internal Auditing.

Answer: False Difficulty: Hard

5. In operational auditing, the preliminary survey serves as a guide for the development
of the audit program.

Answer: True Difficulty: Medium

6. When no weaknesses in internal control are discovered during an operational audit, the
appropriate report will be either standard unqualified or unqualified with explanatory
language.

Answer: False Difficulty: Medium

7. Operational audits are primarily concerned with whether an organization follows

appropriate laws and regulations.

Answer: False Difficulty: Medium

8. Compliance procedures are tests of an organization's controls.

Answer: False Difficulty: Hard

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Chapter 21 Internal, Operational, and Compliance Auditing

9. In an audit in accordance with Government Auditing Standards, the auditors are

required to perform additional compliance procedures beyond those required by
generally accepted auditing standards.

Answer: False Difficulty: Hard

10. In an audit in accordance with the Single Audit Act of 1984, the auditors must test
compliance with the significant requirements of all major programs.

Answer: True Difficulty: Medium

Multiple Choice Questions

11. When auditing an entity's financial statements in accordance with Government

Auditing Standards (the “Yellow Book”), an auditor is required to report on:

I. Noteworthy accomplishments of the program.

II. The scope of the auditor's testing of internal controls.

A) I only.
B) II only.
C) Both I and II.
D) Neither I nor II.

Answer: B Difficulty: Hard Source: AICPA

12. When auditing an entity's financial statements in accordance with Government

Auditing Standards (the “Yellow Book”), an auditor is required to report on:

I. Recommendations for actions to improve operations.

II. The scope of the auditor's tests of compliance with laws and regulations.

A) I only.
B) II only.
C) Both I and II.
D) Neither I nor II.

Answer: B Difficulty: Hard Source: AICPA

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Chapter 21 Internal, Operational, and Compliance Auditing

13. A comprehensive examination of an operating unit or a complete organization to

evaluate its systems, controls, and performance, as measured by management's
objectives.
A) Compilation.
B) Consultation.
C) Operational Audit.
D) “Yellow Book” audit.

Answer: C Difficulty: Medium

14. An audit in accordance with the Single Audit Act does not involve reporting upon:
A) Compliance with provisions of laws that may have a direct and material affect on
each major federal financial assistance program.
B) Financial statements.
C) Internal control over operations.
D) Schedule of expenditures of federal awards.

Answer: C Difficulty: Hard

15. Under the Single Audit Act, the auditor must apply procedures to test for compliance
and test the effectiveness of controls for:

Major Programs NonMajor Programs

A) Yes Yes
B) Yes No
C) No Yes
D) No No

Answer: B Difficulty: Medium

16. Internal auditing is considered to be part of an organization's:

A) Accounting system.
B) Control activities.
C) Monitoring.
D) External controls.

Answer: C Difficulty: Medium

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Chapter 21 Internal, Operational, and Compliance Auditing

17. Which of the following is not one of the attribute standards of the IIA's Standards for
the Professional Practice of Internal Auditing?
A) Independence and objectivity.
B) Outsourcing.
C) Proficiency and professional care.
D) Purpose, authority, and responsibility.

Answer: B Difficulty: Medium

18. Which of the following is not required of an individual seeking to become a certified
internal auditor?
A) Two years work experience in internal auditing or its equivalent.
B) Successful completion of a two-day examination.
C) A baccalaureate degree from an accredited college.
D) One year of supervisory experience.

Answer: D Difficulty: Medium

19. For the highest degree of independence the director of internal auditing should report
directly to:
A) The controller.
B) The audit committee of the board of directors.
C) The executive vice-president.
D) The chief accountant.

Answer: B Difficulty: Easy

20. The operational auditors' preliminary conclusions about potential problem areas are
summarized as:
A) The definition of purpose.
B) The audit program.
C) The preliminary survey.
D) The audit report.

Answer: C Difficulty: Medium

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Chapter 21 Internal, Operational, and Compliance Auditing

21. A legal aid society provides free legal aid to low-income individuals with funds
passed-through the state welfare department from the U.S. Department of Health and
Human Services. In this situation which organization is the primary recipient of the
funds?
A) The state welfare department.
B) The Department of Health and Human Services.
C) The legal aid society.
D) The individual receiving the aid.

Answer: A Difficulty: Hard

22. In an audit in accordance with Government Auditing Standards, the auditors are
required to provide a report on:
A) Compliance with general requirements.
B) The schedule of financial assistance received.
C) The organization's internal control.
D) Findings and questioned costs.

Answer: C Difficulty: Medium

23. Which of the following types of audits is designed to determine that an organization
has complied with the specific requirements of major financial assistance programs?
A) An audit in accordance with Government Auditing Standards.
B) A single audit.
C) An audit in accordance with generally accepted auditing standards.
D) An operational audit.

Answer: B Difficulty: Medium

24. Compliance auditing procedures are:

A) Tests of controls.
B) Observation procedures.
C) Substantive procedures.
D) Confirmation procedures.

Answer: C Difficulty: Medium

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Chapter 21 Internal, Operational, and Compliance Auditing

25. In an audit in accordance Government Auditing Standards, the auditors are required to
provide a report on:
A) Compliance applicable to major federal programs.
B) The Schedule of financial assistance received.
C) Compliance with laws and regulations which are required to be tested by generally
accepted auditing standards.
D) Internal control systems used in administering federal assistance programs.

Answer: C Difficulty: Medium

26. In an audit in accordance with generally accepted auditing standards, the auditors must
test compliance with those laws and regulations that:
A) Have a direct and material effect on the financial statements.
B) Have a direct and material effect on major federal programs.
C) Have a material direct or indirect effect on the financial statements.
D) Have a material effect on major or nonmajor programs.

Answer: A Difficulty: Medium

27. Requirements of federal financial assistance programs that involve significant national
policy are known as:
A) Specific requirements.
B) Major program requirements.
C) General requirements.
D) Primary requirements.

Answer: C Difficulty: Medium

28. Costs paid with federal assistance that appear to be in violation of a law or regulation
are known as:
A) Questioned costs.
B) Noncompliance costs.
C) Improper costs.
D) Illegal costs.

Answer: A Difficulty: Medium

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29. When performing an audit of a city in accordance with the Single Audit Act, an
auditor should adhere to:
A) Standards for the Professional Practice of Internal Auditing.
B) Government Auditing Standards.
C) Operational Auditing Standards.
D) Financial Accounting Standards.

Answer: B Difficulty: Hard

30. A primary purpose of operational auditing standards is to provide:

A) A means of assurance that internal control is operating effectively.
B) Aid to the independent auditor in conducting the audit of financial statements.
C) The results of internal examinations of financial and accounting matters to the
company's top-level management.
D) A measure of management performance in meeting organizational goals.

Answer: D Difficulty: Medium

31. The primary purpose of the internal auditors' evaluation of internal control is to:
A) Determine if management has planned and implemented activities needed to attain
goals and objectives.
B) Determine the extent of tests of controls needed during field work.
C) Identify areas for fraud investigation.
D) Determine if employees have incompatible duties that have compromised the
control environment.

Answer: A Difficulty: Hard Source: IIA

32. According to the IIA's Standards, an internal auditor's working papers should be
reviewed by the:
A) Management of the department being audited.
B) Management of the internal auditing department.
C) Audit committee of the board of directors.
D) Management of the organization's security division.

Answer: B Difficulty: Medium Source: IIA

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Chapter 21 Internal, Operational, and Compliance Auditing

33. Management is beginning to take corrective action on personnel department

deficiencies reported during the last internal audit. According to the IIA's Standards,
the internal auditor should:
A) Oversee the corrective action.
B) Postpone the next audit of the personnel department until the corrective action is
completed.
C) Refrain from judging whether the corrective action will remedy the deficiencies.
D) Follow up to see that the corrective action satisfies the audit recommendations.

Answer: D Difficulty: Medium Source: IIA

34. The internal auditing department provides information about control and quality of
performance to:
A) Management and the board of directors.
B) A level in the organization sufficient to ensure acceptance of all recommendations.
C) Outside agencies for regulatory and financial compliance.
D) Any member of the organization upon request.

Answer: A Difficulty: Easy Source: IIA

35. The GAO standards of reporting for governmental financial audits incorporate the
AICPA standards of reporting and prescribe supplemental standards to satisfy the
unique needs of governmental audits. Which of the following is a supplemental
reporting standard for audits in accordance with Government Auditing Standards?
A) A report on the auditor's understanding of the entity's internal control and
assessment of control risk should be issued.
B) Material indications of illegal acts should be reported in a document with
distribution restricted to senior officials of the entity audited.
C) Instances of abuse, fraud, mismanagement, and waste should be reported to the
organization with legal oversight authority over the entity audited.
D) All privileged and confidential information discovered should be reported to the
senior officials of the organization that arranged for the audit.

Answer: A Difficulty: Medium Source: AICPA

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36. Kent is auditing an entity's compliance with requirements governing a major federal
financial assistance program in accordance with the Single Audit Act. Kent detected
noncompliance with requirements that have a material effect on that program. Kent's
report on compliance should express a(an):
A) Unqualified opinion with a separate explanatory paragraph.
B) Qualified opinion or an adverse opinion.
C) Adverse opinion or a disclaimer of opinion.
D) Limited assurance on the items tested.

Answer: B Difficulty: Medium Source: AICPA

37. The scope of an internal audit is initially defined by the:

A) Audit objectives.
B) Scheduling and time estimates.
C) Preliminary survey.
D) Audit program.

Answer: A Difficulty: Medium Source: IIA

38. An operational audit report which deals with the scrap disposal function in a
manufacturing company is most likely to address:
A) The efficiency and effectiveness of the scrap disposal function and include any
findings requiring corrective action.
B) Whether the scrap material inventory is reported as a current asset.
C) Whether the physical inventory count of the scrap material agrees with the
recorded amount.
D) Whether the scrap materials inventory is valued at the lower of cost or market.

Answer: A Difficulty: Medium Source: IIA

39. Interviewing operating personnel, identifying he objectives of the auditee, identifying

standards used to evaluate performance, and assessing the risk inherent in the auditee's
operations are activities typically performed in which phase of an internal audit?
A) The fieldwork phase.
B) The preliminary survey phase.
C) The audit programming phase.
D) The reporting phase.

Answer: B Difficulty: Medium Source: IIA

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40. In governmental accounting, emphasis is placed on:

A) Total assets owned by the governmental entity.
B) Generating income form funds employed.
C) Expenditures of funds.
D) The flow of funds through the income statement.

Answer: C Difficulty: Hard Source: IIA

41. Which of the following best describes the scope of internal auditing as it has
developed to date?
A) Internal auditing involves appraising the economy and efficiency with which
resources are employed.
B) Internal auditing involves evaluating compliance with policies, plans, procedures,
laws, and regulations.
C) Internal auditing has evolved to verifying the existence of assets and reviewing the
means of safeguarding assets.
D) Internal auditing has evolved to more of an operational orientation from a
financial orientation.

Answer: D Difficulty: Hard Source: IIA

42. In planning an audit, an on-site survey could assist with all of the following, except:
A) Obtaining auditee comments and suggestions on control problems.
B) Obtaining preliminary information on internal control.
C) Identifying areas for audit emphasis.
D) Evaluating the effectiveness of the internal control.

Answer: D Difficulty: Hard Source: IIA

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Essay Questions

43. Internal auditors are an important part of the internal control structures of all types of
organizations.
a. Describe the objectives of an internal auditing function.
b. Explain two ways that internal auditors may maintain independence with respect to
the activities that they audit.

Difficulty: Medium

Answer:
a. Internal auditing is an independent, objective assurance and consulting activity
designed to add value and improve an organization's operations. It helps an
organization accomplish its objectives by bringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management, control,
and governance processes.

b. The internal auditors maintain independence by:

Ensuring that the organizational status of the internal auditing department is
sufficient to permit the accomplishment of its objectives, and

Policies and procedures regarding the assignment of internal auditors to

assignments.

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44. Operational auditing has grown in importance over the last few decades.
a. Define operational auditing.
b. Who are the major users of operational audit reports.
c. List the phases of an operational audit.

Difficulty: Hard

Answer:
a. An operational audit is a comprehensive examination of an operating unit or a
complete organization to evaluate its performance, as measured by management's
objectives. It focuses on effectiveness, efficiency, and economy.

b. The major users of operational reports are top management, including the board of
directors and, especially in the case of governmental organizations, Congress.

c. The phases in an operational audit include:

• Definition of purpose.
• Familiarization.
• Preliminary survey.
• Program development.
• Reporting the findings.
• Follow-up.

45. Many government and nonprofit organizations are required to have an audit in
accordance with Government Auditing Standards.
c. Who develops Government Auditing Standards?
d. Describe the requirements of an audit in accordance with Government Auditing
Standards.
e. Describe the auditors' responsibilities for testing for compliance with laws and
regulations in an audit in accordance with Government Auditing Standards.

Difficulty: Hard

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Answer:
a. The United States General Accounting Office (GAO) establishes Government
Auditing Standards.

b. The requirements of an audit in accordance with Government Auditing Standards

include:
• Perform audit procedures required by generally accepted auditing standard.
• Communicate the nature of the audit and level of assurance provided to
outside individuals or organizations requiring the audit services.
• Consider the results of previous audits and follow-up on significant
findings and recommendations in prior-year audit reports.
• Provide additional audit documentation.
• Perform audit procedures to provide reasonable assurance of detecting
material violations of provisions of contracts and grants.
• Issue written reports on compliance with laws and regulations and on
internal control.
• In some cases, report fraudulent or illegal acts directly to a government
agency or another third party.

c. Under Government Auditing Standards the auditors must perform test of

compliance with laws and regulations that have a direct and material effect on the
financial statements--the same as under generally accepted auditing standards.

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