PMIDTERM TEST : INTERNAL CONTROL (90’)

Part 1 (4,0 marks): Multiple choice question

1) Reasonable assurance allows for
A) low likelihood that material misstatements will not be prevented or detected by internal controls.
B) no likelihood that material misstatements will not be prevented or detected by internal control.
C) moderate likelihood that material misstatements will not be prevented or detected by internal control.
D) high likelihood that material misstatements will not be prevented or detected by internal control.
2) Authorizations can be either general or specific. Which of the following is not an example of a general authorization?
A) automatic reorder points for raw materials inventory
B) a sales manager's authorization for a sales return
C) credit limits for various classes of customers
D) a sales price list for merchandise
3) Before goods are shipped on account, a properly authorized person must
A) prepare the sales invoice.
B) approve the journal entry.
C) approve the customer's credit.
D) verify that the unit price is accurate.
4)Which of the following is not a key control for sales and cash receipts?
A) active board of directors
B) adequate separation of duties
C) internal verification procedures
D) adequate documents and records
5) An act of two or more employees to steal assets and cover their theft by misstating the accounting records would be referred to as
A) collusion.
B) a material weakness.
C) a control deficiency.
D) a significant deficiency.
6) Internal controls can never be regarded as completely effective. Even if company personnel could design an ideal system, its effectiveness
depends on the
A) adequacy of the computer system.
B) proper implementation by management.
C) ability of the internal audit staff to maintain it.
D) competency and dependability of the people using it.
7) A ________ is a document for communicating the description, quantity, and related information for goods ordered by a customer.
A) sales order
B) customer order
C) vendor invoice
D) sales invoice
8) Which of the following components of the control environment define the existing lines of responsibility and authority?
A) organizational structure
B) management philosophy and operating style
C) human resource policies and practices
D) management integrity and ethical values
9) A written purchase order is a contractual document that is
A) an offer to buy goods or services.
B) not enforceable if it is not in writing.
C) prepared by the receiving department.
D) an acceptance of a vendor's catalog offer to sell.
10) Which of the following statements is most correct with respect to separation of duties?
A) A person who has temporary or permanent custody of an asset should account for that asset.
B) Employees who authorize transactions should not have custody of the related assets.
C) Employees who open cash receipts should record the amounts in the subsidiary ledgers.
D) Employees who authorize transactions should have recording responsibility for these transactions.
11) Which of the following is not an accurate statement regarding the acquisition and payment cycle?
A) The personnel in the receiving department should be independent of the storeroom personnel.
B) Goods received should be physically controlled from the time of their receipt until their use or disposal.
C) Accounting records should transfer responsibility for the goods each time they are moved.
D) The accounting department should be responsible for receiving goods and preparing the receiving report.
12) Prenumbered documents will only be useful for control purposes if
A) a different numerical sequence is used for each company.
B) the sequence is accounted for periodically.
C) employees are allowed to use documents out of numerical sequence.
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D) the same numerical sequence is used each accounting period.
13) What critical event must take place before goods can be shipped in order to assure payment can be reasonably expected?
A) determination of correct delivery address
B) credit approval
C) matching of shipping document with sales invoice
D) receipt of sales order from the customer
14) Which of the following best describes the purpose of control activities?
A) the actions, policies and procedures that reflect the overall attitudes of management
B) the identification and analysis of risks relevant to the preparation of financial statements
C) the policies and procedures that help ensure that necessary actions are taken to address risks to the achievement of the entity's objectives
D) activities that deal with the ongoing assessment of the quality of internal control by management
15) Which of the following is not an underlying principle related to risk assessment?
A) The organization should have clear objectives in order to be able to identify and assess the risks relating to the objectives.
B) The auditors should determine how the company's risks should be managed.
C) The organization should consider the potential for fraudulent behavior.
D) The organization should monitor changes that could impact internal controls.
16) Which of the following is not one of the subcomponents of the control environment?
A) management's philosophy and operating style
B) organizational structure
C) adequate separation of duties
D) commitment to competence
17) After a purchase requisition is approved, a ________ must be initiated to purchase the goods or services.
A) purchase order
B) vendor order
C) call order
D) vendor invoice
18) A good way to ensure a credit review is:
A)Not allowing an invoice to be issued without a credit stamp.
B)Not allowing shipment without a completed pick list attached to the sales order
C)Not allowing shipments without a credit stamp on the pick list.
D)Not allowing shipments without a credit stamp on the sales order.
19) Of the following statements about internal controls, which one is least likely to be correct?
A) No one person should be responsible for the custodial responsibility and the recording responsibility for an asset.
B) Transactions must be properly authorized before such transactions are processed.
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.
20) At what point in the acquisition and payment cycle do most companies first recognize the acquisition and related liability on their
records?
A) when the purchase requisition is received by the accounting department
B) when the purchase order is prepared
C) when the company receives the invoice from the vendor
D) when the company receives the goods or services from the vendor
Part 2 (2,0 marks): The following statements are true/false and explain
1. Proper accounting requires an adjustment to the allowance for uncollectible accounts after a customer with an unpaid balance to the
company has declared bankruptcy or after the account has been turned over to a collection agency.
2. Adequate documents and records are a subcomponent of the control environment.
3. A vendor invoice is normally prepared at the time tangible goods are received and indicates the description of goods, the quantity
received, the date received, and other relevant data.
A vendor's invoice is sent with or at the same time as the order and states the amount of goods shipped, the price, and other details
4. An example of a specific authorization is management setting a policy authorizing the ordering of inventory when less than a one-
week supply is on hand.
5. After a check prepared for payment to a vendor includes the signature of an authorized person, the check is now a liability.

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Part 3 (2,0 marks):
Discuss the key internal controls that should be presented in the acquisitions and payment cycle
1, placing orders for goods and services
Authorisation:
- Proper authorization for purchase requisitions ensures that the goods and services acquired are for authorized company purposes,
and it avoids the over-buying/under-buying or buying unnecessary items. Most companies require different levels of authorization
for different types of acquisitions or dollar amounts.
- Prices on purchase orders should be verified against vendor quotes.
Segregation of duties: It needs to have a purchasing department which is independent of the request department to ensure an adequate
quantity of goods and services at a minimum price. The person in charge of purchasing need to be separate from the person approving the
purchase.
Adequate documents and records: Purchase orders should be prenumbered to permit easier accounting for all outstanding purchase orders and
to facilitate control over missing documents and records and should be designed to minimize the likelihood of unintentional omissions on the
form when goods are ordered.
It is necessary to involve the accounting department, purchasing department, user department and goods quality control department when
selecting the supplier
2, receiving goods and services
Adequate documents and records:
- most companies require that the receiving department prepares a receiving report when goods are received, one copy of which is
sent to the storeroom and another to the accounts payable department.
- the accounting records should transfer responsibility for the goods as they are transferred from receiving to storage and from storage
to manufacturing.
Custody of inventory: To prevent theft, it is important that the goods be physically controlled from the time of their receipt until their
disposal.
- The process of receiving goods must be witnessed by the receiving department and storekeeper
- Goods received should be recorded promptly and accurately in the inventory system.
- Periodic inventory reconciliation with accounting book
Segregation of duties: The personnel in the receiving department should be independent of the storeroom personnel and the accounting
department.
3, Payments to supplier
Reconciliation:
- Conduct three-way match: Payable staff verify the propriety of acquisitions by comparing the details on the purchase order,
receiving report, and vendor’s invoice to determine that the descriptions, prices, quantities, terms, and freight on the vendor’s
invoice are correct.
- Reconciliation between supplier statement and detailed tracking data
Segregation of duties:
- personnel who record acquisitions should not have access to cash, marketable securities, and other assets.
- Account payable department should be organized independently from the purchasing, receiving, and warehousing department
- Personnel who prepare checks should be independent of the one who signs and approves the checks
Approval and authorisation: all payments must be approved by an authorized person of the accounting department
Adequate documents and records:
- Payment can only made when there are full original documents (receiving report, invoice, purchase order) attached to the payment
slip or check
- Open a detailed supplier tracking book and check the information before recording accounts payable

Part 4 (2,0 marks):

The following are misstatements that have occurred in Hoa Hong Store, a retail and wholesale grocery company:
1. An accounts payable clerk processed payments to himself by adding a fictitious vendor address to the approved vendor master file.
2. A salesperson sold an entire carload of lamb at a price below cost because she did not know the cost of lamb had increased in the
past week

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Requirement:
1. For each misstatement, identify one or more types of controls that were absent.
2. For each misstatement, suggest a control that may have prevented or detected the misstatement
Absent controls:

Vendor Approval Process: There may not be a rigorous process for verifying and approving vendors in the master file.

Adequate separation of duties: The same person handling accounts payable should not also be responsible for vendor setup or payments.

Control to correct:

Enhanced Vendor Verification: Implement a system where new vendor additions require approval from a manager or a secondary person
who verifies the legitimacy of the vendor.

Restrict the AP clerk from being able to make changes to the approved vendor master file. The purchasing department should be the only one
who can make changes to the vendor master file.

Absent controls:

Price Update Procedures: There might be a lack of systematic communication regarding pricing changes or a failure to update price lists
regularly.

Proper authorization of transactions and activities: Lack of a person who authorizes the order based on the price list of the company

Control to correct:

Regular Price Review Processes: Implement a routine for regularly updating sales staff on pricing changes so that they can update the new
prices timely
There should be a person approving the sale prices, including shipping fees, discounts, rebates and payment terms