Chapter 26

Multiple-Choice Questions
1. easy b The IIA Code of Ethics is based on all but which of the following ethical principles? a. Integrity. b. Independence. c. Competency. d. Confidentiality. Statements on Internal Auditing Standards are issued by the: a. AICPA. b. SEC. c. Internal Auditing Standards Boards. d. Auditing Standards Boards. Internal auditors are responsible to: a. the board of directors. b. management. c. both a and b. d. neither a nor b. Which of the following is not a similarity between external and internal auditors? a. Both must be independent of the company. b. Both must be competent. c. Both use similar methodologies in performing their work. d. Both consider risk and materiality in their work. External auditors consider internal auditors effective if they are: a. independent of the operating units being evaluated. b. competent and well trained. c. have performed relevant audit tests of the internal controls and financial statements. d. all of the above. Auditing standards _______ external auditors to use the internal auditors for direct assistance on the audit. a. discourage b. prohibit c. encourage d. permit The primary source of authoritative literature for doing government audits is the: a. Purple Book. b. Yellow Book. c. Green Book. d. Red Book.

2. easy c

3. easy c

4. easy a

5. easy d

6. easy d

7. easy b

Arens/Elder/Beasley

8. easy c a

When a state or local government agency receives federal financial assistance, it is subject to the audit requirements of: a. b. c. d. Yellow Book Yes No Yes Yes Single Audit Act Yes No Yes No OMB Circular A-133 No Yes Yes No

9. easy c

Which of the following is not one of the broad categories of operational audits? a. Functional audits. b. Organizational audits. c. Single Audit Act audits. d. Special assignment audits. Which of the following groups could not be involved in an operational audit? a. CPA firms. b. Internal auditors. c. Government auditors. d. None of the above answers is correct; that is, all of the above could be involved. The IIAs professional practice framework (including its code of ethics and International Standards for the Professional Practice of Internal Auditing) is commonly referred to as the: a. Blue Book. b. Red Book. c. Green Book. d. Yellow Book. The professional organization which is responsible for providing guidance for internal auditors is the: a. APA. b. IIA. c. ABA. d. AIA. The financial auditing standards of the Yellow Book are ______ the 10 GAAS of the AICPA. a. the same as b. quite different from c. incompatible with d. consistent with Which of the following is not one of the three phases in an operational audit? a. Planning. b. Training and supervising employees. c. Evidence accumulation and evaluation. d. Reporting and follow-up. The correct title of the Yellow Book is: a. Government Auditing Standards. b. IIA Practice Standards. c. Statement of Responsibilities of Internal Auditing. d. Statement of Standards on Accounting and Review Services. The Yellow Book recognizes that, because of the sensitivity of government activities and their

10. easy d

11. easy b

12. easy b

13. easy d

14. easy b

15. medium a

16.

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medium b

public accountability, in government audits the thresholds of acceptable audit risk and tolerable misstatement compared to an audit of a commercial enterprise may be: a. equal. b. lower. c. higher. d. indeterminable.

17. medium b

The Single Audit Act requires that an audit be conducted for recipients who receive total federal funds in any fiscal year of: a. $1,000,000 or more. b. $500,000 or more. c. $300,000 or more. d. $100,000 or more. An audit conducted in accordance with the Yellow Book must include an audit report that states the audit was performed in accordance with: a. GAAS. b. GAGAS. c. GASA. d. SAS. An audit designed to evaluate the efficiency and effectiveness of an organization or some part of an organization would not be called a(n): a. performance audit. b. management audit. c. operational audit. d. compliance audit. Which of the following is not one of the major differences between financial and operational auditing? a. The financial audit is oriented to the past, but an operational audit concerns performance for the future. b. The financial audit report is distributed to many readers, but the operational audit report goes to a few managers. c. Financial audits deal with the information on the financial statements, but operational audits are concerned with the information in the ledgers. d. Financial audits are limited to matters that directly affect the financial statements, but operational audits cover any aspect of efficiency and effectiveness. Before an operational audit for effectiveness can be performed, there must be: a. a financial audit by an independent auditor. b. a financial audit by an internal auditor. c. a review performed by either an independent or an internal auditor. d. specific criteria developed to define effectiveness. Auditors involved in planning, performing, or reporting on audits under GAGAS must complete ____ hours of continuing professional education in each two-year period. a. 20 b. 40 c. 60 d. 80 Which of the following statements regarding types of operational audits is false? a. A functional audit has the advantage of permitting specialization by auditors.

18. medium b

19. medium d

20. medium c

21. medium d

22. medium d

23. medium

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b. c. d.

An advantage of functional auditing is its ability to evaluate interrelated functions. The emphasis in an organizational audit is on how efficiently and effectively functions interact. Special operational auditing assignments arise at the request of management.

24. medium b

The two most important qualities for an operational auditor are: a. personality and appearance. b. independence and competence. c. competence and technical training. d. academic background and sufficient experience. Which of the following is not a difference between operational auditing and financial auditing? a. Both must be CPAs. b. Operational audit reports are usually of a restricted distribution while financial audit reports are widely distributed. c. Operational audits often cover non-financial issues while financial audits do not. d. None of the above is a difference. A typical objective of an operational audit is to determine whether an entitys: a. internal control is adequately operating as designed. b. financial statements present fairly the results of operations. c. specific operating units are functioning efficiently and effectively. b. operational information is in accordance with generally accepted government auditing standards. Which of the following can affect the independence of operational auditors? a. b. c. d. Responsibilities Yes No No Yes Reporting Structure No No Yes Yes

25. medium a

26. medium c

27. medium d

28. challenging d

Which is not a purpose of an economy and efficiency audit? a. Whether the entity is acquiring, protecting, and using resources economically and efficiently. b. The causes of inefficiencies and uneconomical practices. c. Whether the entity has complied with laws and regulations concerning matters of economy and efficiency. d. Each of the above is a purpose. A(n) _________ audit emphasizes how efficiently and effectively functions interact. a. operational b. compliance c. financial d. organizational Which of the following is not a purpose of a program audit as performed by government auditors? a. Determination of the extent to which the desired results established by the legislature are being achieved. b. Determination of the causes of inefficiencies in sponsored programs. c. Determination of the effectiveness of organizations, programs and activities.

29. challenging d

30. challenging b

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d. 31. challenging c

Determination as to whether the entity has complied with laws and regulations applicable to the program.

What distinguishes internal control evaluation and testing for financial and operational auditing? a. Purpose of the work. b. Scope of the work. c. Both a and b. d. Neither a nor b. Of the many hours of continuing professional education required every two years, how many must be in subjects related to the government environment and government auditing for auditors involved in planning, performing and reporting on audits under GAGAS? a. 8 hours b. 16 hours c. 24 hours d. 32 hours To be effective, an internal audit department must report to: a. b. c. d. Operating departments Yes No Yes No The accounting department Yes No No Yes

32. challenging c

33. Challenging b

34. challenging d

External financial statement auditors must obtain evidence regarding what attributes of an internal audit department if the external auditors intend to rely on the internal auditors work? a. b. c. d. Independence from the Audit Committee Yes No Yes No Competence Yes No No Yes

Essay Questions
35. easy What organization establishes auditing standards for internal auditors and what are those standards commonly called? Answer: Auditing standards for internal auditors are established by the Internal Auditing Standards Board. They are commonly known as the Red Book. 36. medium What are several similarities between internal and external auditors? Answer: Both must be competent as auditors and remain objective in performing their work and reporting their results. Both follow a similar methodology in performing their audits, including planning and performing tests of controls and substantive tests. Both consider risk and materiality in deciding the extent of their tests and evaluating results. However, their decisions about materiality and risks may differ, because Arens/Elder/Beasley

external users may have different needs than management or the board. 37. medium External auditors typically consider internal auditors effective if they meet three criteria. What are these criteria? Answer: External auditors typically consider internal auditors effective if they are: Independent of the operating units being evaluated Competent and well-trained Have performed relevant audit tests of the internal controls and financial statements 38. medium How do the risk and materiality thresholds change in a government audit compared to a financial statement audit of a public company? Answer: The Yellow Book recognizes that in government audits the thresholds of acceptable audit risk and materiality may be lower than in an audit of a commercial enterprise. This is because of the sensitivity of government activities and their public accountability.

39. medium

Discuss each of the three phases of an operational audit. Answer:

Planning. In the planning phase, the auditor must determine the scope of the engagement, staff the engagement, obtain background information about the organizational unit, understand internal control, and decide on the appropriate evidence to accumulate. Evidence accumulation and evaluation. In operational auditing, it is common to use documentation, client inquiry, and observation extensively, while confirmation and reperformance are used less extensively for most operational audits than for financial audits. Reporting and follow-up. The audit report is tailored to address the scope of the audit, findings, and recommendations and is typically sent only to management. When recommendations are made to management, follow-up is done to determine whether the recommended changes were made, and if not, why. 40. medium The Institute of Internal Auditors has established Ethical Principles for its members. List each of the principles. Answer: The IIAs ethical principles are: Integrity. Objectivity. Confidentiality. Competency. 41. medium Define internal auditing. Answer: Arens/Elder/Beasley

According to the IIA: Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organizations 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. 42. medium Discuss three major differences between operational and financial auditing. Answer:

Purpose of the audit. Financial auditing emphasizes whether historical information was correctly recorded, whereas operational auditing emphasizes effectiveness and efficiency. Distribution of the reports. For financial auditing, the report typically goes to many users of financial statements, such as stockholders and bankers, whereas operational audit reports are intended primarily for management. Inclusion of nonfinancial areas in operational auditing. Operational audits cover any aspect of efficiency and effectiveness in an organization, whereas financial audits are limited to matters that directly affect the fairness of financial statement presentations.

43. medium

Discuss each of the three broad categories (types) of operational audits. Answer:

Functional. A functional audit deals with auditing one or more functions (e.g., purchasing) in an organization. Organizational. An organizational audit deals with an entire organizational unit, such as a department, branch, or subsidiary. Special assignments. Special assignments audits arise at the request of management when there is a need to investigate a particular area, such as investigating the possibility of fraud in a division, or determining the cause of an ineffective EDP system. 44. medium Operational auditing is the review of an organization for efficiency and effectiveness. Discuss what is meant by the terms effectiveness and efficiency. Answer: Effectiveness refers to the degree to which the organizations objectives and goals are accomplished. Efficiency refers to the degree to which costs are reduced without reducing effectiveness. 45. challenging Audit tests as required by the Single Audit Act must meet several specific objectives. One objective is to determine whether the amounts reported as expenditures were for allowable services. Identify three other specific objectives. Answer: Whether the records show that those who received services or benefits were eligible to receive them. Arens/Elder/Beasley

 Whether matching requirements, levels of effort, and earmarking limitations were met. Whether federal financial reports and claims for advances and reimbursements contain information that is supported by the books and records from which the basic financial statements have been prepared. Whether amounts claimed or used for matching were determined in accordance with OMB Circular A-87 and OMB Circular A-102. 46. challenging The auditing standards of the Yellow Book are consistent with the ten generally accepted auditing standards of the AICPA. There are, however, important additions/modifications in the Yellow Book. For example, the Yellow Book recognizes that materiality and risk are lower due to the nature of the government enterprise. Discuss the other additions/modifications. Answer:

Quality control. Auditors of government entities must have an appropriate system of internal quality control and participate in an external quality control review program. Compliance auditing. The audit should be designed to provide reasonable assurance of detecting material misstatements resulting from noncompliance with provisions of contracts or grant agreements that have a material and direct effect on the financial statements. Reporting. The report on financial statements must describe the scope of the auditors testing of compliance with laws and regulations and internal controls and present the results of those tests, or refer to a separate report containing that information.

47. challenging

In addition to an opinion on whether the financial statements are in accordance with GAAP, identify four other reports required by the OMB Circular A-133. Answer: The following reports are required: An opinion as to whether the schedule of federal awards is presented fairly in all material respects in relation to the financial statements as a whole. A report on internal control related to the financial statements and major programs. A report on compliance with laws, regulations, and the provisions of contracts or grant agreements, noncompliance with which could have a material effect on the financial statements. This report can be combined with the report on internal control. A schedule of findings and questioned costs.

Other Objective Answer Format Questions

48. medium Match seven of the terms (a-o) with the descriptions/definitions provided below (1-7): a. b. c. d. e. Arens/Elder/Beasley Compliance audit Economy and efficiency audit Effectiveness Efficiency Functional audit

f. g. h. i. j. k. l. m. n. o. f m

Government Auditing Standards Government audit Institute of Internal Auditors Operational auditing Organizational audit Program audit Single Audit Act Special assignment IIA Practice Standards Statements on Internal Auditing Standards 1. 2. The official title of the Yellow Book. A management request for an operational audit for a specific purpose, such as investigating the possibility of fraud in a division or making recommendations for reducing the cost of a manufactured product. A government audit to determine whether an entity is acquiring, protecting, and using its resources economically and efficiently and whether the entity has complied with laws and regulations concerning such matters. The degree to which the organizations objectives are accomplished. The review of an organization for efficiency and effectiveness. Federal legislation that provides for a single coordinated audit to satisfy the audit requirements of all federal funding agencies. Statements issued by the Internal Auditing Standards Board of the IIA to provide authoritative interpretation of the IIA Practice Standards.

3.

c i l o 49. easy b 50. easy b 51. easy b 52. easy a 53. easy a 54.

4. 5. 6. 7.

Independence is a fundamental ethical principle for internal auditors. a. True b. False Current professional auditing standards prohibit external auditors from using internal auditors for direct assistance on external audits. a. True b. False Current professional auditing standards require external auditors to use internal auditors for direct assistance on external audits. a. True b. False The objectives of internal auditors are considerably broader than the objectives of external auditors. a. True b. False For financial auditing, the audit report typically goes to many users of financial statements, whereas operational audit reports are intended primarily for management. a. True b. False Integrity is one of the IIAs ethical principles.

Arens/Elder/Beasley

easy a 55. easy b 56. easy b 57. easy a 58. easy b 59. easy a 60. easy a 61. easy b 62. easy a 63. easy a 64. easy b 65. easy a 66. medium a 67.

a. b.

True False

Operational audits are primarily geared toward compliance. a. True b. False Effectiveness refers to the degree to which costs are reduced without reducing efficiency. a. True b. False Efficiency refers to the degree to which costs are reduced without reducing effectiveness. a. True b. False Internal auditing standards are included in the Yellow Book. a. True b. False Government auditing standards are included in the Yellow Book. a. True b. False Effectiveness is concerned with whether defined goals are achieved, whereas efficiency is concerned with whether the goals are achieved with a minimum use of resources. a. True b. False Operational audits may be performed by internal auditors and government auditors, but not by external auditors. a. True b. False Benchmarking is one source of evaluation criteria for completing an operational audit. a. True b. False The two most important qualities for an internal auditor to possess are independence and competence. a. True b. False Program audits are primarily focused on inefficient uses of federal funds in sponsored programs. a. True b. False The formal name of the Yellow Book is Government Auditing Standards. a. True b. False Professional guidelines for performing internal audits for companies are not as well-defined as for external audits. a. True b. False To help them remain independent of the operations they audit, internal auditors should report

Arens/Elder/Beasley

medium b 68. medium a 69. medium a 70. medium a 71. medium b 72. medium b 73. challenging a

directly to the controller. a. True b. False An operational auditor may use engineered standards as evaluation criteria. a. True b. False The Internal Auditing Standards Board issues Statements on Internal Auditing Standards. a. True b. False Operational audits are often categorized as functional, organizational, or special assignments. a. True b. False Internal auditors should have the authority to require implementation of suggestions for improvement. a. True b. False The Red Book specifies all auditing standards issued by the U.S. General Accounting Office. a. True b. False One disadvantage of functional auditing is the failure to evaluate interrelated functions. a. True b. False

Arens/Elder/Beasley