Chapter 3: INTERNAL CONTROL I. RIGH/ WRONG - EXPLANATION 1. .While conducting an audit, auditors always pay attention to the control activities that aims to prevent or detect mistatements in financial statements. 2. Establishing and maintaining internal control are the responsibility of shareholders. 3. .Internal control is generally not effective in preventing fraud from senior executives of the company. 4. Internal audit function is an important component of internal control. II. CASES 1. At a movie theater, a cashier has undertaken the task of collecting the money and selling the ticket by using the ticket machine for continuous order. When entering the theater, viewers present the ticket for a doorman staff far from ticket selling room about 30 meters. The doorman staff tear ticket in half, the other half is put in a locked box. a. Indicate which control procedures are implemented in the money collection phase? b. Suppose the cashier and the doorman staff collusing to embezzling money, what behavior they could do? c. With the same supposition above, suggest control activities can detect that embezzlement. 2. You are responsible for the audit of a Major Steel Fabrication Company. Most of the company’s customers are development or construction companies involved in the building of shopping centres, office complexes, warehouses and other large scale building constructions. During the planning stage, you observe that the building industry is in period of severe decline. You note that this increase the risk associated with the misstatement of several material account balances, including the risk of not identifying and appropriately accounting for potential bad debts. The company’s credit manager, appointed near the beginning of the financial year, regularly reviews the aged list of trade receivables. You have determined, provided this procedure is effective, that it is the only internal control specifically addressing this significant risk upon which you could place reliance. Required: a) List, in point form, all the tests of controls you consider nessesary to determine the likely effectiveness of this control. b) Recommend additional practical and effective internal control procedures the company could introduce to mitigate this risk. 3. The following questions deal with deficiencies in internal control. Choose the best response. a. Which of the following is an example of an operation deficiency in internal control? (1) The company does not have a code of conduct for employees to consider. (2) The cashier has online ability to post write-offs to accounts receivable accounts. (3) Clerks who conduct monthly reconciliation of intercompany accounts do not understand the nature of misstatements that could occur in those accounts. (4) Management does not have a process to identify and assess risks on a recurring basis. b. A material weakness in internal control represents a control deficiency that (1) more than remotely adversely affects a company’s ability to initiate, authorize, record, process, or report external financial statements reliably. (2) results in a reasonable possibility that internal control will not prevent or detect material financial statement misstatements. (3) exists because a necessary control is missing or not properly designed. (4) reduces the efficiency and effectiveness of the entity’s operations. c. An auditor of a large public company identifies a material weakness in internal control. The auditor (1) will be unable to issue an unqualified opinion on the financial statements. (2) must issue a qualified or disclaimer of opinion on internal control over financial reporting. (3) may still be able to issue an unqualified opinion on internal control over financial reporting.