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Chap007 - Chapter 07 Internal Control CHAPTER 7 Internal...

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Chapter 07 - Internal Control CHAPTER 7 Internal Control Review Questions 7-1 Internal control is a process, effected by the entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the categories of (1) effectiveness and efficiency of operations, (2) reliability of financial reporting, and (3) compliance with applicable laws and regulations. 7-2 The five basic components of an organization's internal control are (1) control environment; (2) risk assessment; (3) control activities; (4) (accounting) information and communication and (5) monitoring. 7-3 The control environment is composed of integrity and ethical values; commitment to competence; board of directors or audit committee; management's philosophy and operating style; organizational structure; human resource policies and practices; and assignment of authority and responsibility. 7-4 Separating recordkeeping from custody of the related assets provides an independently maintained record that may periodically be reconciled with assets on hand. This independent record holds the personnel of a custodial department accountable for assets entrusted to their care. If the custodial department maintained the accounting records, opportunity would exist for that department to conceal its errors or shortages by manipulating the records. 7-5 Key factors in protecting a business against losses through embezzlement include adequate internal control, fidelity bonds, and regular audits by independent public accountants. 7-6 The risk assessment component of internal control relates to the factors that affect the risk that the organization’s financial reporting objectives will not be achieved. An awareness of this component contributes to internal control because management's consideration of the possibility that financial statements may be misstated decreases the likelihood of misstatement. 7-7 The two types of monitoring are (1) ongoing monitoring activities, and (2) separate evaluations. Examples of ongoing monitoring activities include continuous monitoring of customer complaints and reviewing the reasonableness of management reports. Separate evaluations include periodic audits by the internal auditors. 7-1
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Chapter 07 - Internal Control 7-8 The four types of control activities are (1) performance review, (2) information processing, (3) physical controls and (4) segregation of duties. Performance reviews contribute to internal control by providing management with an overall indication of whether personnel at various levels are effectively pursuing the objectives of the organization. Information processing controls are performed to check the accuracy, completeness, and authorization of transactions. Physical controls contribute by assuring physical security over both records and other assets. Segregation of duties reduces the opportunities for any one person to both perpetuate and conceal errors or irregularities.
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