Certified Internal Auditor (CIA) Exam — Questions and Answers

Question 1: A firm is financed 40% by debt with a 6% pre-tax cost and 60% by equity with a 10% cost; the tax rate is 25%. What is its WACC?

8.4%
7.8% (Correct answer)
6.6%
8.0%

Correct answer: 7.8%

WACC = 0.4 x 6% x (1 - 0.25) + 0.6 x 10% = 1.8% + 6.0% = 7.8%.

Question 2: What should an accountant do if asked to perform a task outside their competence?

Google the solution
Assign it to a junior staff member
Consult or decline if outside professional ability (Correct answer)
Attempt it anyway

Correct answer: Consult or decline if outside professional ability

If an accountant is asked to perform a task outside their professional competence, they have an ethical obligation to either decline the task or seek appropriate consultation and training to gain the necessary expertise. Attempting a task without the required skills could lead to errors, compromise professional standards, and potentially harm the client or organization. Professional integrity demands acknowledging limitations.

Question 3: Which financial statement manipulation technique involves recording revenue before it is earned?

Channel stuffing and premature revenue recognition (Correct answer)
Capitalizing operating expenses
Overstating the allowance for doubtful accounts
Understating accounts payable

Correct answer: Channel stuffing and premature revenue recognition

Channel stuffing involves pressuring distributors to accept excess inventory to record revenue prematurely before it is truly earned.

Question 4: An internal auditor finds that the same employee can create a new vendor in the master file and approve payments to that vendor. Which control weakness does this represent?

Inadequate physical safeguards
Weak IT general controls over change management
Insufficient independent reconciliation
Lack of segregation of duties (Correct answer)

Correct answer: Lack of segregation of duties

Combining vendor setup with payment approval lets one person create a fictitious vendor and pay it, which is a segregation of duties failure.

Question 5: Which of the following is an IT general control rather than an application control?

A reasonableness check on hours worked
An edit check that rejects invalid customer numbers
A batch total comparison for payroll input
Restricting programmer access to production systems (Correct answer)

Correct answer: Restricting programmer access to production systems

Access controls over production environments apply across all applications and are classified as IT general controls.

Question 6: How should risk be assessed in investment analysis?

Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically (Correct answer)
Use a one-size-fits-all risk profile
Ignore risk for aggressive growth
Risk assessment is only needed for retirees

Correct answer: Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically

Comprehensive risk assessment considers tolerance, capacity, time horizon, and objectives to create appropriate strategies.

Question 7: What is required for a married couple to elect gift splitting?

The spouses must file a joint income tax return
The gift must come from community property
The donee must be a child of both spouses
Both spouses must consent, generally shown on Form 709 (Correct answer)

Correct answer: Both spouses must consent, generally shown on Form 709

Gift splitting treats a gift as made half by each spouse and requires both spouses' consent on a gift tax return.

Question 8: When auditing an ERP system, which procedure would best test the completeness of recorded transactions?

Reviewing system configuration settings
Tracing from source documents to the system (Correct answer)
Interviewing IT personnel about data flows
Vouching from system records back to source documents

Correct answer: Tracing from source documents to the system

Tracing from source documents to the system tests completeness by verifying that transactions originating outside the system were actually captured and recorded.

Question 9: Inventory turnover is cost of goods sold divided by average inventory. COGS is $600,000, beginning inventory is $100,000, and ending inventory is $140,000. What is inventory turnover?

6.0 times
4.0 times
4.3 times
5.0 times (Correct answer)

Correct answer: 5.0 times

Average inventory is $120,000, and $600,000 ÷ $120,000 = 5.0.

Question 10: Which committee of the board of directors bears primary responsibility for overseeing the internal audit function?

Audit Committee (Correct answer)
Nominating Committee
Compensation Committee
Risk Committee

Correct answer: Audit Committee

The audit committee has primary board-level responsibility for overseeing financial reporting, internal controls, and the internal audit function.

Question 11: Why do trustees of an ILIT typically send beneficiaries 'Crummey' notices?

To give beneficiaries a temporary withdrawal right so gifts to the trust qualify as present interests (Correct answer)
To let beneficiaries elect to receive income instead of principal
To satisfy probate court notice requirements
To notify beneficiaries that the insured has died

Correct answer: To give beneficiaries a temporary withdrawal right so gifts to the trust qualify as present interests

A temporary withdrawal right turns a future-interest gift to the trust into a present interest that qualifies for the annual gift tax exclusion.

Question 12: What is the purpose of a business continuity plan (BCP) from an IT audit perspective?

Ensure daily data backups are performed
Test employee cybersecurity awareness
Manage software licensing compliance
Enable the organization to continue critical operations after a disruptive event (Correct answer)

Correct answer: Enable the organization to continue critical operations after a disruptive event

A BCP provides documented procedures to sustain essential business functions during and after major disruptions such as natural disasters or cyberattacks.

Question 13: What fiduciary duty applies to financial planning?

Follow the firm's sales targets above all
Recommend the most expensive products
Maximize the advisor's commission
Act in the client's best interest with loyalty, care, and full disclosure (Correct answer)

Correct answer: Act in the client's best interest with loyalty, care, and full disclosure

Fiduciary duty requires acting in the client's best interest with loyalty, care, and full disclosure of all material facts.

Question 14: What is 'lapping' in the context of accounts receivable fraud?

Recording fictitious sales to inflate revenue
Writing off customer balances and pocketing cash
Issuing duplicate payments to vendors
Using one customer's payment to cover a stolen prior payment (Correct answer)

Correct answer: Using one customer's payment to cover a stolen prior payment

Lapping involves stealing a customer's payment and then covering it with a subsequent customer's payment, creating a rolling shortage.

Question 15: Which type of fraud involves an employee creating fictitious vendors and submitting false invoices for payment?

Ghost vendor scheme (Correct answer)
Skimming
Lapping
Kiting

Correct answer: Ghost vendor scheme

A ghost vendor scheme involves setting up fictitious vendors in the accounts payable system to divert company funds to the fraudster.

Question 16: Which cost behavior classification changes in total with production volume?

Mixed costs
Fixed costs
Sunk costs
Variable costs (Correct answer)

Correct answer: Variable costs

Variable costs are expenses that change in total directly and proportionally with the level of production volume or activity. As a company produces more units, the total variable cost increases, while the variable cost per unit remains constant. This direct relationship makes them distinct from fixed costs, which remain constant in total regardless of production changes.

Question 17: A nonconformance with the Standards affects the overall scope or operation of the internal audit function. The CAE should:

Disclose it only to the external auditor
Correct it silently in the next year
Disclose the nonconformance and its impact to senior management and the board (Correct answer)
Remove the conformance statement without explanation

Correct answer: Disclose the nonconformance and its impact to senior management and the board

Nonconformance that impacts the function's overall scope or operation must be disclosed to senior management and the board.

Question 18: During audit planning, what must the auditor assess?

Employee Turnover Rates
Market Share of the Entity
Risk of Material Misstatement (Correct answer)
Office Supplies Inventory

Correct answer: Risk of Material Misstatement

During audit planning, the auditor must assess the risk of material misstatement, which is the risk that the financial statements contain a significant error before the audit begins. This assessment involves understanding the entity's business, its internal controls, and its environment. A thorough risk assessment helps the auditor design appropriate audit procedures to detect and respond to these risks effectively, ensuring a reliable audit.

Question 19: When assessing IT controls for SOX compliance, an internal auditor must evaluate controls over:

Customer-facing e-commerce systems exclusively
Physical security of all company facilities
Only the general ledger application
All IT systems that have a material impact on financial reporting (Correct answer)

Correct answer: All IT systems that have a material impact on financial reporting

SOX requires evaluation of IT controls over all systems that materially affect the accuracy of financial reporting.

Question 20: Which control activity is specifically designed to prevent a single employee from both authorizing and recording transactions?

Independent verification
Documentation procedures
Physical safeguards
Segregation of duties (Correct answer)

Correct answer: Segregation of duties

Segregation of duties ensures that authorization, recording, and custody functions are divided among different employees to reduce fraud risk.

Question 21: What does a spendthrift provision in a trust generally do?

It stops a beneficiary from assigning their interest and stops creditors from reaching it before distribution (Correct answer)
It requires the trustee to distribute all income at least annually
It lets the grantor revoke the trust if a beneficiary misuses funds
It caps the trustee's annual compensation

Correct answer: It stops a beneficiary from assigning their interest and stops creditors from reaching it before distribution

Spendthrift clauses stop voluntary and involuntary transfers of a beneficiary's interest until the trustee actually distributes it.

Question 22: A company uses MACRS for tax purposes and straight-line depreciation for its books. In the early years, what does this create?

A permanent difference
A deferred tax liability (Correct answer)
A deferred tax asset
A valuation allowance

Correct answer: A deferred tax liability

Faster tax depreciation lowers current taxable income compared with book income, so the company records a deferred tax liability for the future taxable amount.

Question 23: A $1,000 face value bond with a 6% annual coupon is trading at $950. What is its current yield?

6.32% (Correct answer)
6.00%
6.67%
5.70%

Correct answer: 6.32%

Current yield = annual coupon / price = $60 / $950 = 6.32%.

Question 24: An internal auditor's annual bonus depends on the profitability of the business units she audits. What is the main concern?

It breaches confidentiality
It reduces competency
It improves motivation and is encouraged
It may create a conflict of interest that threatens objectivity (Correct answer)

Correct answer: It may create a conflict of interest that threatens objectivity

Pay tied to the results of audited units can bias judgment and threaten objectivity.

Question 25: A seller of real property receives payments over five years. Under the installment method, when is gain recognized?

Entirely when the final payment is received
Only after the seller recovers all of its basis
Proportionately as payments are received (Correct answer)
Entirely in the year of sale

Correct answer: Proportionately as payments are received

Section 453 recognizes gain on each payment using the gross profit percentage, which spreads the tax over the collection period.

Question 26: Which of the following best describes 'risk velocity'?

How often a risk occurs
The speed at which controls are tested
How quickly a risk impacts the organization once it materializes (Correct answer)
The monetary size of a loss

Correct answer: How quickly a risk impacts the organization once it materializes

Velocity measures the time between a risk event occurring and its effects being felt.

Question 27: What does the term 'tone at the top' refer to in fraud prevention?

Volume of internal audit activity
Strength of IT security protocols
Frequency of external audits
Management's commitment to ethical behavior and strong controls (Correct answer)

Correct answer: Management's commitment to ethical behavior and strong controls

Tone at the top refers to senior management's demonstrated commitment to ethics and compliance, which sets the ethical culture for the entire organization.

Question 28: A firm with idle capacity receives a one-time special order for 1,000 units at $18 each. Variable cost is $15 per unit and allocated fixed overhead is $5 per unit. Accepting the order will change operating income by:

$18,000 increase
$2,000 decrease
$3,000 increase (Correct answer)
$5,000 decrease

Correct answer: $3,000 increase

With idle capacity, fixed costs are unaffected, so income rises by 1,000 x ($18 - $15) = $3,000.

Question 29: Actual variable overhead was $22,000 for 4,000 actual direct labor hours; the standard variable overhead rate is $5 per hour. What is the variable overhead spending variance?

$2,000 favorable
$2,000 unfavorable (Correct answer)
$5,000 unfavorable
$0

Correct answer: $2,000 unfavorable

Spending variance = $22,000 - (4,000 x $5) = $2,000 unfavorable.

Question 30: SOX Section 301 requires that the audit committee of a listed company be responsible for which of the following?

Establishing procedures for handling complaints about accounting and auditing matters (Correct answer)
Preparing the company's financial statements
Performing the external audit
Approving all employee salaries

Correct answer: Establishing procedures for handling complaints about accounting and auditing matters

Section 301 requires audit committees to establish procedures for receiving and handling complaints, including anonymous employee submissions.

Question 31: Which fraud detection method relies on the statistical principle that in naturally occurring datasets, leading digits follow a predictable distribution?

Benford's Law (Correct answer)
Parallel simulation
Stratified sampling
Regression testing

Correct answer: Benford's Law

Benford's Law states that the digit 1 appears as the leading digit roughly 30% of the time in natural datasets, and deviations may indicate manipulation.

Question 32: What is the primary purpose of an anonymous fraud hotline in an organization?

Replace the internal audit function
Encourage employees to report suspected fraud without fear of retaliation (Correct answer)
Satisfy external auditor requirements only
Eliminate the need for segregation of duties

Correct answer: Encourage employees to report suspected fraud without fear of retaliation

An anonymous hotline provides a safe channel for employees to report suspected wrongdoing, significantly increasing the likelihood that fraud is detected through tips.

Question 33: An internal auditor discovers that management has acted illegally, and the auditor's organization has a legal obligation to report it to regulators. Under the principle of integrity, the auditor should:

Resign immediately without informing anyone
Keep the matter confidential because all engagement information is confidential
Make disclosures expected by law and the profession through appropriate channels (Correct answer)
Disclose it only to the press to ensure public awareness

Correct answer: Make disclosures expected by law and the profession through appropriate channels

Integrity requires internal auditors to observe the law and make disclosures required by law and the profession.

Question 34: A company's current assets are $400,000, including $100,000 of inventory, and current liabilities are $200,000. What is the quick (acid-test) ratio?

0.5
2.0
1.5 (Correct answer)
1.0

Correct answer: 1.5

($400,000 − $100,000) ÷ $200,000 = 1.5.

Question 35: How should risk be assessed in risk assessment?

Use a one-size-fits-all risk profile
Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically (Correct answer)
Risk assessment is only needed for retirees
Ignore risk for aggressive growth

Correct answer: Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically

Comprehensive risk assessment considers tolerance, capacity, time horizon, and objectives to create appropriate strategies.

Question 36: Which budgeting approach requires managers to justify every expenditure from a base of zero each period?

Zero-based budgeting (Correct answer)
Activity-based budgeting
Flexible budgeting
Incremental budgeting

Correct answer: Zero-based budgeting

Zero-based budgeting ignores prior-year amounts and requires every cost to be justified anew.

Question 37: Under US GAAP, how are debt securities classified as held-to-maturity measured on the balance sheet?

Fair value with changes in other comprehensive income
Fair value with changes in net income
Amortized cost (Correct answer)
Lower of cost or market

Correct answer: Amortized cost

Held-to-maturity debt securities are carried at amortized cost because fair value changes will not be realized.

Question 38: After the Tax Cuts and Jobs Act, which property qualifies for a Section 1031 like-kind exchange?

Any property held for investment, including stock
Real and personal property used in a business
Real property held for business or investment only (Correct answer)
Inventory and real property

Correct answer: Real property held for business or investment only

Since 2018, Section 1031 applies only to real property held for productive use in a business or for investment.

Question 39: Why should internal audit's risk assessment be updated periodically rather than only annually?

Because standards forbid annual plans
To increase audit hours billed
To replace management's risk assessment
Because risks and business conditions change during the year (Correct answer)

Correct answer: Because risks and business conditions change during the year

The audit plan must stay responsive to emerging risks and changes in the organization.

Question 40: Which organization publishes the Code of Ethics for internal auditors?

AICPA
FASB
SEC
IIA (Correct answer)

Correct answer: IIA

The Institute of Internal Auditors (IIA) is the global professional association for internal auditors. It is responsible for publishing the International Standards for the Professional Practice of Internal Auditing (Standards) and a comprehensive Code of Ethics that guides the conduct of internal auditors worldwide. These documents establish the principles and rules of conduct for the profession.

Question 41: Which of the following best describes 'tone at the top' in the context of fraud prevention?

The strictness of the internal audit department's testing
The volume of anti-fraud training provided to employees
Requiring executive sign-off on all journal entries
The ethical culture and values modeled by senior leadership and the board (Correct answer)

Correct answer: The ethical culture and values modeled by senior leadership and the board

Tone at the top refers to the ethical environment established by leadership; a strong ethical culture is the most powerful deterrent to fraud.

Question 42: The CAE is also given responsibility for overseeing the compliance function. What is the appropriate safeguard?

Establish safeguards, such as having compliance assurance done by an independent party, and disclose to the board (Correct answer)
Stop all compliance oversight immediately
Let the compliance manager audit internal audit
No safeguard is needed because compliance is low risk

Correct answer: Establish safeguards, such as having compliance assurance done by an independent party, and disclose to the board

When the CAE has roles beyond internal audit, safeguards must limit impairments, and assurance on those areas should be overseen by an independent party.

Question 43: Regarding fraud, internal auditors are expected to:

Have enough knowledge to evaluate fraud risk and how the organization manages it (Correct answer)
Avoid any work related to fraud
Guarantee that all material fraud will be detected
Have the same expertise as a person whose main job is detecting and investigating fraud

Correct answer: Have enough knowledge to evaluate fraud risk and how the organization manages it

Internal auditors need sufficient fraud knowledge to evaluate fraud risk but are not expected to be fraud investigation experts.

Question 44: Data analytics can help detect payroll fraud by flagging which of the following anomalies?

Employees who take more than two weeks of vacation per year
Employees with direct deposit to the same bank account as a payroll administrator (Correct answer)
Salary increases approved during the fiscal year
Departments with more than ten employees

Correct answer: Employees with direct deposit to the same bank account as a payroll administrator

Shared bank account numbers between employees and payroll administrators is a major red flag indicating ghost employee or paycheck diversion fraud.

Question 45: What is the professional obligation if an accountant identifies fraud?

Post anonymously online
Confront the accused directly
Ignore minor discrepancies
Report it through the appropriate internal channels (Correct answer)

Correct answer: Report it through the appropriate internal channels

Upon identifying fraud, an accountant has a professional and ethical obligation to report it through the appropriate internal channels within the organization. This typically involves informing senior management, the audit committee, or a designated compliance officer. Reporting internally ensures the issue is addressed properly and helps maintain the integrity of financial reporting and internal controls.

Question 46: Why is independence important in internal auditing?

To increase office efficiency
To reduce documentation
To improve profits
To ensure unbiased evaluations (Correct answer)

Correct answer: To ensure unbiased evaluations

Independence is paramount in internal auditing because it ensures that auditors can perform their work without undue influence or interference from management or other stakeholders. This objectivity is critical for providing unbiased evaluations, findings, and recommendations. Maintaining independence enhances the credibility and reliability of the audit function, thereby adding greater value to the organization.

Question 47: Which internal control is most effective at preventing check tampering fraud?

Independent bank reconciliation performed by someone not involved in check preparation (Correct answer)
Storing blank checks in an unlocked drawer for efficiency
Monthly bank reconciliations performed by the check preparer
Requiring dual signatures on all checks

Correct answer: Independent bank reconciliation performed by someone not involved in check preparation

An independent bank reconciliation performed by someone separate from check preparation detects unauthorized disbursements.

Question 48: An internal auditor finds that a risk's inherent rating is high but its residual rating is low. What does this most likely indicate?

Controls in place are effectively mitigating the risk (Correct answer)
The risk appetite has been set too high
Management has accepted the risk without action
The likelihood estimate was calculated incorrectly

Correct answer: Controls in place are effectively mitigating the risk

Residual risk is the risk remaining after controls, so a large drop from inherent risk indicates effective controls.

Question 49: Which of the following best describes a 'shell company' scheme used in financial fraud?

Creating a fictitious entity to funnel unauthorized payments (Correct answer)
Inflating inventory counts
Altering check amounts after approval
Forging bank confirmations

Correct answer: Creating a fictitious entity to funnel unauthorized payments

A shell company scheme involves establishing a fictitious or controlled entity to receive fraudulent payments from the victim organization.

Question 50: Which financial statement reports a company's assets, liabilities, and equity at a specific point in time?

Statement of cash flows
Balance sheet (Correct answer)
Statement of retained earnings
Income statement

Correct answer: Balance sheet

The balance sheet (statement of financial position) is a snapshot as of a single date.

Question 51: Internal audit may state that its engagements are conducted in conformance with the IIA Standards only when:

The external auditor has issued an unqualified opinion
The CAE personally believes the function conforms
Management approves the wording
Results of the quality assurance and improvement program support that statement (Correct answer)

Correct answer: Results of the quality assurance and improvement program support that statement

Conformance claims must be supported by the results of the quality assurance and improvement program, including external assessments.

Question 52: Who is primarily responsible for implementing corrective actions on audit observations?

The audit committee
Management of the audited area (Correct answer)
The external auditor
The internal auditor

Correct answer: Management of the audited area

Management owns the risks and controls and is responsible for remediation, while internal audit monitors follow-up.

Question 53: An internal auditor previously provided consulting advice on designing controls for a new payroll system. Later she is assigned an assurance engagement on the same system. Which is true?

It is acceptable only if the external auditor approves
It may be acceptable if objectivity is not impaired and the impairment risk is managed and disclosed if needed (Correct answer)
Consulting work automatically creates a conflict of interest
Assurance on a previously consulted area is always prohibited

Correct answer: It may be acceptable if objectivity is not impaired and the impairment risk is managed and disclosed if needed

Assurance on areas where consulting was previously provided is allowed when objectivity is not impaired and safeguards are applied.

Question 54: What is the purpose of an IT steering committee in IT governance?

To manage help desk ticket escalations
To write code for new software projects
To perform daily system monitoring tasks
To provide executive oversight and strategic alignment of IT investments (Correct answer)

Correct answer: To provide executive oversight and strategic alignment of IT investments

An IT steering committee aligns IT initiatives with organizational strategy and provides executive-level oversight of IT spending and priorities.

Question 55: Which approach best helps internal audit prioritize compliance audit coverage across many regulations?

Auditing only regulations with the newest effective dates
Auditing regulations in alphabetical order
A compliance risk assessment based on likelihood and impact of noncompliance (Correct answer)
Rotating through all regulations equally each year

Correct answer: A compliance risk assessment based on likelihood and impact of noncompliance

Risk-based planning focuses resources on regulations with the greatest likelihood and consequences of noncompliance.

Question 56: Annual demand is 4,500 units, ordering cost is $100 per order, and holding cost is $10 per unit per year. What is the economic order quantity?

450 units
300 units (Correct answer)
150 units
212 units

Correct answer: 300 units

EOQ = √(2 x 4,500 x 100 / 10) = √90,000 = 300 units.

Question 57: Which of the following is the most common type of occupational fraud according to the ACFE Report to the Nations?

Financial statement fraud
Bribery and kickbacks
Asset misappropriation (Correct answer)
Corruption schemes

Correct answer: Asset misappropriation

Asset misappropriation is by far the most common category of occupational fraud, accounting for the majority of reported cases.

Question 58: Which situation is the clearest example of an impairment to individual objectivity?

An auditor reviewing a department in which their spouse holds a key control role (Correct answer)
An auditor who has audited the area once before
An auditor who completed CPE in the audited area
An auditor who has strong analytical skills

Correct answer: An auditor reviewing a department in which their spouse holds a key control role

Close personal relationships with people responsible for the audited activity create a conflict of interest that impairs objectivity.

Question 59: A decedent leaves assets to a surviving spouse who is not a U.S. citizen. How can the estate still claim a marital deduction?

By leaving the property to a qualified domestic trust (QDOT) (Correct answer)
No marital deduction is ever available for non-citizen spouses
By filing Form 709 for the surviving spouse
By using the charitable deduction instead

Correct answer: By leaving the property to a qualified domestic trust (QDOT)

The unlimited marital deduction generally requires a U.S. citizen spouse unless the property passes to a QDOT.

Question 60: Budgeted sales are 10,000 units, desired ending finished goods are 2,000 units, and beginning finished goods are 1,500 units. How many units must be produced?

11,500
10,500 (Correct answer)
9,500
12,000

Correct answer: 10,500

Production = 10,000 + 2,000 - 1,500 = 10,500 units.

Question 61: Which principle is violated when an internal auditor knowingly takes part in an illegal activity to protect their employer?

Integrity (Correct answer)
Competency
Due professional care
Objectivity only

Correct answer: Integrity

Integrity prohibits knowingly being party to illegal activity or acts that discredit the profession or organization.

Question 62: How should estate planning performance be reported to clients?

Only report positive results
Provide accurate, complete, and timely performance reporting with appropriate benchmarks (Correct answer)
Reporting is only required annually
Let clients check their own accounts

Correct answer: Provide accurate, complete, and timely performance reporting with appropriate benchmarks

Accurate, complete, and timely reporting with appropriate benchmarks enables informed decision-making by clients.

Question 63: Scenario analysis in risk assessment is most useful for:

Calculating depreciation
Recording routine journal entries
Performing bank reconciliations
Evaluating effects of plausible future events on objectives (Correct answer)

Correct answer: Evaluating effects of plausible future events on objectives

Scenario analysis explores how specific hypothetical events would affect the organization.

Question 64: A firm with a high degree of operating leverage will experience:

Lower business risk
Larger percentage changes in EBIT for a given change in sales (Correct answer)
Stable EBIT regardless of sales
More variable costs than fixed costs

Correct answer: Larger percentage changes in EBIT for a given change in sales

High fixed operating costs magnify the effect of sales changes on operating income.

Question 65: Which approach to risk assessment relies primarily on expert judgment and descriptive scales such as high, medium, and low?

Value at risk modeling
Quantitative assessment
Monte Carlo simulation
Qualitative assessment (Correct answer)

Correct answer: Qualitative assessment

Qualitative assessment uses judgment-based descriptive ratings rather than numeric probability models.

Question 66: What fiduciary duty applies to estate planning?

Act in the client's best interest with loyalty, care, and full disclosure (Correct answer)
Recommend the most expensive products
Maximize the advisor's commission
Follow the firm's sales targets above all

Correct answer: Act in the client's best interest with loyalty, care, and full disclosure

Fiduciary duty requires acting in the client's best interest with loyalty, care, and full disclosure of all material facts.

Question 67: Adding a new asset to a portfolio will lower portfolio risk most when the asset's correlation with the existing portfolio is:

+1.0
+0.8
0
−0.5 (Correct answer)

Correct answer: −0.5

The lower (more negative) the correlation, the greater the diversification benefit.

Question 68: A walkthrough of a process is primarily performed to:

Replace substantive testing of account balances
Confirm understanding of the process and verify that controls have been implemented (Correct answer)
Provide sufficient evidence of operating effectiveness for a full year
Detect all instances of fraud in a cycle

Correct answer: Confirm understanding of the process and verify that controls have been implemented

A walkthrough traces one transaction through the process to confirm the auditor's understanding and whether the controls are designed and in place.

Question 69: A company's code of conduct is primarily a governance tool that serves to:

Document the external auditor's responsibilities
Communicate expected ethical standards and behavioral guidelines to all employees (Correct answer)
Replace the need for internal audit oversight
Satisfy tax reporting requirements to the IRS

Correct answer: Communicate expected ethical standards and behavioral guidelines to all employees

A code of conduct is a governance document that communicates the organization's ethical standards and expected behavior, helping establish the ethical culture throughout the organization.

Question 70: What fiduciary duty applies to tax strategies?

Follow the firm's sales targets above all
Recommend the most expensive products
Maximize the advisor's commission
Act in the client's best interest with loyalty, care, and full disclosure (Correct answer)

Correct answer: Act in the client's best interest with loyalty, care, and full disclosure

Fiduciary duty requires acting in the client's best interest with loyalty, care, and full disclosure of all material facts.

Question 71: A bond pays a 5% annual coupon while comparable bonds yield 7%. How will this bond be priced?

At a discount to face value (Correct answer)
At face value
At a premium to face value
At zero until maturity

Correct answer: At a discount to face value

When the coupon rate is below the market yield, the bond sells below par.

Question 72: How should tax strategies performance be reported to clients?

Reporting is only required annually
Provide accurate, complete, and timely performance reporting with appropriate benchmarks (Correct answer)
Only report positive results
Let clients check their own accounts

Correct answer: Provide accurate, complete, and timely performance reporting with appropriate benchmarks

Accurate, complete, and timely reporting with appropriate benchmarks enables informed decision-making by clients.

Question 73: A flexible budget is most useful for performance evaluation because it:

Excludes all fixed costs from the comparison
Is prepared for a single, fixed level of activity
Adjusts budgeted costs to the actual level of activity achieved (Correct answer)
Is updated continuously by adding a new month as one ends

Correct answer: Adjusts budgeted costs to the actual level of activity achieved

Comparing actual costs to a budget at the same activity level isolates spending and efficiency differences.

Question 74: During an engagement, the auditee manager repeatedly delays providing requested documents. What is the internal auditor's most appropriate first step?

Obtain the documents without the manager's knowledge
Discuss the delays directly with the manager to understand causes and agree on a revised timeline (Correct answer)
Issue an unsatisfactory opinion due to scope limitation
Report the manager immediately to the audit committee

Correct answer: Discuss the delays directly with the manager to understand causes and agree on a revised timeline

Resolving issues at the lowest appropriate level through direct communication preserves the relationship and is the expected first step before escalation.

Question 75: Which reporting arrangement best supports the organizational independence of the internal audit function?

The CAE reports both functionally and administratively to the controller
The CAE reports functionally to external auditors
The CAE reports functionally to the CFO and administratively to the board
The CAE reports functionally to the board and administratively to senior management (Correct answer)

Correct answer: The CAE reports functionally to the board and administratively to senior management

A direct functional reporting line to the board is the main structural safeguard for internal audit independence.

Question 76: An employee who steals cash before it is recorded in the accounting system is committing which type of fraud?

Embezzlement via journal entry
Kiting
Skimming (Correct answer)
Lapping

Correct answer: Skimming

Skimming is an off-book fraud where cash is stolen before it is ever entered into the accounting records, making it harder to detect through normal reconciliations.

Question 77: Which practice helps internal audit understand stakeholder expectations when developing the annual audit plan?

Relying only on prior-year plans
Soliciting input from senior management and the board (Correct answer)
Copying the external auditor's plan
Allowing each department to choose its audits

Correct answer: Soliciting input from senior management and the board

Risk-based planning considers input from senior management and the board.

Question 78: Which IT audit approach involves testing application controls by re-performing automated calculations independently to verify system accuracy?

Integrated test facility
Parallel simulation (Correct answer)
Test data method
Embedded audit module

Correct answer: Parallel simulation

Parallel simulation involves the auditor independently replicating the system's processing logic against live data to verify that the system produces correct results.

Question 79: A preferred stock pays a fixed annual dividend of $5 and investors require an 8% return. What is its value?

$65.00
$50.00
$62.50 (Correct answer)
$40.00

Correct answer: $62.50

Preferred stock value = dividend / required return = $5 / 0.08 = $62.50.

Question 80: A 'lapping' scheme in accounts receivable involves:

Issuing duplicate invoices to customers
Inflating revenue by recording fictitious sales
Stealing customer payments and covering the shortage with later receipts (Correct answer)
Writing off valid receivables as uncollectible

Correct answer: Stealing customer payments and covering the shortage with later receipts

Lapping is a fraud where an employee steals cash receipts and conceals the theft by applying subsequent payments to earlier accounts.

Question 81: Which inventory method, during a period of rising prices, generally results in the highest reported net income?

Weighted average
LIFO
Specific identification
FIFO (Correct answer)

Correct answer: FIFO

FIFO charges older, cheaper costs to cost of goods sold, so gross profit is highest when prices rise.

Question 82: An internal auditor transferred from the accounts payable department to internal audit four months ago. She is asked to perform an assurance review of accounts payable. What is the most appropriate action?

Perform the review but have a peer review her workpapers
Decline or be reassigned, since she was responsible for that activity within the past year (Correct answer)
Perform the review because she has the best knowledge of the process
Perform the review only if management approves in writing

Correct answer: Decline or be reassigned, since she was responsible for that activity within the past year

Objectivity is presumed impaired when an auditor gives assurance on an activity they were responsible for within the previous year.

Question 83: How often must an external quality assessment of the internal audit function be performed?

At least once every five years (Correct answer)
At least once every three years
Only when the board requests it
Every year

Correct answer: At least once every five years

External quality assessments must be performed at least once every five years by a qualified, independent assessor or team.

Question 84: Which sampling method gives larger dollar balances a higher chance of selection?

Block sampling
Simple random sampling of line items
Discovery sampling
Monetary unit sampling (Correct answer)

Correct answer: Monetary unit sampling

Monetary unit (probability-proportional-to-size) sampling treats each dollar as a sampling unit, so larger balances are more likely to be selected.

Question 85: Which of the following is an example of an application control rather than an IT general control?

Disaster recovery planning
Input validation edit checks (Correct answer)
Password complexity requirements
Segregation of IT duties

Correct answer: Input validation edit checks

Input validation edit checks (e.g., rejecting non-numeric data in a numeric field) are application-level controls that govern specific data processing within a system.

Question 86: Which of the following best describes a 'data integrity' control in an accounting information system?

Ensuring data is accurate, complete, and unaltered throughout its lifecycle (Correct answer)
Restricting user access to sensitive tables
Encrypting all transmitted data
Ensuring data is backed up daily

Correct answer: Ensuring data is accurate, complete, and unaltered throughout its lifecycle

Data integrity controls ensure that information remains accurate, consistent, and unaltered from creation through storage and reporting.

Question 87: Under the IIA's International Professional Practices Framework (IPPF), which document establishes the purpose, authority, and responsibility of the internal audit activity?

The annual audit report
The internal audit charter (Correct answer)
The risk assessment matrix
The engagement work program

Correct answer: The internal audit charter

The internal audit charter is the formal document that establishes the internal audit activity's purpose, authority, and responsibility, and must be consistent with the IIA's Definition of Internal Auditing and Core Principles.

Question 88: Days inventory outstanding is 45, days sales outstanding is 30, and days payables outstanding is 25. What is the cash conversion cycle?

100 days
60 days
50 days (Correct answer)
40 days

Correct answer: 50 days

Cash conversion cycle = 45 + 30 - 25 = 50 days.

Question 89: An auditee responds to a recommendation by proposing an alternative corrective action. The internal auditor should:

Escalate immediately to the board
Reject any action that differs from the recommendation
Evaluate whether the alternative adequately addresses the underlying risk (Correct answer)
Accept it without evaluation

Correct answer: Evaluate whether the alternative adequately addresses the underlying risk

Management may choose different actions as long as the risk is adequately mitigated.

Question 90: Sales were $100,000 in November and $120,000 in December. 60% is collected in the month of sale and 40% the following month. What are December cash collections?

$120,000
$112,000 (Correct answer)
$108,000
$72,000

Correct answer: $112,000

December collections = 60% x $120,000 + 40% x $100,000 = $72,000 + $40,000 = $112,000.

Question 91: Which analytical procedure would most likely detect a fictitious expense scheme in accounts payable?

Comparison of budgeted vs. actual capital expenditures
Calculation of gross margin by product line
Ratio of total assets to total liabilities
Trend analysis of expense accounts comparing current period to prior periods (Correct answer)

Correct answer: Trend analysis of expense accounts comparing current period to prior periods

Trend analysis comparing current expense balances to prior periods can reveal unexplained spikes that may indicate fictitious expenses.

Question 92: A publicly held corporation pays its CEO $3 million in salary. How much is deductible under Section 162(m)?

$3 million
$2 million
None
$1 million (Correct answer)

Correct answer: $1 million

Section 162(m) limits a public company's deduction for compensation paid to each covered employee to $1 million per year.

Question 93: Under ASC 740, how is the benefit of an uncertain tax position that meets the recognition threshold measured?

At the full amount claimed on the return
At zero until the statute of limitations expires
At the probability-weighted expected value
At the largest amount that is more than 50% likely to be realized on settlement (Correct answer)

Correct answer: At the largest amount that is more than 50% likely to be realized on settlement

After a position passes the more-likely-than-not recognition test, the company recognizes the largest benefit that is more than 50% likely to be realized.

Question 94: Which budgeting approach requires managers to justify every expenditure from a base of zero each period?

Zero-based budgeting (Correct answer)
Incremental budgeting
Flexible budgeting
Continuous (rolling) budgeting

Correct answer: Zero-based budgeting

Zero-based budgeting starts with no prior-year baseline and demands justification for all spending.

Question 95: A department head insists on attending every interview the auditor conducts with their staff. The auditor's BEST response is to:

Allow attendance and accept any limitation without comment
Cancel the interviews
Explain that private interviews may be needed for candid responses and seek agreement, escalating if unresolved (Correct answer)
Report the department head for fraud

Correct answer: Explain that private interviews may be needed for candid responses and seek agreement, escalating if unresolved

Auditors should explain the need for unrestricted access and escalate potential scope limitations if needed.

Question 96: What should an accountant do when facing an ethical dilemma?

Follow the manager’s advice only
Resign immediately
Ignore the issue
Refer to the code of ethics and seek guidance (Correct answer)

Correct answer: Refer to the code of ethics and seek guidance

When faced with an ethical dilemma, an accountant's primary step should be to refer to their professional code of ethics for guidance. This code provides a framework for ethical conduct and decision-making. If the code does not offer a clear solution, seeking advice from supervisors, legal counsel, or professional bodies can help navigate the situation responsibly and ethically.

Question 97: A change from the FIFO to the weighted-average inventory method is accounted for as a:

Correction of an error
Change in accounting principle, applied retrospectively (Correct answer)
Change in reporting entity
Change in accounting estimate, applied prospectively

Correct answer: Change in accounting principle, applied retrospectively

Switching between GAAP-acceptable inventory methods is a change in principle requiring retrospective application.

Question 98: An employee receives restricted stock subject to vesting and expects its value to rise significantly. Which election lets the employee recognize income at grant instead of at vesting?

A Section 1031 election filed within 45 days
A Section 338 election filed within 75 days
A Section 179 election filed with the annual return
A Section 83(b) election filed within 30 days of the transfer (Correct answer)

Correct answer: A Section 83(b) election filed within 30 days of the transfer

A Section 83(b) election taxes the stock's current value at grant, so later appreciation can qualify as capital gain.

Question 99: How should risk be assessed in tax strategies?

Use a one-size-fits-all risk profile
Ignore risk for aggressive growth
Risk assessment is only needed for retirees
Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically (Correct answer)

Correct answer: Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically

Comprehensive risk assessment considers tolerance, capacity, time horizon, and objectives to create appropriate strategies.

Question 100: What continuing education requirement supports risk assessment competence?

Education is only needed when seeking promotion
Ongoing education in regulatory changes, market developments, and best practices (Correct answer)
Read financial news occasionally
Initial licensure is sufficient

Correct answer: Ongoing education in regulatory changes, market developments, and best practices

Financial markets, regulations, and best practices evolve constantly, requiring ongoing education for competent practice.

Question 101: How should risk be assessed in client relations?

Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically (Correct answer)
Risk assessment is only needed for retirees
Use a one-size-fits-all risk profile
Ignore risk for aggressive growth

Correct answer: Evaluate risk tolerance, capacity, time horizon, and investment objectives systematically

Comprehensive risk assessment considers tolerance, capacity, time horizon, and objectives to create appropriate strategies.

Question 102: Which risk response involves purchasing insurance to cover potential losses from a fire at a warehouse?

Risk acceptance
Risk reduction
Risk avoidance
Risk sharing (transfer) (Correct answer)

Correct answer: Risk sharing (transfer)

Insurance transfers or shares the financial impact of a risk with a third party.

Question 103: A constant-mix rebalancing strategy performs best in which market environment?

Strongly trending downward markets
Volatile, mean-reverting (oscillating) markets (Correct answer)
Strongly trending upward markets
Markets with zero volatility

Correct answer: Volatile, mean-reverting (oscillating) markets

Constant-mix buys low and sells high, which pays off when prices oscillate and revert.

Question 104: The concept of 'stewardship' in corporate governance refers to:

The external auditor's duty to detect all fraud
The board's authority to set employee salaries
Management's responsibility to protect and grow assets on behalf of the organization's owners and stakeholders (Correct answer)
The process of auditing third-party vendors

Correct answer: Management's responsibility to protect and grow assets on behalf of the organization's owners and stakeholders

Stewardship in governance means that management acts as a responsible caretaker of the organization's assets and interests on behalf of shareholders and other stakeholders.

Question 105: To get favorable long-term capital gain treatment on incentive stock options, how long must the employee hold the shares?

At least 2 years from grant and 1 year from exercise (Correct answer)
At least 6 months from grant and 6 months from exercise
At least 1 year from grant only
At least 5 years from exercise

Correct answer: At least 2 years from grant and 1 year from exercise

A qualifying ISO disposition requires holding the shares more than 2 years after grant and more than 1 year after exercise.

Question 106: A final engagement communication contained a significant error that has since been discovered. What should the CAE do?

Communicate the corrected information to all parties who received the original communication (Correct answer)
Wait until the next engagement to mention the error
Ask the auditee to correct the report
Correct the workpapers only

Correct answer: Communicate the corrected information to all parties who received the original communication

When a final communication contains a significant error or omission, corrected information must go to everyone who received the original.

Question 107: A portfolio has an expected return of 12%, a standard deviation of 20%, and the risk-free rate is 2%. What is its Sharpe ratio?

0.40
2.00
0.60
0.50 (Correct answer)

Correct answer: 0.50

Sharpe ratio = (12% - 2%) / 20% = 0.50.

Question 108: Breaking a large cash deposit into several smaller deposits specifically to avoid reporting thresholds is known as:

Lapping
Layering
Structuring (Correct answer)
Kiting

Correct answer: Structuring

Structuring is deliberately splitting transactions to evade BSA reporting requirements and is itself a federal crime.

Question 109: Which depreciation method allocates an asset’s cost evenly over its useful life?

Declining Balance
Straight‑Line (Correct answer)
Sum‑of‑the‑Years’‑Digits
Units of Production

Correct answer: Straight‑Line

The Straight-Line depreciation method allocates the cost of an asset evenly over its estimated useful life. It calculates depreciation expense by subtracting the salvage value from the asset's cost and dividing the result by the number of useful years. This method is simple to apply and results in a consistent depreciation expense each period, making it predictable for financial planning.

Question 110: Under the economic substance doctrine codified in Section 7701(o), when is a transaction respected?

Whenever it complies with the literal text of the Code
When it meaningfully changes the taxpayer's economic position and has a substantial non-tax purpose (Correct answer)
Only when the IRS issues a private letter ruling
When it produces a tax benefit greater than its cost

Correct answer: When it meaningfully changes the taxpayer's economic position and has a substantial non-tax purpose

Section 7701(o) requires both a meaningful change in economic position and a substantial purpose apart from federal income tax effects.

Question 111: Combining two securities provides the greatest risk reduction when their returns have which correlation?

Perfectly positive (+1.0)
Zero
Exactly +0.5
Perfectly negative (-1.0) (Correct answer)

Correct answer: Perfectly negative (-1.0)

Perfectly negatively correlated returns offset each other most completely.

Question 112: An auditor uses a heat map plotting impact against likelihood. A risk rated low likelihood but catastrophic impact should generally be:

Automatically transferred to an insurer
Rated as medium and deferred to next year
Given attention because severe impact can outweigh low probability (Correct answer)
Ignored because it is unlikely

Correct answer: Given attention because severe impact can outweigh low probability

High-impact, low-likelihood risks can threaten the organization and warrant monitoring or contingency planning.

Question 113: A part can be made for $5 materials, $4 labor, $2 variable overhead, and $3 fixed overhead (of which $2 is avoidable), or bought for $12. Which choice is better?

Buy, saving $2 per unit
Buy, saving $1 per unit (Correct answer)
Make, saving $2 per unit
Make, saving $1 per unit

Correct answer: Buy, saving $1 per unit

Relevant make cost is $5 + $4 + $2 + $2 = $13 versus $12 to buy, so buying saves $1.

Question 114: What is considered a conflict of interest in accounting?

Accepting a gift from a client
Completing continuing education
Using software to complete taxes
Auditing a company you own shares in (Correct answer)

Correct answer: Auditing a company you own shares in

A conflict of interest arises when an accountant's personal interests or relationships could improperly influence their professional judgment or actions. Auditing a company in which the accountant owns shares creates such a conflict because their financial stake could compromise their objectivity and independence during the audit process. This situation undermines the credibility of the audit findings.

Question 115: An internal auditor finds that a business unit has no process to track changes in applicable regulations. Which compliance program element is most clearly missing?

Whistleblower hotline
Disaster recovery planning
Segregation of duties
Regulatory change management (Correct answer)

Correct answer: Regulatory change management

Regulatory change management identifies new or amended requirements and ensures policies and controls are updated accordingly.

Question 116: Which component of the COSO internal control framework relates to the ethical tone and culture established by an organization's leadership?

Risk Assessment
Monitoring
Control Environment (Correct answer)
Control Activities

Correct answer: Control Environment

The Control Environment is the foundational component of the COSO internal control framework, setting the ethical tone and culture of an organization. It encompasses the integrity, ethical values, competence, and philosophy of management, including the board of directors and senior leadership. A strong control environment is critical for fostering a disciplined and structured approach to internal controls throughout the entity.

Question 117: An auditor discovers that a high-rated risk has no assigned owner in the risk register. What is the primary concern?

No one is accountable for monitoring and responding to the risk (Correct answer)
The risk rating must be lowered
The auditor should become the owner
The register format is inconsistent

Correct answer: No one is accountable for monitoring and responding to the risk

Without an owner, accountability for managing the risk is unclear and responses may not occur.

Question 118: Which encryption concept ensures that a sender cannot later deny having sent a message?

Symmetric encryption
Hashing for data integrity
Non-repudiation via digital signatures (Correct answer)
Public key infrastructure certificate revocation

Correct answer: Non-repudiation via digital signatures

Non-repudiation, achieved through digital signatures, provides proof of origin so a sender cannot deny sending a message.

Question 119: Which activity BEST builds trust with engagement clients before fieldwork begins?

Distributing the prior year's audit findings to all staff
Holding an opening (entrance) meeting to discuss objectives, scope, and timing (Correct answer)
Sending a final report template
Requesting all records for the past five years

Correct answer: Holding an opening (entrance) meeting to discuss objectives, scope, and timing

The opening meeting sets expectations and gives management a chance to raise concerns, building cooperation.

Question 120: Why should internal auditors share draft observations with the auditee before issuing the final report?

To allow management to approve the report's opinion
To transfer responsibility for the findings to management
To meet a legal requirement in all US states
To confirm factual accuracy and obtain management's action plans (Correct answer)

Correct answer: To confirm factual accuracy and obtain management's action plans

Reviewing drafts validates facts and allows management responses to be incorporated.

Question 121: An auditor observes the physical inventory count. Which assertion does observation mainly support?

Existence (Correct answer)
Valuation of obsolete inventory
Classification of inventory as current
Rights and obligations for consigned goods

Correct answer: Existence

Observing the count gives direct evidence that the recorded inventory physically exists.

Question 122: Benford's Law is used in fraud detection to analyze:

The ratio of audit fees to company revenue
Compliance with federal sentencing guidelines
The expected frequency distribution of leading digits in naturally occurring numbers (Correct answer)
Employee background check results

Correct answer: The expected frequency distribution of leading digits in naturally occurring numbers

Benford's Law predicts the frequency of leading digits in datasets; deviations from this distribution can indicate manipulated or fabricated numbers.

Question 123: Under the accrual basis of accounting, when should revenue generally be recognized?

When cash is received from the customer
When the sales contract is signed
When the performance obligation is satisfied (Correct answer)
At the end of the fiscal year

Correct answer: When the performance obligation is satisfied

ASC 606 recognizes revenue when (or as) control of goods or services transfers, satisfying the performance obligation.

Question 124: In a 'bill and hold' fraud scheme, a company records revenue for goods that:

Were manufactured using substandard materials
Were sold below cost
Have been returned by customers
Have been invoiced but not yet shipped or delivered to the customer (Correct answer)

Correct answer: Have been invoiced but not yet shipped or delivered to the customer

A bill and hold scheme records revenue when a sale is invoiced but the goods remain physically held at the seller's warehouse, violating revenue recognition standards.

Question 125: A vendor under audit offers an internal auditor courtesy tickets to a professional sports event worth several hundred dollars. Which response best reflects IIA ethics guidance?

Accept, since the tickets are not cash
Decline, because accepting could impair or appear to impair professional judgment (Correct answer)
Accept, as long as the audit report is not affected
Accept and disclose it in the final audit report

Correct answer: Decline, because accepting could impair or appear to impair professional judgment

Internal auditors should not accept anything that may impair or be presumed to impair their professional judgment.

Question 126: An internal auditor is pressured by a senior executive to soften a finding about weak controls in the executive's division. Which principle requires the auditor to resist?

Confidentiality
Efficiency
Objectivity (Correct answer)
Competency

Correct answer: Objectivity

Objectivity requires unbiased judgment and not letting others' influence subordinate the auditor's judgment.

Question 127: An auditor uses data analytics to compare employee bank account numbers to vendor bank account numbers. What risk is this procedure primarily designed to detect?

Unrecorded liabilities
Fictitious vendor or conflict-of-interest schemes (Correct answer)
Inventory shrinkage
Revenue cutoff errors

Correct answer: Fictitious vendor or conflict-of-interest schemes

Matching employee and vendor bank details can reveal shell vendors set up by employees to divert payments.

Certified Internal Auditor (CIA) Exam

The CIA certification is the only globally recognized certification for internal auditors, demonstrating proficiency in internal audit principles and practices.

125

Questions

150 min

Time Limit

60%

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