AGA GFMC Examination 3: Governmental Financial Management and Control (GFMC) Exam Practice Test

Creditworthiness and Loan Approval:

When creditworthiness is a criterion for government loans, the applicant must demonstrate asatisfactory history of repaying debt, as this reflects their ability to fulfill repayment obligations in the future.

 Why a Satisfactory History Is Required:

Past repayment behavior is considered the best indicator of future performance. Government agencies prioritize reducing the risk of defaults by ensuring applicants have a proven history of managing debt responsibly.

 Why Other Options Are Incorrect:

A. A credit rating from a major bank:While a credit rating is helpful, it is not typically required for government loans. Instead, creditworthiness is evaluated based on repayment history and other financial factors.

C. Sufficient capitalization:This is important for business loans, but it does not address creditworthiness.

D. A promise to pay interest at the government borrowing rate:A promise is not sufficient to establish creditworthiness.

 References and Documents:

OMB Circular A-129:Requires agencies to assess creditworthiness before granting loans.

GAO Loan Management Guide:Highlights repayment history as a key criterion for loan approval.

Responsibility for Internal Controls:

Managementholds the primary responsibility for establishing, implementing, and maintaining an organization’s internal control system.

This responsibility is outlined in frameworks such as COSO’sInternal Control - Integrated Frameworkand the GAO’sGreen Book.

Roles of Other Parties:

A. Accountants: While accountants may assist in designing or assessing controls, they are not primarily responsible.

B. Internal auditors: Their role is to evaluate the effectiveness of controls, not establish them.

D. Audit committee: Provides oversight but does not implement or design controls.

 How to Prioritize Controls Based on Cost and Risk:

The priority of a control is based on its cost-effectiveness. Controls that protect assets with higher risk exposure relative to the cost of the control should be prioritized. The formula to calculate cost-effectiveness is: Cost-Effectiveness=Cost of ControlAsset Amount at Risk\text{Cost-Effectiveness} = \frac{\text{Cost of Control}}{\text{Asset Amount at Risk}}Cost-Effectiveness=Asset Amount at RiskCost of Control​

Lower ratios indicate more cost-effective controls.

 Calculations:

Asset A:$15,000 / $150,000 = 0.10 (10%)

Asset B:$2,500 / $6,000 = 0.42 (42%)

Asset C:$50,000 / $2,000,000 = 0.025 (2.5%)

Asset D:$20,000 / $500,000 = 0.04 (4%)

 Lowest Priority:

Asset Bhas the highest ratio (42%), meaning it is the least cost-effective and should be the lowest priority for controls.

 References and Documents:

COSO Internal Control Framework:Discusses cost-benefit analysis for prioritizing controls.

GAO Risk Management Guide:Emphasizes evaluating control cost-effectiveness relative to asset risk.

Definition of Materiality:

In financial audits, materiality is the threshold above which a misstatement or omission could influence the economic decisions of users of financial statements.

Auditors consider theneeds of reasonable userswhen determining materiality, focusing on what would influence their decision-making.

Explanation of Answer Choices:

A. The auditee determines what is material: Incorrect. The auditor, not the auditee, is responsible for determining materiality.

B. The auditor establishes materiality based on whether a misstatement would influence the judgment made by a reasonable user of the financial statements: Correct. This aligns with auditing standards, such as those in the Yellow Book and AICPA guidance.

C. The entity's main provider of resources typically sets materiality levels: Incorrect. Materiality is not determined by resource providers but by the auditor based on the needs of users.

D. The auditor sets a standard percentage for all entities by transaction class: Incorrect. Materiality varies depending on the entity and its financial circumstances.

Compliance Reporting Under Government Auditing Standards (GAS):

GAS requires auditors to assess compliance with applicable laws, regulations, contracts, and grant agreements during audits.

Compliance reporting typically includes:

Identifying areas of noncompliance.

Describing the auditor's responsibility for compliance testing.

Outlining the scope of compliance testing.

Explanation of Answer Choices:

A. Areas of noncompliance: Included in compliance reporting to highlight where the entity failed to meet requirements.

B. The auditor's responsibility for tests of compliance: GAS requires auditors to clarify their role in compliance testing.

C. Review of major internal control cycles: Correct. While internal controls may be assessed, reviewing "major internal control cycles" is not a direct component of compliance reporting.

D. The scope of the compliance testing: GAS mandates that the scope of testing be disclosed in the compliance report.

 What Is the Current Ratio?

Thecurrent ratiomeasures an entity’s ability to cover its short-term liabilities with its short-term assets. The formula is: Current Ratio=Total Current AssetsTotal Current Liabilities\text{Current Ratio} = \frac{\text{Total Current Assets}}{\text{Total Current Liabilities}}Current Ratio=Total Current LiabilitiesTotal Current Assets​

 Calculation:

Total Current Assets = $1,320

Total Current Liabilities = $810

Current Ratio=1,320810\text{Current Ratio} = \frac{1,320}{810}Current Ratio=8101,320​ Current Ratio≈1.63\text{Current Ratio} ≈ 1.63Current Ratio≈1.63

 Why the Current Ratio Matters:

A current ratio above 1 indicates that the entity has more current assets than current liabilities, suggesting good short-term liquidity.

 Why Other Options Are Incorrect:

A. 0.61, B. 0.98, C. 1.14:These values result from incorrect calculations or misinterpretations of the formula.

 References and Documents:

GAO Financial Analysis Guide:Provides guidance on using the current ratio to assess liquidity.

GASB Financial Reporting Requirements:Highlights the importance of liquidity measures in government financial statements.

Overview of the Prompt Payment Act (PPA):

ThePrompt Payment Act (31 U.S.C. Chapter 39)requires federal agencies to pay vendors for goods and services in a timely manner.

If payment is not made within the required time frame (usually 30 days after receiving a proper invoice), the agency must payinterest penaltiesto the vendor for the late payment.

Explanation of Answer Choices:

A. Invoices immediately when received: Incorrect. Federal agencies are not required to pay invoices immediately; they must process payments within the specified timeframe.

B. Interest when an invoice is paid late: Correct. Agencies must pay interest penalties for late payments.

C. Invoices no later than 60 days after receipt of the invoice: Incorrect. The standard timeframe is 30 days unless otherwise specified in the contract.

D. Interest on intragovernmental invoices: Incorrect. The PPA does not apply to intragovernmental transactions.

Understanding Shared Services:Shared services involve consolidating and centralizing resources, personnel, or processes to achieve efficiency and cost savings. This is common in government organizations looking to optimize operations.

Explanation of Answer Choices:

A. Reduce current staffing levels: While staff reductions may occur as a result, this is not the primary goal.

B. Transfer responsibilities to another entity: This describes outsourcing, not shared services.

C. Efficiently aggregate resources: Correct, as shared services aim to centralize resources for improved efficiency.

D. Provide private business opportunities: This is unrelated to shared services, which focus on internal government operations.

 What Is Efficient Inventory Management?

Efficient inventory management ensures that an organization has the right amount of inventory at the right time to meet operational needs without overstocking or understocking.

Proper inventory management minimizes disruptions to operations, including work stoppages due to lack of necessary materials or supplies.

 Why Is Fewer Instances of Work Stoppage the Correct Answer?

Efficient inventory management ensures that required inventory is available when needed, reducing the risk of work delays or stoppages caused by inventory shortages.

 Why Other Options Are Incorrect:

A. A low inventory turnover ratio:A low turnover ratio often indicates overstocking or slow-moving inventory, which is not a sign of efficiency.

B. High write-offs of obsolete inventory:Efficient management reduces obsolete inventory, leading to fewer write-offs, not more.

D. High total asset turnover:While efficient inventory management may contribute to overall asset efficiency, it does not directly result in a high total asset turnover ratio.

 References and Documents:

GAO Guide on Inventory Management:Emphasizes the role of inventory management in avoiding operational disruptions.

Best Practices for Inventory Management (AGA):Highlights reduced work stoppages as a key benefit of effective inventory control.

Minimum Components of a Government Financial System:

A general ledger is the foundation of any financial system, providing a complete record of all financial transactions.

The definition ofgeneral ledger accountsensures proper classification, tracking, and reporting of financial activities.

Explanation of Answer Choices:

A. Automated transaction processing: Incorrect. While automation is beneficial, it is not a "minimum" requirement. Manual systems can still exist.

B. Debt-reduction analysis: Incorrect. This is a financial management activity, not a core component of the financial system.

C. Performance management reporting: Incorrect. Performance reporting is separate from the foundational financial system.

D. General ledger account definition: Correct. This is a fundamental element of any government financial system.

 What Are the Four General Government Auditing Standards?

These standards, as defined in theGAO Yellow Book (Government Auditing Standards):

Qualifications:Auditors must have the necessary professional skills and competence to perform their work.

Independence:Auditors must remain free from personal, external, and organizational impairments to maintain objectivity.

Due Professional Care:Auditors must exercise care and diligence, adhering to professional standards and ethical requirements.

Quality Control:Auditors must establish and maintain a system of quality control to ensure audit work meets professional standards.

 Why Is Option D Correct?

These four elements are explicitly outlined in the GAO Yellow Book as the core principles of government auditing standards.

 Why Other Options Are Incorrect:

A. Compliance, timeliness, qualifications, and due professional care:Timeliness and compliance are not part of the four general standards; they are components of audit objectives.

B. Supervision, planning, management controls, and evidence:These are aspects of audit performance, not general standards.

C. Planning, internal controls, independence, and irregularities:Planning and internal controls are part of the audit process, not general standards.

 References and Documents:

GAO Yellow Book (Generally Accepted Government Auditing Standards - GAGAS):Lists qualifications, independence, due professional care, and quality control as the four general standards.

AICPA Audit Standards:Aligns with GAGAS in emphasizing these four principles.

 National Performance Management Advisory Commission Framework:

TheNational Performance Management Advisory Commissiondeveloped a comprehensive framework to integrateperformance measurementinto government operations.

One of its primary goals was to incorporate performance metrics into thebudget processto align resource allocation with program outcomes.

This ensures that budgeting decisions are informed by program performance, improving efficiency and accountability.

 Why the Budget Process?

By linking performance to budgeting, governments can prioritize funding for programs that demonstrate effectiveness and reduce funding for underperforming initiatives.

 Why Other Options Are Incorrect:

A. Internal control plan:Internal controls focus on risk management, not incorporating performance measurement.

B. Financial statements:Performance metrics are not reported in financial statements, which focus on financial position and results.

C. Audit procedures:Audits verify financial accuracy and compliance but do not incorporate performance measurement.

 References and Documents:

National Performance Management Advisory Commission Report (2010):Recommends integrating performance measurement into the budget process.

GAO Guide on Performance Budgeting:Explains how performance metrics inform budget decisions.

 What Is an Attestation Engagement?

An attestation engagement is a type of professional service where an independent practitioner (typically an auditor or CPA) evaluates and provides a report on assertions made by another party about a specific subject matter. These engagements follow standards set by organizations like the AICPA or GAO.

 Who Makes the Assertion?

Management's Role:Management is the party responsible for making an assertion about the subject matter under review. For example, management might assert that internal controls are effective or that financial statements are fairly presented.

Auditor/Practitioner’s Role:The auditor or practitioner examines the evidence related to the assertion and provides an opinion or conclusion based on that examination.

User’s Role:The users are the stakeholders (e.g., investors, regulators) who rely on the practitioner’s report, but they do not make assertions.

 Why Other Options Are Incorrect:

B. Auditor/Practitioner:The auditor or practitioner evaluates the assertion made by management, not the other way around.

C. Practitioner:See above—practitioners don’t make assertions.

D. User:Users are the intended audience of the attestation report, not the party making assertions.

 References and Documents:

AICPA Attestation Standards (SSAEs):Clarifies the role of management in making assertions during attestation engagements.

GAO’s Government Auditing Standards (Yellow Book):Provides additional guidance on the roles of parties in attestation engagements.

Type of Engagement for Reviewing Pilot Programs:

A performance audit evaluates theeffectiveness, efficiency, and economyof programs or operations.

In this case, the review of the pilot program assessed the number of families served and the efficiencies achieved through community involvement, which aligns with performance auditing objectives.

Explanation of Answer Choices:

A. Financial audit: Focuses on the accuracy of financial statements, not program effectiveness or efficiency.

B. Single audit: Focuses on compliance with federal grant requirements, not program evaluation.

C. Performance audit: Correct. This type of audit reviews program outcomes and operational efficiencies.

D. Attestation: Provides assurance on specific subject matter but does not evaluate program performance.

Selection Criteria for Contract Awards:

When awarding contracts, federal, state, and local governments typically evaluate contractors based on objective criteria like staff expertise, past performance, and financial position to ensure the contractor can successfully fulfill the contract requirements.

Union affiliationis irrelevant to the contractor’s ability to meet the contractual obligations and is not a valid selection criterion.

Explanation of Answer Choices:

A. Staff expertise: Correctly used to ensure the contractor has qualified personnel.

B. Past performance records: Correctly used to evaluate the contractor’s historical success in fulfilling similar contracts.

C. Union affiliations: Correct. This is not considered a valid selection criterion for contract awards.

D. Financial position: Correctly used to assess the contractor's financial stability.

 What Is Inventory Control?

Inventory controlrefers to the processes and systems used to manage stock levels, including determining how much inventory to keep on hand, reordering stock, and maintaining optimal levels to meet operational needs while minimizing costs.

Determining stock levels is a central function of inventory control, ensuring the organization has the right amount of inventory to meet demand without overstocking or understocking.

 Why Other Options Are Incorrect:

B. Safeguard control:This refers to protecting inventory from theft, damage, or loss, not determining stock levels.

C. Management control:This is a broader term encompassing oversight and governance, not specific to inventory.

D. Supply control:This typically refers to managing supply chains and suppliers, not the internal control of inventory levels.

 References and Documents:

GAO Inventory Management Guide:Defines inventory control as the process of determining and maintaining appropriate stock levels.

Best Practices in Government Inventory Management (AGA):Emphasizes the role of inventory control in balancing supply and demand.

 What Is Pay.gov?

Pay.govis anelectronic lockbox systemmanaged by the U.S. Department of the Treasury. It allows federal agencies to collect payments electronically, improving efficiency and reducing the time and cost associated with manual payment processing.

It supports online payments for taxes, fees, and other government-related obligations.

 Why Is It an Electronic Lockbox?

Pay.gov consolidates and processes payments on behalf of federal agencies, similar to how a lockbox service processes payments for private businesses.

 Why Other Options Are Incorrect:

A. Zero-balance account:This refers to a type of bank account that maintains a balance of zero by automatically transferring funds as needed, unrelated to Pay.gov’s purpose.

B. Concentration system:Refers to pooling funds from multiple accounts into one central account, not payment processing.

D. Data warehouse system:A data warehouse stores and organizes large amounts of data for analysis, unrelated to payment collection.

 References and Documents:

U.S. Treasury Pay.gov Website:Describes Pay.gov as an electronic lockbox for federal payment processing.

GAO Financial Management Systems Guide:Highlights the role of electronic lockboxes like Pay.gov in improving efficiency.

 What Is Internal Control Over Financial Reporting?

Internal control over financial reporting (ICFR) ensures the reliability of an entity’s financial statements. It focuses on maintaining accurate, complete, and properly valued financial information that complies with accounting standards and meets the needs of users.

 Why Is Option C Correct?

Proper valuation of assets and liabilities is a critical component of ICFR. It ensures that financial statements fairly represent the entity's financial position.

Cost allocation is also essential where applicable, such as assigning costs to programs or projects.

 Why Other Options Are Incorrect:

A. Sufficient spending authority and financial resources exist:This relates to budgetary control, not financial reporting.

B. Physical inventory of capitalized assets:Conducting a physical inventory is part of asset management, not financial reporting assertions.

D. Legislatively directed program goals:Meeting program goals is related to performance reporting, not ICFR.

 References and Documents:

GAO Standards for Internal Control (Green Book):Stresses the importance of proper valuation and cost allocation for accurate financial reporting.

COSO Framework:Emphasizes ICFR’s role in ensuring reliable and accurate financial statements.

GAO and External Audit Standards:The Government Accountability Office (GAO) uses the Yellow Book as its primary standard. However, it may also reference external standards from recognized international and professional auditing organizations. INTOSAI is specifically mentioned in the Yellow Book as a source of additional standards for governmental audits.

Explanation of Answer Choices:

A. Public Company Accounting Oversight Board (PCAOB): This regulates audits of publicly traded companies, not government entities.

B. International Auditing and Assurance Standards Board (IAASB): This focuses on global private-sector audits, not specifically government-related.

C. International Organization of Supreme Audit Institutions (INTOSAI): Correct. INTOSAI sets audit standards for public-sector auditors worldwide and is relevant for the GAO.

D. AICPA: While the AICPA sets standards for U.S. auditors, INTOSAI is more relevant for international public-sector audits.

Performance Audit Objectives:

Performance audits evaluate theeffectiveness,efficiency, andeconomyof government programs, operations, or activities.

These audits focus on improving operations, achieving program goals, and ensuring responsible use of public resources.

Explanation of Answer Choices:

A. Providing an opinion on the entity's financial statement: This is the objective of a financial statement audit, not a performance audit.

B. Assessing program effectiveness, economy, and efficiency: Correct. This is the primary objective of performance audits.

C. Providing an opinion on a subject matter that is the responsibility of another party: This aligns with attestation engagements, not performance audits.

D. Issuing a report of findings based upon an agreed-upon procedure: This describes agreed-upon procedures engagements, not performance audits.

 Why Verify Transit Use Before Taxi Use?

The program is intended for employees who commute by public transit. Verifying transit use on the day the taxi service was used ensures employees are adhering to program rules.

Random sampling is cost-effective and practical for identifying abuse without needing to review all records.

 Why Other Options Are Incorrect:

A. Looking for individuals using the service more than 10 times:This only identifies overuse but does not confirm whether program rules were followed.

B. Checking destination addresses for hospitals/clinics:This assumes all emergencies involve medical visits, which is not always the case.

C. Matching destination addresses to home addresses:This does not confirm transit use and may not identify abuse of the program.

 References and Documents:

GAO Fraud Prevention Guide:Recommends using random sampling to check compliance with program rules.

Best Practices for Internal Controls in Benefit Programs:Emphasizes verifying eligibility and usage to detect potential abuse.

 What Is Net Present Value (NPV)?

NPV analysisevaluates the profitability of long-term investments by calculating the present value of expected cash inflows and outflows over time, discounted at a specified rate (e.g., the opportunity cost of capital).

It helps decision-makers compare investment options by quantifying their value in today’s dollars.

 Why NPV Is Appropriate for Long-Term Investments:

It considers thetime value of money(a dollar today is worth more than a dollar in the future).

NPV helps the treasurer evaluate and prioritize investments based on their overall profitability and financial impact over the long term.

 Why Other Options Are Incorrect:

B. Regression Analysis:This statistical method analyzes relationships between variables but is not commonly used for evaluating long-term investments.

C. Horizontal Analysis:Focuses on financial data changes over time (e.g., year-to-year comparisons), not investment decisions.

D. Ratio Analysis:Measures financial performance but does not evaluate the profitability of long-term investment alternatives.

 References and Documents:

GAO Guide on Investment Decision-Making:Recommends using NPV for evaluating long-term projects and investments.

OMB Circular A-94:Provides guidelines for using NPV in benefit-cost analysis of federal investments.

Audit Opinions:

Auditors issue opinions onfinancial statement auditsto provide assurance about whether the financial statements are presented fairly in accordance with applicable accounting standards (e.g., GAAP).

Other types of audits, such as performance or forensic audits, do not typically result in opinions but may provide findings or recommendations.

Explanation of Answer Choices:

A. Performance audits: These assess efficiency, effectiveness, or economy but do not include an opinion.

B. Compliance audits: These assess adherence to laws or regulations and may include findings but not an opinion.

C. Financial statement audits: Correct. These audits include an auditor’s opinion on the fairness of the financial statements.

D. Forensic audits: These focus on fraud investigation and result in findings, not an opinion.

 Role of Management in Internal Control Evaluation:

Responsibility for Risk Identification:Management has the primary responsibility for designing, implementing, and maintaining an effective system of internal controls. As part of this process, management identifies the risks related to fraud, waste, and abuse that could impact financial reporting or operational efficiency.

Mitigating Risks:Once risks are identified, management is responsible for mitigating them by developing appropriate policies, procedures, and controls.

 Role of the Auditor in Internal Control Evaluation:

Assessing Control Effectiveness:Auditors are not responsible for designing or implementing controls; rather, their role is to evaluate whether the controls put in place by management are effective. They do this through testing, observation, and other audit procedures.

Fraud Risk Assessment:As part of their duties under Generally Accepted Government Auditing Standards (GAGAS), auditors must assess the risk of material misstatement due to fraud and evaluate how management’s controls address those risks.

 Why Other Options Are Incorrect:

B.Auditors do not identify risks—this is management's job. Auditors evaluate and assess the controls already in place.

C.Determining risk tolerance is a governance and management responsibility, not the joint responsibility of auditors and management.

D.Management mitigates risks, but auditors don’t monitor compliance with controls—they test and evaluate the controls as part of their audit procedures.

 References and Documents:

GAGAS (Yellow Book) by GAO:Emphasizes management’s responsibility for risk identification and the auditor’s responsibility for assessing control effectiveness.

COSO Internal Control Framework (2013):Highlights management’s responsibility for risk assessment and control design, while auditors provide independent assurance.

 Why Shared Services Agreements Are Cost-Effective:

A shared services agreement allows multiple school districts to pool resources and share the costs of special education services, such as specialized staff, transportation, or facilities.

This reduces duplication of services, increases efficiency, and helps lower costs without reducing the quality of education provided.

 Why Federal Maintenance of Effort (MOE) Requirements Matter:

Under federal law, schools must maintain a certain level of funding for special education services to receive federal grants. Cutting budgets or shifting costs directly to parents would likely violate MOE requirements.

 Why Other Options Are Incorrect:

A. Shift a portion of the costs in the form of a fee to parents:This violates federal regulations, as public schools cannot charge parents for special education services.

B. Decrease budget allocation for special education services:This would also violate MOE requirements and reduce services for students with special needs.

D. Outsource special needs services to a private contractor:While outsourcing can be an option, it may not always reduce costs and could introduce additional risks (e.g., quality concerns or compliance issues).

 References and Documents:

Individuals with Disabilities Education Act (IDEA):Mandates federal MOE requirements for special education funding.

GAO Report on Shared Services in Education:Highlights cost-saving benefits of shared services agreements.

 What Are Open-Ended Mutual Funds?

Open-ended mutual funds are investment vehicles that allow investors to buy and sell shares at the current net asset value (NAV), which is determined daily.

These funds are highly liquid and can be easily valued, making them a sound investment option for pension funds.

 Why Are They Suitable for Pension Funds?

Pension funds require investments that are easily valued, transparent, and provide liquidity to meet benefit obligations. Open-ended mutual funds meet all these criteria.

 Why Other Options Are Incorrect:

B. Reverse repurchase agreements:While they can be part of investment strategies, they are not easily valued compared to open-ended mutual funds.

C. Derivative instruments:Derivatives can be complex and difficult to value, making them less suitable for pension funds that prioritize transparency and simplicity.

D. Internal investment pools:These are investment vehicles used by governments, but their valuation may not be as straightforward or frequent as mutual funds.

 References and Documents:

GAO Guide to Investment Management for Pension Funds:Recommends transparent, easily valued investments like mutual funds.

AICPA Pension Plan Audit Guidelines:Emphasizes liquidity and valuation in pension fund investments.

 What Are We Solving For?

We are calculating thepresent value (PV)of $20,550 to be received at theend of year 2using a discount rate of10%.

The formula for present value is: PV=FV(1+r)nPV = \frac{FV}{(1 + r)^n}PV=(1+r)nFV​ Where:

FVFVFV = Future Value = $20,550

rrr = Discount Rate = 10% or 0.10

nnn = Time Period = 2 years

 Calculation:

PV=20,550(1+0.10)2PV = \frac{20,550}{(1 + 0.10)^2}PV=(1+0.10)220,550​ PV=20,550(1.10)2PV = \frac{20,550}{(1.10)^2}PV=(1.10)220,550​ PV=20,5501.21PV = \frac{20,550}{1.21}PV=1.2120,550​ PV≈16,983PV ≈ 16,983PV≈16,983

 Why Other Options Are Incorrect:

A. $16,440:Results from incorrect discounting for one year instead of two.

C. $18,495:Results from applying a lower discount rate or an incorrect formula.

D. $20,550:This is the future value, not the present value.

 References and Documents:

GAO Financial Analysis Guide:Explains present value calculations for investment decision-making.

AICPA Present Value Guidelines:Provides step-by-step guidance on time value of money calculations.

 Definition of Inherent Risk:

Inherent risk refers to the risk of material misstatement in financial statements or other reports due to the nature of the subject matter, without considering any controls in place. It arises from the complexity, judgment, or uncertainty involved in the underlying transactions or calculations.

 Why This Is Inherent Risk:

TheFederal Credit Reform Actrequires complex calculations to estimate loan subsidies, interest rates, and cash flows. These calculations inherently involve significant judgment and estimation, making them prone to errors. This is a classic example of inherent risk because the complexity exists regardless of controls.

 Why Other Options Are Incorrect:

A. Audit Risk:This refers to the overall risk that the auditor may issue an incorrect opinion. In this case, the issue is about the inherent complexity of the calculations, not the auditor’s procedures.

B. Control Risk:This is the risk that errors will not be prevented or detected due to weak internal controls. While control risk could contribute to misstatements, it is not the primary issue in this example.

C. Detection Risk:This is the risk that auditors will not detect a misstatement. This risk relates to audit procedures, not the inherent complexity of the calculations.

 References and Documents:

GAO Yellow Book on Risk Assessment:Explains inherent risk in the context of government financial reporting.

AICPA Standards on Audit Risk (AU-C 315):Highlights inherent risk as arising from the nature of transactions or subject matter.

Definition of Output Measures:

Output measures trackthe results of providing goods or services, such as the number of items produced or services delivered.

These measures focus onquantityrather than quality or outcomes.

Explanation of Answer Choices:

A. Activity measures: Incorrect. Activity measures refer to inputs or processes, not results.

B. Outcome measures: Incorrect. Outcome measures assess the impact or effectiveness of a program, not the quantity of goods/services provided.

C. Output measures: Correct. Output measures focus on results (e.g., number of services delivered).

D. Workload measures: Incorrect. Workload measures assess the volume of work performed but do not necessarily report on the results.

 Why Hire Contractors for Management Control Evaluations?

Management may decide to bring in external contractors when there are gaps in the organization’s capacity to perform evaluations internally. One key factor is thelack of management expertise—if management lacks the necessary knowledge or experience to evaluate controls effectively, it may outsource this task to qualified contractors.

 Why Other Options Are Incorrect:

B. Availability of Qualified Contractors:While availability is a factor, it’s not a variable that influences the decision to outsource. Instead, it’s a logistical consideration once the decision has been made.

C. Suspicion of Internal Fraud:Suspicion of fraud may lead to investigations, but hiring contractors to evaluate controls is driven by expertise gaps rather than fraud concerns.

D. Knowledge of Systemic Deficiencies:If management already has knowledge of systemic deficiencies, they may focus on remediation rather than outsourcing evaluations.

 References and Documents:

GAO Standards for Internal Control in the Federal Government (Green Book):Emphasizes the need for knowledgeable personnel to evaluate controls.

GAGAS (Yellow Book):Highlights the role of external expertise in cases where internal expertise is insufficient.

 Why Measure Performance Based on Cost per Ton of Trash Collected?

Costper ton of trash collectedis a direct, objective, and quantifiable measure of the contractor’s performance. It reflects how efficiently the contractor is operating relative to the amount of trash being managed.

This measure aligns with the principle of output-based performance evaluation, which focuses on results (e.g., tons of trash collected) rather than inputs or unrelated factors.

 Why Other Options Are Incorrect:

A. Per mile traveled:Mileage is not directly tied to performance; it depends on the route structure and geography, not the quantity of trash collected.

C. Comparison with closest comparable jurisdiction:While this may provide context, it is not a specific performance measure.

D. Per employee:Employee count does not directly measure performance or efficiency in trash collection operations.

 References and Documents:

GAO Guide on Contract Performance Evaluation:Recommends using measurable and outcome-based metrics like cost per ton collected for performance reviews.

Best Practices in Local Government Contracting (AGA):Highlights output-based measures for evaluating contractor performance.

Scope of Single Audit:The scope includes:

Financial Statements: Ensuring accurate reporting of financial activities.

Internal Controls: Evaluating effectiveness in compliance with federal requirements.

Compliance: Ensuring compliance with the terms and conditions of the award.

Explanation of Answer Choices:

A. Financial statements: Included in the audit.

B. Internal controls: Included to ensure compliance.

C. Performance results: Correct. Single audits do not assess program outcomes or effectiveness.

D. Compliance with terms of the award: Included to ensure federal funds are used appropriately.