Final answer:
An observed condition indicating a tested control did not function as intended is known as a control exception. It identifies deviations from expected control procedures but is distinct from significant deficiencies or material weaknesses.
Step-by-step explanation:
An observed condition that provides evidence that the control being tested did not operate as intended is called a control exception. When performing internal audits or controls testing, the objective is to determine whether established procedures and processes are followed and risk is effectively mitigated. If deviations from the expected control procedure are identified, they are deemed as exceptions. This can highlight a potential risk for the business if not addressed promptly. A control exception does not immediately indicate that a significant deficiency or material weakness exists; however, if these exceptions are numerous or severe, they could be indicative of more substantial issues. In contrast, an attribute sampling could be used as part of the testing process to identify control exceptions, and a material weakness is a more egregious issue that implies a reasonable possibility that a company's financial statements could contain a material misstatement that will not be prevented or detected on a timely basis.