Deck 2: The Auditors Responsibilities Regarding Fraud and Mechanisms to Address Fraud: Regulation and Corporate Governance

Question 1

Management compensation that is tied to profits may create incentives to commit fraud.

Answer 1

True

Question 2

The fraud triangle requires the auditor to actively consider and assess the risk of fraud for clients and their financial statements.

Answer 2

False

Question 3

An example of fraudulent financial reporting is the CFO intentionally overstating sales to boost profits.

Answer 3

True

Question 4

Fraud detection procedures should only be performed for clients that have had fraud problems in the past.

Question 5

The most important lesson to be learned from The Great Salad Oil Swindle is that auditors can commit fraud by falsely including inventory that does not exist.

Question 6

Pressure upon management to manipulate financial information is a common characteristic in fraud cases.

Question 7

Rationalization is one element of the Fraud Triangle.

Question 8

Professional skepticism is required on audit engagements that have a high risk of fraud but can be disregarded for all other engagements.

Question 9

Fraud is an intentional act involving the use of deception that results in a material misstatement of the financial statements.

Question 10

An example of fraudulent financial reporting is the treasurer's diversion of hundreds of thousands of dollars into a personal money market account.

Question 11

Management may feel pressure to maintain debt covenants, which is a deterrent to fraud.

Question 12

Auditors need to consider fraud arising from misappropriation of assets and fraudulent financial reporting.

Question 13

Consideration of fraud in financial statement audits is a relatively new concept derived originally from the Sarbanes-Oxley Act.

Question 14

BruceCo. has accounted for the revenue of Jiffy Mac, Inc., one of its suppliers as though it were its subsidiary. BruceCo. has probably committed fraud because of its misapplication of consolidation principles.

Question 15

The onslaught of fraud in financial statements over the recent decade has been the first of its kind in history.

Question 16

The auditor is responsible for actively considering fraud risks in order to obtain reasonable assurance that the financial statements are free of material fraud.

Question 17

According to professional audit standards, the audit team should assemble early in the planning stages of an audit to conduct a fraud "brainstorming" meeting in order to determine the types of fraud that may occur with the client.

Question 18

If an auditor discovers evidence of fraud, the planned audit procedures should be adjusted accordingly.

Question 19

The auditor is not responsible for the presentation of financial statements; therefore, the auditor has no responsibility for fraud in the financial statements.

Question 20

Once the fraud assessment is complete in the planning stage, the auditor need not consider fraud further.

Question 21

Management always uses journal entries to commit fraud because they are not reviewed by auditors.

Question 22

Audit tests do not relate to fraud testing because testing for fraud is conducted in a separate engagement.

Question 23

According to the PCAOB, the detection of material fraud is a reasonable expectation of users of audited financial statements.

Question 24

When fraud risk is great in the organization under audit, procedures applied are likely to be more extensive.

Question 25

When the risk of fraud is high in financial statements, the auditor should assign less experienced auditors to the engagement.

Question 26

A board of directors that is actively involved in monitoring management mitigates opportunities to commit fraud.

Question 27

During the time period of 1998 to 2007, the median size of public company perpetrating fraud rose tenfold to $100 million (as compared to the previous ten years).

Question 28

The audit team should develop its own ideas about how fraud may be performed by the client and then covered up.

Question 29

Auditors are responsible to fraud even if it has an immaterial effect on the financial statements.

Question 30

The auditor must perform a brainstorming session with client management in order to plan the procedures to be performed.

Question 31

One fraud risk factor includes the presence of domineering members of management who seek the ultimate loyalty of subordinates.

Question 32

The landmark Enron fraud in the early 2000's involved the movement of significant debt off the books to related, unconsolidated entities.

Question 33

Complex transactions such as derivative instruments provide management certain opportunities to manipulate financial statements to its advantage.

Question 34

Various types of ways that fraud could be perpetrated should be hypothesized by the auditor prior to conducting audit testing.

Question 35

Audit procedures to detect fraud are generally an expansion of normal audit procedures.

Question 36

According to COSO studies, the majority of the frauds took place at companies that were listed on the Over-The-Counter (OTC) market, rather than those listed on the NYSE or NASDAQ.

Question 37

Rationalization involves the mindset of the fraudster to justify committing the fraud.

Question 38

The Sarbanes-Oxley Act significantly enhanced criminal penalties for crimes involving the destruction or alteration of corporate audit records.

Question 39

Auditors must keep a questioning mind when analyzing management responses to inquiry and auditors should strive to obtain corroborating evidence before accepting the management responses.

Question 40

The auditor should not consider that fraud is present in revenue accounts because revenue is not typically a very complex account.

Question 41

The auditor has a responsibility to design the audit to provide absolute assurance of detecting material fraud.

Question 42

One of the primary goals of the PCAOB is to restore confidence in which group?

A) The SEC.
B) Boards of Directors.
C) Internal auditors.
D) Independent auditors.

Question 43

Transparency is a desirable, but not critical, element of effective corporate governance.

Question 44

Successful corporate governance depends upon successful management of the company, as management has the primary responsibility for creating a culture of performance with integrity and ethical behavior.

Question 45

Professional skepticism involves such things as questioning and corroborating management responses to inquiries and determining the authenticity of documents.

Question 46

An audit must be performed by persons who can make sound judgments relating to complex accounting issues.

Question 47

Corporate governance is a process by which the owners, but not the creditors, exert control and require accountability for the resources entrusted to the organization.

Question 48

Implementing an effective ethical environment is primarily the responsibility of the audit committee of the Board of Directors.

Question 49

Why is fraud detection an important part of the audit?

A) Auditors are required to seek out and find all fraud, regardless of its magnitude.
B) Auditors expect that management will make them aware of any fraud in the financial statements.
C) Society expects that financial statements have not been materially misstated due to fraud.
D) Society realizes that some fraud was not intended to be discovered by auditors.

Question 50

Any major disagreement the auditor has with management should be discussed with the audit committee.

Question 51

The audit committee is a subcommittee of the board of directors comprised of independent outside directors.

Question 52

Formulating corporate strategy and risk management policy is primarily the responsibility of the Board of Directors.

Question 53

The audit committee should have the authority to hire and fire the external auditor.

Question 54

Managers of organizations are hired by Boards of Directors to perform responsibilities such as the implementation of internal control.

Question 55

The auditor can be satisfied with less than persuasive evidence in the audit process because of the belief that management is honest.

Question 56

The audit committee must be composed of outsiders such as the organization's attorney and audit partner.

Question 57

The objective of financial reporting is to provide useful information to interested users.

Question 58

Management of companies should have the ability to hire and fire the external auditor.

Question 59

Audit committees of publicly traded companies must establish whistleblowing mechanisms within the company.

Question 60

According to the Sarbanes-Oxley Act, the audit committee must have at least 3 independent members.

Question 61

Which of the following actions was a key element of the Enron audit fraud?

A) Capitalizing line costs rather than expensing them.
B) Misrepresenting bribes from suppliers as a reduction of operating costs.
C) Shifting debt to off-balance sheet special entities.
D) Concealing large losses related to securities investments.

Question 62

Which of the following represents the size of company that has historically committed fraudulent financial reporting or that has experienced asset misappropriation by its employees?

A) Large corporations.
B) Middle-market corporations.
C) Small and start-up companies.
D) All companies.

Question 63

What is the primary determinant in the difference between fraud and errors in financial statement reporting?

A) The materiality of the misstatement.
B) The intent to deceive.
C) The level of management involved.
D) The type of transaction affected.

Question 64

Which of the following is a specific corporate governance responsibility of Executive Management?

A) Approving major changes, such as mergers.
B) Approving non-audit work performed by the audit firm.
C) Reviewing the budget of the internal audit function.
D) Implementing an effective ethical environment.

Question 65

The fraud triangle says three conditions are generally present in the client's organization when fraud occurs. Which of the following is not one of those conditions?

A) Incentives.
B) Professional Skepticism.
C) Opportunity.
D) Ability to rationalize fraud.

Question 66

According to professional audit standards, how might an understanding of the nature of fraud that may occur in the client organization be identified by an audit firm?

A) Fraud training courses from actual corporate fraud ex-criminals.
B) Conducting a brainstorming session with the members of the audit team.
C) Circulating a survey to the client company employees for completion.
D) Discussions with other audit firms.

Question 67

Which of the following is a stated principle of a NYSE report identifying key core governance principles?

A) Members of the Board of Directors should be primarily independent members.
B) Effective corporate governance should be viewed as a compliance obligation.
C) Effective corporate governance should be integrated with the company's business strategy.
D) The Board of Directors has the primary responsibility for creating a culture of integrity and ethical behavior.

Question 68

Which of the following best describes professional skepticism?

A) An intent to deceive.
B) An attitude of intrusion and obstinacy.
C) A character that does not waver.
D) A questioning mind.

Question 69

Which of the following best represents fraud related to financial reporting?

A) The transfer agent issues 40,000 shares of the company's stock to a friend without authorization by the board of directors.
B) The controller of the company decreases warranty expense by $3 million because the company will otherwise miss analysts' expectations this quarter.
C) The in-house attorney receives payments from the French government for negotiating the development of a new plant in Paris.
D) The accounts receivable clerk covers up the theft of cash receipts by writing off older receivables without authorization.

Question 70

The Center for Audit Quality (CAQ) report identifies which of the following ways in which individuals involved in the financial reporting process can mitigate the risk of fraudulent financial reporting?

A) Individuals involved in financial reporting need to acknowledge that there needs to exist a strong, highly ethical tone at the top of an organization that permeates the corporate culture, including an effective fraud risk management program.
B) Individuals involved in financial reporting need to continually exercise professional skepticism.
C) Individuals involved in financial reporting need to remember that strong communication among those involved in the financial reporting process is critical.
D) All of the above.

Question 71

What type of fraud occurs when the deposits of current investors are used to pay returns on the deposits of previous investors with no real investment happening?

A) Skimming.
B) Ponzi Scheme
C) Channel Stuffing.
D) Payroll Fraud.

Question 72

According to professional auditing standards, which of the following best represents a type of fraudulent financial reporting?

A) Management accrues a liability and discloses the possible outcome of a lawsuit prior to settling the matter.
B) Management reclassifies a negative cash balance by decreasing cash and increasing a current liability.
C) Management discloses its failure to meet loan covenants but states that a waiver has been received.
D) Management intentionally excludes a subsidiary from its consolidated results that it controls significantly.

Question 73

Which of the following is a specific governance responsibility of the Board of Directors of a public corporation?

A) Managing and reviewing operations.
B) Approving corporate strategy.
C) Implementing effective internal controls.
D) Selecting the external audit firm.

Question 74

What should an audit team do when it discovers that fraud risk factors are present on an audit engagement?

A) Retract from the client and inform regulatory bodies.
B) Modify procedures to actively search for the existence of fraud.
C) Reduce the amount of evidence required and resort to management inquiry.
D) Turn the audit over to forensic accountants.

Question 75

Which of the following statements reflects an auditor's responsibility for detecting?fraud?

A) An auditor is not responsible for discovering fraudulent acts involving employee collusion.
B) The audit should be planned to detect only fraud caused by departures from GAAP.
C) An auditor is only responsible for detecting fraudulent financial reporting.
D) An auditor should design the audit to provide reasonable assurance of detecting?errors and fraud that are material to the financial statements.

Question 76

Which of the following situations represents a risk factor that relates to misstatements arising from misappropriation of assets?

A) A high turnover of senior management.
B) A lack of independent checks.
C) A strained relationship between management and the predecessor auditor.
D) An inability to generate cash flow from operations.

Question 77

Who is most often involved in perpetrating fraudulent financial reporting?

A) The auditors and the attorneys.
B) The treasurer and the board of directors.
C) The chief executive and chief financial officers.
D) The shareholders and the chief operating officer.

Question 78

What is the best way an auditor can detect fraud in the financial statements?

A) Use professional skepticism.
B) Understand Generally Accepted Accounting Standards.
C) Brainstorm with the client to find the types of fraud occurring.
D) Actively search for errors in the financial statements.

Question 79

How must an auditor address fraud in the planning stage?

A) The auditor must test for fraud in the planning stage by sampling accounts.
B) The auditor must consider the likelihood of fraud existing in the company in the planning stage.
C) The auditor must realize that most people are honest and not automatically assume that fraud exists when planning the audit.
D) The auditor must not be aggressive in its initial approach to fraud as trust may be lost by the client.

Question 80

Which of the following best represents actions that may indicate fraud is pervasive throughout the company under audit?

A) The company's management negotiates deals with vendors in such a manner as to pay lower prices.
B) The company's management drives luxury vehicles and takes vacations to exotic places.
C) The company's management takes an overly aggressive approach to revenue recognition.
D) The company's management estimates bad debts using an aged accounts receivables ledger rather than as a percent of sales.