Deck 11: Fraud Auditing

Question 1

Define fraud and distinguish between the two main categories of fraud.

Answer 1

In the context of financial statement auditing, fraud is defined as an intentional misstatement of the financial statements.
The two main categories of fraud are fraudulent financial reporting and misappropriation of assets.Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users of the financial statement.Misappropriation of assets involve theft of an entity's assets.

Question 2

Fraud is more prevalent in smaller businesses and not-for-profit organizations because it is more difficult for them to maintain:

A)adequate separation of duties.
B)adequate compensation.
C)adequate financial reporting standards.
D)adequate supervisory boards.

Answer 2

A

Question 3

Which of the following best defines fraud in a financial statement auditing context?

A)Fraud is an unintentional misstatement of the financial statements.
B)Fraud is an intentional misstatement of the financial statements.
C)Fraud is either an intentional or unintentional misstatement of the financial statements, depending on materiality.
D)Fraud is either an intentional or unintentional misstatement of the financial statements, depending on consistency.

Answer 3

B

Question 4

The two main categories of fraud are fraudulent financial reporting and misappropriation of assets.

Question 5

Which of the following is not a factor that relates to opportunities to commit fraudulent financial reporting?

A)Lack of controls related to the calculation and approval of accounting estimates
B)Ineffective oversight of financial reporting by the board of directors
C)Management's practice of making overly aggressive forecasts
D)High turnover of accounting, internal audit, and information technology staff

Question 6

Companies may intentionally understate earnings when income is high to create ________ that may be used in future years to increase earnings.

A)income smoothing
B)cookie jar reserves
C)cash
D)sales

Question 7

Which of the following is not a factor that relates to opportunities to misappropriate assets?

A)Inadequate internal controls over assets
B)Presence of large amounts of cash on hand
C)Inappropriate segregation of duties or independent checks on performance
D)Adverse relationships between management and employees

Question 8

"Cookie jar reserves" are often created by companies whenever their earnings are high to create reserves for future periods when earnings need to be "boosted" upward.

Question 9

Which of the following is a factor that relates to incentives or pressures to commit fraudulent financial reporting?

A)Significant accounting estimates involving subjective judgments
B)Excessive pressure for management to meet debt repayment requirements
C)Management's practice of making overly aggressive forecasts
D)High turnover of accounting, internal audit, and information technology staff

Question 10

Which of the following is a factor that relates to attitudes or rationalization to commit fraudulent financial reporting?

A)Significant accounting estimates involving subjective judgments
B)Excessive pressure for management to meet debt repayment requirements
C)Management's practice of making overly aggressive forecasts to third parties
D)High turnover of accounting, internal audit and information technology staff

Question 11

Fraudulent financial reporting usually involves manipulation of amounts rather than disclosures.

Question 12

Which of the following is a form of earnings management in which revenues and expenses are shifted between periods to reduce fluctuations in earnings?

A)Fraudulent financial reporting
B)Expense smoothing
C)Income smoothing
D)Each of the above is correct.

Question 13

Misappropriation of assets is normally perpetrated at the lowest levels of the organization hierarchy.

Question 14

Which of the following are elements of the fraud triangle?

A)
B)
C)
D)

Question 15

Which of the following is a category of fraud?

A)
B)
C)
D)

Question 16

Most cases of fraudulent reporting involve:

A)inadequate disclosures.
B)an overstatement of income.
C)an overstatement of liabilities.
D)an overstatement of expenses.

Question 17

Misappropriation of assets is normally perpetrated by:

A)members of the board of directors.
B)employees at lower levels of the organization.
C)management of the company.
D)the internal auditors.

Question 18

Financial statement manipulation risk is arguably present for all companies' financial statements.However, the risk is elevated for companies that:

A)are heavily regulated.
B)have low amounts of debt.
C)have to make significant judgments for accounting estimates.
D)operate in stable economic environments.

Question 19

Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users.

Question 20

________ is fraud that involves theft of an entity's assets.

A)Fraudulent financial reporting
B)A "cookie jar" reserve
C)Misappropriation of assets
D)Income smoothing

Question 21

"An attitude, character, or set of ethical values exist that allow management or employees to commit a dishonest act …." describes the opportunities condition included in the fraud triangle.

Question 22

The same three fraud triangle risk conditions apply to fraudulent financial reporting and misappropriation of assets.

Question 23

Who is most likely to perpetrate fraudulent financial reporting?

A)Members of the board of directors
B)Production employees
C)Management of the company
D)The internal auditors

Question 24

As part of the brainstorming sessions, auditors are directed to emphasize:

A)
B)
C)
D)

Question 25

Which of the following matters related to the auditor's consideration of material misstatements due to fraud are required to be documented?

A)Reasons supporting a conclusion that there is not a significant risk of material improper expense recognition
B)Procedures performed to obtain information necessary to identify and assess the risks of material fraud
C)Results of the internal auditor's procedures performed to address the risk of management override of controls
D)Discussions with management regarding the hiring of a new plant manager

Question 26

Which of the following would the auditor be most concerned about regarding a heightened risk of intentional misstatement?

A)Senior management emphasizes that it is very important to beat analyst estimates of earnings every reporting period.
B)Senior management emphasizes that budgeted amounts for expenses are to be achieved for each reporting period or explained in the variance analysis report.
C)Senior management emphasizes that job rotation is a worthwhile corporate objective.
D)Senior management emphasizes that job evaluations are based on performance.

Question 27

Determine from the following the factor that would most likely elevate the auditor's concern about the risk of financial statement fraud.

A)Company cannot borrow debt capital without restrictive covenants.
B)Company finds it difficult to sell equity capital for expansion.
C)Company has a significant portion of liquid assets on its balance sheet.
D)Company reports substantial net income but ever decreasing cash flow from operations.

Question 28

A common incentive for companies to manipulate financial statements is a decline in the company's financial prospects.

Question 29

Which of the following does not represent an increased opportunity to commit fraud?

A)Related party transactions
B)The company founder is the CEO and Chairman of the Board.
C)The financial statements involve accounting estimates.
D)The company is a new audit client for the CPA firm.

Question 30

An ineffective board of director oversight over financial reporting is an example of an incentives/pressures risk factor.

Question 31

Auditor's need to exhibit professional skepticism when auditing a client.This auditing standard is best expressed by which of the following?

A)The auditor neither assumes dishonesty or honesty of management.
B)The auditor assumes dishonesty of management.
C)The auditor assumes honesty of management.
D)The auditor assumes management lacks integrity.

Question 32

Fraud is more prevalent in large businesses than small businesses and not-for-profit organizations.

Question 33

In the fraud triangle, fraudulent financial reporting and misappropriation of assets:

A)share little in common.
B)share most of the same risk factors.
C)share the same three conditions.
D)share most of the same conditions.

Question 34

List and briefly describe the three conditions for fraud.

Question 35

List and briefly describe examples of risk factors for each condition of fraud for fraudulent financial reporting.

Question 36

The pressure to do "whatever it takes" to meet goals is one of the main reasons why financial statement fraud occurs.

Question 37

Which of the following questions is the auditor not required to ask company management when assessing fraud risk?

A)Does management have knowledge of any fraud or suspected fraud within the company?
B)What are the nature of the fraud risks identified by management?
C)Is management using all assets effectively?
D)What internal controls have been implemented to address the fraud risks?

Question 38

Incentives and opportunities are two conditions that are generally present when financial statement fraud occurs.

Question 39

When assessing the risk for fraud, the auditor must be cognizant of the fact that:

A)the existence of fraud risk factors means fraud exists.
B)analytical procedures must be performed on revenue accounts.
C)horizontal analysis is not useful in helping to determine unusual financial statement relationships.
D)the auditor cannot make inquiries about fraud to company personnel who have no financial statement responsibilities.

Question 40

Which of the following is a factor that relates to incentives to misappropriate assets?

A)Significant accounting estimates involving subjective judgments
B)Significant personal financial obligations
C)Management's practice of making overly aggressive forecasts
D)High turnover of accounting, internal audit and information technology staff

Question 41

Management is responsible for:

A)
B)
C)
D)

Question 42

Which of the following is not a likely source of information to assess fraud risks?

A)Communications among audit team members
B)Inquiries of management
C)Analytical procedures
D)Consideration of fraud risks discovered during recent audits of other clients

Question 43

Senior management is responsible for promoting a culture of honesty and ethics.Describe what that implies for the organization.

Question 44

The "tone at the top" provides a foundation upon which a more detailed code of conduct can be developed to provide specific guidance for the organization and its employees.Components of a code of conduct may include sections on 1)general employee conduct, 2)relationships with clients and suppliers and 3)conflicts of interest.Give a narrative description of what might be included in each of the above components of a code of conduct.

Question 45

Information and idea exchange sessions by the audit team are required by current auditing standards.

Question 46

Explain professional skepticism and the need for maintaining professional skepticism during an audit.

Question 47

Which of the following parties is responsible for implementing internal controls to minimize the likelihood of fraud?

A)External auditors
B)Audit committee members
C)Management
D)Committee of Sponsoring Organizations

Question 48

Financial statements of all companies are potentially subject to manipulation.

Question 49

Briefly discuss the brainstorming session required by current auditing standards.Be sure to include a list of ideas that should be addressed in the session.

Question 50

Which party has the primary responsibility to oversee an organization's financial reporting and internal control process?

A)The board of directors
B)The audit committee
C)Management of the company
D)The financial statement auditors

Question 51

When the auditor receives inconsistent responses from management and others within the organization, the auditor should obtain additional audit evidence to resolve the inconsistency.

Question 52

If employees have positive feelings about their employers, they are less likely to commit fraud.

Question 53

Upon discovering information that indicates a material misstatement due to fraud, the auditor must assume that the misstatement is an isolated incident.

Question 54

Fraud awareness training should be:

A)broad and all-encompassing.
B)extensive and include details for all functional areas.
C)specifically related to the employee's job responsibility.
D)focused on employees understanding the importance of ethics.

Question 55

Describe the sources of information gathered to assess fraud risks.

Question 56

Management must recognize that almost any employee is capable of committing a dishonest act under the right circumstances.

Question 57

Research indicates that the most effective way to prevent and deter fraud is to:

A)implement programs and controls that are based on core values embraced by the company.
B)hire highly ethical employees.
C)communicate expectations to all employees on an annual basis.
D)terminate employees who are suspected of committing fraud.

Question 58

The presence of fraud risk factors increases the likelihood of fraud and may suggest that fraud is being perpetrated.

Question 59

Management and the board of directors are responsible for setting the "tone at the top."

Question 60

Which of the following is the best reason for management to emphasize fraud prevention and deterrence?

A)It is often more effective and economical for companies to focus on fraud prevention and deterrence rather than on fraud detection.
B)Collusion is impossible to detect.
C)The AICPA requires management to implement a fraud prevention program.
D)All of the above are equally valid reasons.

Question 61

Because fraud perpetrators are often knowledgeable about audit procedures, auditors should incorporate unpredictability into the audit plan.

Question 62

As part of designing and performing procedures to address management override of controls, auditors must perform which of the following procedures?

A)
B)
C)
D)

Question 63

Fictitious revenues:

A)increase accounts receivable turnover.
B)understate the gross margin percentage.
C)lower accounts receivable turnover.
D)have no impact on the gross margin percentage.

Question 64

The auditors should pay careful attention to accounting principles that involve subjective measurements or complex transactions.

Question 65

List the three main types of revenue manipulations employed to commit fraudulent financial reporting and give an example for each type.

Question 66

Auditing standards specifically require auditors to identify ________ as a fraud risk in most audits.

A)overstated assets
B)understated liabilities
C)improper revenue recognition
D)overstated expenses

Question 67

Which of the following is a correct statement regarding the misappropriation of receipts involving revenue?

A)One of the easiest frauds to detect is when a sale is not recorded and the cash from the sale is stolen.
B)If a customer's payment is stolen, regular billing of unpaid accounts can uncover the fraud unless the fraud perpetrator does something to hide the theft.
C)Misappropriation of cash receipts is generally as material as fraudulent reporting of revenues.
D)Analytical procedures can detect relatively small thefts of sales and related cash receipts.

Question 68

Company management is often under pressure to increase revenue and/or net income.One approach is to use a "bill and hold" arrangement.This is an example of which of the following?

A)Significant accounting estimates
B)Fictitious revenue recorded
C)Premature revenue recognized
D)Alteration of cutoff documents

Question 69

Fictitious revenue transactions have the same level of documentary evidence as legitimate transactions.

Question 70

Auditors are required to perform certain procedures in every audit to address the risk of management override of internal controls.What are these procedures?

Question 71

When analyzing accounts for fraud risk:

A)companies will generally attempt to overstate accounts payable and net income.
B)the inventory account is generally not susceptible to fraud since the auditor must verify the existence of the inventory.
C)payroll is rarely a significant risk for fraudulent financial reporting.
D)fixed assets are rarely stolen because of their large size.

Question 72

Analytical procedures can be very effective in detecting inventory fraud.Which of the following analytical procedures would not be useful in detecting fraud?

A)Gross margin percentage
B)Inventory Turnover
C)Cost of sales percentage
D)Accounts receivable turnover

Question 73

Audit committee oversight also serves as a deterrent to fraud by senior management.

Question 74

When the allowance for doubtful accounts is understated, bad debt expense is understated and net income is also understated.

Question 75

Auditors may identify conditions during fieldwork that change or support a judgment about the initial assessment of fraud risks.Which of the following is not a condition which should alert an auditor that the initial assessment should be changed?

A)The subsidiary ledger agrees to the general ledger.
B)Discrepancies in the accounting records
C)Unusual relationships between the auditor and management
D)Missing or conflicting evidence

Question 76

When dealing with revenue frauds:

A)the most egregious form of revenue fraud involves premature revenue recognition.
B)premature revenue recognition involves recognizing the revenue after the accounting standards requirements have been met.
C)premature revenue recognition is the same as cutoff errors.
D)side agreements can modify the terms of the sales transaction and should be analyzed carefully.

Question 77

The most common fraud in the acquisition and payment cycle is for the perpetrator to issue payments to fictitious vendors and deposit the cash in fictitious accounts.What procedures could the company take to prevent this type of fraud?

Question 78

Two of the most useful warning signals that can indicate that revenue fraud is occurring are:

A)analytical procedures and documentary discrepancies.
B)analytical procedures and misappropriation of assets.
C)documentary discrepancies and vague responses to inquiries.
D)missing audit evidence and vague responses to inquiries.

Question 79

A company is concerned with the theft of cash after the sale has been recorded.One way in which fraudsters conceal the theft is by a process called "lapping." Which of the following best describes lapping?

A)Reduce the customer's account by recording a sales return
B)Write off the customer's account
C)Apply the payment from another customer to the customer's account
D)Reduce the customer's account by recording a sales allowance

Question 80

Auditors should rely on original, rather than duplicate, copies of documents.