Deck 4: Management Fraud and Audit Risk

Question 1

Prior to,or in conjunction with,the information-gathering procedures for an audit,audit team members should discuss the potential for material misstatement due to fraud.Which of the following best characterizes the mind-set that the audit team should maintain during this discussion?

A)Presumptive
B)Judgmental
C)Criticizing
D)Questioning

Answer 1

D

Question 2

Certain conditions and circumstances are often present when management fraud occurs.Which of the following is not such a condition or circumstance?

A)Unfavorable industry conditions
B)Lack of working capital
C)High liquidity
D)Slow customer collections

Answer 2

C

Question 3

External auditors are responsible

A)for authenticating documents.
B)for reporting immaterial frauds to a level of management at least one level above the people involved.
C)for finding all intentional misstatements concealed by collusion.
D)for reporting all frauds to outside agencies or parties.

Answer 3

B

Question 4

Which of the following analytical procedures most likely would be used during the planning stage of an audit?

A)Comparing current-year to prior-year sales volumes
B)Reading the financial statements and notes and considering the adequacy of evidence
C)Comparing the current-year ratio of aggregate salaries paid to the number of employees to the prior-year's ratio
D)Reading the letter from the client's attorney and considering the threat of litigation

Question 5

Management fraud generally refers to

A)unintentional mistakes.
B)noncompliance.
C)intentional distortions of financial statements.
D)violations of GAAS.

Question 6

An auditor assesses the risk of material misstatement because it

A)is relevant to the auditor's understanding of the control environment.
B)provides assurance that the auditor's overall materiality levels are appropriate.
C)indicates to the auditor where inherent risk may be the greatest.
D)affects the level of detection risk that the auditor may accept.

Question 7

The major emphasis in GAAS related to consideration of fraud in a financial statement audit (AU 240)is on

A)employee misappropriation of assets.
B)management fraud.
C)client fraud on customers.
D)employee embezzlement.

Question 8

When fraud risk is significant,and management cooperation is unsatisfactory,the auditors will most likely

A)perform extended audit procedures.
B)consult with fraud examiners.
C)report directly to the Securities and Exchange Commission within one day.
D)withdraw from the engagement.

Question 9

An auditor's analytical procedures indicate a lower than expected return on an equity method investment.This situation most likely could have been caused by

A)an error in recording amortization of the excess of the investor's cost over the investment's underlying book value.
B)the investee's decision to reduce cash dividends declared per share of its common stock.
C)an error in recording the unrealized gain from an increase in the fair value of available-for-sale securities in the income account for trading securities.
D)a substantial fluctuation in the price of the investee's common stock on a national stock exchange.

Question 10

In auditing related party transactions,an auditor ordinarily places primary emphasis on

A)the probability that related party transactions will recur.
B)confirming the existence of the related parties.
C)verifying the valuation of the related party transactions.
D)the adequacy of the disclosure of the related party transactions.

Question 11

While performing an audit of the financial statements of a company for the year ended December 31,year 1,the auditor notes that the company's sales increased substantially in December,year 1,with a corresponding decrease in January,year 2.In assessing the risk of fraudulent financial reporting or misappropriation of assets,what should be the auditor's initial indication about the potential for fraud in sales revenue?

A)There is a broad indication of misappropriation of assets.
B)There is an indication of theft of the entity's assets.
C)There is an indication of embezzling receipts.
D)There is a broad indication of financial reporting fraud.

Question 12

Inherent risk and control risk differ from detection risk in which of the following ways?

A)Inherent risk and control risk are calculated by the client.
B)Inherent risk and control risk exist independently of the audit.
C)Inherent risk and control risk are controlled by the auditor.
D)Inherent risk and control risk exist as a result of the auditor's judgment about materiality.

Question 13

If not already performed during the overall review stage of the audit,the auditor should perform analytical procedures relating to which of the following transaction cycles?

A)Payroll
B)Revenue
C)Purchasing
D)Inventory

Question 14

Which of the following statements concerning noncompliance by clients is correct?

A)An auditor's responsibility to detect noncompliance that has a direct and material effect on the financial statements is the same as that for errors and frauds.
B)An audit in accordance with generally accepted auditing standards normally includes audit procedures specifically designed to detect noncompliance that has an indirect but material effect on the financial statements.
C)An auditor considers noncompliance from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions.
D)An auditor has no responsibility for noncompliance that has an indirect effect on the financial statements.

Question 15

According to auditing standards,external auditors' responsibilities for indirect noncompliance do not include

A)designing audit procedures to detect noncompliance in the absence of specific information brought to the auditors' attention.
B)performing audit procedures when specific information indicates that possible noncompliance may have a material indirect effect on financial statements.
C)considering the qualitative materiality of known and suspected noncompliance.
D)obtaining written management representations concerning the absence of violations of laws and regulations.

Question 16

Which of the following would not be considered an analytical procedure?

A)Converting dollar amounts of income statement account balances to percentages of net sales for comparison with industry averages
B)Developing the current year's expected net sales based on the sales trend of similar entities within the same industry
C)Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics
D)Estimating the current year's expected expenses based on the prior year's expenses and the current year's budget

Question 17

While performing interim audit procedures of accounts receivable,numerous unexpected errors are found resulting in a change of risk assessment.Which of the following audit responses would be most appropriate?

A)Move detailed analytical procedures from year end to interim.
B)Increase the dollar threshold of vouching customer invoices.
C)Send negative accounts receivable confirmations instead of positive accounts receivable confirmations.
D)Use more experienced audit team members to perform year-end testing.

Question 18

Which of the following information that comes to an auditor's attention most likely would raise a question about the occurrence of illegal acts?

A)The exchange of property for similar property in a nonmonetary transaction
B)The discovery of unexplained payments made to government employees
C)The presence of several difficult-to-audit transactions affecting expense accounts
D)The failure to develop adequate procedures that detect unauthorized purchases

Question 19

Analytical procedures are most appropriate when testing which of the following types of transactions?

A)Payroll and benefit liabilities
B)Acquisitions and disposals of fixed assets
C)Operating expense transactions
D)Long-term debt transactions

Question 20

Independent auditors who consider fraud in the course of financial statement audits are well-advised to quantify "materiality" in terms of

A)the maximum amount of asset overstatement that might mislead investors in relation to the latest financial statements under audit.
B)a maximum percentage of net income overstatement that might mislead investors in relation to the latest financial statements under audit.
C)a cumulative amount of misstatement of assets or income over several years past and current that might mislead investors in relation to the latest financial statements under audit.
D)controversial accounting measurements that might mislead investors in relation to the latest financial statements under audit.

Question 21

The probability that an audit team will give an inappropriate opinion on financial statements best describes

A)audit risk.
B)inherent risk.
C)control risk.
D)detection risk.

Question 22

An audit team uses the assessed risk of material misstatement to

A)evaluate the effectiveness of the entity's internal control policies and activities.
B)identify transactions and account balances where inherent risk is at the maximum.
C)indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high.
D)determine the acceptable level of detection risk for financial statement assertions.

Question 23

Jones,CPA,is auditing the financial statements of XYZ Retailing Inc.What assurance does Jones provide that direct effect noncompliance that is material to XYZ's financial statements,and noncompliance that has a material,but indirect effect on the financial statements will be detected?

A)Direct effect noncompliance: Reasonable; Indirect effect noncompliance: None
B)Direct effect noncompliance: Reasonable; Indirect effect noncompliance: Reasonable
C)Direct effect noncompliance: Limited; Indirect effect noncompliance: None
D)Direct effect noncompliance: Limited; Indirect effect noncompliance: Reasonable

Question 24

If fictitious credit sales were recorded,and the fictitious accounts receivable were later directly written off as bad debt expense,

A)income would be overstated.
B)income would be understated.
C)income would not be misstated.
D)accounts receivable would be understated.

Question 25

Based on audit evidence gathered and evaluated,an auditor decides to increase the assessed level of control risk from that originally planned.To achieve an overall audit risk level that is substantially the same as the planned audit risk level,the auditor would

A)decrease substantive testing.
B)decrease detection risk.
C)increase inherent risk.
D)increase materiality levels.

Question 26

Which of the following statements best describes auditors' responsibility to detect errors and frauds?

A)Auditors should design an audit to provide reasonable assurance of detecting errors and frauds that are material to the financial statements.
B)Auditors are responsible to detect material errors,but have no responsibility to detect material frauds that are concealed through employee collusion or management override of the internal control structure.
C)Auditors have no responsibility to detect errors and frauds unless analytical procedures or tests of transactions identify conditions causing a reasonably prudent auditor to suspect that the financial statements were materially misstated.
D)Auditors have no responsibility to detect errors and frauds because an auditor is not an insurer and an audit does not constitute a guarantee.

Question 27

When determining the inherent risk related to an account balance,an auditor theoretically does not explicitly consider the

A)liquidity of the account.
B)degree of management estimation involved in determining the proper account balance.
C)related internal control policies and procedures.
D)complexity of calculations involved.

Question 28

Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the expectations (estimates)developed by the auditor.If management is unable to provide an acceptable explanation,the auditor should

A)consider the matter a scope limitation.
B)perform additional audit procedures to investigate the matter further.
C)intensify the audit with the expectation of detecting management fraud.
D)withdraw from the engagement.

Question 29

Inherent risk is the

A)probability that some accounts are more susceptible to misstatement than others.
B)probability that the client's internal control policies and procedures will fail to detect material misstatements.
C)probability that material misstatements have occurred in transactions entering the accounting system used to develop financial statements.
D)probability that the auditor may not detect material misstatements in the financial statements.

Question 30

The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when,in fact,such misstatement actually exists is

A)audit risk.
B)inherent risk.
C)control risk.
D)detection risk.

Question 31

For audits of financial statements made in accordance with generally accepted auditing standards,the use of analytical procedures is required to some extent.

A)As a substantive test: Yes; In the final review stage: Yes
B)As a substantive test: Yes; In the final review stage: No
C)As a substantive test: No; In the final review stage: Yes
D)As a substantive test: No; In the final review stage: No

Question 32

Generally accepted auditing standards states that analytical procedures

A)should be applied in the planning and final review stages of the audit and as a substantive test during the audit.
B)should be applied in the planning and final review stages of the audit and can be used as a substantive test during the audit.
C)should be applied in the planning stage and can be applied as a substantive test and in the final review stage.
D)should be applied in the final review stage,and can be applied as a substantive test and in the planning stage.

Question 33

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if

A)the noncompliance is a violation of generally accepted accounting principles.
B)the client does not take the remedial action that the auditor considers necessary.
C)the illegal act was committed during a prior year that was not audited.
D)the auditor has already assessed control risk at the maximum level.

Question 34

Which of the following would not likely be found in the minutes of the board of directors?

A)Amount of dividends declared
B)Approval to pledge assets as security for debts
C)Authorization of officers' salaries
D)Approval of a new desktop computer for the controller

Question 35

The acceptable level of detection risk is inversely related to the

A)assurance provided by substantive tests.
B)risk of misapplying audit procedures.
C)preliminary judgment about materiality levels.
D)risk of failing to discover material misstatements.

Question 36

The existence of audit risk is recognized by the statement in the auditor's standard report that the

A)auditor is responsible for expressing an opinion on the financial statements,which are the responsibility of management.
B)financial statements are presented fairly,in all material respects,in conformity with applicable financial reporting framework.
C)audit includes examining,on a test basis,evidence supporting the amounts and disclosures in the financial statements.
D)auditor obtains reasonable assurance about whether the financial statements are free of material misstatement.

Question 37

The risk of material misstatement differs from detection risk in that it

A)arises from the misapplication of audit procedures.
B)may be assessed in either quantitative or non-quantitative terms.
C)exists independently of the financial statement audit.
D)can be changed at the auditor's discretion.

Question 38

If control risk increases,and all other risks in the audit risk model stay constant except the one referred to below,which of the following statements is correct?

A)Detection risk will decrease.
B)Inherent risk will increase.
C)Audit risk will decrease.
D)Detection risk will increase.

Question 39

In the planning stage,analytical procedures are used to

A)identify potential problem areas.
B)provide direct evidence about the balances in accounts.
C)determine the mathematical correctness of the financial statements.
D)perform all of these.

Question 40

When an auditor becomes aware of possible noncompliance by a client,the auditor should obtain an understanding of the nature of the act to

A)evaluate the effect on the financial statements.
B)determine the reliability of management's representations.
C)consider whether other similar acts may have occurred.
D)recommend remedial actions to the audit committee.

Question 41

What assurance does the auditor provide that errors,frauds,and direct effect noncompliance that are material to the financial statements will be detected?

A)Errors: Limited; Frauds: Negative; Direct effect noncompliance: Limited
B)Errors: Limited; Frauds: Limited; Direct effect noncompliance: Reasonable
C)Errors: Reasonable; Frauds: Limited; Direct effect noncompliance: Limited
D)Errors: Reasonable; Frauds: Reasonable; Direct effect noncompliance: Reasonable

Question 42

Horizontal analysis refers to

A)the trend of income from year to year of persons suspected of fraud.
B)changes of financial statement numbers and ratios across several years.
C)financial statement amounts expressed each year as a proportion of a base amount.
D)the change in a suspect's net worth from the beginning to the end of a period.

Question 43

Which of the following accounts tends to be most predictable for purposes of analytical procedures?

A)Accounts receivable
B)Travel and entertainment expense
C)Interest expense
D)Income taxes payable

Question 44

Inherent risk and control risk differ from detection risk in that inherent risk and control risk are

A)elements of audit risk whereas detection risk is not.
B)changed at the auditor's discretion whereas detection risk is not.
C)considered at the individual account-balance level whereas detection risk is not.
D)functions of the client and its environment whereas detection risk is not.

Question 45

The auditor uses the assessed level of risk of material misstatement to determine the acceptable level of detection risk for financial statement assertions.As the acceptable level of detection risk decreases,the auditor may do one or more of the following except change the

A)nature of substantive tests to more effective procedures.
B)timing of substantive tests,such as performing them at year-end rather than at an interim date.
C)extent of substantive tests,such as using larger sample sizes.
D)assurances provided by substantive tests to a lower level.

Question 46

Which of the following is an acceptable response to fraud risks related to sales that were identified in an audit?

A)Exercise professional skepticism when performing sales testing.
B)Increase the assessment of control risk for sales.
C)Increase the assessment of detection risk for sales.
D)Perform additional substantive sales procedures on a surprise basis.

Question 47

Analytical procedures used in planning an audit should focus on

A)reducing the scope of tests of controls and substantive tests.
B)providing assurance that potential material misstatements will be identified.
C)enhancing the auditor's understanding of the client's business.
D)assessing the adequacy of the available evidential matter.

Question 48

Sources of financial and nonfinancial data do not include

A)financial account information for comparable prior periods.
B)nonfinancial information such as physical production statistics.
C)company budgets and forecasts.
D)Bureau of Labor statistics.

Question 49

Which of the following is not required by AU 240,"Consideration of Fraud in a Financial Statement Audit"?

A)Conduct a continuing assessment of the risks of material misstatement due to fraud throughout the audit.
B)Conduct a discussion by the audit team of the risks of material misstatement due to fraud.
C)Conduct the audit with professional skepticism,which includes an attitude that assumes balances are incorrect until verified by the auditor.
D)Conduct inquiries of shareholders as to their views about the risks of fraud and their knowledge of any fraud or suspected fraud.

Question 50

The purpose of an audit strategy is

A)to provide a defense against litigation.
B)to gain an understanding of the client.
C)to comply with securities law.
D)to set the scope,timing,and direction for auditing each relevant assertion.

Question 51

If tests of controls induce the auditor to change the assessed level of control risk for Property Plant & Equipment from 50% to 100%,and audit risk (6%)and inherent risk remain constant,the acceptable level of detection risk

A)would most likely change from 10% to 5%.
B)would most likely change from 20% to 40%.
C)would most likely change from 30% to 15%.
D)would be unchanged,because the auditor has control over detection risk.
E)cannot be determined because inherent risk is not given.

Question 52

Auditors would use the Enterprise Risk Model.

A)To reduce the client's business risk
B)To determine detection risk
C)To evaluate management's risk assessment
D)To monitor client risk

Question 53

The type of financial analysis that expresses balance sheet accounts as percentages of total assets is known as

A)horizontal analysis.
B)vertical analysis.
C)net worth analysis.
D)expenditure analysis.

Question 54

Auditors use brainstorming

A)to heighten the audit team's awareness of fraud potential.
B)to heighten management's awareness of fraud potential.
C)to determine detection risk.
D)to set materiality.

Question 55

When an auditor increases the planned assessed level of control risk because certain control activities were determined to be ineffective,the auditor would most likely increase the

A)extent of substantive tests of details.
B)level of inherent risk.
C)extent of tests of controls.
D)level of detection risk.

Question 56

Experience has shown that the many large fraudulent transactions can be found in

A)systematic processing of large volumes of day-to-day ordinary transactions.
B)payroll fraudsters' mistakes in using unissued Social Security numbers.
C)petty cash embezzlements.
D)non-routine,nonsystematic journal entries.

Question 57

Managing Business Risk is the responsibility of

A)the auditors.
B)management.
C)the SEC.
D)the PCAOB.

Question 58

If an auditor encounters significant risks at the client,the auditor should do all of the following except

A)inform the SEC.
B)perform extended procedures.
C)include more experienced auditors on the engagement.
D)perform tests closer to year end.

Question 59

Analytical procedures are audit methods of evaluating financial statement accounts by studying and comparing relationships among financial and nonfinancial data.The primary purpose of analytical procedures conducted during the planning stages is to

A)identify the appropriate schedules to be prepared by the client.
B)identify the types of errors or frauds that can occur in transactions.
C)identify unusual conditions that deserve additional audit effort.
D)determine the existence of unrecorded liabilities or overstated assets.

Question 60

Which of the following pieces of information discovered by an auditor when performing substantive tests of account balances would most likely raise red flags about the possible existence of material fraudulent financial reporting?

A)Paper copies of paid invoices and cancelled checks are microfiched and then destroyed.
B)The controller requires that you schedule any audit inquiries for after lunch each day,not in the morning.
C)The petty cash fund custodian never takes a vacation.
D)The client's estimate of the allowance for doubtful accounts is lower than the auditor's independent evaluation of the allowance.

Question 61

Analytical procedures are evaluations of financial information made by a study of plausible relationships among financial and nonfinancial data.Understanding and evaluating such relationships are essential to the audit process.
The following financial statements were prepared by ABC Manufacturing Co.for the year ended December 31,2013.Also presented are various financial statement ratios for Holiday as calculated from the prior year's financial statements.Sales represent net credit sales.The total assets and the receivables and inventory balances at December 31,2013,were the same as at December 31,2012.
Required:
Items 1 through 9 below represent financial ratios that the auditor calculated during the prior year's audit.For each ratio,calculate the current year's ratio from the financial statements presented above.

Question 62

This question tests your ability to perceive the place(s)where various potential problems may exist and the type of problem (overstatement or understatement)that may exist.It asks that you supply the words or descriptions that complete the analysis begun by applying analytical procedures.
Required:
For each of the items below,identify the account(s)that need(s)to be audited carefully and the reason (i.e.,potential overstatement or understatement of _______).
a.If the current year accounts receivable are larger than last year but the allowance for doubtful accounts is the same.
b.If the current year inventory is larger than last year and the current year gross margin (profit)is larger.
c.If current year long-term liabilities are larger than last year and the interest expense is the same.
d.If current year fixed assets are larger and current depreciation expense is the same as last year.

Question 63

Can an auditor place complete reliance on internal control to the exclusion of other audit procedures? Explain your answer using the audit risk model.

Question 64

Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data.They range from simple comparisons to the use of complex models involving many relationships and elements of data.They involve comparisons of recorded amounts,or ratios developed from recorded amounts,to expectations developed by auditors.
Required:
a.Describe the broad purposes of analytical procedures.
b.Identify the sources of information from which an auditor develops expectations.

Question 65

What are the independent auditor's responsibilities to detect and report errors and frauds?

Question 66

Why is it important for auditors to understand their clients' business risks?

Question 67

Analytical procedures are one type of evidence gathering procedure.According to auditing standards,there are five general forms of analytical procedures.Auditing standards also provide examples of five sources of information for analytical procedures.

Question 68

Post,CPA,accepted an engagement to audit the financial statements of General Co.,a new client.General is a publicly held retailing entity that recently replaced its operating management.In the course of applying audit procedures,Post discovered that General's financial statements may be materially misstated due to the existence of fraud.
Required:
Describe Post's responsibilities on the circumstances described above.
Describe Post's responsibilities for reporting on General's financial statements and other communications if Post is precluded from applying necessary procedures in searching for frauds.
Describe Post's responsibilities for reporting on General's financial statements and other communications if Post concludes that General's financial statements are materially affected by frauds.(AICPA adapted)