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.

Accepted Answer

The audit team should maintain a questioning mind-set during discussions about the potential for material misstatement due to fraud. This involves being alert to conditions that may indicate possible fraud and critically assessing audit evidence.

Question 2

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.

Accepted Answer

If fraud risk is significant and management cooperation is unsatisfactory, the auditors should withdraw from the engagement in order to maintain their independence and avoid any legal or reputational risks associated with potential fraud. Performing extended audit procedures or consulting with fraud examiners may not be sufficient in such a situation. Reporting directly to the SEC is a serious step that should only be taken when there is evidence of illegal activity, and not simply due to a lack of management cooperation.

Question 3

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.

Accepted Answer

Analytical procedures are typically used for testing operating expense transactions, as they involve a significant amount of financial data that can be easily compared and analyzed over time. These procedures are less applicable to transactions such as payroll and benefit liabilities, acquisitions and disposals of fixed assets, and long-term debt, which involve more complex accounting treatments and less easily comparable data.

Question 4

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.

Accepted Answer

Projecting a deviation rate by comparing the results of a statistical sample with the actual population characteristics is a substantive procedure, not an analytical procedure. Analytical procedures involve comparisons of financial information to identify significant differences or trends. Options A, B, and D all involve comparisons or estimates that would be considered analytical procedures.

Question 5

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.

Accepted Answer

During the planning stage of an audit, auditors often use analytical procedures such as comparing current-year to prior-year sales volumes to identify areas of potential risk and to help in planning the audit approach.

Question 6

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.

Accepted Answer

External auditors are not responsible for designing audit procedures specifically to detect noncompliance unless there is specific information indicating potential noncompliance that could materially affect the financial statements. Their primary focus is on the financial statements' accuracy and compliance with the applicable financial reporting framework.

Question 7

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.

Accepted Answer

Analytical procedures are most commonly used in the revenue cycle, as it involves the largest amount of transactions and therefore provides a good basis for comparison and trend analysis. While analytical procedures may be relevant in other transaction cycles, the revenue cycle is typically the most important for these types of procedures.

Question 8

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.

Accepted Answer

When unexpected errors are found in accounts receivable during an interim audit, increasing the risk assessment, using more experienced audit team members for year-end testing is an appropriate response. This ensures that the audit team has the necessary expertise to deal with the complexities and potential issues identified, enhancing the quality and reliability of the audit process.

Question 9

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.

Accepted Answer

Materiality should consider cumulative misstatements over several years, as they can collectively mislead investors even if individual misstatements seem immaterial.

Question 10

The major emphasis in GAAS related to consideration of fraud in a financial statement audit (AU-C 240) is on:
A)employee misappropriation of assets.
B)management fraud.
C)client fraud on customers.
D)employee embezzlement.

Accepted Answer

The major emphasis in GAAS related to consideration of fraud in a financial statement audit (AU-C 240) is on management fraud, which involves intentional misleading or misrepresenting financial statements by the management of the client. While employee misappropriation of assets and embezzlement are types of fraud that should also be considered, they are not the main focus of AU-C 240. Client fraud on customers is also not relevant to the audit of financial statements, as it involves fraud committed by the client on its customers, who are external to the client's financial reporting process.

Question 11

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.

Accepted Answer

The discovery of unexplained payments made to government employees is a red flag for illegal acts, such as bribery or kickbacks, and would likely raise concern for an auditor. Choices A, C, and D may raise other audit concerns, but do not necessarily indicate the occurrence of illegal acts.

Question 12

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.

Accepted Answer

The 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. This is stated in auditing standard AU-C section 250, which requires auditors to obtain reasonable assurance that the financial statements are free from material misstatement, whether caused by error, fraud, or noncompliance with laws and regulations. The auditor should design audit procedures to detect such noncompliance and report it to those charged with governance.

Question 13

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.

Accepted Answer

The abrupt increase in sales followed by a corresponding decrease in the following month is a red flag for financial reporting fraud. The company may be inflating the December sales figures to make the financial statements look better and then deflating the January figures to compensate for the overstatement. This is a classic manipulation technique used to deceive the public about a company's financial health. Therefore, the auditor should be particularly cautious while auditing the sales revenue and gather more evidence to ensure that the reported sales figures are accurate and conform to GAAP.

Question 14

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.

Accepted Answer

The adequacy of the disclosure of the related party transactions is the primary emphasis in auditing related party transactions. This is because related party transactions are often subject to potential conflict of interest or manipulation, and adequate disclosure ensures transparency and accountability. While the probability of recurrence, existence of related parties, and valuation of transactions may also be important, they are secondary to disclosure adequacy.

Question 15

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.

Accepted Answer

A lower than expected return on an equity method investment could be due to an error in recording amortization of the excess of the investor's cost over the investment's underlying book value. This could result in overstating the investment's value in the investor's financial statements, which could lead to a lower-than-expected return. The other choices are less likely to cause this issue.

Question 16

Management fraud generally refers to:
A)unintentional mistakes.
B)noncompliance.
C)intentional distortions of financial statements.
D)violations of GAAS.

Accepted Answer

Management fraud refers to intentional distortions of financial statements by the management with the intention to deceive investors, creditors or other stakeholders. It involves deliberate misrepresentation, omission or manipulation of financial information in order to create a false impression about the financial health of a company.

Question 17

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.

Accepted Answer

The auditor assesses the risk of material misstatement because it affects the level of detection risk that the auditor may accept. Detection risk is the risk that the auditor's procedures will not detect a material misstatement that exists, and it is the only component of audit risk that the auditor can directly control. As such, the auditor must assess the risk of material misstatement in order to determine how much detection risk can be accepted.

Question 18

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.

Accepted Answer

High liquidity would not typically be a condition or circumstance for management fraud as having ample cash on hand would not necessarily incentivize fraudulent behavior. On the other hand, unfavorable industry conditions, lack of working capital, and slow customer collections could all create pressure for management to fraudulently manipulate financial statements.

Question 19

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.

Accepted Answer

External auditors are responsible for reporting immaterial frauds to a level of management at least one level above the people involved. They are not responsible for authenticating documents or finding all intentional misstatements concealed by collusion. Also, they are not necessarily required to report all frauds to outside agencies or parties, only those that meet certain criteria (such as being material and having a significant impact on financial statements).

Question 20

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.

Accepted Answer

Inherent risk and control risk are inherent to the client's operations and systems, and may exist even if an audit is not conducted, whereas detection risk is specific to the audit and can be controlled by the auditor through testing procedures. Inherent risk and control risk are not calculated by the client, and while the auditor may assess and evaluate these risks, they cannot control them directly. Materiality is a factor in assessing inherent risk and control risk, but it is not the sole basis for these assessments.

Quiz 4: Management Fraud and Audit Risk

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?

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

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

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

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

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

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?

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?

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

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

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

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

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

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:

Management fraud generally refers to:

An auditor assesses the risk of material misstatement because it:

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

External auditors are responsible:

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