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

Question 1

Rationalization involves the mindset of the fraudster to justify committing the 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 is an intentional act involving the use of deception that results in a misstatement of the financial statements.

Question 5

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

Question 6

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 7

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

Question 8

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

Question 9

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

Question 10

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

Question 11

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 12

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

Question 13

Opportunity is one element of the fraud triangle.

Question 14

Asset misappropriations are the primary fraud scheme in small businesses,and the perpetrators are usually the owners.

Question 15

The auditor should not consider that fraud is present in revenue accounts because revenue recognition does not typically play a role in fraudulent financial reporting.

Question 16

Related-party transactions provide management certain opportunities to manipulate financial statements.

Question 17

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

Question 18

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

Question 19

The onslaught of fraud in financial statements over the past two decades has been the first of its kind in history.

Question 20

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 21

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

Question 22

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

Question 23

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

Question 24

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

Question 25

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

Question 26

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

Question 27

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 28

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

Question 29

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

Question 30

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

Question 31

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 32

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

Question 33

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

Question 34

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

Question 35

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

Question 36

Auditing standards have historically reflected an expectation that auditors will detect and report every instance of material fraud.

Question 37

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

Question 38

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

Question 39

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

Question 40

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

Question 41

Formulating corporate strategy and risk management policy is primarily the responsibility of the board of directors.

Question 42

Effective 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 43

Implementing an effective ethical environment is primarily the responsibility of the audit committee of the board of directors.

Question 44

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

Question 45

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 46

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

Question 47

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 48

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 from its consolidated results a subsidiary that it controls significantly.

Question 49

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

Question 50

The Sarbanes-Oxley Act established the PCAOB,which is an agency of the U.S.government funded by taxpayers.

Question 51

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

Question 52

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

Question 53

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

Question 54

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

Question 55

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

Question 56

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

Question 57

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

Question 58

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

Question 59

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

Question 60

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

Question 61

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 62

Management of Premium Discovery Company is compensated through large salaries,stock options,and bonuses tied to the company's working capital growth.The CEO is constantly holding meetings to ensure that management is on target for increased operating income each month.Based solely on the preceding information,which element of the fraud triangle exists at the Premium Discovery Company?

A)Incentive.
B)Opportunity.
C)Rationalization.
D)Expectation.

Question 63

The fraud triangle has three elements.Which of the elements must be present for a fraud to occur?

A)All elements must be present for fraud to occur.
B)At least two of the three elements must be present for fraud to occur.
C)Fraud can occur if any one of the elements is present.
D)None of the above.

Question 64

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 65

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

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

Question 66

Which action was a key element in the Wells Fargo fraud case?

A)Inflating assets by falsely overstating cash held in customers' accounts.
B)Creating fake customer accounts to boost employees' bonuses.
C)Employee theft from customers' accounts.
D)Top management's recording of fictitious fees to increase reported revenues.

Question 67

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

A)Professional skepticism.
B)Incentives.
C)Opportunity.
D)Rationalization.

Question 68

Which action was a key element in the WorldCom fraud case?

A)Recording bartered exchange transactions as revenue.
B)Overstating cash by falsely recording cash held at major banks.
C)Recognizing revenue on the sale of impaired assets.
D)Concealing large losses related to securities investments.

Question 69

Which of the following is an example of fraud?

A)A mistake in processing accounting data.
B)An incorrect accounting estimate arising from misinterpretation of facts.
C)Misappropriation of an asset.
D)A mistake in the application of accounting principles.

Question 70

Which of the following creates an opportunity for fraud to be committed in an organization?

A)Management demands financial success.
B)Poor internal control.
C)Commitments tied to debt covenants.
D)Management is aggressive in its application of accounting rules.

Question 71

Which of the following frauds is most common?

A)Chief financial officer's misappropriation of funds.
B)Misapplication of revenue recognition principles.
C)Management's theft of cash held in reserve accounts.
D)Over-recording expenses related to stock options.

Question 72

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 73

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)Ponzi Scheme.
B)Skimming.
C)Channel Stuffing.
D)Off-Balance Sheet Fraud.

Question 74

Sam Jones,controller of Mitnikco,spends three days researching the accounting standards to find loopholes in the "rules" and to make a case for recognizing revenue earlier,rather than in later years.In the end,Sam and the other members of management determine that they will reduce the company's deferred revenue accounts and begin accounting for all revenues as agreements are signed.Based solely on the preceding information,which element of fraud is represented by the actions of Mitnikco management?

A)Pressures.
B)Opportunity.
C)Rationalization.
D)Skepticism.

Question 75

Which of the following is not an element of the fraud triangle?

A)Incentive.
B)Rationalization.
C)Deception.
D)Opportunity

Question 76

Which of the following statements about the Bernie Madoff Ponzi scheme is false?

A)Madoff took advantage of his unique ties to the investment community (he was the former Chair of the NASDAQ)to create trust and encourage further investments.
B)Madoff began perpetrating the fraud shortly before passage of the Sarbanes-Oxley Act,and the provisions of that Act ultimately led to discovery of the fraud.
C)Madoff was sentenced to 150 years in prison.
D)The estimated amount missing from client accounts,including fabricated gains,was almost $65 billion.

Question 77

Which of the following frauds involved primarily asset misappropriation?

A)Enron.
B)WorldCom.
C)Dell.
D)Koss.

Question 78

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 officer.
D)The shareholders and the chief operating officer.

Question 79

Which of the following best describes professional skepticism?

A)An intent to deceive.
B)An attitude of intrusion and obstinacy.
C)A firm commitment to auditing standards and ethics.
D)A questioning mind.

Question 80

Which of the following is a common incentive or condition that increases the likelihood for fraudulent financial reporting?

A)Ineffective segregation of assets.
B)Significant related party transactions.
C)Management bonuses based on reported earnings.
D)Access to undeposited cash.