Deck 5: Fraud in Financial Statements and Auditor Responsibilities

Question 1

The expectations gap refers to:

A) The space that exists between a train coming into the station and the platform used to board the train
B) The difference between what the public expects an audit to uncover and what the profession believes is the purpose of an audit
C) The difference between projected earnings based on analysts' expectations and actually earnings
D) The difference between what the audit sets out to discover and what it actually does discover

Answer 1

B

Question 2

Which of the following is not correct about materiality?

A) The concept of materiality recognizes that some matters are more important for fair presentation of financial statements
B) Materiality judgments are made in light of surrounding circumstances and necessarily involve quantitative and qualitative judgments
C) Materiality should be predictable from audit to audit so that the readers of financial statements know what constitutes materiality
D) An auditor's consideration of materiality is influenced by the auditor's perception of the need of the readers of the financial statements

Answer 2

C

Question 3

Which of the following is an element of the introductory paragraph of an auditor's report?

A) Identifies the type of opinion the auditor is giving
B) Identifies the entity, financial statements being audited and time period
C) Identifies audit testing and procedures used
D) Identifies the generally accepted auditing standards followed in conducting the audit

Answer 3

B

Question 4

One of the rules of professional conduct and repeated in GAAS, due care, requires a member to discharge professional responsibilities with _____________.

A) Confidentiality and integrity
B) Objectivity and ethics
C) Standard morals and ethics
D) Competence and diligence

Question 5

Which of the following summarizes the essence of field work standards of GAAS?

A) Quality of professionals that perform an audit
B) Criteria for judging the quality of audit work
C) Whether the auditor was independent in conducting the audit
D) Whether the auditor reviewed the client's financial statements for adherence to GAAP

Question 6

Which of the following is not a component of internal control?

A) Control environment
B) Information and communication systems
C) Monitoring of controls
D) Independence of the audit committee

Question 7

Susie is an auditor with XYZ Audit firm. The Senior Audit member has told her that all fieldwork must be completed by the end of the week. Susie knows that corners have been cut and certain tests not completed due to the time constraints. The integrity of the firm could be compromised. What should Susie do?

A) Do nothing.
B) Talk with the chain of command of the client to see that her concerns are dealt with.
C) Follow the chain of command of XYZ to see that her concerns are dealt with.
D) Talk with a reporter from the Wall Street Journal.

Question 8

Some critics claim the usefulness of the audit report is limited because:

A) Auditors do not examine all of the transactions
B) Language in the audit report relies on subjective evaluations such as what is meant by "reasonable"
C) Transactions examined are based on materiality and risk assessment determinations
D) All of these may create doubts about usefulness

Question 9

Which of the following is not an element of the auditor's responsibility of the auditor's report?

A) States the auditor's responsibility to express an opinion on the financial statements
B) States the audit provides reasonable assurance that the statements are free of material misstatement
C) States audit provides reasonable basis for the opinion
D) States the audit evaluates the overall financial statement presentation

Question 10

The auditors' determination of whether the financial statements "present fairly" is based on:

A) Whether the users are able to assess the reliability of the financial statements
B) Whether the statements have been prepared in accordance with the same GAAP used from one year to another
C) Whether the auditor has been able to gather sufficient evidence to warrant the statement that the financial statements present fairly
D) Whether the accounting principles used are appropriate in the circumstances

Question 11

The auditor's responsibility with regard to illegal acts is greatest when:

A) The illegal acts have an indirect and material effect on financial statement amounts
B) The illegal acts have a direct and material effect on financial statement amounts
C) The illegal acts have a direct and immaterial effect on financial statement amounts
D) Illegal acts exist regardless of the effects on the financial statements

Question 12

Which of the following is not one of the reporting standards of GAAS that guides auditors in formulating the audit opinion?

A) The financial statements have followed GAAP.
B) Consistency in the application of GAAP.
C) Adequate disclosures exist in the statements.
D) Gathering sufficient audit evidence to warrant an opinion.

Question 13

Adverse opinions are preceded by a separate paragraph that should meet all of the following except for:

A) Substantive alternative treatments of GAAP
B) Substantive reasons for the adverse opinion
C) Principal effect of the adverse treatment on financial position and results of operations and cash flows
D) Entitled "Basis for Adverse Opinion"

Question 14

Deliberately underbidding for an audit engagement to obtain a client and secure more lucrative management advisory or consulting services is known as?

A) Opinion shopping
B) High-balling
C) Low-balling
D) Client shopping

Question 15

Typically, when a going concern issue exists the auditor should:

A) Issue an unmodified opinion with an emphasis-of-matter paragraph
B) Explain the reasons for the going concern issue
C) Indicate where management's plans to deal with the going concern are addressed
D) All of these

Question 16

Which of the following is true about PCAOB audit standards?

A) The required standards apply to all companies
B) The required standards apply to all public companies only
C) The required standards apply to all privately held companies only
D) The required standards apply to all not-for-profit entities

Question 17

Which of the following summarizes the essence of general standards of GAAS?

A) Quality of professionals that perform an audit
B) Criteria used to judge whether the audit has met quality requirements
C) The standards that guide auditors in issuing the audit report
D) Whether the auditor obtained sufficient competent evidential matter to render an opinion

Question 18

Which of the following is the most likely reason for an auditor to issue a modified opinion with a qualification?

A) Inability to gather any sufficient relevant information to form the basis for the opinion
B) Misstatements that are material and pervasive
C) Going concern issue
D) Misstatements that are material but not pervasive

Question 19

When would it be appropriate for an auditor to withdraw from an engagement?

A) In order to avoid issuing an adverse opinion.
B) When that auditor cannot observe the taking of inventory or is unable to confirm receivables.
C) When the auditor concludes that management cannot be trusted.
D) When the auditor has overbooked too much work.

Question 20

Under which of the following set of circumstances might the auditors disclaim an opinion?

A) The financial statements contain a departure from generally accepted accounting principles, the effect of which is material
B) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion
C) There has been a material change between periods in the method of the application of accounting principles
D) Differences with management that lead to trust issues on the part of the auditor

Question 21

Auditors are responsible to detect and correct errors when they are:

A) Material
B) Material or immaterial
C) Due to an illegal act
D) Management fails to correct for the error

Question 22

In performing risk assessment the auditor should identify the following types of misstatements:

A) Known and unknown misstatements
B) Likely and unknown misstatements
C) Known and likely misstatements
D) All material misstatements

Question 23

What is the motive behind the PCAOB Integrated Audit Concept?

A) Elevation of importance of internal controls
B) Improvement of the quality and integrity of both internal controls over financial reporting and independent financial statement audits
C) Improvement of the speed and reliability of both corporate financial reporting and independent financial statement audits
D) Elevation of importance of independent financial statement audits

Question 24

Which of the following is not part of the fraud triangle?

A) Incentives
B) Opportunity
C) Materiality
D) Rationalization

Question 25

The difference between an error in the financial statements as compared to fraud is:

A) An error is always an intentional act designed to deceive another party
B) Fraud is always an intentional act designed to deceive another party
C) An error always leads to a qualification of the auditors' opinion
D) Fraudulent financial reporting is always material in amount

Question 26

All of the following tend to be rationalizations for fraud except for:

A) We need to protect the shareholders and keep the stock price high
B) All companies use aggressive accounting techniques
C) The employee will be fired unless s/he goes along with the fraud
D) We are correcting a temporary problem that will not exist in the future

Question 27

The fraud at Tyco included each of the following acts except for:

A) Benefits given to certain members of the board of directors to secure their silence about the fraud
B) Corporate assets used by members of top management for personal purposes
C) Setting up special-purpose-entities to keep debt off Tyco's books
D) Related party transactions that were not adequately disclosed

Question 28

Each of the following represents a pressure that might lead to fraud except for:

A) Desire to maximize the value of stock options
B) Budget pressures
C) Meet financial analysts' earnings expectations
D) Ability to carry out the fraud

Question 29

The misappropriation of assets refers to:

A) The deliberate use of company assets for personal reasons
B) The deliberate overstatement of financial statements
C) The deliberate omission of disclosures from the statements
D) All of these

Question 30

PCAOB Auditing Standard No.4 requires that the external auditors should take each of the following steps when reporting on whether a material weakness still exists in the internal controls except for:

A) Evaluate whether management has accepted responsibility for the effectiveness of internal control
B) Evaluate whether management asserts whether the controls are effective in correcting the material weakness
C) Evaluate whether management has obtained sufficient evidence to support its assessment
D) Evaluate whether management has conducted an audit of internal controls

Question 31

The first step for an auditor who concludes an illegal act exists is to:

A) Bring the matter to the attention of the audit committee
B) Bring the matter to the attention of the SEC
C) Assess the impact of the illegal act on the financial statements
D) Assess the impact of the illegal act on the auditor's opinion

Question 32

Backdating options refers to:

A) Crossing out the date of exercise on the option certificate and changing it to an earlier date when the stock price was lower
B) Changing the grant date of the options to lower the exercise price and reduce reported earnings
C) Granting options to employees working for the company in years prior to the granting of the options
D) Changing the future exercise price to correspond market increases in the stock price

Question 33

Members of the audit committee are responsible for each of the following except for:

A) Considering risks identified by the external auditor
B) Assessing whether management has set the appropriate ethical tone for the organization
C) Discussing with the external auditors financial reporting matters of concern
D) Rendering an audit opinion after examining the entity's financial statements and internal controls

Question 34

The auditors' responsibility to communicate findings with respect to fraud can best be summarized as:

A) Communicate to the audit committee the existence of fraud but not the amount involved
B) Communicate to the audit committee both material and immaterial amounts of fraud that are detected
C) Communicate to the SEC the existence of fraud but not the amount involved
D) Communicate to the SEC both material and immaterial amounts of fraud that are detected

Question 35

The Private Securities Litigation Reform Act imposes additional requirements on public companies reporting to the SEC and their auditors when:

A) The illegal act has a material effect on the financial statements
B) Senior management and the board have not acted properly to correct for the act
C) The failure to correct for the action is reasonably expected to warrant a departure from the standard audit report
D) All of these are additional requirements

Question 36

An auditor concludes that a client has committed an illegal act that has not been properly accounted for or disclosed. The auditor should withdraw from the engagement if the

A) Auditor is precluded from obtaining sufficient competent evidence about the illegal act
B) Illegal act has an effect on the financial statements that is both material and direct
C) Auditor cannot reasonably estimate the effect of the illegal act on the financial statements
D) Client refuses to take the remedial steps deemed necessary by the auditors

Question 37

The purpose of the fraud triangle is to identify:

A) The causes of when the audit opinion should be qualified.
B) To identify the causes of and reasons for fraud when there may be intentional misstatements or omissions of amounts or disclosures in the financial statements.
C) To identify the causes of when there is a lack of independence in performing an audit.
D) All of these.

Question 38

In an audit, the auditor has a requirement to address risk assessment with respect to:

A) The design and performance of audit procedures to respond to assessed risks
B) Whether the standards close the expectation gap
C) The role and responsibilities of the audit committee in preventing fraud
D) All of these

Question 39

The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the financial reporting of public companies during the 1998-2007 periods when business failures due to accounting fraud were high and found that:

A) Top management was frequently involved in the fraud with the CEO and/or CFO being the most frequently involved
B) The most common fraud technique involved understating expenses
C) The audit committee always sanctioned the fraud
D) A minority of audit reports issued during the fraud period contained unqualified audit opinions

Question 40

All of the following are in a position to commit fraud except for:

A) Employees who have access to assets
B) Top management who can override internal controls
C) External auditors who audit the financial statements
D) All of these are in a position to commit fraud

Question 41

In the ZZZZ best case, Barry Minkow was sentenced to 5 years for his involvement in

A) A fraudulent insurance restoration scam
B) Insider trading on Lennar stock
C) Stealing from a San Diego church
D) Overcharging a LA housewife for carpet cleaning services

Question 42

Larry is the controller of ABC Industries and has a difference of opinion on an accounting matter with the CFO. Larry is told that the very survival of the company depends on his going along with the proposed accounting treatment that has been approved by the CEO and increases earnings 20 percent above what Larry believes it should be. If Larry goes along with the CFO, he is reasoning at what stage in Kohlberg's model:

A) Stage 1
B) Stage 2
C) Stage 3
D) Stage 4

Question 43

The primary issue discussed in the Krispy Kreme case was:

A) Use of special-purpose-entities to keep debt off the books
B) Use of "round trip" transactions to accelerate the recording of earnings
C) Internal controls over operating activities
D) Internal controls over the making of doughnuts

Question 44

Which is not part of the required links of the chain of command that the controller should follow to inform of a material misstatement in the financial statements?

A) Audit Committee of Board of Directors
B) CEO
C) External auditor
D) CFO

Question 45

In the Imperial Valley Thrift & Loan case, each of the following were reasons for the going concern issue except for:

A) The magnitude of loan losses
B) Insufficient equity capital
C) Operating losses over an extended period of time
D) Questions about the collectability of outstanding loans

Question 46

PCAOB Auditing Standard No.16 require the auditor to communicate with the audit committee all but?

A) Significant accounting policies and practices
B) Critical accounting practices and policies
C) Significant unusual transactions
D) The procedures followed by the auditor in evaluating evidence

Question 47

A study conducted of financial statement restatements during the period of 2007 through 2009 indicated a decline in the number of restatements that were attributed to each of the following except for:

A) Improved audits of financial statements
B) Improved reliability of internal controls
C) A more relaxed approach of the SEC regarding materiality and the need to file restatements
D) Companies making and reporting fewer mistakes or catching fewer mistakes

Question 48

If a company is seeking out views of different accounting firms until they find one with a desired accounting treatment, it would be called _____.

A) Low-balling
B) Under bidding
C) Opinion shopping
D) Option pricing

Question 49

Which of the following is not a consideration in determining a measure of materiality?

A) Risks of material misstatements due to fraud
B) Quantitative assessment of the importance of the difference of opinion with client management on an accounting issues
C) Qualitative assessment of the importance of the difference of opinion with client management on an accounting issues
D) Importance of audit committee in the organization

Question 50

XYZ Company requires that its internal auditor must bring all accounting and financial reporting matters of concern to the CFO and CEO before going to the audit committee. The weakness in internal controls is most likely to lead to which element of the fraud triangle when instances of fraud occur

A) Pressure
B) Opportunity
C) Rationalization
D) Professional skepticism

Question 51

In which of the following circumstances would a qualified opinion be appropriate?

A) The statements are not in conformity with generally accepted accounting principles regarding stock options plans and but does not have pervasive effect on the financial statements.
B) The statements are not in conformity with generally accepted accounting principles regarding stock options plans and has pervasive effect on the financial statements.
C) The auditor has been unable to obtain sufficient competent evidential matter.
D) The principal auditors decide to withdraw from the engagement due to distrust of management.

Question 52

In the Computer Associates case, each of the following allegations were made against the company except for the following:

A) Backdating software contracts into the prior month
B) Executing contracts with preprinted dates from prior quarter
C) Misusing company resources by members of top management
D) Extending quarters by at least 3 business days

Question 53

Which of the following is an example of opinion shopping by a company?

A) Changing auditors due to the quality of work by the auditors
B) Changing auditors due to wanting a different accounting treatment than required by the external auditor
C) Changing auditors due to the size of the audit fees
D) Changing auditors due to conflicts over the nature and scope of the audit

Question 54

Management's attitude toward aggressive financial statement reporting and its emphasis on meeting projected profit numbers would significantly influence an entity's control environment when

A) Internal auditors report to the audit committee
B) The audit committee is active in overseeing the entity's financial reporting
C) Management is dominated by one shareholder with little other governance
D) Management does not have a stock option plan

Question 55

An ethical dilemma for professional accountants is when a conflict exists between each of the following except for:

A) The auditor and client
B) Different accounting members of management
C) The CEO and board of directors
D) All of these

Question 56

Which of the following is not an element of COSO Enterprise Risk Management?

A) Enhancing risk response decisions
B) Reducing operating surprises and losses
C) Seizing opportunities
D) Improving deployment of information technology

Question 57

The framework of COSO Enterprise Risk Management is to

A) Incorporate enhanced internal control principles into enhanced corporate governance
B) Incorporate enhanced audit sampling procedures in the testing of internal controls
C) Incorporate enhanced corporate governance into internal control principles
D) Incorporate enhanced audit sampling procedures in substantive testing

Question 58

Which of the following is not an essential area of fraud considerations assessed by the auditors?

A) Assessing the possibility of fraud
B) Whether management deliberatively committed fraud
C) Identifying risks of fraud
D) Evaluating the characteristics of fraud

Question 59

Which of the following is not true of "reasonable assurance"?

A) The auditors have exercised due care
B) The audit opinion is a guarantee that material misstatements have been identified
C) The audit has been properly planned and supervised
D) The auditors have followed GAAS

Question 60

Because of the risk of material misstatement, an audit of financial statements in accordance with GAAS should be planned and performed with

A) Objective judgment
B) Professional skepticism
C) Internal controls
D) Due care

Question 61

What are the audit committee's responsibilities with respect to fraud and risk assessment? How do such responsibilities relate to the communication that should take place between the external auditor and audit committee?

Question 62

In the Tyco fraud the corporate governance system completely broke down. Explain the failings in the corporate governance system at Tyco and how the Sarbanes-Oxley Act addresses those failings.

Question 63

Kohlberg's model addresses the stages of moral development a person might move through in developing a strong sense of ethics. Analyze each of those stages with respect to the three elements of the fraud triangle. How can an individual resist the temptation to become involve in fraud by possessing the characteristics of behavior included in each stage?

Question 64

Differentiate between the auditors' responsibilities to detect errors, fraud, and illegal acts. How would you assess the ethics of a company that has experienced each event with respect to motivation and the integrity of those who go along with such events?

Question 65

The Groupon case deals with all but the following issues?

A) Improperly estimated customer returns
B) Improper recognition of gross revenue
C) Used a new innovative metric of "Adjusted Consolidated Segment Operating Income"
D) Blamed material weakness on their auditors EY

Question 66

The Dunco Industries case deals with issues related to:

A) The timing of revenue recognition and shipping date of merchandise
B) The timing of revenue recognition and delivery date of merchandise
C) The timing of expense recognition on accrual accounts
D) Manual entries after the quarter's close that lacked sufficient supporting documentation

Question 67

The Audit Client Consideration case deals with issues related to:

A) Acceptance of new clients
B) Issues that arise between the predecessor audit firm and the client
C) Going concern issues raised by previous auditors
D) All of these

Question 68

Campus Fast is a new audit client. Client Fast uses public WiFi to place and deliver restaurant take out for students at the Up and Coming State University. Campus Fast was founded by three highly ambitious MBA students at the university. The business plan is to find a buyer or place an IPO of the company by graduation in two years. The founders expect to pay off all student loans, take a tour around the world and then start another company. In order for the business plan to work on the timeline for graduation, the business must meet highly ambitious earnings numbers. Additionally, the company is dealing with two situations that the founders would like to keep from the auditors:
1) The company has been using free, unsecured public WiFi to take orders via the Internet. The customer may pay via the Internet. Several students, who all happen to be members of the same student organization on campus, are claiming that using Campus Fast has allowed their identity to be stolen. One student is claiming that she had $12,000 of charges on her credit card to the unsecured Internet site of Campus Fast. Management plans to pay off the complaining students and keep the true liability off the balance sheet. The reason is Campus Fast is concerned that an interested buyer may become concerned about the unsecured site and might get scared by the student complaints.
2) The company guarantees fast delivery. It has offered to pay any speeding or other moving violation tickets to its delivery drivers. Unfortunately one of the drivers was involved in an accident due to running a red light. The passenger in the other car is in critical condition and the intensive care unit in the hospital. The driver has promised the family of the passenger that the company will make good on any expenses and admitted the company policy on repaying all traffic tickets. Attorneys for the injured party are threatening to sue and publicize the situation. The founders do not have enough cash to take care of this problem but are still trying to keep the situation from the auditors and potential buyer.
Using the internal control framework from SAS 55, 98, COSO and Enterprise Risk Management, assess the internal controls at Campus Fast and risk environment.

Question 69

Explain the circumstances under which an auditor should give each of the following opinions:
(a) Unmodified opinion
(b) Unmodified opinion with an emphasis-of-matter paragraph
(c) Qualified opinion
(d) Adverse opinion

Question 70

Professional skepticism is considered to be a critical element of conducting an audit. Describe the elements of professional skepticism and how it relates to carrying out an audit in accordance with GAAS.

Question 71

The primary accounting issue in the Royal Ahold case is:

A) Fraudulent recording of revenues on sales to customers
B) Fraudulent use of company resources by top management for personal purposes
C) Fraudulent inflation of promotional allowances to increase operating income
D) Fraudulent inflation of inventory to reduce losses on the income statement
Essay Questions

Question 72

The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the financial reporting of public companies during the 1998-2007 periods when business failures due to accounting fraud were high. Describe the major findings of COSO with respect to financial statement fraud.

Question 73

Describe the steps that auditors should take under Auditing Standard No. 4 of the PCAOB to report on whether a previously reported material weakness still exists.

Question 74

Fannie Mae's financial statements were investigated because of allegations that the company:

A) Deferred derivative losses on the balance sheet thereby inflating profits
B) Used derivatives to hid subprime loans
C) Sold derivatives to increase cash flows prior to bank financing
D) All of these

Question 75

Explain each of the three sides of the fraud triangle with respect to how it contributes toward the possibility that fraud in the financial statements may be present. Are there differences with respect to how each element might influence occupational fraud and fraudulent financial statements? Explain.

Question 76

The First Community Bank case contained each of the following deficiencies except for:

A) The loan loss reserves of the bank were understated
B) The level of impairment of existing bank loans was material
C) The collateral for loans was insufficient
D) All of these

Question 77

Internal controls, an internal audit function, and an audit committee are all elements of a strong corporate governance system. How should an external auditor evaluate these elements in making a risk assessment? What are the ethical signs that each system is operating as intended?

Question 78

Why is materiality one of the most difficult judgments to make in auditing financial statements?