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Unformatted text preview: Chapter 9: Auditing for Fraud Key 1. Since management can collude to perpetrate a fraud, the auditor has limited responsibility for
detecting fraud in the financial statements.
FALSE 2. An example of a defalcation is the CFO intentionally overstating the accounts receivable and
sales to boost profits.
FALSE 3. The auditor of financial statements has a responsibility to actively consider fraud in order to
obtain reasonable assurance that financial statements are free of material fraud.
TRUE 4. According to the Association of Certified Fraud Examiners, corruption includes the act of
accepting undue payments from suppliers to accept products into the organization.
TRUE 5. It is considered fraud for an employee of an organization to wrongly use influence to procure a
personal benefit that is contrary to their duty to the organization.
TRUE 6. An example of financial statement manipulation is the treasurer's diversion of hundreds of
thousands of dollars into a personal money market account.
FALSE 7. BruceCo. has accounted for the revenue of Jiffy Mac, Inc., one of its suppliers as though it
were its subsidiary. BruceCo only owns 2% of Jiffy and does not exercise any influence or
control, nor is it considered a Variable Interest Entity. BruceCo. has probably committed fraud
because of its blatant misapplication of consolidation principles.
TRUE 8. Consideration of fraud in financial statement audits is a relatively new concept derived
originally from SAS 99.
FALSE 9. The most important lesson to be learned from the famous “salad oil case” is that a client can
commit fraud by falsely moving inventory during a physical count to overstate the inventory
TRUE 10. The onslaught of fraud in financial statements over the recent decade has been the first of its
kind in history.
FALSE 11. SAS 99 requires the auditor to more actively consider and assess the risk of fraud for clients
and their financial statements than had been required in the past.
TRUE 12. SAS 99 procedures must only be performed for clients that have had fraud concerns in the
FALSE 13. If an auditor discovers risk of fraud in the application of SAS 99 procedures, the audit
procedures should be adjusted accordingly.
TRUE 14. Professional skepticism is required on audit engagements that have a high risk of fraud but
can be disregarded for audit engagements with low risk of fraud.
FALSE 15. According to professional audit standards, the audit team should meet 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.
TRUE 16. Once the fraud assessment is complete in the planning stage, the auditor need not consider
FALSE 17. Pressure perceived by management to manipulate financial information is a common
characteristic in fraud cases
TRUE 18. Management compensation that is tied to profits may contribute to incentives to commit
TRUE 19. Management may feel pressure to maintain debt covenants, which is a deterrent to fraud.
FALSE 20. Internal controls are implemented in order to give perpetrators the impression that the risk of
being caught is low.
FALSE 21. Complex transactions such as derivative instruments provide management certain
opportunities to manipulate financial statements to its advantage.
TRUE 22. A board of directors that is actively involved in monitoring management mitigates
opportunities to commit fraud.
TRUE 23. Rules based accounting sometimes contributes to the rationalization of financial reporting
TRUE 24. The auditor should not presume that fraud is present in revenue recognition by management
because the auditor must remain objective.
FALSE 25. Management rarely uses journal entries to commit fraud because they are easily noticed by
FALSE 26. Auditors must keep a questioning mind when analyzing management responses to inquiry
and they should strive to obtain corroborating evidence before accepting the responses.
TRUE 27. The auditor must perform a brainstorming meeting with client management in order to plan
the procedures to be performed and the inventory locations to be visited.
FALSE 28. Channel stuffing is often a form of fraud by financial manipulation and can be noticed by the
auditor by performing analytical procedures directed toward the discovery of fraud indicators.
TRUE 29. One fraud risk factor includes the presence of domineering members of management who
seek the ultimate loyalty of subordinates.
TRUE 30. The audit team should develop its own idea about how fraud may be perpetrated and hidden
by the client.
TRUE 31. Audit tests do not relate to fraud testing because fraud testing will be performed in a different
FALSE 32. When the risk of fraud is high in financial statements, the auditor should assign less
experienced auditors to the engagement.
FALSE 33. Types of fraud should be hypothesized by the auditor after performing analytical procedures
for the discovery of fraud factors.
TRUE 34. When fraud risk is high in the organization under audit, the nature, timing and extent of
procedures applied will likely need to be changed.
TRUE 35. Management fraud must be immediately reported by the auditor to the SEC rather than
wasting time reporting it to the audit committee or board of directors.
FALSE 36. Forensic accountants need to have superior interviewing and people skills.
TRUE 37. The focus of forensic accounting is similar to financial statement auditing in that it is directed
to the fairness of financial statements.
FALSE 38. Auditors are responsible to detect all illegal acts committed by the company and its
FALSE 39. The landmark Enron fraud in the early 2000's involved the movement of significant debt off
the books to related, unconsolidated entities.
TRUE 40. An ideal method of footing a large report and recalculating extensions is the use of
generalized audit software to extract the data and perform the test.
TRUE 41. When weaknesses in internal control are found, the auditor should develop audit procedures
to explicitly test for the existence of the type of fraud or misstatement that could occur because
of the weakness.
TRUE 42. For illegal acts that have a direct effect on the financial statements, the auditor has a
responsibility to design the audit to provide reasonable assurance of detecting material
TRUE 43. When preliminary fraud risk is high the auditor should pay close attention to areas of the
audit that are highly subjective and increase the predictability of the audit procedures.
FALSE 44. The auditor can be satisfied with less than persuasive evidence in the audit process because
of the believe that management is honest.
FALSE 45. Professional skepticism involves such things as questioning and corroborating management
responses to inquiries and determining the authenticity of documents.
TRUE 46. Audits of financial statements are valuable to the detection of fraud because:
A. Auditors are not required to seek out and find all fraud.
B. Auditors expect that management will make them aware of any fraud in the financial
C. Society expects that the auditor will ensure that financial statements have not been materially
misstated due to fraud.
D. Society realizes that some fraud is not capable of being discovered by auditors. 47. Detection of fraud is integral to the audit function. The best reason for this is that:
A. unless auditors can provide assurance that the financial statements are free of material
misstatements due to fraud, there is no justification for the audit function.
B. the AICPA has mandated that the auditor take on more responsibility than previously required
because of management's demand for fraud finding.
C. it is the responsibility of the auditor to provide internal control over a client organization
sufficient to discover or prevent fraud from occurring.
D. auditor fraud is a large concern of shareholders and the audit committee must continually
monitor the auditors to ensure they are not misstating financial statements. 48. Which of the following represents the size of company that has most commonly committed
fraud in its financial reporting and by its employees?
A. Large corporations.
B. Middle-market corporations.
C. Small and start-up companies.
D. All companies. 49. What is the primary determinate in the difference between fraud and errors in financial
A. The materiality of the misstatement.
B. The intent to deceive.
C. The level of management involved.
D. The type of transaction effected. 50. Which of the following is not an example of a type of defalcation?
A. A warehouse employee takes home two units of electronic entertainment inventory each week
B. The president of the company utilizes the organization's cash to add a floor to her 15,000
square foot house.
C. The chief financial officer of the company falsely adds $20 million to the accounts receivable
and revenue accounts.
D. The treasurer of the company makes an unauthorized wire transfer from the organization's
bank to a personal account in Grand Cayman. 51. Which of the following best represents financial statement fraud?
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 a contingent liability 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. 52. According to professional auditing standards, which of the following best represents a type
of financial reporting fraud that might occur?
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 increasing cash and also increasing a
C. Management discloses its failure to meet loan covenants but states that a waiver has been
D. Management intentionally excludes a material subsidiary from its consolidated results that it
controls significantly. 53. Which of the following would most likely be considered intentional misapplication of
accounting principles on financial statements?
A. A capital lease is presented as periodic rent expense rather than interest and depreciation.
B. A deferred tax asset is reduced to zero with a valuation allowance.
C. Insurance is amortized.
D. Revenues for up-front fees are deferred rather than recognized immediately. 54. Which of the following is most likely considered a material omission from the rules of
financial statement reporting?
A. The company no longer discloses a previously settled contingency.
B. The company does not present the fair value of all current assets on the balance sheet.
C. A privately held company does not disclose earnings per share.
D. A company with a net loss does not present a statement of cash flows. 55. Which of the following is an example of a common type of financial reporting fraud?
A. Capitalizing major overhauls to operating equipment.
B. Deferring service revenue until it is delivered to customers.
C. Recording sales for inventory sold with the right to return.
D. Excluding a contingent liability that has been settled. 56. Which of the following best represents an example of fraud utilizing the lapping technique?
A. An employee transfers cash on the last day of the year in order to double record it in the bank
B. An employee creates a fictional vendor and requests payment to a personal P.O. box.
C. An employee opens the mail to cover up payroll fraud received on a fictional person.
D. An employee covers up the stealing of receipts by posting to the wrong customer accounts. 57. Which of the following are most often involved in perpetrating fraud in financial statement
A. The auditors and the attorneys.
B. The audit committee members.
C. The chief executive and chief financial officers.
D. The accounts payable clerks. 58. What is the best method an auditor may use to detect fraud in the financial statements of
A. Use professional skepticism.
B. Understand and properly apply Generally Accepted Accounting Standards.
C. Brainstorm with the client to find the types of fraud occurring.
D. Actively search for all errors in the financial statements. 59. The audit of financial statements includes the initial approach of addressing fraud. How must
an auditor address fraud in the planning stage?
A. The auditor must test for fraud in the planning stage by sampling accounts.
B. The auditor must consider the likelihood of fraud existing in the company in the planning
C. The auditor must realize that most people are honest and not automatically assume that fraud
exists when planning the audit.
D. The auditor must not be aggressive in its initial approach to fraud as trust may be lost by the
client. 60. If the audit team discovers that fraud risk factors are present on an engagement, it should
A. resign from the client and inform the audit committee and regulatory authorities.
B. modify procedures to actively search for the existence of fraud.
C. reduce the amount of evidence required and resort to management inquiry.
D. turn the audit over to forensic accountants. 61. The threshold of materiality may be lowered in the case of potential fraud in the financial
statements under audit. Why is this different from the usual materiality levels set by auditors?
A. The intentional act of committing fraud itself becomes material, regardless of dollar amounts.
B. Fraud is not relative to internal control, which requires larger materiality limits.
C. The act of fraud is a characteristic of certain types of managers, therefore, materiality is
D. Normal audit procedures are designed to catch all fraud, even the smallest of infractions. 62. Which of the following best represents actions that may indicate fraud is pervasive
throughout the company under audit?
A. The company's management negotiates deals with vendors in such a manner as to pay lower
B. The company's management drives luxury vehicles and takes personal vacations to exotic
C. The company's management takes an overly aggressive approach to revenue recognition.
D. The company's management estimates bad debts using an aged accounts receivables ledger
rather than as a percent of sales. 63. Professional skepticism is best described as:
A. an intent to deceive.
B. an attitude of intrusion and obstinacy.
C. a character that does not waver.
D. a questioning mind. 64. According to professional audit standards, how might an understanding of the nature of fraud
that may occur in the client organization best be identified by the audit firm?
A. Fraud training courses from actual corporate fraud ex-criminals.
B. Conducting a brainstorming meeting with the members of the audit team.
C. Circulating a survey to the client company employees for completion.
D. Discussions with other CPA firms. 65. Which of the following is required of the audit team relative to its consideration of fraud in a
financial statement audit?
A. Documentation in the audit file.
B. Communication with the AICPA.
C. Modification of client financial records.
D. Termination of the manager responsible for the fraud. 66. What is the greatest benefit that can be derived by discussing fraud factors with management
of the client organization under audit?
A. Greater credibility with the client organization and its management.
B. The impression on the client that potential fraud is not being considered by an independent
C. Further consideration of the risks, and discussion of how management can reduce the risks.
D. Full disclosure of all fraud occurring during the year under audit in the company. 67. Which of the following risks of fraud should ordinarily be presumed on a financial statement
audit by the audit team?
A. Chief financial officer misappropriation of funds.
B. Misapplication of revenue recognition principles.
C. Management's inappropriate use of reserves.
D. Lack of expenses related to stock options. 68. Relative to internal controls, what is a primary risk of fraud in the client company?
A. The risk that management overrides controls.
B. The risk that management changes controls each year.
C. The risk that management carefully enforces and monitors controls.
D. The risk that the audit committee monitors controls. 69. How will the results of the auditor's assessment of fraud risk factors further affect the
planned audit procedures?
A. Audit procedures and fraud assessment do not relate.
B. The assessment may require a re-audit of previous periods.
C. By the assignment of qualified audit staff to risky areas of the engagement.
D. Management will be called upon to assist in coordinating audit procedures. 70. When is the assessment of fraud risk on a single engagement completed by the audit team?
A. Upon completion of the planning stage.
B. Once internal control is understood.
C. Only after the audit risk model has been used to design tests.
D. Once the audit is complete. 71. Protection Transparency, Inc. is being audited by Messer and Bromely, LLP. During the
assessment of fraud, Messer and Bromely discover that the controller has been creating fictional
sales and posting them to the general ledger. Who should the auditors make aware of this issue?
A. Protection Transparency's legal counsel.
B. The federal law enforcement agency.
C. The chairman of Protection Transparency's audit committee.
D. The predecessor auditor of Protection Transparency. 72. 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 upon the above information only, what type of probable motivation is there to
commit fraud at the Premium Discovery Company?
D. Expectation. 73. 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. 74. Wafflemart Corporation is a leader in its industry. It commands suppliers and is the envy of
its competitors with its ability to name its price to customers. Management is compensated with a
relatively high level of stock options. The Company has consistently met analysts expectations
for stock price performance for each of the last 32 quarters. What are the typical motivators of
Wafflemart's situation noted above?
A. Wafflemart has pressure to commit fraud.
B. Wafflemart has incentive to commit fraud.
C. Wafflemart has opportunity to commit fraud.
D. Wafflemart has rationalization to commit fraud. 75. Sam Jones, controller of Mitnikco, spends three days researching the accounting statements
to find loopholes in the "rules" and to make a case for recognizing revenue earlier, rather than in
later years. In the end, this enables the Company to achieve its earnings targets. What are the
motivations of Mitnikco management based solely on the information above?
D. Skepticism 76. There are many important reasons to diligently plan for an audit. If an audit firm wrongly
skips the planning stage of an audit, what will be detrimental relative to fraud?
A. The firm will not be able to apply GAAP to the financial statements.
B. The firm will not adequately identify the types of fraud that may occur in the client company.
C. The firm will not be able t...
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- Spring '17
- Nha Khanh