Deck 10: Fraud Auditing

Question 1

Define fraud and distinguish between the two main categories of fraud.

Answer 1

In the context of financial statement auditing, fraud is defined as an intentional misstatement of the financial statements.
The two main categories of fraud are fraudulent financial reporting and misappropriation of assets. Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users of the financial statements. Misappropriation of assets involve theft of an entity's assets.

Question 2

Misappropriation of assets is normally perpetrated at the lowest levels of the organization hierarchy.

Answer 2

True

Question 3

Companies may intentionally understate earnings when income is high to create ________ that may be used in future years to increase earnings.

A) income smoothing
B) cookie jar reserves
C) cash
D) sales

Answer 3

B

Question 4

Fraudulent financial reporting

A) always involves inadequate disclosures.
B) can be intentional or unintentional.
C) can involve understating net income in order to reduce income taxes.
D) all of the above.

Question 5

Most cases of fraudulent reporting involve

A) inadequate disclosures.
B) an overstatement of income.
C) an overstatement of liabilities.
D) an overstatement of expenses.

Question 6

Misappropriation of assets is normally perpetrated by

A) members of the board of directors.
B) employees at lower levels of the organization.
C) management of the company.
D) the internal auditors.

Question 7

According to the Association of Certified Fraud Examiners, losses from misappropriation schemes are higher than losses from financial statement frauds.

Question 8

Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users.

Question 9

________ is fraud that involves theft of an entity's assets.

A) Fraudulent financial reporting
B) A "cookie jar" reserve
C) Misappropriation of assets
D) Income smoothing

Question 10

Which of the following is a form of earnings management in which revenues and expenses are shifted between periods to reduce fluctuations in earnings?

A) fraudulent financial reporting
B) expense smoothing
C) income smoothing
D) Each of the above is correct.

Question 11

"Cookie jar reserves" are often created by companies whenever their earnings are low to create reserves for future periods when earnings need to be "boosted" upward.

Question 12

According to the Association of Certified Fraud Examiners (ACFE), the average company loses ________ percent of its revenues to fraud.

A) one
B) five
C) ten
D) fifteen

Question 13

To counter higher than expected earnings, companies may deliberately overstate bad debt expense and reserves for obsolete inventory.

Question 14

One technique to smooth income is to increase the value of inventory and other assets of an acquired company at the time of the acquisition, resulting in lower earnings when the assets are later sold.

Question 15

Which of the following is a category of fraud?

A)
B)
C)
D)

Question 16

Which of the following best defines fraud in a financial statement auditing context?

A) Fraud is an unintentional misstatement of the financial statements.
B) Fraud is an intentional misstatement of the financial statements.
C) Fraud is either an intentional or unintentional misstatement of the financial statements, depending on materiality.
D) Fraud is either an intentional or unintentional misstatement of the financial statements, depending on consistency.

Question 17

The two main categories of fraud are fraudulent financial reporting and misappropriation of assets.

Question 18

Which of the following is an accurate statement regarding the misappropriation of assets?

A) In most cases, the amounts involved are material to the financial statements.
B) Misappropriation of assets can easily increase in size over time and can lead to significant reputational harm.
C) Management should not be concerned about minor misappropriations.
D) Asset misappropriation schemes are less common than fraudulent financial statement schemes.

Question 19

Fraudulent financial reporting may also involve inadequate disclosures in the financial statements.

Question 20

Fraudulent financial reporting usually involves manipulation of amounts rather than disclosures.

Question 21

Which of the following is not a risk factor that the auditor should take into account when considering the possibility of misappropriation of assets at an audit client?

A) The presence of inventory items which are large in size and low in value
B) Employees with access to cash who have adverse relationships with management
C) The audit client announces required layoffs six months from now
D) An approved vendor list to detect unauthorized or fictitious vendors is not properly controlled

Question 22

Which of the following is a factor that relates to incentives/pressures to misappropriate assets?

A) weak internal controls
B) significant personal financial obligations
C) management's practice of making overly aggressive forecasts
D) anger and fear

Question 23

Incentives and opportunities are two conditions that are generally present when financial statement fraud occurs.

Question 24

Which of the following is a factor that relates to incentives or pressures to commit fraudulent financial reporting?

A) significant accounting estimates involving subjective judgments
B) excessive pressure for management to meet debt repayment requirements
C) management's practice of making overly aggressive forecasts
D) high turnover of accounting, internal audit, and information technology staff

Question 25

Which of the following are elements of the fraud triangle?

A)
B)
C)
D)

Question 26

Which of the following is a risk factor related to opportunities and financial statement fraud?

A) ineffective communication of company values
B) promotions inconsistent with expectations
C) significant related-party transactions
D) adverse relationships between management and employees

Question 27

Which of the following is a factor that relates to attitudes or rationalization to misappropriate assets?

A) significant accounting estimates involving subjective judgments
B) excessive pressure for management to meet debt repayment requirements
C) a sense of superiority by executives
D) high turnover of accounting, internal audit and information technology staff

Question 28

Although the financial statements of all companies are potentially subject to manipulation, the risk is greater for companies that

A) are heavily regulated.
B) have low amounts of debt.
C) have to make significant judgments for accounting estimates.
D) operate in stable economic environments.

Question 29

Which of the following is not a risk factor that the auditor should take into account when considering the possibility of fraudulent financial reporting at an audit client?

A) Significant accounting estimates are not difficult for the auditor to verify and justify.
B) Board members' personal net worth is threatened if the entity's financial performance does not meet market expectations.
C) Increasing business complexity occurs as a result of numerous recent acquisitions.
D) Information technology personnel are found to be not keeping up with the latest trends in internal controls and data security.

Question 30

According to a KPMG survey, which of the following is not often cited as an incentive to engage in fraudulent financial reporting?

A) personal financial incentives
B) the desire to fund an extravagant lifestyle
C) the need to meet pre-specified business performance targets
D) an improvement in the company's financial prospects

Question 31

Which of the following would the auditor be most concerned about regarding a heightened risk of intentional misstatement?

A) Senior management emphasizes that it is very important to beat analyst estimates of earnings every reporting period.
B) Senior management emphasizes that budgeted amounts for expenses are to be achieved for each reporting period or explained in the variance analysis report.
C) Senior management emphasizes that job rotation is a worthwhile corporate objective.
D) Senior management emphasizes that job evaluations are based on performance.

Question 32

Fraud is more prevalent in large businesses than small businesses and not-for-profit organizations.

Question 33

In the fraud triangle, fraudulent financial reporting and misappropriation of assets

A) share little in common.
B) share most of the same risk factors.
C) share the same three conditions of the fraud triangle.
D) share most of the same conditions. of the fraud triangle.

Question 34

Which of the following is not a factor that relates to opportunities to misappropriate assets?

A) inadequate internal controls over assets
B) presence of large amounts of cash on hand
C) inappropriate segregation of duties or independent checks on performance
D) adverse relationships between management and employees

Question 35

According to a KPMG survey, most fraud perpetrators

A) are over the age of 65.
B) work on the assembly line.
C) have worked for the company for over ten years.
D) are female.

Question 36

Which of the following is not a factor that relates to opportunities to commit fraudulent financial reporting?

A) lack of controls related to the calculation and approval of accounting estimates
B) ineffective oversight of financial reporting by the board of directors
C) management's set of ethical values
D) high turnover of accounting, internal audit, and information technology staff

Question 37

Turnover in accounting personnel can create a rationalization for misstatement.

Question 38

List and briefly describe cases and examples of fraudulent financial reporting.

Question 39

Fraud is more prevalent in smaller businesses and not-for-profit organizations because it is more difficult for them to maintain

A) adequate separation of duties.
B) adequate compensation.
C) adequate financial reporting standards.
D) adequate supervisory boards.

Question 40

Relating to opportunities, why do most people commit fraud?

A) They need to fund an extravagant lifestyle.
B) They feel a sense of superiority.
C) There are weak internal controls.
D) They need to meet pre-specified business targets.

Question 41

When assessing fraud risk,

A) fraud risk is assessed only at the overall financial statement level.
B) the auditor's assessment of fraud risk should be ongoing throughout the audit.
C) if the auditor concludes that there is a risk of material misstatement due to fraud, auditing standards require that the risks be treated as pervasive.
D) auditing standards require that the auditor presume there is a risk of fraud in the inventory account.

Question 42

In vertical analysis, the account balance is compared to the previous period, and the percentage change for the period is calculated.

Question 43

Upon discovering information that indicates a material misstatement due to fraud, the auditor must assume that the misstatement is an isolated incident.

Question 44

A common incentive for companies to manipulate financial statements is a decline in the company's financial prospects.

Question 45

Ineffective oversight by the board of directors over financial reporting is an example of an incentives/pressures risk factor.

Question 46

The presence of fraud risk factors increases the likelihood of fraud and may suggest that fraud is being perpetrated.

Question 47

As part of the brainstorming sessions, auditors are directed to emphasize

A)
B)
C)
D)

Question 48

Which of the following is not a likely source of information to assess fraud risks?

A) communications among audit team members
B) inquiries of management
C) analytical procedures
D) consideration of fraud risks discovered during recent audits of other clients

Question 49

List and briefly describe examples of risk factors for each condition of fraud for fraudulent financial reporting.

Question 50

A lack of controls over payments to vendors can cause revenue fraud.

Question 51

Auditing standards require that the auditor presume that there is a risk of fraud in revenue recognition.

Question 52

Upon discovering information that indicates a material misstatement due to fraud may have occurred, auditors should

A) acquire additional evidence as needed.
B) thoroughly probe the issues.
C) consult with other team members.
D) all of the above.

Question 53

When assessing the risk for fraud, the auditor must be cognizant of the fact that

A) the existence of fraud risk factors means fraud exists.
B) analytical procedures must be performed on revenue accounts.
C) horizontal analysis is not useful in helping to determine unusual financial statement relationships.
D) the auditor cannot make inquiries about fraud to company personnel who have no financial statement responsibilities.

Question 54

Which of the following is a true statement regarding professional skepticism?

A) Auditors reject most potential clients perceived as lacking honesty and integrity.
B) If the auditor has past experience with a client, they can assume the client is honest.
C) Material frauds occur in most of the audits of financial statements.
D) Professional skepticism is required only during the planning phase.

Question 55

In the fraud triangle, fraudulent financial reporting and misappropriation of assets share the same conditions and risk factors.

Question 56

List and briefly describe the three conditions for fraud.

Question 57

The pressure to do "whatever it takes" to meet goals is one of the main reasons why financial statement fraud occurs.

Question 58

Information and idea exchange sessions by the audit team are required by current auditing standards.

Question 59

Which of the following questions is the auditor not required to ask company management when assessing fraud risk?

A) Does management have knowledge of any fraud or suspected fraud within the company?
B) What is the nature of the fraud risks identified by management?
C) Is management using all assets effectively?
D) What internal controls have been implemented to address the fraud risks?

Question 60

When the auditor receives inconsistent responses from management and others within the organization, the auditor should obtain additional audit evidence to resolve the inconsistency.

Question 61

Most auditors will encounter a material fraud during their auditing careers.

Question 62

Material frauds are frequent compared to the number of financial statement audit conducted annually in the U.S.

Question 63

Briefly discuss the brainstorming session required by current auditing standards. Be sure to include a list of ideas that should be addressed in the session.

Question 64

Who is responsible for setting the "tone at the top"?

A) management
B) PCAOB
C) audit committee
D) SEC

Question 65

Which of the following parties is responsible for implementing internal controls to minimize the likelihood of fraud?

A) external auditors
B) audit committee members
C) management
D) Committee of Sponsoring Organizations

Question 66

Which of the following is the best reason for management to emphasize fraud prevention and deterrence?

A) It is often more effective and economical for companies to focus on fraud prevention and deterrence rather than on fraud detection.
B) Collusion is impossible to detect.
C) The AICPA requires management to implement a fraud prevention program.
D) All of the above are equally valid reasons.

Question 67

Discuss the need for maintaining professional skepticism during an audit.

Question 68

Auditing standards state that the auditor should focus inquiries regarding fraud with the board of directors and management of their audit clients, and not spend time making inquiries of personnel outside of the normal financial reporting lines of responsibility.

Question 69

If the auditor discovers information indicating a material misstatement due to fraud may have occurred, the auditor should immediately withdraw from the audit engagement.

Question 70

An effective code of conduct should contain the company's policies regarding

A) conflicts of interests.
B) kickbacks.
C) gifts and entertainment.
D) all of the above.

Question 71

When the auditor concludes there is a risk of material misstatement due to fraud, auditing standards do not require to automatically treat those risks as significant risks.

Question 72

The Securities and Exchange Commissions will set up the Office of the Whistleblower sometime in the near future in an effort to combat fraud and offer monetary rewards for being a whistleblower.

Question 73

For significant risks, including fraud risks, the auditor should obtain an understanding of the internal controls related to the risks.

Question 74

Which of the following is not one of the elements to prevent, deter, and detect fraud according to the AICPA?

A) performing analytical procedures
B) culture of honesty and high ethics
C) management's responsibility to evaluate risks of fraud
D) audit committee oversight

Question 75

Research indicates that the most effective way to prevent and deter fraud is to

A) implement programs and controls that are based on core values embraced by the company.
B) hire highly ethical employees.
C) communicate expectations to all employees on an annual basis.
D) terminate employees who are suspected of committing fraud.

Question 76

Which party has the primary responsibility to oversee an organization's financial reporting and internal control process?

A) the board of directors
B) the audit committee
C) management of the company
D) the financial statement auditors

Question 77

Describe the five sources of information gathered to assess fraud risks.

Question 78

Management is responsible for

A)
B)
C)
D)

Question 79

Fraud awareness training should be

A) broad and all-encompassing.
B) extensive and include details for all functional areas.
C) specifically related to the employee's job responsibility.
D) focused on employees understanding the importance of ethics.

Question 80

If the auditor discovers that a current year sale should be recorded in the following year, the auditor should determine if this situation was intentional by the client or fraud committed by the client.