Deck 4: Management Fraud and Audit Risk

Question 1

Auditing standards require that analytical procedures be applied in the beginning stages of each audit.

Answer 1

True

Question 2

The nature of extended procedures for fraud detection is limited to those listed in the Professional Standards and Practices for Certified Fraud Examiners.

Answer 2

False

Question 3

Control risk should not be assessed so low that auditors place complete reliance on controls and do not perform any other audit work.

Answer 3

True

Question 4

Knowledge and understanding of a client's business is absolutely essential in completing an audit.

Question 5

Fraud consists of knowingly making material misrepresentation of fact with the intent of inducing someone to believe the falsehood and suffer a loss.

Question 6

Audit care and attention should be greater where business and inherent risks are judged to be lower.

Question 7

The audit risk model assumes that elements of audit risk are independent and therefore multiplicative.

Question 8

Frauds are unintentional misstatements or omissions of accounts or disclosures in financial statements.

Question 9

Auditors look for relationships that do not make sense as indicators of problems in the accounts and use such indicators to plan further audit work.

Question 10

Generally,fraudulent financial statements show financial performance and ratios that are better than current industry experience.

Question 11

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.

Question 12

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

A) Employee misappropriation of assets.
B) Management fraud.
C) Client fraud on customers.
D) Employee embezzlement.

Question 13

The auditing profession official standard for an acceptable level of overall audit risk is 0.05 at the current level.

Question 14

Audit risk (AR)is a quality criterion based on professional judgment.

Question 15

Management fraud generally refers to

A) Unintentional mistakes.
B) Noncompliance.
C) Intentional distortions of financial statements.
D) Violations of GAAS.

Question 16

The demographics of white-collar criminals are similar to those of typical bank robbers.

Question 17

Analytical procedures are considered to be "soft" evidence and therefore considered ineffective.

Question 18

Knowledge of the client's business from preliminary analytical procedures can help auditors identify problem areas and make broad risk assessments.

Question 19

Detection risk occurs when internal control activities fail to detect material misstatements.

Question 20

Audits are not designed to detect material errors and fraud in financial statements.

Question 21

The existence of audit risk is recognized by the statement in the auditor's standard report that the

A) Auditor is responsible for expressing an opinion on the financial statements, which are the responsibility of management.
B) Financial statements are presented fairly, in all material respects, in conformity with applicable financial reporting framework.
C) Audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.
D) Auditor obtains reasonable assurance about whether the financial statements are free of material misstatement.

Question 22

The risk of material misstatement differs from detection risk in that it

A) Arises from the misapplication of audit procedures.
B) May be assessed in either quantitative or nonquantitative terms.
C) Exists independently of the financial statement audit.
D) Can be changed at the auditor's discretion.

Question 23

When determining the inherent risk related to an account balance,an auditor theoretically does not explicitly consider the

A) Liquidity of the account.
B) Degree of management estimation involved in determining the proper account balance.
C) Related internal control policies and procedures.
D) Complexity of calculations involved.

Question 24

If control risk increases and all other risks in the audit risk model stay constant except the one referred to below,which of the following statements is correct?

A) Detection risk will decrease.
B) Inherent risk will increase.
C) Audit risk will decrease.
D) Detection risk will increase.

Question 25

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.

Question 26

If fictitious credit sales were recorded and the fictitious accounts receivable were later directly written off as bad debt expense

A) Income would be overstated.
B) Income would be understated.
C) Income would not be misstated.
D) Accounts receivable would be understated.

Question 27

Which of the following statements best describes auditors' responsibility to detect errors and frauds?

A) Auditors should design an audit to provide reasonable assurance of detecting errors and frauds that are material to the financial statements.
B) Auditors are responsible to detect material errors but have no responsibility to detect material frauds that are concealed through employee collusion or management override of the internal control structure.
C) Auditors have no responsibility to detect errors and frauds unless analytical procedures or tests of transactions identify conditions causing a reasonably prudent auditor to suspect that the financial statements were materially misstated.
D) Auditors have no responsibility to detect errors and frauds because auditors are not insurers and an audit does not constitute a guarantee.

Question 28

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements most likely would withdraw from the engagement if

A) The noncompliance is a violation of generally accepted accounting principles.
B) The client does not take the remedial action that the auditor considers necessary.
C) The illegal act was committed during a prior year that was not audited.
D) The auditor has already assessed control risk at the maximum level.

Question 29

Inherent risk is the

A) Probability that some accounts are more susceptible to misstatement than others.
B) Probability that the client's internal control policies and procedures will fail to detect material misstatements.
C) Probability that material misstatements have occurred in transactions entering the accounting system used to develop financial statements.
D) Probability that the auditor may not detect material misstatements in the financial statements.

Question 30

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.

Question 31

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.

Question 32

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 an indirect material 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.

Question 33

The acceptable level of detection risk is inversely related to the

A) Assurance provided by substantive tests.
B) Risk of misapplying audit procedures.
C) Preliminary judgment about materiality levels.
D) Risk of failing to discover material misstatements.

Question 34

Based on audit evidence gathered and evaluated,an auditor decides to increase the assessed level of control risk from that originally planned.To achieve an overall audit risk level that is substantially the same as the planned audit risk level,the auditor would

A) Decrease substantive testing.
B) Decrease detection risk.
C) Increase inherent risk.
D) Increase materiality levels

Question 35

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.

Question 36

When an auditor becomes aware of possible noncompliance by a client,the auditor should obtain an understanding of the nature of the act to

A) Evaluate the effect on the financial statements.
B) Determine the reliability of management's representations.
C) Consider whether other similar acts may have occurred.
D) Recommend remedial actions to the audit committee.

Question 37

The probability that an audit team will give an inappropriate opinion on financial statements best describes

A) Audit risk.
B) Inherent risk.
C) Control risk.
D) Detection risk.

Question 38

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.

Question 39

An audit team uses the assessed risk of material misstatement to

A) Evaluate the effectiveness of the entity's internal control policies and activities.
B) Identify transactions and account balances where inherent risk is at the maximum.
C) Indicate whether materiality thresholds for planning and evaluation purposes are sufficiently high.
D) Determine the acceptable level of detection risk for financial statement assertions.

Question 40

The risk that an auditor's procedures will lead to the conclusion that a material misstatement does not exist in an account balance when,in fact,such misstatement actually exists is

A) Audit risk.
B) Inherent risk.
C) Control risk.
D) Detection risk.

Question 41

Horizontal analysis refers to

A) The trend of income from year to year of persons suspected of fraud.
B) Changes of financial statement numbers and ratios across several years.
C) Financial statement amounts expressed each year as a proportion of a base amount.
D) The change in a suspect's net worth from the beginning to the end of a period.

Question 42

Generally accepted auditing standards state that analytical procedures

A) Should be applied in the planning and final review stages of the audit and as a substantive test during the audit.
B) Should be applied in the planning and final review stages of the audit and can be used as a substantive test during the audit.
C) Should be applied in the planning stage and can be applied as a substantive test in the final review stage.
D) Should be applied in the final review stage and can be applied as a substantive test in the planning stage.

Question 43

Analytical procedures used in planning an audit should focus on

A) Reducing the scope of tests of controls and substantive tests.
B) Providing assurance that potential material misstatements will be identified.
C) Enhancing the auditor's understanding of the client's business.
D) Assessing the adequacy of the available evidential matter.

Question 44

The auditor uses the assessed level of risk of material misstatement to determine the acceptable level of detection risk for financial statement assertions.As the acceptable level of detection risk decreases,the auditor may do one or more of the following except change the

A) Nature of substantive tests to more effective procedures.
B) Timing of substantive tests, such as performing them at year-end rather than at an interim date.
C) Extent of substantive tests, such as using larger sample sizes.
D) Assurances provided by substantive tests to a lower level.

Question 45

Sources of financial and nonfinancial data do not include

A) Financial account information for comparable prior periods.
B) Nonfinancial information such as physical production statistics.
C) Company budgets and forecasts.
D) Bureau of Labor statistics.

Question 46

Which of the following would not likely be found in the minutes of the board of directors?

A) Amount of dividends declared.
B) Approval to pledge assets as security for debts.
C) Authorization of officers' salaries.
D) Approval of a new desktop computer for the controller.

Question 47

What assurance does the auditor provide that errors,frauds,and direct effect noncompliance that are material to the financial statements will be detected?

A) Errors: limited; frauds: negative; direct effect noncompliance: limited.
B) Errors: limited; frauds: limited; direct effect noncompliance: reasonable.
C) Errors: reasonable; frauds: limited; direct effect noncompliance: limited.
D) Errors: reasonable; frauds: reasonable; direct effect noncompliance: reasonable.

Question 48

An auditor who encounters significant risks at the client should do all of the following except

A) Inform the SEC.
B) Perform extended procedures.
C) Include more experienced auditors on the engagement.
D) Perform tests closer to year-end.

Question 49

The type of financial analysis that expresses balance sheet accounts as percentages of total assets is known as:

A) Horizontal analysis.
B) Vertical analysis.
C) Net worth analysis.
D) Expenditure analysis.

Question 50

Which of the following is not required by AU 240,"Consideration of Fraud in a Financial Statement Audit"?

A) Conduct a continuing assessment of the risks of material misstatement due to fraud throughout the audit.
B) Conduct a discussion by the audit team of the risks of material misstatement due to fraud.
C) Conduct the audit with professional skepticism, which includes an attitude that assumes balances are incorrect until verified by the auditor.
D) Conduct inquiries of shareholders as to their views about the risks of fraud and their knowledge of any fraud or suspected fraud.

Question 51

Analytical procedures are audit methods of evaluating financial statement accounts by studying and comparing relationships among financial and nonfinancial data.The primary purpose of analytical procedures conducted during the planning stages is to

A) Identify the appropriate schedules to be prepared by the client.
B) Identify the types of errors or frauds that can occur in transactions.
C) Identify unusual conditions that deserve additional audit effort.
D) Determine the existence of unrecorded liabilities or overstated assets.

Question 52

Experience has shown that the many large fraudulent transactions can be found in

A) Systematic processing of large volumes of day-to-day ordinary transactions.
B) Payroll fraudsters' mistakes in using unissued Social Security numbers.
C) Petty cash embezzlements.
D) Nonroutine, nonsystematic journal entries.

Question 53

For audits of financial statements made in accordance with generally accepted auditing standards,the use of analytical procedures is required to some extent

A) As a substantive test: yes; in the final review stage: yes
B) As a substantive test: yes; in the final review stage: no
C) As a substantive test: no; in the final review stage: yes
D) As a substantive test: no; in the final review stage: no

Question 54

Assume that application of analytical procedures revealed significant unexplained differences between recorded amounts and the expectations (estimates)developed by the auditor.If management is unable to provide an acceptable explanation,the auditor should

A) Consider the matter a scope limitation.
B) Perform additional audit procedures to investigate the matter further.
C) Intensify the audit with the expectation of detecting management fraud.
D) Withdraw from the engagement.

Question 55

Which of the following pieces of information discovered by an auditor when performing substantive tests of account balances would most likely raise red flags about the possible existence of material fraudulent financial reporting?

A) Paper copies of paid invoices and cancelled checks were microfiched and then destroyed.
B) The controller requires that you schedule any audit inquiries daily after lunch, not in the morning.
C) The petty cash fund custodian never takes a vacation.
D) The client's estimate of the allowance for doubtful accounts is lower than the auditor's independent evaluation of the allowance.

Question 56

Jones,CPA,is auditing the financial statements of XYZ Retailing,Inc.What assurance does Jones provide that direct effect noncompliance that is material to XYZ's financial statements and noncompliance that has a material but indirect effect on the financial statements will be detected?

A) Direct effect noncompliance: Reasonable; indirect effect noncompliance: none.
B) Direct effect noncompliance: Reasonable; indirect effect noncompliance: reasonable.
C) Direct effect noncompliance: Limited; indirect effect noncompliance: none.
D) Direct effect noncompliance: Limited; indirect effect noncompliance: reasonable.

Question 57

Inherent risk and control risk differ from detection risk in that inherent risk and control risk are

A) Elements of audit risk whereas detection risk is not.
B) Changed at the auditor's discretion whereas detection risk is not.
C) Considered at the individual account balance level whereas detection risk is not.
D) Functions of the client and its environment whereas detection risk is not.

Question 58

An auditor who increases the planned assessed level of control risk because certain control activities were determined to be ineffective would most likely increase the

A) Extent of substantive tests of details.
B)

Question 59

In the planning stage,analytical procedures are used to

A) Identify potential problem areas.
B) Provide direct evidence about the balances in accounts.
C) Determine the mathematical correctness of the financial statements.
D) All of the above.

Question 60

Which of the following accounts tends to be most predictable for purposes of analytical procedures?

A) Accounts receivable.
B) Travel and entertainment expense.
C) Interest expense.
D) Income taxes payable.

Question 61

If tests of controls induce the audit team to change the assessed level of control risk for fixed assets from 0.4 to 1.0 and audit risk (0.05)and inherent risk remain constant,the acceptable level of detection risk is most likely to

A) Change from 0.1 to 0.04.
B) Change from 0.2 to 0.3.
C) Change from 0.25 to 0.1.
D) Be unchanged.

Question 62

Under the Private Securities Litigation Reform Act,independent auditors are required to

A) Report in writing all instances of noncompliance to the client's board of directors.
B) Report to the SEC all instances of noncompliance they believe have a material effect on financial statements if the board of directors does not first report to the SEC.
C) Report clearly inconsequential noncompliance to the audit committee of the client's board of directors.
D) Resign from the audit engagement and report the instances of noncompliance to the SEC.

Question 63

The risk of material misstatements is composed of which audit risk components?

A) Inherent risk and control risk.
B) Control risk and detection risk.
C) Inherent risk and detection risk.
D) Inherent risk, control risk, and detection risk.

Question 64

Which of the following engagement planning procedures would most likely assist the auditor in identifying related-party transactions before the balance-sheet date?

A) Interviewing internal auditors about their reporting responsibilities.
B) Reviewing accounting records for recurring transactions occurring near year-end.
C) Inspecting communications with the client's legal counsel regarding recorded contingent liabilities.
D) Scanning the minutes for significant transactions with members of the board of directors.

Question 65

If sales were overstated by recording a false credit sale at the end of the year,where could you find the false "dangling debit"?

A) Inventory.
B) Cost of goods sold.
C) Bad debt expense.
D) Accounts receivable.

Question 66

The purpose of an audit strategy is

A) To provide a defense against litigation.
B) To gain an understanding of the client.
C) To comply with securities law.
D) To set the scope, timing, and direction for auditing each relevant assertion.

Question 67

Which of the following circumstances would most likely cause an audit team to perform extended procedures?

A) Supporting documents are produced when requested.
B) The client made several large adjustments at or near year-end.
C) The company has recently hired a new chief financial officer after the previous one retired.
D) The company maintains several different petty cash funds.

Question 68

Auditing standards do not require auditors of financial statements to

A) Understand the nature of errors and frauds.
B) Assess the risk of occurrence of errors and frauds.
C) Design audits to provide reasonable assurance of detecting errors and frauds.
D) Report all errors and frauds found to police authorities.

Question 69

The auditors assessed risk of material misstatement at 0.50 and said they wanted to achieve a 0.05 risk of failing to express a correct opinion on financial statements that were materially misstated.What detection risk do the auditors plan to use for planning the remainder of the audit work?

A) 0.20.
B) 0.10.
C) 0.75.
D) 0.00.

Question 70

The risk that the auditors' own procedures will lead to the decision that material misstatements do not exist in the financial statements when in fact such misstatements do exist is

A) Audit risk.
B) Inherent risk.
C) Control risk.
D) Detection risk.

Question 71

Which of the following is an acceptable response to fraud risks related to sales that were identified in an audit?

A) Exercise professional skepticism when performing sales testing.
B) Increase the assessment of control risk for sales.
C) Increase the assessment of detection risk for sales.
D) Perform additional substantive sales procedures on a surprise basis.

Question 72

If tests of controls induce the auditor to change the assessed level of control risk for property plant & equipment from 50 percent to 100 percent and audit risk (6 percent)and inherent risk remain constant,the acceptable level of detection risk

A) Would most likely change from 10 percent to 5 percent.
B) Would most likely change from 20 percent to 40 percent.
C) Would most likely change from 30 percent to 15 percent.
D) Would be unchanged because the auditor has control over detection risk.
E) Cannot be determined because inherent risk is not given.

Question 73

Which of the following is a specific procedural response to a particular fraud risk in an account balance or class of transactions?

A) Exercising more professional skepticism.
B) Carefully avoiding conducting interviews with people in the fraud-rich areas.
C) Performing procedures such as inventory observation and cash counts on a surprise or unannounced basis.
D) Studying management's selection and application of accounting principles more carefully.

Question 74

The likelihood that material misstatements may have entered the accounting system and not been detected and corrected by the client's internal control is referred to as

A) Inherent risk.
B) Control risk.
C) Detection risk.
D) Risk of material misstatement.

Question 75

One of the typical characteristics of management fraud is

A) Falsification of documents in order to misappropriate funds from an employer.
B) Victimization of investors through the use of materially misleading financial statements.
C) Illegal acts committed by management to evade laws and regulations.
D) Conversion of stolen inventory to cash deposited in a falsified bank account.

Question 76

Managing business risk is the responsibility of

A) The auditors.
B) Management.
C) The SEC.
D) The PCAOB.

Question 77

Auditors would use the enterprise risk model

A) To reduce the client's business risk.
B) To determine detection risk.
C) To evaluate management's risk assessment.
D) To monitor client risk.

Question 78

Auditors are responsible for the quality of the work related to management and control of

A) Inherent risk.
B) Business risk.
C) Control risk.
D) Detection risk.

Question 79

It is acceptable under generally accepted auditing standards for an audit team to

A) Assess risk of material misstatement at high and achieve an acceptably low audit risk by performing extensive detection work.
B) Assess control risk at zero and perform a minimum of detection work.
C) Assess inherent risk at zero and perform a minimum of detection work.
D) Decide that audit risk can be 40 percent.

Question 80

Auditors use brainstorming

A) To heighten the audit team's awareness of fraud potential.
B) To heighten management's awareness of fraud potential.
C) To determine detection risk.
D) To set materiality.