Deck 11: Fraud Auditing

Question 1

Which of the following is a category of fraud?

A)
B)
C)
D)

Answer 1

A

Question 2

Which of the following is one of the conditions for fraud described in SAS No. 99?

A)
B)
C)
D)

Answer 2

A

Question 3

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

Answer 3

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 statement. Misappropriation of assets involve theft of an entity's assets.

Question 4

Financial statement manipulation risk is arguably present for all companies' financial statements. However, the risk is elevated for companies that:

A) are heavily regulated.
B) have foreign subsidiaries.
C) have to make significant judgments for accounting estimates.
D) operate in stable economic environments.

Question 5

Determine from the following the factor that would most likely elevate the auditor's concern about the risk of financial statement fraud.

A) company cannot borrow debt capital without restrictive covenants
B) company finds it difficult to sell equity capital for expansion
C) company has a significant portion of liquid assets on its balance sheet
D) company reports substantial net income but ever decreasing cash flow from operations

Question 6

Who is most likely to perpetrate fraudulent financial reporting?

A) members of the board of directors
B) production employees
C) management of the company
D) the internal auditors

Question 7

________ 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 8

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 9

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

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

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 practice of making overly aggressive forecasts.
D) High turnover of accounting, internal audit, and information technology staff.

Question 12

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 13

Companies may intentionally understate earnings when income is high to create a reserve of "earnings" that may be used in future years to increase earnings. This practice is known as:

A) performance-based management.
B) earnings management.
C) asset management.
D) expense management.

Question 14

With respect to misappropriation of assets, most frauds involve:

A)
B)
C) Yes No
D)

Question 15

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

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

In the context of financial statement auditing, fraud is defined as an intentional misstatement of a material fact regarding balances, transactions or presentation of the financial statements.

Question 18

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

Question 19

Fraud is more prevalent in smaller businesses and not-for-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 20

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

Question 21

Auditors should consider risk factors related to incentives, opportunities, and attitudes whenever they assess the likelihood of material misstatements due to fraud.

Question 22

List and briefly describe the three conditions for fraud arising from fraudulent financial reporting and misappropriation of assets as described in SAS No. 99.

Question 23

An example of a fraud risk factor describing opportunities is "ineffective board of director oversight over financial reporting."

Question 24

Auditor's need to exhibit professional skepticism when auditing a client. This auditing standard is best expressed by which of the following?

A) the auditor neither assumes dishonesty or honesty of management
B) the auditor assumes dishonesty of management
C) the auditor assumes honesty of management
D) the auditor assumes management lacks integrity

Question 25

An example of a fraud risk factor describing incentives/pressures is "ineffective board of director oversight over financial reporting."

Question 26

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 27

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

Question 28

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.
D) share most of the same conditions.

Question 29

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 30

While performing their audit, the audit team uncovers fraud that is likely to have an immaterial affect on the financial statements taken as whole. In this case the auditors should:

A) plan on additional audit procedures to determine the exact amount of the fraud.
B) communicate with legal authorities as to the identity of the fraudsters.
C) disclose the fraud to the appropriate level of management or to the audit committee.
D) call the whistleblower hotline and name the suspected individuals.

Question 31

The same three fraud triangle risk conditions apply to fraudulent financial reporting and misappropriation of assets.

Question 32

"An attitude, character, or set of ethical values exist that allow management or employees to commit a dishonest act …." describes the opportunities condition included in the fraud triangle.

Question 33

Which of the following most accurately defines professional skepticism as it is used in auditing standards?

A) It either assumes management is honest or slightly dishonest, but neither all the time.
B) It neither assumes that management is dishonest nor assumes unquestioned honesty.
C) It assumes management is honest most of the time.
D) It assumes that management is dishonest in only rare instances.

Question 34

Which of the following does NOT represent an increased opportunity to commit fraud?

A) Related Party Transactions
B) the company founder is the CEO and Chairman of the Board
C) the financial statements involve accounting estimates
D) the company is a new audit client for the CPA firm

Question 35

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

Question 36

SAS No. 99 requires auditors to document which of the following matters related to the auditor's consideration of material misstatements due to fraud?

A) Reasons supporting a conclusion that there is not a significant risk of material improper expense recognition.
B) Procedures performed to obtain information necessary to identify and assess the risks of material fraud.
C) Results of the internal auditor's procedures performed to address the risk of management override of controls.
D) Discussions with management regarding separation of duties.

Question 37

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

A)
B)
C)
D)

Question 38

These two conditions are generally present when material misstatements due to fraud occur-incentives and opportunities.

Question 39

Which of the following is a factor that relates to attitudes or rationalization 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 40

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

A) Significant accounting estimates involving subjective judgments.
B) Significant personal financial obligations.
C) Management's practice of making overly aggressive forecasts.
D) High turnover of accounting, internal audit and information technology staff.

Question 41

Senior management is responsible for promoting a culture of honesty and ethics. Describe what that implies for the organization.

Question 42

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 43

Briefly discuss the brainstorming session required by SAS No. 99. Be sure to include a list of ideas that should be addressed in the session.

Question 44

Financial statements of all companies are potentially subject to manipulation.

Question 45

The "tone at the top" provides a foundation upon which a more detailed code of conduct can be developed to provide specific guidance for the organization and its employees. Components of a code of conduct may include sections on 1) general employee conduct, 2) relationships with clients and suppliers and 3) conflicts of interest. Give a narrative description of what might be included in each of the above components of a code of conduct.

Question 46

Describe the sources of information gathered to assess fraud risks.

Question 47

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 48

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

A) collusion and false documentation make fraud detection difficult to detect
B) collusion is impossible to detect
C) false Documentation is impossible to detect
D) all of the above are equally valid reasons

Question 49

The board of directors has the primary oversight responsibility to assess fraud risks and establish corporate governance programs and controls to prevent, deter, and detect fraud.

Question 50

The audit committee is responsible for determining an organization's financial reporting and internal control processes.

Question 51

Management and the board of directors are responsible for setting the "tone at the top."

Question 52

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

Question 53

Information and idea exchange sessions by the audit team are required by SAS No. 99.

Question 54

Professional skepticism requires auditors to "either assume that management is dishonest or they have questionable honesty."

Question 55

Explain professional skepticism and the need for maintaining professional skepticism during an audit.

Question 56

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 57

SAS No. 99 does not specifically indicate which members of an audit engagement team must attend a brainstorming session.

Question 58

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 59

Management is responsible for:

A)
B)
C)
D)

Question 60

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 61

A company is concerned with the theft of cash after the sale has been recorded. One way in which fraudsters conceal the theft is by a process called "lapping". Which of the following best describes lapping?

A) reduce the customer's account by recording a sales return
B) write off the customer's account
C) apply the payment from another customer to the customer's account
D) reduce the customer's account by recording a sales allowance

Question 62

Which of the following is not a category of inquiry used by auditors?

A) Assessment inquiry
B) Declarative inquiry
C) Interrogative inquiry
D) Informational inquiry

Question 63

Company management is often under pressure to increase revenue and/or net income. One approach is to use a "bill and hold" arrangement. This is an example of which of the following?

A) adjustments to revenue accounts
B) fictitious revenue recorded
C) premature revenue recognized
D) alteration of cutoff documents

Question 64

________ inquiry is used to ascertain whether information already obtained is correct, factual or truthful.

A) Assessment
B) Declarative
C) Interrogative
D) Informational

Question 65

One of the strongest internal corporate governance mechanisms over senior management is the audit committee of the board of directors.

Question 66

Which of the following is least likely to uncover fraud?

A) External auditors
B) Internal auditors
C) Internal controls
D) Management

Question 67

You are conducting an audit and you are concerned about revenue recognition issues because of timing concerns due to proper cutoff and channel stuffing (sales to distributors above "normal" business needs. Describe at least two audit procedures that would best address your concerns?

Question 68

When the auditor suspects that fraud may be present, SAS No. 99 requires the auditor to:

A) terminate the engagement with sufficient notice given to the client.
B) issue an adverse opinion or a disclaimer of opinion.
C) obtain additional evidence to determine whether material fraud has occurred.
D) re-issue the engagement letter.

Question 69

Because fraud perpetrators are often knowledgeable about audit procedures, SAS No. 99 requires auditors to incorporate unpredictability into the audit plan.

Question 70

With whom should the auditor communicate whenever he or she determines that senior management fraud may be present, even if the matter might be considered inconsequential?

A) PCAOB
B) audit committee
C) an appropriate level of management that is at least one level above those involved
D) the internal auditors

Question 71

As part of designing and performing procedures to address management override of controls, auditors must perform which of the following procedures?

A)
B)
C)
D)

Question 72

Analytical procedures can be very effective in detecting inventory fraud. Which of the following analytical procedures would NOT be useful in detecting fraud?

A) Gross margin percentage
B) Inventory Turnover
C) Cost of sales percentage
D) Accounts payable turnover

Question 73

The most common fraud in the acquisition and payment cycle is for the fraudster to issue payments to fictitious vendors and deposit the cash in fictitious accounts. What procedures could the company take to prevent this type of fraud?

Question 74

Auditors may identify conditions during fieldwork that change or support a judgment about the initial assessment of fraud risks. Which of the following is not a condition which should alert an auditor that the initial assessment should be changed?

A) preliminary assessment of control risk has been modified
B) discrepancies in the accounting records
C) unusual relationships between the auditor and management
D) missing or conflicting evidence

Question 75

Auditors are required to perform certain procedures in every audit to address the risk of management override of internal controls. What are these procedures?

Question 76

________ inquiry is used when the auditor seeks responses from the interviewee about his or her knowledge of an event or circumstance.

A) Assessment
B) Declarative
C) Interrogative
D) Informational

Question 77

What are the three main types of revenue manipulations employed to commit fraudulent financial reporting and give an example for each type?

Question 78

The audit team has identified and documented fraud risk. Their next step should be to:

A) evaluate factors that should reduce risk.
B) develop programs to test for fraud.
C) proceed with performing tests of controls.
D) proceed with performing substantive tests of balances.

Question 79

According to SAS No. 99, auditors are required to assume that which of the following has significant risk of fraud?

A) overstated assets
B) understated liabilities
C) improper revenue recognition
D) overstated expenses

Question 80

All misstatements the auditor finds during the audit should be evaluated for any indication of fraud.