Canvas MC: Chapter 10
2) 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) The subsidiary ledger agrees with the general ledger. B) discrepancies in the accounting records C) unusual relationships between the auditor and management D) missing or conflicting evidence
A Terms: Alert auditor to change initial assessment of fraud risks Diff: Moderate Objective: LO 10-5 AACSB:
3) As part of the brainstorming sessions, auditors are directed to emphasize A) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks Yes Yes B) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks No No C) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks Yes No D) How management could perpetrate and conceal fraudulent financial reporting The audit team's response to potential fraud risks No Yes
A Terms: Auditors directed to emphasize in brainstorming sessions Diff: Moderate Objective: LO 10-3 AACSB:
3) Which of the following is a category of fraud? A) Fraudulent financial reporting Misappropriation of assets Yes Yes B) Fraudulent financial reporting Misappropriation of assets No No C) Fraudulent financial reporting Misappropriation of assets Yes No D) Fraudulent financial reporting Misappropriation of assets No Yes
A Terms: Category of fraud Diff: Easy Objective: LO 10-1 AACSB:
7) 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
A Terms: Corporate governance oversight to reduce fraud risks Diff: Moderate Objective: LO 10-4 AACSB:
10.5 Learning Objective 10-5 1) As part of designing and performing procedures to address management override of controls, auditors must perform which of the following procedures? A) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases Yes Yes B) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases No No C) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases Yes No D) Examine journal entries for evidence of possible misstatements due to fraud Review accounting estimates for biases No Yes
A Terms: Designing and performing procedures to address override controls Diff: Moderate Objective: LO 10-5 AACSB:
4) 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.
A Terms: Fraud more prevalent in smaller business and not-for-profit organizations Diff: Moderate Objective: LO 10-2 AACSB:
3) When the auditor identifies risk at the assertion level, A) the auditor may need to obtain audit evidence that is more reliable and relevant. B) the auditor may choose to conduct substantive testing during interim periods rather than at the end of the period. C) the auditor may decrease the sample size. D) both a and b
A Terms: Fraud risk Diff: Moderate Objective: LO 10-5 AACSB:
1) Which of the following are elements of the fraud triangle? A) Attitudes/rationalization Risk Factors Opportunities Yes No Yes B) Attitudes/rationalization Risk Factors Opportunities No Yes Yes C) Attitudes/rationalization Risk Factors Opportunities Yes No No D) Attitudes/rationalization Risk Factors Opportunities No Yes No
A Terms: Fraud triangle Diff: Easy Objective: LO 10-2 AACSB:
11) Which of the following is an accurate statement regarding assets and fraud risk? A) Companies will often capitalize repairs as fixed assets. B) Since fixed assets are often large, there is little theft of fixed assets. C) Intangible assets are recorded at cost and valuation issues therefore are not a fraud risk. D) Since companies have few fixed assets, there is no need for them to be periodically inventoried.
A Terms: Fraudulent financial reporting risk; assets Diff: Moderate Objective: LO 10-6 AACSB:
11) 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.
A Terms: Heightened risk of intentional misstatement Diff: Easy Objective: LO 10-2 AACSB:
5) An auditor uses ________ inquiry to corroborate or contradict prior information. A) assessment B) declarative C) interrogative D) informational
A Terms: Inquiry used to ascertain whether information already obtained is correct Diff: Moderate Objective: LO 10-7 AACSB:
2) Which of the following is least likely to uncover fraud? A) external auditors B) internal auditors C) internal controls D) management
A Terms: Lease likely to uncover of fraud risks Diff: Moderate Objective: LO 10-7 AACSB:
6) Management is responsible for A) Identifying and measuring fraud risks Taking steps to mitigate identified risks Yes Yes B) Identifying and measuring fraud risks Taking steps to mitigate identified risks No No C) Identifying and measuring fraud risks Taking steps to mitigate identified risks Yes No D) Identifying and measuring fraud risks Taking steps to mitigate identified risks No Yes
A Terms: Management responsibilities for fraud risks Diff: Moderate Objective: LO 10-4 AACSB:
3) 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.
A Terms: Most effective way to prevent and deter fraud Diff: Moderate Objective: LO 10-4 AACSB:
1) Which of the following is 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.
A Terms: Professional skepticism when auditing a client Diff: Moderate Objective: LO 10-3 AACSB:
1) 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.
A Terms: Reason for management to emphasize fraud prevention and deterrence Diff: Moderate Objective: LO 10-4 AACSB:
8) Who is responsible for setting the "tone at the top"? A) management B) PCAOB C) audit committee D) SEC
A Terms: Responsibility for setting tone at the top Diff: Easy Objective: LO 10-4 AACSB:
6) Two of the most useful warning signals that can indicate that revenue fraud is occurring are A) analytical procedures and documentary discrepancies. B) analytical procedures and misappropriation of assets. C) documentary discrepancies and vague responses to inquiries. D) missing audit evidence and vague responses to inquiries.
A Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:
4) Auditors are required to perform certain procedures in every audit to address the risk of management override of internal controls. What are these procedures?
Auditing procedures require the following to be performed to address the risk of management override of controls: • Examine journal entries and other adjustments for evidence of possible misstatements due to fraud. • Review accounting estimates for bias. • Evaluate the business rationale for significant unusual transactions. Terms: Audit procedures required to address the risk of management override of internal controls Diff: Moderate Objective: LO 10-5 AACSB:
8) Discuss the need for maintaining professional skepticism during an audit.
Auditing standards require that the audit be planned and performed with an attitude of professional skepticism in all aspects of the engagement, recognizing the possibility that a material misstatement could exist regardless of the auditor's prior experience with the integrity and honesty of client management and those charged with governance. In practice, maintaining this attitude can be difficult because, despite some recent high-profile financial statement frauds, material frauds are infrequent compared to the number of audits of financial statements conducted annually. Terms: Professional skepticism Diff: Moderate Objective: LO 10-3 AACSB:
9) 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.
Auditing standards require the audit team to conduct discussions to share insights from more experienced audit team members and to "brainstorm" ideas that address several ideas. The ideas that should be discussed are: • How and where the entity's financial statements might be susceptible to material misstatements due to fraud. This includes known external and internal factors affecting the entity that might (1) create an incentive or pressure for management to commit fraud (2) provide the opportunity for fraud to be perpetrated, including the risk of management override of internal controls, and (3) indicate a culture or environment that enables management to rationalize fraudulent acts. • How management could perpetrate and conceal fraudulent financial reporting. • How assets of the entity could be misappropriated. • How the auditor might respond to the susceptibility of material misstatements due to fraud. Terms: Brainstorming session required by auditing standards Diff: Moderate Objective: LO 10-3 AACSB:
7) 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.
B Terms: Assessment against a defendant of the full loss suffered by a plaintiff Diff: Moderate Objective: LO 10-3 AACSB:
5) 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.
B Terms: Assessment of fraud risk Diff: Moderate Objective: LO 10-3 AACSB:
7) 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
B Terms: Auditor communicates with whom when senior management fraud may be present Diff: Moderate Objective: LO 10-7 AACSB:
3) 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
B Terms: Category of inquiry used by auditors Diff: Moderate Objective: LO 10-7 AACSB:
1) 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.
B Terms: Definition of fraud in financial statement auditing Diff: Easy Objective: LO 10-1 AACSB:
5) 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
B Terms: Factor that relates to incentives or pressures to commit fraudulent financial reporting Diff: Moderate Objective: LO 10-2 AACSB:
8) 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
B Terms: Factor that relates to incentives to misappropriate assets Diff: Moderate Objective: LO 10-2 AACSB:
1) To address heightened risks of fraud, the auditor can do all of the following except A) use specialists to assist in evaluating the accuracy and reasonableness of management's key estimates. B) decrease the amount of substantive tests. C) use ACL or IDEA to search for fictitious revenue transactions. D) use EXCEL to perform analytical procedures at the disaggregated level.
B Terms: Fraud risk Diff: Moderate Objective: LO 10-7 AACSB:
4) Most cases of fraudulent reporting involve A) inadequate disclosures. B) an overstatement of income. C) an overstatement of liabilities. D) an overstatement of expenses.
B Terms: Fraudulent financial reporting Diff: Easy Objective: LO 10-1 AACSB:
2) 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
B Terms: Intentionally understate earnings; Reserve earnings Diff: Easy Objective: LO 10-1 AACSB:
10) 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.
B Terms: Misappropriation of assets Diff: Moderate Objective: LO 10-1 AACSB:
7) 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.
B Terms: Misappropriation of assets normally; perpetrators Diff: Easy Objective: LO 10-1 AACSB:
5) 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
B Terms: Party with primary responsibility to oversee organization's financial reporting and internal control processes Diff: Moderate Objective: LO 10-4 AACSB:
8) Which of the following is a correct statement regarding the misappropriation of receipts involving revenue? A) One of the easiest frauds to detect is when a sale is not recorded and the cash from the sale is stolen. B) If a customer's payment is stolen, regular billing of unpaid accounts can uncover the fraud unless the fraud perpetrator does something to hide the theft. C) Misappropriation of cash receipts is generally as material as fraudulent reporting of revenues. D) Analytical procedures can detect relatively small thefts of sales and related cash receipts.
B Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:
9) According to the Association of Certified Fraud Examiners, the average company loses ________ percent of its revenues to fraud. A) one B) five C) ten D) fifteen
B Terms: Revenues lost to fraud Diff: Moderate Objective: LO 10-1 AACSB:
2) 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) significant accounting estimates B) fictitious revenue recorded C) premature revenue recognized D) alteration of cutoff documents
C Terms: Bill and hold arrangement to increase revenue and/or net income Diff: Moderate Objective: LO 10-6 AACSB:
9) 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.
C Terms: Characteristics of fraud perpetrators Diff: Moderate Objective: LO 10-2 AACSB:
1) Auditing standards require that auditors document A) specific risks of fraud identified at the financial statement level, but not at the assertion level. B) all conversations with management. C) results of the procedures performed to address the risk of management override of controls. D) all of the above.
C Terms: Documenting fraud assessment Diff: Moderate Objective: LO 10-8 AACSB:
12) 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
C Terms: Factor relates to opportunities to commit fraudulent financial reporting Diff: Easy Objective: LO 10-2 AACSB:
3) 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
C Terms: Factor relates to opportunities to commit fraudulent financial reporting Diff: Moderate Objective: LO 10-2 AACSB:
6) 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
C Terms: Factor that relates to incentives to misappropriate assets Diff: Moderate Objective: LO 10-2 AACSB:
2) 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.
C Terms: Financial statement manipulation risk is elevated Diff: Easy Objective: LO 10-2 AACSB:
6) 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.
C Terms: Form of earnings management Diff: Easy Objective: LO 10-1 AACSB:
4) 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.
C Terms: Fraud awareness training Diff: Moderate Objective: LO 10-4 AACSB:
9) When analyzing accounts for fraud risk, A) companies will generally attempt to overstate accounts payable and net income. B) the inventory account is generally not susceptible to fraud since the auditor must verify the existence of the inventory. C) payroll is rarely a significant risk for fraudulent financial reporting. D) fixed assets are rarely stolen because of their large size.
C Terms: Fraud risk Diff: Moderate Objective: LO 10-6 AACSB:
13) 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.
C Terms: Fraud risk conditions and opportunity Diff: Moderate Objective: LO 10-2 AACSB:
5) ________ 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
C Terms: Fraud that involves theft of entity's assets Diff: Easy Objective: LO 10-1 AACSB:
10) 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.
C Terms: Fraud triangle Diff: Moderate Objective: LO 10-2 AACSB:
8) 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
C Terms: Fraudulent financial reporting Diff: Easy Objective: LO 10-1 AACSB:
10) When dealing with fraudulent financial reporting risk for accounts payable, A) companies will generally tend to overstate accounts payable. B) it is difficult for the auditor to verify if all liabilities have been recorded if prenumbered receiving reports are used. C) companies have used fictitious reductions to accounts payable to overstate net income. D) accounts payable is rarely a significant risk area for fraudulent financial reporting.
C Terms: Fraudulent financial reporting risk; accounts payable Diff: Moderate Objective: LO 10-6 AACSB:
3) 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
C Terms: Lapping; Theft of cash Diff: Moderate Objective: LO 10-6 AACSB:
2) 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
C Terms: Party responsible for implementing internal controls to minimize likelihood of fraud Diff: Moderate Objective: LO 10-4 AACSB:
6) When the auditor suspects that fraud may be present, auditing standards require 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.
C Terms: Requirements of auditor when fraud is suspected Diff: Moderate Objective: LO 10-7 AACSB:
7) Fictitious revenues A) increase accounts receivable turnover. B) understate the gross margin percentage. C) lower accounts receivable turnover. D) have no impact on the gross margin percentage.
C Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:
4) 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?
C Terms: Sources of information to assess fraud risks; inquiries of management Diff: Moderate Objective: LO 10-3 AACSB:
10.6 Learning Objective 10-6 1) Auditing standards specifically require auditors to identify ________ as a fraud risk in most audits. A) overstated assets B) understated liabilities C) revenue recognition D) overstated expenses
C Terms: Specific fraud risk areas Diff: Moderate Objective: LO 10-6 AACSB:
4) 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 receivable turnover
D Terms: Analytical procedures to detect inventory fraud Diff: Challenging Objective: LO 10-6 AACSB:
2) 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
D Terms: Criteria by which an auditor evaluates information Diff: Easy Objective: LO 10-3 AACSB:
9) 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.
D Terms: Elements of code of conduct Diff: Moderate Objective: LO 10-4 AACSB:
7) 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
D Terms: Factor that relates to opportunities to misappropriate assets Diff: Moderate Objective: LO 10-2 AACSB:
8) Most frauds are detected by A) a confession by the fraudster. B) IT controls. C) law enforcement. D) a tip.
D Terms: Fraud detection methods Diff: Moderate Objective: LO 10-7 AACSB:
4) ________ inquiry is used to obtain information about facts and details that the auditor does not have, usually about past or current events or processes. A) Assessment B) Declarative C) Interrogative D) Informational
D Terms: Inquiry used when auditor seeks responses Diff: Moderate Objective: LO 10-7 AACSB:
5) When dealing with revenue frauds, A) the most egregious form of revenue fraud involves premature revenue recognition. B) premature revenue recognition involves recognizing the revenue after the accounting standards requirements have been met. C) premature revenue recognition is the same as cutoff errors. D) side agreements can modify the terms of the sales transaction and should be analyzed carefully.
D Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:
6) 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
D Terms: Source of information to assess fraud risks Diff: Challenging Objective: LO 10-3 AACSB:
11) In vertical analysis, the account balance is compared to the previous period, and the percentage change for the period is calculated.
FALSE Terms: Analytical procedures Diff: Moderate Objective: LO 10-3 AACSB:
13) Upon discovering information that indicates a material misstatement due to fraud, the auditor must assume that the misstatement is an isolated incident.
FALSE Terms: Assessment of fraud risk Diff: Moderate Objective: LO 10-3 AACSB:
14) "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.
FALSE Terms: Cookie jar reserves Diff: Easy Objective: LO 10-1 AACSB:
2) If auditors determine that there is not a significant risk of material improper revenue recognition, no documentation of this decision is required.
FALSE Terms: Documenting fraud assessment Diff: Easy Objective: LO 10-8 AACSB:
17) According to the Association of Certified Fraud Examiners, losses from misappropriation schemes are higher than losses from financial statement frauds.
FALSE Terms: Fraud and main categories Diff: Easy Objective: LO 10-1 AACSB:
10) The auditor has a responsibility to notify law enforcement when fraud is suspected.
FALSE Terms: Fraud detection and law enforcement Diff: Moderate Objective: LO 10-7 AACSB:
11) Most frauds are discovered by accident.
FALSE Terms: Fraud detection methods Diff: Easy Objective: LO 10-7 AACSB:
17) Fraud is more prevalent in large businesses than small businesses and not-for-profit organizations.
FALSE Terms: Fraud prevalence in organizations Diff: Easy Objective: LO 10-2 AACSB:
14) When the allowance for doubtful accounts is understated, bad debt expense is understated and net income is also understated.
FALSE Terms: Fraud risk Diff: Moderate Objective: LO 10-6 AACSB:
20) Ineffective oversight by the board of directors over financial reporting is an example of an incentives/pressures risk factor.
FALSE Terms: Fraud risk factor describing incentives/pressures Diff: Moderate Objective: LO 10-2 AACSB:
23) In the fraud triangle, fraudulent financial reporting and misappropriation of assets share the same conditions and risk factors.
FALSE Terms: Fraud triangle risk conditions Diff: Moderate Objective: LO 10-2 AACSB:
18) Turnover in accounting personnel can create a rationalization for misstatement.
FALSE Terms: Fraud triangle risk conditions Diff: Moderate Objective: LO 10-2 AACSB:
19) A lack of controls over payments to vendors can cause revenue fraud.
FALSE Terms: Opportunities conditions included in fraud triangle Diff: Moderate Objective: LO 10-2 AACSB:
15) Fictitious revenue transactions have the same level of documentary evidence as legitimate transactions.
FALSE Terms: Revenue recognition and fraud Diff: Moderate Objective: LO 10-6 AACSB:
11) Define fraud and distinguish between the two main categories of fraud.
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. Terms: Fraud and main categories Diff: Easy Objective: LO 10-1 AACSB:
15) List and briefly describe examples of risk factors for each condition of fraud for fraudulent financial reporting.
Incentives/Pressures: 1. Financial stability or profitability is threatened by economic, industry, or entity operating conditions. 2. Excessive pressure for management to meet debt repayment or other debt covenant requirements. 3. Management or the board of directors' personal net worth is materially threatened by the entity's financial performance. Opportunities: 1. Significant accounting estimates involve subjective judgments or uncertainties that are difficult to verify. 2. Ineffective board of director or audit committee oversight over financial reporting. 3. High turnover or ineffective accounting, internal audit, or information technology staff. 4. Deficient internal controls. 5. Significant related party transactions. Attitudes/Rationalization: 1. Inappropriate or ineffective communication and support of the entity's values. 2. Known history of violations of securities laws and other laws and regulations. 3. Management's practice of making overly aggressive or unrealistic forecasts to analysts, creditors, and other third parties. Terms: Risk factors for conditions of fraud Diff: Challenging Objective: LO 10-2 AACSB:
11) Senior management is responsible for promoting a culture of honesty and ethics. Describe what that implies for the organization.
Note: responses with examples may vary Management cannot act one way and expect others in the company to behave differently. Through its actions and communications, management can show that dishonest or unethical behavior is not tolerated, even if the results benefit the company. For example, statements by management about the absolute need to meet operating and financial targets create undue pressures that may lead employees to commit fraud to achieve them. In contrast, statements indicating management's desire to aggressively pursue the entity's goals and targets while at the same time requiring honest and ethical actions to achieve those goals, clearly indicates to employees that integrity is a requirement. Whichever course management pursues, its actions establish the "tone at the top." Terms: Management responsibility for promoting a culture of honesty and ethics Diff: Challenging Objective: LO 10-4 AACSB:
15) Audit committee oversight also serves as a deterrent to fraud by senior management.
TRUE Terms: Audit committee and fraud Diff: Challenging Objective: LO 10-4 AACSB:
5) Because fraud perpetrators are often knowledgeable about audit procedures, auditors should incorporate unpredictability into the audit plan.
TRUE Terms: Auditors to incorporate unpredictability into audit plan Diff: Moderate Objective: LO 10-5 AACSB:
13) The two main categories of fraud are fraudulent financial reporting and misappropriation of assets.
TRUE Terms: Categories of fraud; Fraudulent financial reporting and misappropriation of assets Diff: Easy Objective: LO 10-1 AACSB:
16) Incentives and opportunities are two conditions that are generally present when financial statement fraud occurs.
TRUE Terms: Conditions present when material misstatements due to fraud occur Diff: Easy Objective: LO 10-2 AACSB:
12) Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures with the intent to deceive users.
TRUE Terms: Fraud in financial statement auditing Diff: Easy Objective: LO 10-1 AACSB:
16) Auditing standards require that the auditor presume that there is a risk of fraud in revenue recognition.
TRUE Terms: Fraud risk Diff: Moderate Objective: LO 10-3 AACSB:
16) Auditors should rely on original, rather than duplicate, copies of documents.
TRUE Terms: Fraud risk Diff: Moderate Objective: LO 10-6 AACSB:
17) The two most common areas of fraud in payroll are the creation of fictitious employees and the overstatement of individual payroll hours.
TRUE Terms: Fraud risk Diff: Moderate Objective: LO 10-6 AACSB:
13) Auditors may expand other substantive procedures to address the heightened risks of fraud.
TRUE Terms: Fraud risk Diff: Moderate Objective: LO 10-7 AACSB:
21) A common incentive for companies to manipulate financial statements is a decline in the company's financial prospects.
TRUE Terms: Fraud risk factor describing incentives/pressures Diff: Moderate Objective: LO 10-2 AACSB:
16) Fraudulent financial reporting usually involves manipulation of amounts rather than disclosures.
TRUE Terms: Fraudulent financial reporting Diff: Moderate Objective: LO 10-1 AACSB:
12) Information and idea exchange sessions by the audit team are required by current auditing standards.
TRUE Terms: Information and idea exchange by audit team sessions required by current audit standards Diff: Moderate Objective: LO 10-3 AACSB:
12) Interrogative inquiry is often confrontational.
TRUE Terms: Inquiry techniques Diff: Moderate Objective: LO 10-7 AACSB:
15) Misappropriation of assets is normally perpetrated at the lowest levels of the organization hierarchy.
TRUE Terms: Misappropriation of assets Diff: Moderate Objective: LO 10-1 AACSB:
14) Management must recognize that almost any employee is capable of committing a dishonest act under the right circumstances.
TRUE Terms: Mitigating fraud risks Diff: Moderate Objective: LO 10-4 AACSB:
13) If employees have positive feelings about their employers, they are less likely to commit fraud.
TRUE Terms: Positive work environment Diff: Moderate Objective: LO 10-4 AACSB:
14) The presence of fraud risk factors increases the likelihood of fraud and may suggest that fraud is being perpetrated.
TRUE Terms: Presence of fraud risk factors Diff: Moderate Objective: LO 10-3 AACSB:
15) When the auditor receives inconsistent responses from management and others within the organization, the auditor should obtain additional audit evidence to resolve the inconsistency.
TRUE Terms: Presence of fraud risk factors Diff: Moderate Objective: LO 10-3 AACSB:
6) The auditors should pay careful attention to accounting principles that involve subjective measurements or complex transactions.
TRUE Terms: Responding to the risk of fraud Diff: Moderate Objective: LO 10-5 AACSB:
12) Management and the board of directors are responsible for setting the "tone at the top."
TRUE Terms: Responsibility for setting tone at the top Diff: Easy Objective: LO 10-4 AACSB:
22) The pressure to do "whatever it takes" to meet goals is one of the main reasons why financial statement fraud occurs.
TRUE Terms: Risk factors related to incentives, opportunities, and attitudes Diff: Moderate Objective: LO 10-2 AACSB:
17) For significant risks, including fraud risks, the auditor should obtain an understanding of the internal controls related to the risks.
TRUE Terms: Significant risk Diff: Moderate Objective: LO 10-3 AACSB:
13) The most common fraud in the acquisition and payment cycle is for the perpetrator 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?
• Allowing payments to be made only to approved vendors • Detailed review of legitimacy of approved vendors • Careful review of document authorizing the acquisition • Segregation of duties between authorizing payments and authorizing the acquisition • Canceling supporting documents to prevent their use as support for multiple payments Terms: Procedures to prevent fraud in the acquisition and payment cycle Diff: Challenging Objective: LO 10-6 AACSB:
14) List and briefly describe the three conditions for fraud.
• Incentives/pressures — Management or other employees have incentives or pressures to commit fraud. • Opportunities — Circumstances provide opportunities for management or employees to commit fraud. • Attitudes/Rationalization — An attitude, character, or set of ethical values exists that allows management or employees to intentionally commit a dishonest act, or they are in an environment that imposes sufficient pressure that causes them to rationalize committing a dishonest act. Terms: Conditions for fraud Diff: Moderate Objective: LO 10-2 AACSB:
10) 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.
(may vary) General employee conduct—Employees should conduct themselves in a businesslike manner and prohibit unprofessional activities such as drinking, gambling, fighting, and swearing, while on the job. Relationships with client and suppliers—Employees should avoid investing in or acquiring a financial interest in any business organization that has a contractual relationship with the organizations. Conflicts of Interest—Employees are expected to perform their duties conscientiously, honestly, and in accordance with the best interests of the organization and to not use their positions or knowledge gained for private or personal advantage. Terms: Elements of code of conduct Diff: Challenging Objective: LO 10-4 AACSB:
10) Describe the five sources of information gathered to assess fraud risks.
The five sources of information to assess fraud risk are: • Communications among audit team members. The following ideas should be "brainstormed" (1) How and where the entity's financial statements might be susceptible to material misstatements due to fraud, including known external and internal factors that might (a) create an incentive or pressure for management to commit fraud, (b) provide the opportunity for fraud to be perpetrated, and (c) indicate a culture or environment that enables management to rationalize fraudulent acts. (2) How management could perpetrate and conceal fraudulent financial reporting. (3) How anyone might misappropriate assets of the entity. (4) How the auditor might respond to the susceptibility of material misstatements due to fraud. • Inquiries of management. These inquiries should address whether management has knowledge of any fraud or suspected fraud within the company. Auditors should also inquire about management's process of assessing fraud risks, the nature of fraud risks identified by management, any internal controls implemented to address those risks, and any information about fraud risks and related controls that management has reported to the audit committee or others charged with governance. • Risk factors. The auditor must evaluate whether fraud risk factors indicate incentives or pressures to perpetrate fraud, opportunities to carry out fraud, or attitudes or rationalizations used to justify a fraudulent action. • Analytical procedures. Auditors must perform analytical procedures during the planning and completion phases of the audit to help identify unusual transaction or events that might indicate the presence of material misstatements in the financial statements. Analytical procedures include ratio analysis, horizontal analysis, and vertical analysis. • Other procedures. Auditors should consider all information they have obtained in any phase or part of the audit as they assess the risk of fraud. Information about management's integrity and honesty, inquires and analytical procedures, and information considered in assessing inherent and control risks, may lead to auditor concerns about the likelihood of misstatements due to fraud. Terms: Sources of information to assess fraud risks; inquiries of management Diff: Challenging Objective: LO 10-3 AACSB:
12) List the three main types of revenue manipulations employed to commit fraudulent financial reporting and give an example for each type.
The three main types of revenue manipulation are: • Fictitious revenues — preparation of fictitious documentary evidence for sales and reduction of inventory. • Premature revenue recognition — bill and hold; side agreements; unlimited right of return. • Manipulation of adjustments to revenues — adjustments to the sales and returns allowance account, i.e., not recording returns; also, understating the estimate for bad debts which reduces the bad debt expense and understates the allowance for doubtful accounts. Terms: Types of revenue manipulation Diff: Moderate Objective: LO 10-6 AACSB:
9) What types of inquiry techniques might an auditor use when making inquiries of client personnel? What are the uses of each technique?
There are three main types of inquiry available for use by auditors. These are informational inquiry, assessment inquiry, and interrogative inquiry. Informational inquiry is used to obtain information about facts and details that the auditor does not have. Assessment inquiry is used to corroborate or contradict prior information. Interrogative inquiry is often used when the auditor seeks responses from an individual about his or her knowledge of an event or circumstances. It is often used to determine if the individual is being deceptive or purposely omitting disclosure of key knowledge of facts, events, or circumstances. This type of inquiry is often confrontational in nature. Terms: Inquiry techniques Diff: Challenging Objective: LO 10-7 AACSB:
