Auditing Chapter 6
Which of the following statements is the most correct regarding errors and fraud? A) An error is unintentional, whereas fraud is intentional. B) Frauds occur more often than errors in financial statements. C) Errors are always fraud and frauds are always errors. D) Auditors have more responsibility for finding fraud than errors.
A) An error is unintentional, whereas fraud is intentional.
Which of the following statements best describes the auditor's responsibility with respect to illegal acts that do not have a material effect on the client's financial statements? A) Generally, the auditor is under no obligation to notify parties other than personnel within the client's organization. B) Generally, the auditor is under an obligation to inform the PCAOB. C) Generally, the auditor is obligated to disclose the relevant facts in the auditor's report. D) Generally, the auditor is expected to compel the client to adhere to requirements of the Foreign Corrupt Practices Act.
A) Generally, the auditor is under no obligation to notify parties other than personnel within the client's organization.
True or False. An audit generally provides no assurance that illegal acts that do not have a direct effect on the financial statements will be detected. A) True B) False
A) True
True or False. As the impact from noncompliance is further removed from affecting the financial statements, the less likely the auditor is to become aware of or recognize noncompliance when auditing the financial statements. A) True B) False
A) True
True or False. Asking the right questions and probing further until the auditor is satisfied with the responses can help the auditor to detect a material misstatement in the financial statements. A) True B) False
A) True
True or False. Auditors have a higher degree of responsibility for detecting illegal acts that have a direct effect on the financial statements than illegal acts that do not have a direct effect on the financial statements. A) True B) False
A) True
True or False. Because they operate the business on a daily basis, a company's management knows more about the company's transactions and related assets, liabilities, and equity than the auditors. A) True B) False
A) True
True or False. Other than inquiring of management about policies they have established to prevent illegal acts and whether management knows of any laws or regulations that the company has violated, the auditor should not search for illegal acts that do not have a direct effect on the financial statements unless there is reason to believe they may exist. A) True B) False
A) True
True or False. The annual reports of many public companies include a statement about management's responsibilities and relationship with the CPA firm. A) True B) False
A) True
True or False. When an auditor believes that an illegal act may have occurred, the first step he or she should take is to gather additional evidence to determine the extent of the illegality and if there is a direct impact on the financial statements. A) True B) False
A) True
Why does the auditor divide the financial statements into smaller segments? A) Using the cycle approach makes the audit more manageable. B) Most accounts have few relationships with others and so it is more efficient to break the financial statements into smaller pieces. C) The cycle approach is used because auditing standards require it. D) All of the above are correct.
A) Using the cycle approach makes the audit more manageable.
The most important general ledger account included in and affecting several cycles is the: A) cash account. B) inventory account. C) income tax expense and liability accounts. D) retained earnings account.
A) cash account.
The auditor's best defense when material misstatements are not uncovered is to have conducted the audit: A) in accordance with generally accepted auditing standards. B) as effectively as reasonably possible. C) in a timely manner. D) only after an adequate investigation of the management team.
A) in accordance with generally accepted auditing standards.
The concept of reasonable assurance indicates that the auditor is: A) not a guarantor of the correctness of the financial statements. B) not responsible for the fairness of the financial statements. C) responsible only for issuing an opinion on the financial statements. D) responsible for finding all misstatements.
A) not a guarantor of the correctness of the financial statements.
When an auditor believes that an illegal act may have occurred, the auditor should first: A) obtain an understanding of the nature and circumstances of the act. B) consult with legal counsel or others knowledgeable about the illegal act. C) discuss the matter with the audit committee. D) withdraw from the engagement.
A) obtain an understanding of the nature and circumstances of the act.
An auditor should recognize that the application of auditing procedures may produce evidence indicating the possibility of errors or fraud and therefore should: A) plan and perform the engagement with an attitude of professional skepticism. B) not rely on internal controls that are designed to prevent or detect errors or fraud. C) design audit tests to detect unrecorded transactions. D) extend the work to audit the majority of the recorded transactions and records of an entity.
A) plan and perform the engagement with an attitude of professional skepticism.
The auditor has considerable responsibility for notifying users as to whether or not the statements are properly stated. This imposes upon the auditor a duty to: A) provide reasonable assurance that material misstatements will be detected. B) be a guarantor of the fairness in the statements. C) be equally responsible with management for the preparation of the financial statements. D) be an insurer of the fairness in the statements.
A) provide reasonable assurance that material misstatements will be detected.
When dealing with laws and regulations that do not have a direct effect on the financial statements, the auditor: A) should inquire of management about whether the entity is in compliance with such laws and regulations. B) has no responsibility to determine if any violations of these laws has occurred. C) must report all violations, including inconsequential violations, to the audit committee. D) should perform the same procedures as for violations having a direct effect on the financial statements.
A) should inquire of management about whether the entity is in compliance with such laws and regulations.
The objective of an audit of the financial statements is an expression of an opinion on: A) the fairness of the financial statements in all material respects. B) the accuracy of the financial statements. C) the accuracy of the annual report. D) the accuracy of the balance sheet and income statement.
A) the fairness of the financial statements in all material respects.
If several employees collude to falsify documents, the chance a normal audit would uncover such acts is: A) very low. B) very high. C) zero. D) none of the above.
A) very low.
True or False. Auditing standards indicate that reasonable assurance is a moderate, but not absolute, level of assurance that the financial statements are free of material misstatement. A) True B) False
B) False
True or False. Audits are expected to provide a higher degree of assurance for the detection of material frauds than is provided for an equally material error. A) True B) False
B) False
True or False. Errors are usually more difficult for an auditor to detect than frauds. A) True B) False
B) False
True or False. The auditor's first course of action when an illegal act is uncovered should be to immediately notify the appropriate authorities, including but not limited to, law enforcement and the Securities and Exchange Commission.
B) False
True or False. The auditors determine which disclosures must be presented in the financial statements. A) True B) False
B) False
True or False. The objective of the audit of financial statements by an independent auditor is to verify that the financial statements are free of misstatements and accurately represent the company's financial position and results of operations. A) True B) False
B) False
Why does the auditor divide the financial statements into segments around the financial statement cycles? A) Most auditors are trained to audit cycles as opposed to entire financial statements. B) The approach aids in the assignment of tasks to different members of the audit team. C) The cycle approach is required by auditing standards. D) The cycle approach allows the auditor to detect illegal acts.
B) The approach aids in the assignment of tasks to different members of the audit team.
Which of the following statements best describes the auditor's responsibility regarding the detection of fraud? A) The auditor is responsible for the failure to detect fraud only when such failure clearly results from nonperformance of audit procedures specifically described in the engagement letter. B) The auditor is required to provide reasonable assurance that the financial statements are free of both material errors and fraud. C) The auditor is responsible for detecting material financial statement fraud, but not a material misappropriation of assets. D) The auditor is responsible for the failure to detect fraud only when an unqualified opinion is issued.
B) The auditor is required to provide reasonable assurance that the financial statements are free of both material errors and fraud.
Which of the following is an accurate statement concerning the auditor's responsibility to consider laws and regulations? A) Auditors can follow an easy, step-by-step procedure to determine how laws and regulations impact the financial statements. B) The auditor's responsibility will depend on whether the laws or regulations are expected to have a direct impact on the financial statements. C) It is the responsibility of the auditor to determine if an act constitutes noncompliance. D) The auditor must inform an outside party if management has knowingly not complied with a law or regulation.
B) The auditor's responsibility will depend on whether the laws or regulations are expected to have a direct impact on the financial statements.
An audit must be performed with an attitude of professional skepticism. Professional skepticism consists of two primary components: a questioning mind and: A) the assumption that upper-level management is dishonest. B) a critical assessment of the audit evidence. C) the assumption that all employees are motivated by greed. D) verification of all critical information by independent third parties.
B) a critical assessment of the audit evidence.
"The auditor should not assume that management is dishonest, but the possibility of dishonesty must be considered." This is an example of: A) unprofessional behavior. B) an attitude of professional skepticism. C) due diligence. D) a rule in the AICPA's Code of Professional Conduct.
B) an attitude of professional skepticism.
An auditor discovers that the company's bookkeeper unintentionally made an mistake in calculating the amount of the quarterly sales. This is an example of: A) employee fraud. B) an error. C) misappropriation of assets. D) a defalcation.
B) an error.
If a client has violated federal tax laws: A) the auditor must notify the IRS. B) and the amount is significant, the auditor should communicate with those charged with governance. C) the noncompliance generally will not impact the financial statements. D) the auditor does not need to evaluate the effects of the noncompliance on other aspects of the audit.
B) and the amount is significant, the auditor should communicate with those charged with governance.
One of the characteristics of professional skepticism is ________, which is the conviction to decide for oneself, rather than accepting the claims of others. A) interpersonal understanding B) autonomy C) suspension of judgment D) self-esteem
B) autonomy
The responsibility for adopting sound accounting policies and maintaining adequate internal control rests with the: A) board of directors. B) company management. C) financial statement auditor. D) company's internal audit department.
B) company management.
When an auditor knows that an illegal act has occurred, she must: A) report it to the proper governmental authorities. B) consider the effects on the financial statements, including the adequacy of disclosure. C) withdraw from the engagement. D) issue an adverse opinion.
B) consider the effects on the financial statements, including the adequacy of disclosure.
The essence of the attest function is to: A) assure the consistent application of correct accounting procedures. B) determine whether the client's financial statements are fairly stated in accordance with an applicable financial reporting framework. C) examine individual transactions so that the auditor may certify as to their validity. D) detect collusion and fraud.
B) determine whether the client's financial statements are fairly stated in accordance with an applicable financial reporting framework.
In comparing management fraud with employee fraud, the auditor's risk of failing to discover the fraud is: A) greater for management fraud because managers are inherently more deceptive than employees. B) greater for management fraud because of management's ability to override existing internal controls. C) greater for employee fraud because of the higher crime rate among blue collar workers. D) greater for employee fraud because of the larger number of employees in the organization.
B) greater for management fraud because of management's ability to override existing internal controls.
The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to: A) the auditor. B) management. C) both management and the auditor equally. D) management for the statements and the auditor for the notes.
B) management.
A questioning mindset: A) means the auditor must prove every statement that management makes to them. B) means the auditor should approach the audit with a "do not trust anyone" mental outlook. C) assures that the auditor will only accept honest clients. D) means the auditor should approach the audit with a "trust but verify" mental outlook.
B) means the auditor should approach the audit with a "do not trust anyone" mental outlook.
Most illegal acts affect the financial statements: A) directly. B) only indirectly. C) both directly and indirectly. D) materially if direct; immaterially if indirect.
B) only indirectly.
Fraudulent financial reporting is most likely to be committed by whom? A) Line employees of the company B) Outside members of the company's board of directors C) Company management D) The company's auditors
C) Company management
Which of the following is the auditor least likely to do when aware of an illegal act? A) Discuss the matter with the client's legal counsel. B) Obtain evidence about the potential effect of the illegal act on the financial statements. C) Contact the local law enforcement officials regarding potential criminal wrongdoing. D) Consider the impact of the illegal act on the relationship with the company's management.
C) Contact the local law enforcement officials regarding potential criminal wrongdoing.
Which of the following statements is true of a public company's financial statements? A) Sarbanes-Oxley requires the CEO only to certify the financial statements. B) Sarbanes-Oxley requires the CFO only to certify the financial statements. C) Sarbanes-Oxley requires the CEO and CFO to certify the financial statements. D) Sarbanes-Oxley requires neither the CEO nor the CFO to certify the financial statements.
C) Sarbanes-Oxley requires the CEO and CFO to certify the financial statements.
Which of the following would most likely be deemed a direct-effect illegal act? A) Violation of federal employment laws B) Violation of federal environmental regulations C) Violation of federal income tax laws D) Violation of civil rights laws
C) Violation of federal income tax laws
One of the characteristics of professional skepticism is_______, which is a desire to investigate beyond the obvious. A) self-esteem B) an interpersonal understanding C) a search for knowledge D) a questioning mindset
C) a search for knowledge
When using the cycle approach to segmenting the audit, the reason for treating capital acquisition and repayment separately from the acquisition of goods and services is that: A) the transactions are related to financing a company rather than to its operations. B) most capital acquisition and repayment cycle accounts involve few transactions, but each is often highly material and therefore should be audited extensively. C) both A and B are correct. D) neither A nor B is correct.
C) both A and B are correct.
Misappropriation of assets: A) is generally committed by company management. B) harms the users of the financial statements by providing them incorrect financial data for their decision making. C) causes harm to stockholders because the assets are no longer available to their rightful owners. D) causes the financial statements to be misstated since the misappropriation usually involves material amounts.
C) causes harm to stockholders because the assets are no longer available to their rightful owners.
When comparing the auditor's responsibility for detecting employee fraud and for detecting errors, the profession has placed the responsibility: A) more on discovering errors than employee fraud. B) more on discovering employee fraud than errors. C) equally on discovering errors and employee fraud. D) on the senior auditor for detecting errors and on the manager for detecting employee fraud.
C) equally on discovering errors and employee fraud.
If the auditor believes that the financial statements are not fairly stated or is unable to reach a conclusion because of insufficient evidence, the auditor: A) should withdraw from the engagement. B) should request an increase in audit fees so that more resources can be used to conduct the audit. C) has the responsibility of notifying financial statement users through the auditor's report. D) should notify regulators of the circumstances.
C) has the responsibility of notifying financial statement users through the auditor's report.
The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not ________ are detected. A) important to the financial statements B) statistically significant to the financial statements C) material to the financial statements D) identified by the client
C) material to the financial statements
When the auditor identifies or suspects noncompliance with laws and regulations, the auditor: A) should discuss the matter with those whom they believe committed the illegal act. B) begin communication with the FASB in accordance with PCAOB regulations. C) may disclaim an opinion on the basis of scope limitations if he is precluded by management from obtaining sufficient appropriate evidence. D) should withdraw from the engagement.
C) may disclaim an opinion on the basis of scope limitations if he is precluded by management from obtaining sufficient appropriate evidence.
Auditing standards make ________ distinction(s) between the auditor's responsibilities for searching for errors and fraud. A) little B) a significant C) no D) various
C) no
In certifying their annual financial statements, the CEO and CFO of a public company certify that the financial statements comply with the requirements of: A) GAAP. B) the Sarbanes-Oxley Act. C) the Securities Exchange Act of 1934. D) GAAS.
C) the Securities Exchange Act of 1934.
The auditor's evaluation of the likelihood of material employee fraud is normally done initially as a part of: A) tests of controls. B) tests of transactions. C) understanding the entity's internal control. D) the assessment of whether to accept the audit engagement.
C) understanding the entity's internal control.
Which of the following statements is usually true? A) Materiality is easy to quantify. B) Fraudulent financial statements are often easy for the auditor to detect, especially when there is collusion among management. C) Reasonable assurance is a low level of assurance that the financial statements are free from material misstatement. D) An item is considered material if it would likely have changed or influenced the decisions of a reasonable person using the statements.
D) An item is considered material if it would likely have changed or influenced the decisions of a reasonable person using the statements.
Which of the following is not one of the reasons that auditors provide only reasonable assurance on the financial statements? A) The auditor commonly examines a sample, rather than the entire population of transactions. B) Accounting presentations contain complex estimates which involve uncertainty. C) Fraudulently prepared financial statements are often difficult to detect. D) Auditors believe that reasonable assurance is sufficient in the vast majority of cases.
D) Auditors believe that reasonable assurance is sufficient in the vast majority of cases.
In describing the cycle approach to segmenting an audit, which of the following statements is not true? A) All general ledger accounts and journals are included at least once. B) Some journals and general ledger accounts are included in more than one cycle. C) The "capital acquisition and repayment" cycle is closely related to the "acquisition of goods and services and payment" cycle. D) The "inventory and warehousing" cycle may be audited at any time during the engagement since it is unrelated to the other cycles.
D) The "inventory and warehousing" cycle may be audited at any time during the engagement since it is unrelated to the other cycles.
If the auditor were responsible for making certain that all of management's assertions in the financial statements were absolutely correct: A) bankruptcies could no longer occur. B) bankruptcies would be reduced to a very small number. C) audits would be much easier to complete. D) audits would not be economically practical.
D) audits would not be economically practical.
When planning the audit, if the auditor has no reason to believe that illegal acts exist, the auditor should: A) include audit procedures which have a strong probability of detecting illegal acts. B) still include some audit procedures designed specifically to uncover illegalities. C) ignore the issue. D) make inquiries of management regarding their policies for detecting and preventing illegal acts and regarding their knowledge of violations, and then rely on normal audit procedures to detect errors, irregularities, and illegalities.
D) make inquiries of management regarding their policies for detecting and preventing illegal acts and regarding their knowledge of violations, and then rely on normal audit procedures to detect errors, irregularities, and illegalities.
Auditors accumulate evidence to: A) defend themselves in the event of a lawsuit. B) determine if the financial statements are correct. C) satisfy the requirements of the Securities Acts of 1933 and 1934. D) reach a conclusion about the fairness of the financial statements.
D) reach a conclusion about the fairness of the financial statements.
When an auditor discovers or suspects noncompliance with a law or regulation (illegal act), unless the matters involved are inconsequential, the auditor should: 1. Consider the effects of the illegal act on the financial statements, including the adequacy of disclosures. If the auditor concludes that disclosures are inadequate, the auditor should express a qualified or adverse opinion on the financial statements. If the auditor is precluded by management or those charged with governance from obtaining sufficient appropriate evidence to evaluate whether noncompliance that may be material to the financial statements has occurred or is likely to have occurred, the auditor should express a qualified opinion or disclaim an opinion on the financial statements on the basis of the scope limitation. 2. Communicate with those charged with governance matters involving noncompliance with laws and regulations that came to the auditor's attention during the course of the audit. If the matter is believed to be intentional and material, it should be communicated to those charged with governance, such as the board of directors, as soon as practicable. 3. Identify whether a responsibility exists to report the identified or suspected noncompliance to parties outside the entity, such as regulatory authorities. 4. Evaluate the effects of the noncompliance on other aspects of the audit, including the auditor's risk assessment and the reliability of other representations from management.
Discuss the actions an auditor should take when an illegal act is identified or suspected.
The primary difference between errors and frauds is that errors are unintentional misstatements of the financial statements, whereas frauds are intentional misstatements. Illegal acts are violations of laws or government regulations, other than frauds. An example of an error is a mathematical mistake when footing the columns in the sales journal. An example of a fraud is the creation of fictitious accounts receivable. An example of an illegal act is the dumping of toxic waste in violation of the federal environmental protection laws.
Discuss the differences between errors, frauds, and illegal acts. Give an example of each.
Auditing standards make no distinction between the auditor's responsibilities for searching for errors and fraud. In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detect because management or the employees perpetrating the fraud attempt to conceal the fraud. Still, the difficulty of detection does not change the auditor's responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud. The auditor's responsibility for uncovering illegal acts that have a direct effect on the financial statements is the same as for errors and fraud. However, the auditor is not required to search for illegal acts that do not have a direct effect on the financial statements unless there is reason to believe they exist.
Discuss the differences in the auditor's responsibilities for discovering (1) material errors, (2) material fraud (3) illegal acts having a direct effect on the financial statements, and (4) illegal acts that do not have a direct effect on the financial statements.
• Most audit evidence results from testing a sample of a population. Sampling involves some risk of not uncovering material misstatements. • Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events. As a result, the auditor has to rely on evidence that is persuasive but not convincing. • Fraudulently prepared financial statements are often very difficult for the auditor to detect, especially when there is collusion among management.
Discuss three reasons why auditors are responsible for "reasonable" but not "absolute" assurance.
The six characteristics of skepticism are: 1. Questioning mindset - a disposition to inquiry with some sense of doubt 2. Suspension of judgment - withholding judgment until appropriate evidence is obtained 3. Search for knowledge - a desire to investigate beyond the obvious, with a desire to corroborate 4. Interpersonal understanding - recognition that people's motivations and perceptions can lead them to provide biased or misleading information 5. Autonomy - the self-direction, moral independence, and conviction to decide for oneself, rather than accepting the claims of others 6. Self-esteem - the self-confidence to resist persuasion and to challenge assumptions or conclusions.
The concept of professional skepticism has been a foundational element of auditing standards for year and continues to be difficult to implement in practice. Recent academic research on the topic of professional skepticism suggests that there are six characteristics to skepticism. List and briefly describe each of these characteristics.
