09 Fraud, Error and Non-Compliance

 

Auditing

 Fraud, Error and Non-compliance

–

FAR EASTERN UNIVERSITY FRAUD, ERROR and NON-COMPLIANCE 1. 

Which of the following foll owing most accurately summarizes what is meant by the term “material misstatement”? misstatement”?   A.  Fraud and direct-effect illegal acts B.  Fraud involving senior management and material fraud C.  Material error, material fraud and certain illegal acts D.  Material error and material illegal acts

2. 

Misstatement in the financial statements statements can arise from from the fraud or error. The distinguishing factor between fraud and error is whether the underlying action that results in the misstatement of the financial statements is I.  Intentional or unintentional II.  Rational or irrational A.  I only B.  II only C.  Both I and II D.  Neither I nor II

3. 

 “Error” includes  includes  A.  Engaging in complex transactions that are structured to misrepresent the financial financi al position or financial performance of the entity. B.  Concealing, or not disclosing, facts that could affect the amounts recorded in the financial statements. C.  An incorrect accounting estimate arising from oversight or misinterpretation of facts. D.  Intentional misapplication of accounting policies relating to amounts, classification, manner of presentation, or disclosure.

4. 

Which of the following foll owing acts are considered fraud? I.  Changing of records and documents II.  Misinterpretation of facts III.  Misappropriation of assets IV.  Recording of transactions without documentation V.  Clerical mistakes A.  I and II only B.  III only C.  I, III and IV only D.  I, II, III, IV and V

5. 

Which of the following statements is correct? A.  Errors in the financial statements stat ements can be ignored because they are intentional. B.  Err Errors ors in the financial statements require adjustment of the client’s accounting records.  records.  C.  Fraud requires attention of the auditor, but errors do not. D.  Fraud has serious implications only because of their monetary effect on the financial statements.

Open using Adobe reader and PC

6. 

Which of the following statements concerning fraud is incorrect? A.  Fraud generally involves incentive or pressure to commit fraud, a perceived opportunity to do so, and some rationalization of the act. B.  Two types of misstatements relevant to the auditor include material misstatements arising from fraudulent financial reporting and material misstatements arising from misappropriation of assets. C.  Fraud involves actions of management but excludes the actions of employees or third parties. D.  An audit rarely involves the authentication of documentation; thus, fraud may go undetected by the auditor.

7. 

Fraudulent financial reporting involves intentional misstatements including omissions of amounts or disclosures in financial statements to deceive financial statement users. It may be accomplished in a number of ways, including A.  Embezzling receipts. B.  Stealing physical assets or intellectual property C.  Using an entity's assets for personal use. D.  Manipulation, falsification, or alteration of accounting records or supporting documentation from which the financial statements are prepared.

8. 

The primary responsibility for the prevention and detection of fraud rests with A.  The auditor B.  Management of the entity C.  Those charged with governance of the entity D.  Both those charged with governance of the entity and management

9. 

Which of the following foll owing statements best describes an auditor’s responsibility regarding misstateme misstatements? nts?   A.  An auditor should obtain absolute assurance that material misstatements in the financial statements will be detected. B.  An auditor should obtain reasonable assurance that the financial statements taken as a whole are free from material misstatements, whether caused by fraud or error. C.  An auditor is responsible to detect material errors but has no responsibility to detect material fraud that is concealed through employee collusion or management override of internal control. D.  An auditor’s failure to detect a material misstatement resulting from fraud is an indication of noncompliance with the requirements of the Philippine Phil ippine Standards on Auditing.

 

10.

Because of the risk of material an audit of financial statements in accordance with PSAs should be planned and performed with an misstatement, attitude of A.  Impartial conservatism. B.  Professional skepticism. C.  Independent integrity. D.  Objective judgment.

Auditing (Theoretical Concepts) by Raymund Francis Escala

HANDOUT 09  09 

Page 1 of 5 

 

Auditing  Fraud, Error and Non-compliance 11.  Which of the following foll owing statements is/are correct? Statement 1: The auditor is not and cannot be held responsible for the prevention of fraud and error. Statement 2: Annual audits may be carried out which may not act as deterrent. A.  Only statement 1 is correct B.  Only statement 2 is correct C.  Both statements are correct D.  Both statements are incorrect –

12. 

When is the auditor responsible for detecting fraud? A.  When the fraud did not result from collusion. B.  When third parties are likely to rely on the client’s financial statements. sta tements. C.  When the client’s system of internal i nternal control is judged by the auditor to be inadequate. inadequate.   D.  When the application of generally accepted auditing standards would have uncovered the fraud.

13. 

An auditor should recognize that the application of auditing procedures may produce evidential matter indicating the possibility of errors or irregularities and therefore should A. B.   C.  D. 

Design audit tests to detect unrecorded transactions. Extend the work to audit most recorded transactions and records records of an entity. Plan and perform the engagement with an attitude of professional skepticism. Not depend on internal accounting control features that are designed to prevent or detect errors or irregularities.

14. 

Whether the auditor has performed an audit in i n accordance with PSA is determined by A.  The adequacy of the audit procedures performed in the circumstances and the suitability of the auditor’s report based on the result of these t hese procedures. B.  The absence of material misstatements C.  The absence of material errors D.  The Securities and Exchange Commission

15. 

The regular examination of financial statements is not primarily designed to disclose fraud and other irregularities although their discovery may result. Normal audit procedure procedures s are more likely to d detect etect a fraud arising from: A.  Failure to record cash receipts for services rendered B.  Collusion on the part of several employees C.  Forgeries on company checks D.  Theft of inventories

16. 

When obtaining an understanding of the entity and its environment, including its internal control, the auditor may identify events or conditions that indicate an incentive or pressure to commit fraud or provide an opportunity to commit fraud. Such events or conditions are rreferred eferred to as A.  Fraud conditions B.  Fraud risk factors C.  Fraud environment D.  Fraudulent activities

Open using Adobe reader and PC

17. 

Which of the the following characteristics most likely would heighten an auditor’s concern about risk of intentional manipulation of financial statements? A.  Turnover of senior accounting personnel is low. B.  Insiders recently purchased additional shares of the entity’s stock. stock . C.  Management places substantial emphasis on meeting earnings projections. D.  The rate of change in the entity’s industry is slow. slow.  

18. 

Which of the following foll owing conditions or events may create incentive/pressures to commit fraud? A.  Inadequate accounting system of authorization and approval of transactions. B.  Lack of mandatory vacations for employees performing key control functions. C.  Excessive pressure on management or operating personnel to meet financial targets established by those charged with governance, including sales or profitability incentive goals. D.  Inadequate access controls over automated records.

19. 

Opportunities to misappropriate assets increase when there are (select the exception) A.  Large amounts of cash on hand or processed B.  Inventory items that are small in size, of high value, or in high demand C.  Known or anticipated future employee layoffs D.  Easily convertible assets, such as bearer bonds, computer chips or diamonds

20. 

The following are examples of fraud risk factors relating to misstatements arising from misappropriation of assets, except A.  Inadequate segregation of duties or independent checks. B.  Inadequate physical safeguards over cash, investments, inventory, or fixed asset. C.  Recurring negative cash flows from operating activities while reporting earnings and earnings growth. D.  Adverse relationship between the entity and employees with access to cash or other assets susceptible to theft created by recent changes made to employee compensation or benefit plans.

21. 

Which of the following statements is correct? A.  It is usually easier for the auditor to uncover irregularities than errors. B.  It is usually easier for the auditor to uncover errors than irregularities. C.  It is usually equally difficult for the auditor to uncover errors or irregularities. D.  None of the given statements is i s correct.

22. 

When conducting an audit, errors that arouse suspicion of fraud should be given greater attention than other errors. This is an examp example le of applying the criterion of A.  Reliability of evidence B.  Materiality C.  Risk D.  Dual-purpose testing

Auditing (Theoretical Concepts) by Raymund Francis Escala

HANDOUT 09  09 

Page 2 of 5 

 

Auditing

 Fraud, Error and Non-compliance

–

23. 

When planning the audit, the auditor should make inquiries inquiries of management. Such inquiries should address address the following, except A.  Management’s assessment of the risk that the financial statements may be misstated due to fraud. fraud.   B.  Management’s process for identifying and responding respon ding to the risks of fraud in the entity. C.  Management’s consideration of how an element of unpredictability will be incorporated into the nature, timing, and extent of the audit procedures to be performed. D.  Management’s communication, if any, to those charge charged d with governance regarding its processes for identifying and responding to the risks of fraud in the entity.

24. 

Which of the following statements describes why a properly designed and executed audit may not detect a material fraud? A.  Audit procedures that are effective for detecting unintentional misstatements may be ineffective for an intentional misstatement that is concealed through collusion. B.  An audit is designed to provide reasonable assurance of detecting material errors, but there is no similar responsibility concerning material fraud. C.  The factors considered in assessing control risk indicated an increased risk of intentional misstatements, but only a low risk of unintentional errors in the financial statements. D.  The auditor did not consider factors influencing audit risk for account balances that have pervasive effects on the financial statements taken as a whole.

25. 

When an independent auditor’s examination of financial statements discloses special circumstances that make the auditor suspect that material errors and irregularities may exist, the auditor’s initial course of action should be to to   A.  Recommend that the client pursue the suspected fraud to a conclusion that is agreeable to the auditor. B.  Extend normal audit procedures procedures in an attempt to detect the full extent of the suspected fraud. C.  Reach an understanding with the proper client representative as to whether the auditor or client is to make the investigation necessary to determine if a fraud has in fact occurred. D.  Decide whether the fraud, if in fact it sho uld exist, might be of such a magnitude as to affect the auditor’s report on the financial statements.

26. 

When the auditor’s regular examination leading to an opinion on the financial statement discloses specific circumstances that make him suspect that fraud may exist and he concludes that the results of such fraud, if any, could not be so material as to affect his opinion, he should A.  Make a note in his working papers of the possibility of a fraud of immaterial amount so as to pursue the matter next year. B.  Rea Reach ch an understanding with the client as to whether the auditor or the client, subject to auditor’s review, is to make the investigation necessary to determine whether fraud has occurred and, if so, the amount thereof. C.  Refer the matter to the appropriate representatives of the clients with the recommendations that is to be pursued to a conclusion. D.  Immediately extend his audit procedures to determine if fraud has occurred and, if i f so, the amount thereof.

27. 

Which of the following is correct concerning the required documentation in the working papers of the performance of the assessment of the risk of material misstatements due to fraud? A.  All risk factors considered should be documented and the response to each documented. B.  Those risk factors identified and the auditor’s audit or’s response to them should be documented. documented.   C.  The major categories of risk factors must be identified, but the particular responses to risk factors identified need not be documented. D.  No specific documentation is required.

28. 

The following statements relate to communication of misstatements resulting from fraud to management and to those charged with governance. Which is false? A.  The auditor need not bring to the attention of those charged with governance, any material weaknesses in internal control related to the prevention and detection of fraud. B.  If the auditor has identified a fraud, whether or not it results in a material misstatement in the financial statements, the auditor should communicate these matters to the appropriate level of management on a timely basis, and consider the need to report such matters to those charged with governance.

Open using Adobe reader and PC

C.  If the auditor has obtained evidence that indicates that fraud may exist (even if the potential effect on the financial statements would not be material), the auditor should communicate these matters to the appropriate level of management on a timely basis, and consider the need to report such matters to those charged with governance. D.  The auditor's communication with those charged with governance may be made orally or in writing. 29. 

It refers to acts of omission or commission by the entity being audited, either intentional or unintentional, which are contrary to prevailing laws or regulations. A.  Noncompliance B.  Illegal acts C.  Deplorable acts D.  Unforgivable acts

30. 

A violation of laws or governmental regulations by the audited entity or its management or employees acting on behalf of the entity is called A.  An error B.  An illegal act C.  Fraud D.  Fraudulent financial reporting

31. 

According to PSA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”, the following are indications that noncompliance may have occurred, except A.  Investigation by government departments or payment payment of fines or penalties. B.  Management is dominated by one person or a small group and there is no effective oversight board or committee. C.  Unauthorized transactions or improperly i mproperly recorded transactions. D.  Purchasing at prices significantly above or below market price.

Auditing (Theoretical Concepts) by Raymund Francis Escala

HANDOUT 09  09 

Page 3 of 5 

 

Auditing

 Fraud, Error and Non-compliance

–

32. 

In order to plan the audit, the auditor should obtain a general understanding of the legal and regulatory framework applicable to the entity and the industry and how the entity is complying with that framework. To obtain this understanding, the following procedures would ordinarily be considered by the auditor, except A.  Use the existing understanding of the entity's industry, regulatory, and other external factors. B.  Inquire of management concerning the entity's policies and procedures regarding compliance with laws and regulations. C.  Inquire of management as to the laws and regulations that may be expected to have a fundamental effect on the operations of the entity. D.  Inspect correspondence with relevant licensing or regulatory authorities.

33. 

When an auditor becomes aware of a possible illegal act by a client, the auditor should obtain understanding of the nature of the act to A.  Increase the assessed level of control risk. B.  Evaluate the effect on the financial statements. C.  Recommend remedial actions to the audit committee.

34. 

D.  Determine the reliability of management’s representations. representations.   If the auditor concludes that the noncompliance has a material effect on the financial statements, and has not been properly reflected in the financial statements, the auditor should express A.  A disclaimer of opinion B.  A qualified or an unqualified opinion C.  A qualified opinion or an adverse opinion D.  A qualified opinion or a disclaimer of opinion

35. 

An auditor who discovers that client employees have committed an illegal act that has a material effect on the client’s financial statements, most likely li kely would withdraw from the engagement if if A.  The illegal act is a violation of generally accepted accounting principles. B.  The client does not take the remedial action that the auditor considers necessary. necessary. C.  The illegal act was committed during a prior year that was not audited. D.  The auditor has already assessed control risk at the maximum level.

36. 

An auditor concludes that a client has committed an illegal act that has not been properly accounted for or disclosed. The auditor shou should ld withdraw fro from m the engagement if A.  Auditor is precluded from obtaining sufficient competent evidence about the illegal ill egal act. B.  Illegal act has an effect on the financial statements that is both material and direct. C.  Auditor cannot reasonably estimate the effect of the illegal act on the financial statements. D.  Client refuses to accept the auditor’s report as modified for the illegal act.  act.  

37. 

According to PSA 260, those matters that arise from the audit of financial statements and, in the opinion of the auditor, are both important and relevant to those charged with governance in overseeing the financial reporting and disclosure process are called A.  Auditor's findings B.  Significant audit matters C.  Audit matters of governance interest D.  Material misstatements in the statements

Open using Adobe reader and PC

38. 

Which of the following foll owing statements relating to communication of audit mat ters of governance interest is incorrect? A.  Audit matters of governance interest include only those matters that have come to the attention of the auditor as a result of the performance of the audit. B.  In an audit in accordance with PSAs, the auditor should design audit procedures for the specific purpose of identifying matters of governanc governance e interest. C.  The auditor should identify relevant persons who are charged with governance and with whom audit matters of governance interest are to be communicated. D.  The auditor's communications with those charged with governance may be made orally or in i n writing.

39. 

Which of the following foll owing matters an auditor is required to communicate to the entity’s audit committee? committee?     A.  The The basis for assessing control risk below maximum. B. auditor’s auditor’s preliminary judgments aboutthe materiality levels.  levels.   C.  The justification for performing substantive procedures at interim dates. D.  The process used by management in formulating sensitive accounting estimates.

40. 

Should an auditor communicate the following matters to an audit committee of a public entity? A B C   Significant audit adjustments recorded by the entity Yes Yes No about    Management’s consultation with other accountants about  significant accounting matters Yes Yes Yes 

D No



No

41. 

Which of the following fol lowing statements is/are correct? Statement 1: The auditor should communicate audit matters of governance interest arising from the audit of financial statements with those charged with governance of an entity. Statement 2: The auditor should determine the relevant persons who are charged with governance and with whom audit matters of governance interest are communicated. A.  Only statement 1 is correct B.  Only statement 2 is correct C.  Both statements are correct D.  Both statements are incorrect

42. 

The auditor’s communication with those charged charged with governance may be made orally or in writing. writing. The auditor’s decision whether to communicate orally or in writing is i s affected by factors except: A.  The nature, sensitivity and significance of the audit matters of governance interest to be communicated. B.  The arrangements made with respect to periodic meetings or reporting of audit matters of governance interest. C.  The size, operating structure, legal structure and communications processes of the entity being audited.

Auditing (Theoretical Concepts) by Raymund Francis Escala

HANDOUT 09  09 

Page 4 of 5 

 

Auditing  Fraud, Error and Non-compliance D.  The amount of past contact and dialogue the auditor has with those charged with governance. –

43. 

Under PSA 260, “Communications of Audit Matters with Those Charged with Governance”, the effectiveness of communications is enhanced by developing a constructive working relationship between the auditor and those charged with governance. governance. This relationship is develo developed ped while maintaining an attitude of A.  Objectivity and confidentiality B.  Professional independence and confidentiality C.  Loyalty and objectivity D.  Professional independence and objectivity

SELF-TEST QUIZZERS 1.  Fraud includes all of the following except: a.  Recording of transactions without substance b.  Suppression or omission of the effects of transactions from records or documents c.  Mathematical or clerical mistakes in the underlying records and accounting data d.  Misappropriation of assets 2. 

Which of the following is not an example of an error? a.  Entity personnel make mistakes in gathering or processing accounting data from which financial statements are prepared. b.  Entity personnel alter accounting records from which financial statements are prepared. c.  Entity personnel overlook or misinterpret facts, causing accounting estimates to be incorrect. d.  Entity personnel make mistakes in the application of accounting principles.

3. 

Fraud involving one or more members of management or those charged with governance is referred to as a.  Management fraud c. Fraudulent financial reporting b.  Employee fraud d. Misappropriation of assets

4. 

Which of the following foll owing statements is/are correct? Statement 1: The responsibility for the prevention and detection of fraud and error rests with the auditor through implementation of accounting and internal control systems. Statement 2: The accounting and internal control systems eliminate the possibility of fraud and error. a.  Only statement 1 is correct c. Both statements are correct b.  Only statement 2 is correct d. Both statements are incorrect

5. 

Which of the following is least likely a category of fraud risk factors that relate to misstatements, resulting from fraudulent financial reporting? a.   Opportunity Incentive or to pressure b. commit the act

6. 

c. Rationalization the act d. Susceptibility ofofassets to misappropria misappropriation tion

Opportunities to misappropriate assets increase when there are a.  Known or anticipated future employee layoffs. b.  Promotions, compensation, or other rewards inconsistent with expectations. c.  Recent or anticipated changes to employee compensation or benefit plans, d.  Inventory items that are small in size, of high value, or in high demand.

Open using Adobe reader and PC

7. 

If the auditor has determined that there may be fraud that may have material effect on the financial statements, all of the following should be done except a.  Consider the implications for other aspects of the audit. b.  Discuss the matter with the level of management where fraud might have occurred. c.  Try to obtain evidence to determine whether the fraud is material and what its effect will be on the financial statements. d.  If appropriate, suggest that the client consult with legal counsel on matters of law.

8. 

The most likely explanation explanation why the auditor’s examination cannot reasonably be expected to bring all illegal acts by the client to the auditor’s attention is that  that   a.  Illegal acts are perpetrated by management override of internal control. b.  Illegal acts by clients often relate to operating aspects rather than accounting aspects. c.  The client’s internal control may be so strong that the auditor performs only minimal substantive testing. testing.   d.  Illegal acts may be perpetrated by the only person in the client’s organization with access to both ass ets and the accounting records.

9. 

It is used to determine the role of persons entrusted with the supervision, control and direction of an entity. a.  Oversight b. Governance c. Direction d. Control

10. 

Which of the following statements is correct concerning an auditor’s required communication with an entity’s audit committee? a.  This communication should include disagreements with management about significant audit adjustments, whether or not satisfactorily resolved. b.  If matters are communicated orally, it is necessary to repeat the communication of recurring matters each year. c.  If matters are communicated in writing, the report is required to be distributed to both the audit committee and management. d.  This communication is required to occur before the auditor’s report on report  on the financial statements is issued.

SUGGESTED ANSWERS TO SELF-TEST QUIZZERS (CBADD DBBBA)

Success is the maximum utilization utilization of the ability that you have. - Zig Ziglar The way to succeed is to double your error rate. - Thomas Watson -- END OF HANDOUTS --

Auditing (Theoretical Concepts) by Raymund Francis Escala

HANDOUT 09  09 

Page 5 of 5