Ch 4 – Management Fraud and Audit Risk – Flashcards
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4.20 Enterprise risk management is the responsibility of: a. company management b. the external auditors c. the company's insurance providers d. all of the above
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a. company management
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4.21 Failure to meet company objectives is a result of: a. information risk b. audit risk c. business risk d. inherent risk
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c. business risk
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4.22 Auditing standards do not require auditors of financial statements to: a. understand the nature of errors and frauds b. assess the risk of occurrence of errors and frauds c. design audits to provide reasonable assurance of detecting errors and frauds d. report all errors and frauds found to police authorities
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d. report all errors and frauds found to police authorities
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4.23 If sales were overstated by recording a false credit sale at the end of the year, where could you find the false "dangling debt"? a. inventory b. cost of goods sold c. bad debt expense d. accounts receivable
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d. accounts receivable
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4.24 One of the typical characteristics of management fraud is: a. falsification of documents in order to misappropriate funds from an employer b. victimization of investors through the use of materiality misleading financial statements c. illegal acts committed by management to evade laws and regulations d. conversion of stolen inventory to cash deposited in a falsified bank account
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b. victimization of investors through the use of materiality misleading financial statements
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4.25 Which of the following circumstances would most likely cause an audit team to perform extended procedures? a. supporting documents are produced when requested b. the client made several large adjustments at or near year-end c. the company has recently hired a new chief financial officer after the previous one retired d. the company maintains several different petty cash funds
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b. the client made several large adjustments at or near year-end
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4.26 The likelihood that material misstatements may have entered the accounting system and not been detected and corrected by the client's internal control is referred to as: a. inherent risk b. control risk c. detection risk d. risk of material misstatement
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d. risk of material misstatement (CR x IR) detection risk - "risk of detection failure", risk that audit procedures will fail to detect misstatements greater than tolerable misstatement * high DR = good internal controls = less evidence low DR = ineffective int. controls = more evidence inherent risk - "account/transaction risk", likelihood of material misstatement before considering internal controls (*high IR implies a risky segment/account/ transaction) control risk - "risky controls", assessment of whether misstatements will be prevented or detected by internal controls (*high CR implies ineffective controls)
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4.27 The risk of material misstatement is composed of which audit risk components? a. inherent risk and control risk b. control risk and detection risk c. inherent risk and detection risk d. inherent risk, control risk and detection risk
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a. inherent risk and control risk
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4.28 The risk that the auditors' own testing procedures will lead to the decision that material misstatements do not exist in the financial statements when in fact such misstatements do exist is: a. audit risk b. inherent risk c. control risk d. detection risk
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d. detection risk
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4.29 The auditors assessed risk of material misstatement at 0.50 and said they wanted to achieve a 0.05 risk of failing to express a correct opinion on financial statements that were materially misstated. What detection risk do the auditors plan to use for planning the remainder of the audit work? a. 0.20 b. 0.10 c. 0.75 d. 0.00
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b. 0.10 *AR = DR x CR x IR .05 = DR x (0.50) .05/0.5 = DR DR = 0.10
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4.30 If tests of controls induce the audit team to change the assessed level of control risk for fixed assets from 0.4 to 1.0 and audit risk (0.5) and inherent risk remain constant, the acceptable level of detection risk is most likely to: a. change from 0.1 to 0.04 b. change from 0.2 to 0.3 c. change from 0.25 to 0.1 d. be unchanged
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c. change from 0.25 to 0.1
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4.31 Which of the following is a specific audit procedure that would be completed in response to a particular fraud risk in an account balance or class of transactions? a. exercising more professional skepticism b. carefully avoiding conducting interviews with people in areas that are most susceptible to fraud c. performing procedures such as inventory observation and cash counts on a surprise or unannounced basis d. studying management's selection and application of accounting principles more carefully
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c. performing procedures such as inventory observation and cash counts on a surprise or unannounced basis
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4.32 Analytical procedures are generally used to produce evidence from: a. confirmations mailed directly to the auditors by client customers b. physical observation of inventories c. relationships among current financial balances and prior balances, forecasts, and nonfinancial data d. detailed examination of external, external-internal, and internal documents
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c. relationships among current financial balances and prior balances, forecasts, and nonfinancial data
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4.33 Which of the following relationships between types of analytical procedures and sources of information are most logical? a. analytical procedure - comparison of current account balances with prior periods source of info - physical production statistics b. analytical procedure - comparison of current account balances with expected balances source of info - company's budgets and forecasts c. analytical procedure - evaluation of current account balances with relation to predictable historical patterns source of info - published industry ratios d. analytical procedure - evaluation of current account balances with relation to nonfinancial info source of info - company's own comparative financial statements
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b. analytical procedure - comparison of current account balances with expected balances source of info - company's budgets and forecasts
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4.34 Analytical procedures can be used in which of the following ways? a. as a means of overall review near the end of an audit b. as "attention-directing" methods when planning an audit at the beginning c. as substantive audit procedures to obtain evidence during an audit d. all of the above
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d. all of the above a. as a means of overall review near the end of an audit b. as "attention-directing" methods when planning an audit at the beginning c. as substantive audit procedures to obtain evidence during an audit
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4.35 Analytical procedures used when planning an audit should concentrate on: a. weaknesses in the company's internal control activities b. predictability of account balances based on individual significant transactions c. management assertions in financial statements d. accounts and relationships that can represent specific potential problems and risks in the financial statements
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d. accounts and relationships that can represent specific potential problems and risks in the financial statements
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4.36 When a company that sells its products with a positive gross profit increases its sales by 15 percent and its cost of goods sold by 7 percent, the cost of goods sold ratio will: a. increase b. decrease c. remain unchanged d. not be able to be determined with the information provided
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b. decrease
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4.37 Auditors are not responsible for accounting estimates with respect to: a. making the estimates b. determining the reasonableness of estimates c. determining the estimates are presented in conformity with GAAP d. determining that estimates are adequately disclosed in the financial statements
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a. making the estimates
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4.38 An audit strategy memorandum contains: a. specifications of auditing standards relevant to the financial statements being audited b. specifications of procedures the auditors believe appropriate for the financial statements under audit c. documentation of the assertions under audit, the evidence obtained, and the conclusions reached d. reconciliation of the account balances in the financial statements with the account balances in the client's general ledger
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b. specifications of procedures the auditors believe appropriate for the financial statements under audit
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4.39 It is acceptable under generally accepted auditing standards for an audit team to: a. assess risk of material misstatement at high and achieve an acceptably low audit risk by performing extensive substantive tests b. assess control risk at zero and perform a minimum of detection work c. assess inherent risk at zero and perform a minimum of detection work d. decide that audit risk can be 40 percent
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a. assess risk of material misstatement at high and achieve an acceptably low audit risk by performing extensive substantive tests
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4.40 Under the Private Securities Litigation Reform Act (the Act), independent auditors are required to first: a. report in writing all instances of noncompliance with the Act to the client's board of directors b. report to the SEC all instances of noncompliance with the Act they believe have a material effect on financial statements if the board of directors does not first report to the SEC c. report clearly inconsequential noncompliance with the Act to the audit committee of the client's board of directors d. resign from the audit engagement and report the instances of noncompliance with the Act to the SEC
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a. report in writing all instances of noncompliance with the Act to the client's board of directors
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4.41 When evaluating whether accounting estimates made by management are reasonable, auditors would be most interested in which of the following? a. key factors that are consistent with prior periods b. assumptions that are similar to industry guidelines c. measurements that are objective and not susceptible to bias d. evidence of conservative systematic bias
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d. evidence of conservative systematic bias
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4.42 An audit committee is: a. composed on internal auditors b. composed of members of the audit team c. composed of members of a company's board of directors who are not involved in the day-to-day operations of the company d. a committee composed of persons not associating in any way with the client or the board of directors
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c. composed of members of a company's board of directors who are not involved in the day-to-day operations of the company
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4.43 When auditors become aware of noncompliance with a law or regulation committed by client personnel, the primary reason that the auditors should obtain a better understanding of the nature of the act is to: a. recommend remedial actions to the audit committee b. evaluate the effect of the noncompliance on the financial statements c. determine whether to contact law enforcement officials d. determine whether other similar acts could have occurred
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b. evaluate the effect of the noncompliance on the financial statements
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4.44 Which of the following statements best describes auditors' responsibility for detecting a client's noncompliance with a law or regulation? a. the responsibility for detecting noncompliance exactly parallels the responsibility for errors and frauds b. auditors must design tests to detect all material noncompliance that indirectly affects the financial statements c. auditors must design tests to obtain reasonable assurance that all noncompliance with direct material financial statement effects is detected d. auditors must design tests to detect all noncompliance that directly affects the financial statements
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c. auditors must design tests to obtain reasonable assurance that all noncompliance with direct material financial statement effects is detected
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4.45 Auditors perform analytical procedures in the planning stage of an audit for the purpose of: a. deciding the matters to cover in an engagement letter b. identifying unusual conditions that deserve more auditing effort c. determining which of the financial statement assertions are the most important for the client's financial statements d. determining the nature, timing and extent of further audit procedures for auditing inventory
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b. identifying unusual conditions that deserve more auditing effort
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4.46 A primary objective of analytical procedures used in the final review stage of an audit is to: a. identify account balances that represent specific risks relevant to the audit b. gather evidence from tests of details to corroborate financial statement assertions c. detect fraud that may cause the financial statements to be misstated d. assist the auditor in evaluating the overall financial statement presentation
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d. assist the auditor in evaluating the overall financial statement presentation
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4.47 An auditor's analytical procedures indicate a lower than expected return on an equity method investment. This situation most likely could have been caused by: a. an error in recording amortization of the excess of the investor's cost over the investment's underlying book value b. the investee's decision to reduce cash dividends declared per share of its common stock c. an error in recording the unrealized gain from an increase in the fair value of available-for sale securities in the income account for trading securities d. a substantial fluctuation in the price of the investee's common stock on a national stock exchange
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a. an error in recording amortization of the excess of the investor's cost over the investment's underlying book value
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4.48 Which of the following risk types increase when an auditor performs substantive analytical audit procedures for financial statement accounts at an interim date? a. inherent b. control c. detection d. sampling
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c. detection
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4.49 Which of the following matters relating to an entity's operations would an auditor most likely consider as an inherent risk factor in planning an audit? a. the entity's fiscal year ends on June 30 b. the entity enters into significant derivative transactions as hedges c. the entity's financial statements are generated at an outside service center d. the entity's financial data is available only in computer-readable form
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b. the entity enters into significant derivative transactions as hedges
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4.50 What is the primary objective of the fraud brainstorming session? a. determine audit risk and materiality b. identify whether analytical procedures should be applied to the revenue accounts c. assess the potential for material misstatement due to fraud d. determine whether the planned procedures in the audit plan will satisfy the general audit objectives
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c. assess the potential for material misstatement due to fraud
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 1. the client lacks sufficient working capital to continue operations
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audit risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 2. The client fails to detect employee theft of inventory from the warehouse because there are no restrictions on warehouse access and the client does not reconcile inventory on had to recorded amounts on a timely basis
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audit risk control risk inherent risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 3. the company is publicly traded
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audit risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 4. the auditor has identified numerous material misstatements during the prior year audit engagements
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inherent risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 5. the assigned staff on the audit engagement lack the necessary skills to identify actual errors in an account balance when examining audit evidence accumulated
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detection risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 6. the client is one of the industry's largest based on its size and market share
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audit risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 7. the client engages in several material transactions with entities owned by family members of several of the client's senior executives
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inherent risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 8. the allowance for doubtful accounts is based on significant assumptions made by management
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inherent risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 9. the audit plan omits several necessary audit procedures
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detection risk
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HO4.2 Independent risk factors. Identify which of the following audit risk model components relates most directly to each risk factor: 10. the client fails to reconcile bank accounts to recorded cash balances
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control risk
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4.67 a. What are the requirements for auditors to plan procedures to detect direct-effect compliance versus indirect-effect compliance?
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Direct-effect compliance: auditors responsibility to design procedures to provide reasonable assurance Ie. Direct effect on a specific account or disclosure; Tax evasion Indirect-effect compliance: auditors responsibility to follow-up on suspected violations material to the financial statements ; no assurance Ie. EEO, insider securities trading, OSHA, FDA, environmental protection issues
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 1. a manufacturer inflates expenses on its corporate tax return
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direct -effect directly affects tax expense and accrual accounts
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 2. a retailer pays men more than women for performing the same job
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indirect-effect does not have direct effect on a specific account or disclosure
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 3. a coal mining company fails to place proper ventilation in its mines
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indirect-effect does not have direct effect on a specific account or disclosure
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 4. a military contractor inflates the overhead applied to a combat vehicle
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direct-effect directly affects inventory account
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 5. an insurance company fails to maintain required reserves for losses
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direct-effect directly affects reserve for losses account
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 6. an exporter pays a bribe to a foreign government official so that government will buy its products
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indirect-effect a violation of Foreign Corrupt Practices Act but does not have direct-effect on a specific account or disclosure
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 7. a company backdates its executive stock options to lower the exercise price
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direct-effect directly affects accrual of compensation expense
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4.67 b. For each of the following instances of noncompliance, explain why they are either direct-effect or indirect-effect noncompliance: 8. a company fails to fund its pension plan in accordance with ERISA
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direct-effect directly affects pension plan reserve account
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What are the (3) factors affecting inherent risk?
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1. nature of client's business - industry practices, non-routine practices, makeup of the population 2. audit experience - prior audit results, initial vs. repeat engagement, audit judgment 3. culture - related parties, fraudulent financial reporting, misappropriation of assets
