Far Eastern University

ACCOUNTING 1.1

Chapter 2: FRAUD

1)When planning and performing audit procedures and evaluating and reporting the results thereof, the auditor should

1. 1. Search for errors that would have a material effect and for fraud that would have either material or immaterial effect on the financial statements.
   2. Consider the risk of misstatements in the financial statements resulting from fraud or error.
   3. Search for fraud that would have a material effect and for errors that would have either material or immaterial effect on the financial statements.
   4. Consider the risk of material misstatements in the financial statements resulting from fraud or error.

2. The term “fraud” refers to an intentional act by one or more individuals among management, those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage. Which statement is correct regarding fraud?
   1. Auditors make legal determinations of whether fraud has actually occurred.
   2. Misstatement of the financial statements may not be the objective of some frauds.
   3. Fraud involving one or more members of management or those charged with governance is referred to as “employee fraud”.
   4. Fraud involving only employees of the entity is referred to as “management fraud”.

3. Which of the following illustrates a perceived opportunity to commit fraud?
   1. Individuals are living beyond their means.
   2. Management is under pressure, from sources outside or inside the entity, to achieve an expected (and perhaps unrealistic) earnings target.
   3. An individual believes internal control could be circumvented because the individual is in a position of trust or has knowledge of specific weaknesses in the internal control system.
   4. All of the above.

4. Auditing standards require that auditors be aware of relevant factors relating to fraudulent reporting. Which of the following statements is false concerning fraudulent reporting?
   1. Fraud frequently involves a pressure or an incentive to commit fraud and a perceived opportunity to do so.
   2. Two types of fraud relevant to the auditor include material misstatements arising from fraudulent financial reporting and material misstatements arising from misappropriation of assets.
   3. Fraud involves actions of management but excludes the actions of employees or third parties.
   4. An audit rarely involves the authentication of documentation; thus, fraud may go undetected by the auditor.

5. Which of the following is an example of fraudulent financial reporting?
   1. Company management changes inventory count tags and overstates ending inventory, while understating cost of goods sold.
   2. The treasurer diverts customer payments to his personal due, concealing his actions by debiting an expense account, thus overstating expenses.
   3. An employee steals inventory, and the “shrinkage” is recorded in cost of goods sold.
   4. An employee steals small tools from the company and neglects to return them; the cost is reported as a miscellaneous operating expense.

6. Fraudulent financial reporting involves intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users. Fraudulent financial reporting least likely involve
   1. Deception such as manipulation, falsification, or alteration of accounting records or supporting documents from which the financial statements are prepared.
   2. Misrepresentation in, or intentional omission from, the financial statements of events, transactions or other significant information.
   3. Intentional misapplication of accounting principles relating to measurement, recognition, classification, presentation, or disclosure.
   4. Embezzling receipts, stealing physical or intangible assets, or causing an entity to pay for goods and services not received.

7. The types of intentional misstatements that are relevant to the auditor’s consideration of fraud include

1. Misstatements resulting from fraudulent financial reporting
2. Misstatements resulting from misappropriation of assets

a. I and II b. I only c. II only d. Neither I nor II

8. Which of the following statements describes why a properly designed and executed audit may not detect a material fraud?
   1. Audit procedures that are effective for detecting an unintentional misstatement may be ineffective for an intentional misstatement that is concealed through collusion.
   2. An audit is designed to provide reasonable assurance of detecting material errors, but there is no similar responsibility concerning material fraud.
   3. 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.
   4. The auditor did not consider factors influencing audit risk for account balances that have pervasive effects on the financial statements taken as a whole.

9. Which of the following inquiries are auditors required to make of management regarding fraud?
   1. Whether management has ever intentionally violated the securities law.

1. 2. Whether management has any knowledge of fraud that has been perpetrated on or within the entity.
   3. Management’s attitudes toward its employees.
   4. Auditors are not required to make inquiries of management relating to fraud.

10. The subsequent discovery of a material misstatement of the financial statements resulting from fraud or error, in and of itself, indicates:

11. In general, material fraud perpetrated by which of the following are most difficult to detect?

1. Cashier.
2. Keypunch operator.
3. Internal auditor.
4. Controller.

12. The regular examination of financial statements is not primarily designed to disclose fraud and other irregularities although their discovery may result. Normal audit procedures are more likely to detect a fraud arising from

1. Forgeries on company checks.
2. Failure to record cash receipts for services rendered.
3. Theft of inventories.
4. Collusion on the part of several employees.

13. The following are examples of error, except

1. A mistake in gathering or processing data from which financial statements are prepared.
2. An incorrect accounting estimate arising from oversight or misinterpretation of facts.
3. A mistake in the application of accounting principles relating to measurement, recognition, classification, presentation, or disclosure.
4. Misrepresentation in the financial statements of events, transactions or other significant information.

14. Which of the following characteristics most likely would heighten an auditor’s concern about the risk of intentional manipulation of financial statements?

1. Turnover of senior accounting personnel is low.
2. Insiders recently purchased additional shares of the entity’s stock.
3. Management places substantial emphasis on meeting earnings projection.
4. The rate of change in the entity’s industry is slow.

15. Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity’s financial statements?

1. Management places little emphasis on meeting earnings projections.
2. The board of directors makes all major financing decisions.

3. Reportable conditions previously communicated to management are not corrected.
4. Transactions selected for testing are not supported by proper documentation.

16. Which of the following circumstances most likely would cause an auditor to believe that material misstatements may exist in an entity’s financial statements?

1. Accounts receivable confirmation requests yield significantly fewer responses than expected.
2. Audit trails of computer-generated transactions exist only for a short-time.
3. The chief financial officer does not sign the management representation letter until the last day of the auditor’s fieldwork.
4. Management consults with other accountants about significant accounting matters.

17. When fraud has been identified, CPA responsibility consists of

1. Report the matter to the police.
2. He is not at all responsible.
3. He should have prevented it.
4. Determination of its extent.

18. 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 misstatement due to fraud?

1. All risk factors considered should be documented and the response to each documented.
2. Those risk factors identified and the auditor’s response to them should be documented.
3. The major categories of risk factors must be identified, but the particular responses to risk factors identified need not be documented.
4. No specific documentation is required.

19. When an auditor becomes aware of a possible illegal act by a client, the auditor should obtain an understanding of the nature of the act to

1. Evaluate the effect on the financial statements.
2. Determine the reliability of management’s representation.
3. Consider whether other similar acts may have occurred.
4. Recommend remedial actions to the audit committee.

20. Which of the following statements concerning illegal acts by clients is correct?

1. An auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and irregularities.
2. An audit in accordance with GAAS normally includes audit procedures specifically designed to detect illegal acts that have an indirect but material effect on the financial statements.
3. An auditor considers illegal acts from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions.
4. An auditor has no responsibility to detect illegal acts by clients that have an indirect effect on the financial statements.