Chapter 2 TB Flashcards by Angel Lea Regalado

An example of fraudulent financial reporting is the CFO intentionally overstating sales to boost profits.

T or F?

TRUE

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Asset misappropriations are the primary fraud scheme in small businesses, and the perpetrators are usually the owners.

T or F?

FALSE

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Auditors need to consider fraud arising from misappropriation of assets and fraudulent financial reporting.

T or F?

TRUE

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Fraud is an intentional act involving the use of deception that results in a misstatement of the financial statements.

T or F?

TRUE

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An example of fraudulent financial reporting is the treasurer’s diversion of hundreds of thousands of dollars into a personal money market account.

T or F?

FALSE

Asset misappropriation

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BruceCo. has accounted for the revenue of Jiffy Mac, Inc., one of its suppliers, as though it were its subsidiary. BruceCo. has probably committed fraud because of its misapplication of consolidation principles.

T or F?

TRUE

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An example of fraudulent financial reporting is the treasurer’s diversion of hundreds of thousands of dollars into a personal money market account.

T or F?

FALSE

Asset misappropriation

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T or F?

TRUE

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The most important lesson to be learned from The Great Salad Oil Swindle is that auditors can commit fraud by falsely including inventory that does not exist.

T or F?

FALSE

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The fraud triangle requires the auditor to actively consider and assess the risk of fraud for clients and their financial statements.

T or F?

FALSE

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Rationalization involves the mindset of the fraudster to justify committing the fraud.

T or F?

TRUE

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Pressure upon management to manipulate financial information is a common characteristic in fraud cases.

T or F?

TRUE

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Management may feel pressure to maintain debt covenants, which is a deterrent to fraud.

T or F?

FALSE

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The auditor should not consider that fraud is present in revenue accounts because revenue recognition does not typically play a role in fraudulent financial reporting.

T or F?

FALSE

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During the time period 1998 to 2007, the median size of the public company perpetrating fraud rose tenfold to $100 million (as compared to the previous ten years).

T or F?

TRUE

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Opportunity is one element of the fraud triangle.

T or F?

TRUE

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The landmark Enron fraud in the early 2000’s involved the movement of significant debt off the books to related, unconsolidated entities.

T or F?

TRUE

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The auditor is responsible for actively considering fraud risks in order to obtain reasonable assurance that the financial statements are free of material fraud.

T or F?

TRUE

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If an auditor discovers evidence of fraud, the planned audit procedures should be adjusted accordingly.

T or F?

TRUE

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Related-party transactions provide management certain opportunities to manipulate financial statements.

T or F?

TRUE

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According to professional audit standards, the audit team should assemble early in the planning stages of an audit to conduct a fraud “brainstorming” meeting in order to determine the types of fraud that may occur with the client.

T or F?

TRUE

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Audit procedures to detect fraud are generally an expansion of normal audit procedures.

T or F?

FALSE

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Auditors must keep a questioning mind when analyzing management responses to inquiry, and auditors should strive to obtain corroborating evidence before accepting management’s responses.

T or F?

TRUE

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According to the PCAOB, the detection of material fraud is a reasonable expectation of users of audited financial statements.

T or F?

TRUE

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Various ways by which fraud could be perpetrated should be hypothesized by the auditor prior to conducting audit testing. ##Clarifier T or F?

TRUE

Auditors are responsible to detect fraud even if it has an immaterial effect on the financial statements. ## Clarifier T or F?

FALSE

The auditor can be satisfied with less than persuasive evidence in the audit process because of the belief that management is honest. ## Clarifier T or F?

FALSE

An audit must be performed by persons who can make sound judgments relating to complex accounting issues. ## Clarifier T or F?

TRUE

The Sarbanes-Oxley Act established the PCAOB, which is an agency of the U.S. government funded by taxpayers. ## Clarifier T or F?

FALSE ## Footnote The Public Company Accounting Oversight Board (PCAOB) is a *nonprofit corporation* created by the Sarbanes–Oxley Act of 2002 to oversee the audits of public companies and other issuers in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports.

Management compensation that is tied to profits may create incentives to commit fraud. ## Clarifier T or F?

TRUE

The audit committee is a subcommittee of the board of directors comprised of independent outside directors. ## Clarifier T or F?

TRUE

The audit committee must be composed of outsiders such as the organization's attorney and audit partner. ## Clarifier T or F?

FALSE ## Footnote The audit committee is a subcommittee of the board of directors comprised of independent outside directors.

Management of companies should have the ability to hire and fire the external auditor. ## Clarifier T or F?

FALSE ## Footnote Audit Committee

A board of directors that is actively involved in monitoring management mitigates opportunities to commit fraud. ## Clarifier T or F?

TRUE

Transparency is a desirable, but not critical, element of effective corporate governance. ## Clarifier T or F?

FALSE

The onslaught of fraud in financial statements over the past two decades has been the first of its kind in history. ## Clarifier T or F?

FALSE

Implementing an effective ethical environment is primarily the responsibility of the audit committee of the board of directors. ## Clarifier T or F?

FALSE

Managers of organizations are hired by boards of directors to perform responsibilities such as the implementation of internal control. ## Clarifier T or F?

TRUE

Formulating corporate strategy and risk management policy is primarily the responsibility of the board of directors. ## Clarifier T or F?

FALSE ## Footnote Formulating corporate strategy and risk management policy is primarily the responsibility of the *management.*

One fraud risk factor includes the presence of domineering members of management who seek the ultimate loyalty of subordinates. ## Clarifier T or F?

TRUE

Which of the following best represents fraud related to financial reporting? The transfer agent issues 40,000 shares of the company's stock to a friend without authorization by the board of directors. The controller of the company decreases warranty expense by $3 million because the company will otherwise miss analysts' expectations this quarter. The in-house attorney receives payments from the French government for negotiating the development of a new plant in Paris. The accounts receivable clerk covers up the theft of cash receipts by writing off older receivables without authorization.

According to professional auditing standards, which of the following best represents a type of fraudulent financial reporting? Management accrues a liability and discloses the possible outcome of a lawsuit prior to settling the matter. Management reclassifies a negative cash balance by decreasing cash and increasing a current liability. Management discloses its failure to meet loan covenants but states that a waiver has been received. Management intentionally excludes from its consolidated results a subsidiary that it controls significantly.

What type of fraud occurs when the deposits of current investors are used to pay returns on the deposits of previous investors with no real investment happening? Ponzi Scheme. Skimming. Channel Stuffing. Off-Balance Sheet Fraud.

Which of the following situations represents a risk factor that relates to misstatements arising from misappropriation of assets? A high turnover of senior management. A lack of independent checks. A strained relationship between management and the predecessor auditor. An inability to generate cash flow from operations.

Which of the following is an example of fraud? A mistake in processing accounting data. An incorrect accounting estimate arising from misinterpretation of facts. Misappropriation of an asset. A mistake in the application of accounting principles.

C ## Footnote Fraud is *intentional*

What is the primary determinant in the difference between fraud and errors in financial statement reporting? The materiality of the misstatement. The intent to deceive. The level of management involved. The type of transaction affected.

Which of the following frauds is most common? Chief financial officer’s misappropriation of funds. Misapplication of revenue recognition principles. Management's theft of cash held in reserve accounts. Over-recording expenses related to stock options.

Which of the following statements about the Bernie Madoff Ponzi scheme is false? Madoff took advantage of his unique ties to the investment community (he was the former Chair of the NASDAQ) to create trust and encourage further investments. Madoff began perpetrating the fraud shortly before passage of the Sarbanes-Oxley Act, and the provisions of that Act ultimately led to discovery of the fraud. Madoff was sentenced to 150 years in prison. The estimated amount missing from client accounts, including fabricated gains, was almost $65 billion.

The fraud triangle identifies three elements that are generally present in the client’s organization when fraud occurs. Which of the following is not one of those elements? Professional skepticism. Incentives. Opportunity. Rationalization

Which of the following is a common incentive or condition that increases the likelihood for *fraudulent financial reporting*? Ineffective segregation of assets. Significant related party transactions. Management bonuses based on reported earnings. Access to undeposited cash.

Which of the following is not an element of the fraud triangle? Incentive. Rationalization. Deception. Opportunity

Management of Premium Discovery Company is compensated through large salaries, stock options, and bonuses tied to the company's working capital growth. The CEO is constantly holding meetings to ensure that management is on target for increased operating income each month. Based solely on the preceding information, which element of the fraud triangle exists at the Premium Discovery Company? Incentive. Opportunity. Rationalization. Expectation.

Sam Jones, controller of Mitnikco, spends three days researching the accounting standards to find loopholes in the "rules" and to make a case for recognizing revenue earlier, rather than in later years. In the end, Sam and the other members of management determine that they will reduce the company's deferred revenue accounts and begin accounting for all revenues as agreements are signed. Based solely on the preceding information, which element of fraud is represented by the actions of Mitnikco management? Pressures. Opportunity. Rationalization. Skepticism.

Which of the following creates an opportunity for fraud to be committed in an organization? Management demands financial success. Poor internal control. Commitments tied to debt covenants. Management is aggressive in its application of accounting rules.

The fraud triangle has three elements. Which of the elements must be present for a fraud to occur? All elements must be present for fraud to occur. At least two of the three elements must be present for fraud to occur. Fraud can occur if any one of the elements is present. None of the above.

Which of the following actions was a key element of the Enron audit fraud? Capitalizing line costs rather than expensing them. Misrepresenting bribes from suppliers as a reduction of operating costs. Shifting debt to off-balance sheet special entities. Concealing large losses related to securities investments.

Who is most often involved in perpetrating fraudulent financial reporting? The auditors and the attorneys. The treasurer and the board of directors. The chief executive and chief financial officer. The shareholders and the chief operating officer.

Which of the following frauds involved primarily asset misappropriation? Enron. WorldCom. Dell. Koss.

Which action was a key element in the WorldCom fraud case? Recording bartered exchange transactions as revenue. Overstating cash by falsely recording cash held at major banks. Recognizing revenue on the sale of impaired assets. Concealing large losses related to securities investments.

Which action was a key element in the Wells Fargo fraud case? Inflating assets by falsely overstating cash held in customers’ accounts. Creating fake customer accounts to boost employees’ bonuses. Employee theft from customers’ accounts. Top management’s recording of fictitious fees to increase reported revenues.

What is the best way an auditor can detect fraud in the financial statements? Actively search for errors in the financial statements. Understand Generally Accepted Accounting Standards. Brainstorm with the client to find the types of fraud occurring. Use professional skepticism

Which of the following best describes professional skepticism? An intent to deceive. An attitude of intrusion and obstinacy. A firm commitment to auditing standards and ethics. A questioning mind.

Why is fraud detection an important part of the audit? Auditors are required to seek out and find all fraud, regardless of its magnitude. Auditors expect that management will make them aware of any fraud in the financial statements. Society expects that financial statements have not been materially misstated due to fraud. Society realizes that some fraud was not intended to be discovered by auditors.

One of the primary goals of the PCAOB is to restore confidence in which group? The SEC. Boards of directors. Internal auditors. Independent auditors.

Which of the following statements reflects an auditor’s responsibility for detecting fraud? An auditor is not responsible for discovering fraudulent acts involving employee collusion. The audit should be planned to detect only fraud caused by departures from GAAP. An auditor is only responsible for detecting fraudulent financial reporting. An auditor should design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.

How must an auditor address fraud in the planning stage? The auditor must test for fraud in the planning stage by sampling accounts. The auditor must consider the likelihood of fraud existing in the company in the planning stage. The auditor must realize that most people are honest and not automatically assume that fraud exists when planning the audit. The auditor must not be aggressive in its initial approach to fraud, as trust may be lost by the client

What should an audit team do when it discovers that fraud risk factors are present on an audit engagement? Withdraw from the engagement and inform regulatory bodies. Modify procedures to actively search for the existence of fraud. Reduce the amount of evidence required and resort to management inquiry. Turn the audit over to forensic accountants.

Which of the following best represents actions that may indicate fraud is pervasive throughout the company under audit? The company's management negotiates deals with vendors in such a manner as to pay lower prices. The company's management drives luxury vehicles and takes vacations to exotic places. The company's management takes an overly aggressive approach to revenue recognition. The company's management estimates bad debts using an aged accounts receivables ledger rather than as a percent of sales

According to professional audit standards, how might auditors gain an understanding of the nature of fraud that may occur in the client organization? Fraud training courses from actual corporate fraud ex-criminals. Conducting a brainstorming session with the members of the audit team. Circulating a survey to the client company employees for completion. Discussions with other audit firms

What should auditors and others involved in the financial reporting process do to mitigate the risk of fraudulent financial reporting? Acknowledge that there needs to exist a strong, highly ethical tone at the top of an organization that permeates the corporate culture, including an effective fraud risk management program. Continually exercise professional skepticism. Remember that strong communication among those involved in the financial reporting process is critical. All of the above

There are many important reasons for diligent audit planning. If an audit firm wrongly skips the *planning stage* of an audit, what will be the effect relative to fraud detection? The firm will not be able to apply GAAP to the financial statements. The firm will not adequately identify the types of fraud that may occur in the client company. The firm will not be able to perform direct tests of account balances. The firm will lack the competency and technical training necessary to complete the audit in accordance with GAAS.

Which of the following statements about fraud or fraud detection is true? Management may physically alter evidence to perpetrate and conceal the fraud. Fraudulent financial reporting is generally not material enough to consider. Journal entries will supply evidence necessary to detect fraud. The advent of new technology prevents fraud, thereby leading to less fraud over time.

Which of the following factors should an auditor consider in evaluating the effect of fraud upon the planned audit procedures? The type of fraud that may occur. The potential materiality of fraud. The likelihood of fraud occurring. All of the above.

Which of the following statements is true concerning the fraud risk model? Assessing incentive is the first phase of the model. The fraud risk model should be reviewed with the audit team. The fraud risk model should be modified based on a review of internal controls. Auditors do not use a fraud risk model.

How did the Sarbanes-Oxley Act strengthen auditor independence? By requiring auditors to provide reports in accordance with the Foreign Corrupt Practices Act. By requiring auditors to report the nature of any auditor-client disagreements to the SEC. By requiring the lead partner to rotate off the audit engagement at least every five years. By requiring a different audit firm from the one that performs the audit to prepare the client’s tax return.

How frequently does the PCAOB inspect registered accounting firms that audit 100 or more issuers? Annually. Every two years. Every three years Every five years.

The PCAOB has how many board members? Three Five Seven Nine

Which of the following is a responsibility of the PCAOB? To set financial reporting standards for public companies. To set financial reporting standards for private companies. To set audit standards for public companies. To set audit standards for private companies.

How often does the PCAOB inspect registered accounting firms that audit fewer than 100 issuers? Annually. Every two years. Every three years. Every five years.

According to the Sarbanes-Oxley Act, which of the following items is the independent auditor required to report to the audit committee? Materiality limits for audit testing. Critical accounting policies and practices. The extent of audit testing in high-risk accounts. A list of probable fraud errors identified in audit planning.

Fraud detection procedures should only be performed for clients that have had fraud problems in the past. ## Clarifier T or F?

FALSE

Under the Sarbanes-Oxley Act, which of the following services performed by registered accounting firms for their audit clients would not impair their independence? Systems design. Tax services. Appraisal services. Internal audit services.

Which of the following items are registered audit firms not required to report to the audit committee? Critical accounting policies and practices. Alternative treatments of financial information within generally accepted accounting principles that have been considered by management, as well as the preferred treatment of the audit firm. A list of all audit procedures performed. Significant written communications between the audit firm and management.

Which of the following are management responsibilities under the Sarbanes-Oxley Act of 2002? Certify in reports filed with the SEC that the report does not contain untrue statements of material facts. Disclose material deficiencies in controls to the audit committee. Design internal controls. Certify in reports filed with the SEC that the company’s internal controls are effective in preventing fraud.

Which of the following is a stated principle of a NYSE report identifying key core governance principles? The board of directors should consist of an equal number of independent and non-independent directors. Effective corporate governance should be viewed as a compliance obligation. Effective corporate governance should be integrated with the company’s business strategy. The board of directors has the primary responsibility for creating a culture of integrity and ethical behavior.

Professional skepticism is required on audit engagements that have a high risk of fraud but can be disregarded for all other engagements. ## Clarifier T or F?

FALSE

Which of the following is a specific corporate governance responsibility of executive management? Approving major changes, such as mergers. Approving non-audit work performed by the audit firm. Reviewing the budget of the internal audit function. Implementing an effective ethical environment.

Which of the following is a specific governance responsibility of the board of directors of a public corporation? Managing and reviewing operations. Approving corporate strategy. Implementing effective internal controls. Selecting the external audit firm.

Protection Transparency, Inc. is being audited by Messer and Bromely, LLP. During the assessment of fraud, Messer and Bromely discover that the controller has been creating fictional sales and posting them to the general ledger. Who should the auditors make aware of this issue? The chairman of Protection Transparency’s audit committee. The local police. Protection Transparency's legal counsel. The predecessor auditor of Protection Transparency.

Which of the following is a NYSE mandated guideline for corporate governance? Boards need to consist entirely of independent directors. Boards must have an audit committee with a minimum of three independent directors. Boards must have a compensation committee with a minimum of three independent directors. CFOs must provide an annual certification of compliance with corporate governance standards.

Once the fraud risk assessment is complete in the planning stage, the auditor need not consider fraud further ## Clarifier T or F?

FALSE

Which of the following best describes how corporate governance influences an organization? By exerting control over management. By holding management accountable for its actions. By exerting control and requiring accountability for the resources entrusted to the organization. By exerting control over the internal control environment.

Who is responsible for operating an enterprise? The auditor. The audit committee. Management. The board of directors.

Which of the following is not a specific responsibility of an audit committee as mandated by the NYSE? Discussing the company’s financial statements with the external auditor. Setting hiring policies for former employees of the external auditor. Creating and implementing internal controls. Discussing financial information provided to analysts.

Which of the following best describes the audit committee’s oversight responsibility? Provide oversight of reporting outside the organization. Provide oversight of internal auditing function. Provide oversight of the external audit. All of the above.

Auditing standards have historically reflected an expectation that auditors will detect and report every instance of material fraud. ## Clarifier T or F?

FALSE

Under the NYSE corporate governance guidelines, which of the following committees should a corporation’s board of directors establish? Nominating/corporate governance committee. Audit committee. Compensation committee All of the above.

Which of the following is not one of management’s responsibilities? Developing financial and other reports that meet the needs of users. Engaging a qualified auditor. Implementing effective internal controls. Implementing an effective ethical environment.

The audit team should develop its own ideas about how fraud may be performed by the client then covered up. ## Clarifier T or F?

TRUE

The auditor must have a brainstorming session with client management in order to plan the procedures to be performed ## Clarifier T or F?

FALSE

When the risk of fraud is high in financial statements, the auditor should assign less experienced auditors to the engagement. ## Clarifier T or F?

FALSE

When fraud risk is great in the organization under audit, procedures applied are likely to be more extensive. ## Clarifier T or F?

TRUE

The auditor has a responsibility to design the audit to provide absolute assurance of detecting material fraud. ## Clarifier T or F?

FALSE ## Footnote *reasonable assurance*

Professional skepticism involves such things as questioning and corroborating management responses to inquiries and determining the authenticity of documents ## Clarifier T or F?

TRUE

Consideration of fraud in financial statement audits is a relatively new concept derived originally from the Sarbanes-Oxley Act. ## Clarifier T or F?

FALSE

According to the Sarbanes Oxley Act, the audit committee must have at least 3 independent members who are financial experts ## Clarifier T or F?

FALSE

Any major disagreement the auditor has with management should be discussed with the audit committee ## Clarifier T or F?

TRUE

Audit committees of publicly traded companies must establish whistle-blowing mechanisms within the company. ## Clarifier T or F?

TRUE

The audit committee should have the authority to hire and fire the external auditor ## Clarifier T or F?

TRUE

Effective corporate governance depends upon successful management of the company, as management has the primary responsibility for creating a culture of performance with integrity and ethical behavior. ## Clarifier T or F?

TRUE