Chapter 3: Fraud And Error

Question 1

1. Material misstatement may emanate from all of the following except
   a. fraud
   b. limitations of the audit
   c. error
   d. noncompliance with laws and regulations

Question 2

2. An intentional act by one or more individuals among management employees, or third parties which results in misinterpretation of financial statements refers to
   a. Error
   b. Noncompliance
   c. Fraud
   d. Illegal acts

Question 3

3. The responsibility for the detection and prevention of errors, fraud and noncompliance with laws and regulations rests with
   a. Auditor
   b. Client’s legal counsel
   c. Client management
   d. Internal auditor

Question 4

4. The management responsibility to detect and prevent fraud ad error is accomplished by
   a. Implementing adequate quality control system
   b. Having an annual audit of financial statements
   c. Implementing adequate accounting and internal control system
   d. Issuing a representation letter to the auditor

Question 5

5. The auditor’s best defense when material misstatements in the financial statements are not uncovered in the audit is that
   a. The audit was conducted in accordance with generally accepted accounting principles
   b. Client is guilty of contributory negligence
   c. The audit was conducted in accordance with PSAs
   d. The financial statements are client’s responsibility

Question 6

6. The following statements relate to the auditor’s responsibility for the detection of errors and fraud. Identify the correct statements.
   I. Due to the inherent limitations of the audit, there is a possibility that material misstatements in the financial statements may not be detected.
   II. The subsequent discovery of material misstatement of the financial information resulting from fraud or error does not, in itself, indicate that the auditor failed to follow the basic principles and
   essential procedures of an audit.
   a. I only
   b. Both statements are true
   c. II only
   d. Both statements are false

Question 7

7. The risk that the audit will fail to uncover a material misstatement is eliminated
   a. If client has good internal control
   b. If client follows generally accepted accounting principles
   c. When the auditor has complied with PSAs
   d. Under no circumstances

Question 8

8. What primarily differentiates fraud from an error?
   a. Materiality
   b. Effect on misstatements
   c. Intent
   d. Frequency of occurrence

Question 9

9. The term “error” refers to unintentional misrepresentation of financial information. Examples of errors are when
   I Assets have been misappropriated
   II transactions without substance have been recorded
   III Records and documents have been manipulated and falsified
   IV The effects of the transactions have been omitted from the records
   a. All of the above statements are true
   b. Only statements I and III are true
   c. All of the above statements are false
   d. Only statements II and IV are true

Question 10

10. Which of the following is an example of an error?
    a. Defalcation
    b. Suppression or omission of the effects of transactions from the records or documents
    c. Recording of transactions without substance
    d. Misapplication of accounting policies

Question 10

11. Which of the following is an “error” as distinguished from “fraud”?
    a. Embezzlement of company’s fund
    b. Window dressing
    c. Clerical mistakes in the processing of transactions
    d. lapping

Question 11

12. Which of the following could be an example of fraud?
    a. Errors in the application of the accounting principles
    b. Clerical errors in accounting data underlying the financial statements
    c. Misinterpretation of facts that existed when financial statements were prepared
    d. Misappropriation of assets or group of assets

Question 12

13. Which of the following statements best identifies the two types of fraud?
    a. Theft of assets and employees fraud
    b. Misappropriation of asset and defalcation
    c. Management fraud and employee fraud
    d. Fraudulent financial reporting and management fraud

Question 13

14. Fraudulent financial reporting is often called
    a. management fraud
    b. misappropriation of assets
    c. defalcation
    d. employee fraud

Question 14

15. Which one of the following terms relates to the embezzling of receipts?
    a. Manipulation
    b. Misrepresentation
    c. Misappropriation
    d. Misapplication

Question 15

16. Which of the following is an example of fraudulent financial reporting?
    a. Company management changes inventory count tags and overstates ending inventory, while understating cost of goods sold
    b. The treasurer diverts customer payments to his personal due, concealing his actions by debiting an expanse account, thus overstating expenses
    c. An employee steals small tools from the company and neglects to return them; the cost is reported as a miscellaneous operating expense
    d. An employee omitted an entry to record a bank transfer to cover a cash shortage

Question 16

17. Which of the following statements best describes an auditor’s responsibility to detect errors and fraud?
    a. An auditor should assess the risk that errors and fraud may cause the financial statements to contain material misstatements and should design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.
    b. An auditor is responsible to detect material errors, but has no responsibility to detect material fraud that are concealed through employee collusion or management override of the internal control structure
    c. An auditor has no responsibility to detect errors and fraud unless analytical procedures or tests of transactions identify conditions causing a reasonably prudent auditor to suspect that the financial
    statements were materially misstated.
    d. An auditor has o responsibility to detect errors and fraud because an auditor is not an insurer and an audit does not constitute a guarantee

Question 17

18. “The auditor would ordinarily expect to find evidence to support management representations and not assume that they are necessarily correct.” This is an example of
    a. unprofessional behavior
    b. an attitude of professional skepticism
    c. due diligence
    d. a rule in the code of Professional Conduct

Question 18

19. Which of the following statements is true?
    a. It is usually easier for the auditor to uncover fraud than errors
    b. It is usually easier for the auditor to uncover errors than fraud
    c. It is usually equally difficult for the auditor to uncover errors or fraud
    d. Usually, the auditor does not design procedures to uncover fraud or errors

Question 19

20. The most difficulty type of misstatement to detect is fraud based on
    a. The overrecording of transactions
    b. The nonrecording of transactions
    c. Recorded transactions in subsidiaries
    d. Related party receivable

Question 20

21. If an auditor was engaged to discover errors or fraud and the auditor performed extensive detail work, which of the following could the auditor be expected to detect?
    a. Mispostings of recorded transactions
    b. Unrecorded transactions
    c. Counterfeit signatures on paid checks
    d. Collusive fraud

Question 21

22. Which of the following statements is incorrect?
    a. The responsibility for the prevention and detection of fraud and errors rests with management
    b. The auditor is not and can be held responsible for the detection of fraud or error
    c. In planning an audit, the auditor should assess the risk that fraud or error may cause the financial statements to contain material misstatements
    d. The risk of not detecting material fraud is higher than the risk of not detecting a material misstatement arising from error

Question 22

23. Which of the following statements about fraud or error is incorrect?
    a. The auditor is not an can not be held responsible for the prevention of fraud and error
    b. the responsibility for the prevention and detection of fraud and error rests with management
    c. The auditor should plan and perform the audit with an attitude of professional skepticism, recognizing that conditions or events may be found that fraud or error may exist
    d. The likelihood of detecting fraud is ordinarily higher than that of detecting error

Question 23

24. Which of the following is not an assurance that the auditors give to the parties who rely on the financial statements?
    a. Auditors know how that amounts and disclosures in the financial statements were produced
    b. Auditors give assurance that the financial statements are accurate
    c. Auditors gathered enough evidence to provide a reasonable basis for forming an opinion
    d. If the evidence allows the auditors to do so, auditors give assurance in the form of opinion, as to whether the financial statements taken as a whole are fairly presented in conformity with GAAP

Question 24

25. The risk of not detecting material misstatement resulting from fraud is greater than the risk of not detecting a material misstatements arising from error, because:
    a. The auditor designs only procedures to detect material error but o procedures are designed to detect material fraud
    b. Fraud ordinarily involves acts designed to conceal it, such as collusion, forgery, or deliberate failure to record transactions
    c. The professional standards do not require the auditor to discover information that is indicative of fraud
    d. It is the responsibility of the management to detect fraud and the auditor’s responsibility is confined only to the detection of material errors

Question 25

26. Which of the following is a category of risk factors that should be considered when assessing risk of misstatements arising from misappropriation of assets?
    a. condition of internal control
    b. financial stability of the entity
    c. management characteristics
    d. industry condition

Question 25

27. Which of the following is correct concerning a “fraud risk factor”?
    a. Its presence indicates that the risk of fraud is high
    b. It has been observed in circumstances where frauds have occurred
    c. It requires modifications of the planned procedures
    d. It is also a material weakness in internal control

Question 26

30. Which of the following characteristics most likely would heighten an auditor’s concern about the 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
    c. Management places substantial emphasis o meeting earnings projections
    d. The rate of change in the entity’s industry is low

Question 26

28. When considering fraud risk factors relating to management characteristics, which of the following is
    least likely to indicate a risk of possible misstatement due to fraud?
    a. Failure to correct known reportable conditions on timely basis
    b. Nonfinancial management’s preoccupation with the selection of accounting principles
    c. Significant portion of management’s compensation represented by bonuses based upon achieving
    unduly aggressive operating results
    d. Use of unusually conservative accounting practices

Question 27

29. Which of the following is most likely to be a response to the auditor’s assessment that the risk of material misstatement due to fraud for the existence of inventory is high?
    a. Observe test counts of inventory at certain locations on an unannounced basis
    b. Perform analytical procedures rather than taking test counts
    c. Request that inventory be counted prior to year end
    d. Request that inventory counts at the various locations be counted on different dates so as to allow the same auditor to be present at every count

Question 28

31. Because of the risk of material misstatement, an audit of financial statements in accordance with PSA should be planned and performed with an attitude of
    a. Objective judgment
    b. Independent integrity
    c. Professional skepticism
    d. Impartial conservatism

Question 28

32. Individuals who commit fraud are ordinarily able to rationalize the act and also have an
    Incentive
    Opportunity
    a. Yes Yes
    b. Yes No
    c. No Yes
    d. No No

Question 29

33. Which of the following most likely to be considered a risk factor relating to fraudulent financial reporting?
    a. Domination of management by top managers
    b. Large amount of cash processed
    c. Negative cash flows from operations
    d. Small high-peso inventory items

Question 30

34. Which of the following most likely to be presumed to represent fraud risk on audit?
    a. Capitalization of repairs and maintenance into the property, plant, and equipment asset account.
    b. Improper revenue recognition
    c. Improper interest expense accrual
    d. Introduction of significant new products

Question 31

35. Which of the following conditions or events would least likely increase the risk of fraud or errors?
    a. Questions with respect to competence or integrity of management
    b. Unusual pressures within the entity
    c. Unusual transactions
    d. Lack of transaction trail

Question 32

36. Which of the following conditions identified during fieldwork of an audit is most likely to affect the auditor’s assessment of the risk of misstatement due to fraud?
    a. Checks for significant amount outstanding at year end
    b. Computer generated documents
    c. Missing documents
    d. Year-end adjusting journal entries

Question 33

37. Which of the following would be least likely to suggest to an auditor that the client’s financial statements are materially misstated?
    a. There are numerous delays in preparing timely internal financial reports
    b. Management does not correct internal control structure weaknesses that it knows about
    c. Differences are reflected in the customer’s confirmation replies
    d. There have been two new controllers this year

Question 34

38. Which of the following circumstances least likely would cause an auditor to consider whether material misstatements exist in an entity’s financial statements?
    a. Management is dominated by several individuals
    b. The industry in which the entity operates is declining
    c. There is inadequate working capital due to declining profit
    d. Supporting records that should be readily available are frequently not produced when requested

Question 35

39. Which of the following circumstances would least likely cause an auditor to consider whether a material misstatement exists?
    a. The turnover of senior accounting personnel is exceptionally low
    b. Management places substantial emphasis on meeting earning projections
    c. There are significant unusual transactions near year-end
    d. Operating and financing decisions are dominated by one person

Question 36

40. Which of the following circumstances most likely would cause an auditor to believe that material misstatements exist in a entity’s financial statements?
    a. Operating and financing decisions are dominated by top management
    b. Audit trails of computer-generated transaction exist only for a short period of time
    c. The chief financial officer does not sign the management representation letter until the last day of the auditor’s fieldwork
    d. There were substantial payments for services that appear excessive in relation to services provided

Question 37

41. Which of the following conditions would not normally cause the auditor to question whether material errors or possible fraud exists?
    a. The accounting department is oversatisfied
    b. Differences exist between control accounts and supporting subsidiary records
    c. Transactions are not supported by proper documentations
    d. There are frequent changes of auditors and lawyers

Question 38

42. Which of the following characteristics most likely would heighten an auditor’s concern about the risk of material misstatements in a entity’s financial statements?
    a. The entity’s industry is experiencing declining customer demand
    b. The rate of change in the entity’s industry is low
    c. Bank reconciliation statements usually include in-transit deposits
    d. Equipment is often sold at a loss before being fully depreciated

Question 39

43. Which of the following conditions or events increases the risk of error or fraud?
    a. Management is dominated by several individuals
    b. There are frequent changes of auditors or legal counsel
    c. There is a significant low turnover of senior accounting personnel
    d. The entity does not correct internal control weaknesses that it knows about

Question 40

44. All of the following conditions are indicators of possible pressures on an entity except
    a. The industry I which the entity operates is declining
    b. There is inadequate working capital due to declining profits or too rapid expansion
    c. The client is heavily dependent on one or a few products or customers
    d. There is a significant and prolonged understaffing of the accounting department

Question 41

45. During the course of an audit engagement, the CPA discovers specific circumstances that lead him to the belief that employee fraud that has a material effect on the financial statements may have occurred. In such a case the CPA should
    a. Tactfully approach the suspected employee and attempt to resolve the matter with him
    b. Ascertain that the client understand that the ordinary examinations not primarily designed to disclose fraud or defalcations
    c. Perform appropriate modified or additional procedures to confirm or dispel the auditor’s suspicion
    d. After advising the client of his findings, suggest that an investigation has to be made to discover whether fraud has in fact occurred

Question 42

46. If a auditor believes that material errors or fraud exist, the auditor should
    a. Consider the implications and discuss the matter with appropriate level ofmanagement
    b. Make the investigation necessary to determine whether errors or fraud have in fact occurred
    c. Request that management investigate whether errors or fraud have in fact occurred
    d. Consider whether errors or errors were the result of employee’s failure to comply with specific controls

Question 43

47. When the auditor believes a misstatement is or may be the result of fraud but that the effect of the
    misstatements is not material to the financial statements, which of the following steps is required?
    a. Consider the implications for other aspects of the audit
    b. Resign from the audit
    c. Commence a fraud examination
    d. Contact regulatory authorities

Question 44

48. Which of the following is an incorrect statement?
    a. The auditor ca not assume that fraud or error is an isolated occurrence unless there is an evidence to the contrary
    b. If the auditor suspects that error may exist, he should immediately communicate it to the management even if the potential effect on financial statements is immaterial
    c. Fraud and error should be reported to a level of management at least one level above those involved
    d. Normally, the CPA does not have any responsibility to communicate confidential information noted during the audit to the regulatory authorities

Question 45

49. If the auditor believes that the fraud or error has a material effect on the financial statements but the client is not willing to correct the misstatement, the auditor would most likely issue
    a. standard audit report
    b. qualified or adverse opinion
    c. qualified or disclaimer of opinion
    d. unmodified opinion with emphasis of matter paragraph

Question 46

50. If the auditor is precluded by the entity from obtaining evidence to evaluate whether fraud or error that may be material to the financial statements has occurred, the auditor should issue a report that
    contains
    a. a adverse opinion
    b. a unmodified opinion
    c. either qualified or adverse opinion
    d. either qualified opinion or a disclaimer of opinion

Question 47

51. When a user sees that a standard unmodified opinion has been expressed by an external auditor, he or she may correctly infer that:
    a. o material errors were found during the engagement
    b. no embezzlement remain undetected
    c. ay system defects encountered during the engagement have been corrected to the auditor’s satisfaction
    d. any differences between management and the auditor on accounting matters have been resolved to the auditor’s satisfaction

Question 48

52. Judgments about the increased risk of misstatement of the financial statements due to fraud may influence the auditor’s professional judgments in the following ways except:
    a. The auditor’s ability to assess control risk below the maximum may be reduced and the auditor should be sensitive to the ability of the management to override controls
    b. The audit team may be selected in ways that ensure that a knowledge, skill, ad ability of personnel assigned significant engagement responsibilities are commensurate with the auditor’s assessment of the level of risk
    c. The auditor should plan and audit to provide a guarantee that the financial statements are free of material misstatements, whether due to fraud or error
    d. The audit team may approach the audit with a heightened level of professional skepticism Noncompliance with laws and regulations

Question 49

53. The term used to refer to acts of omission or commission by the entity being audited, either intentional or unintentional, which are contrary to the prevailing laws and regulations is
    a. Fraud
    b. Misappropriation
    c. Noncompliance
    d. Defalcation

Question 50

54. Generally the decision to notify parties outside the client’s organization regarding a noncompliance with laws and regulations is the responsibility of the
    a. independent auditor
    b. client’s legal counsel
    c. management
    d. internal auditors

Question 51

55. Which of the following statements about noncompliance is incorrect?
    a. An audit in accordance with PSA can not be expected to detect noncompliance with all laws and regulations
    b. It is management’s responsibility to ensure that entity’s operations are conducted in accordance with laws and regulations
    c. An auditor can not be held responsible for preventing noncompliance
    d. The determination as to whether a particular act constitutes noncompliance is ultimately based on the judgment of the auditor

Question 52

56. Presented below are circumstances that may indicate the occurrence of noncompliance with laws and regulations. Which is the exception?
    a. Payment of fines or penalties
    b. Payment for unspecified services to consultants, related parties, or government employees
    c. Purchasing at prices significantly above or below market price
    d. Payments for goods or services to the country from which the goods or services originated

Question 53

57. Which of the following conditions would least likely indicate the occurrence of noncompliance?
    a. Investigation by government agencies
    b. Payments without proper documentation
    c. Purchasing a real property for a price that is significantly higher than the seller’s book value
    d. Existence of an accounting system which fails to provide an adequate audit trail or sufficient evidence

Question 54

58. Which of the following conditions would most likely indicate a possible noncompliance with laws and regulations?
    a. Media comment
    b. Purchasing land for a price significantly different from the seller’s recorded amount
    c. Payment of commission to sales agent
    d. Payment for specified services to consultant

Question 55

60. When the auditor becomes aware of information concerning a possible instance of noncompliance, the auditor should
    a. Notify the regulatory agencies
    b. Determine who was responsible for the act
    c. Obtain understanding of the nature of the act, and the circumstances in which it has occurred and sufficient information to evaluate the possible effect on the financial statements
    d. Express an adverse opinion on the client’s financial statements

Question 56

59. According to PSA 250, the risk of not detecting material misstatement due to noncompliance is high. This can be attributed to all of the following factors, except:
    a. There are many laws and regulations relating principally to the operating aspects of the entity, that typically do not have a material effect o the financial statements
    b. The detection prevention and detection of noncompliance rests with managements
    c. The effectiveness of audit procedures may be affected by the limitations of the audit
    d. Noncompliance may involve conduct designed to conceal it

Question 57

61. An auditor who discovers that client has not complied with laws and regulations that has a material effect o the financial statements most likely would withdraw from the engagement if
    a. the noncompliance was a violation of GAAP
    b. the client does not take remedial action that the auditor considers necessary
    c. the noncompliance was committed last year when financial statements were not audited
    d. the auditor has already assess control risk at the maximum level

Question 58

62. Which of the following does not properly describe a procedure that the auditor performs in connection with noncompliance?
    a. The auditor should obtain a general understanding of legal and regulatory framework applicable to the entity
    b. The auditor should perform procedures to identify instances of noncompliance with laws and regulations
    c. The auditor should obtain oral representation that management has disclosed to the auditor all known actual or possible noncompliance with laws and regulations
    d. The auditor should obtain sufficient appropriate evidence about compliance with laws and regulations

Question 59

63. Which statement is incorrect regarding the auditor’s consideration of laws and regulations in an audit of financial statements?
    a. In order to plan the audit, the auditor should obtain a specific understanding of the legal and regulatory framework applicable to the entity and the industry ad how the entity is complying with that framework
    b. When the auditor becomes aware of information concerning a possible instance of noncompliance, the auditor should evaluate the possible effect o the financial statements
    c. If the auditor concludes that the noncompliance has a material effect on the financial statements ad has not been properly reflected in the financial statements, the auditor should express a qualified or an adverse opinion
    d. The auditor may withdraw from the engagement when the entity does not take the remedial action that the auditor considers necessary in the circumstances even when the noncompliance is not
    material to the financial statements

Question 60

64. Which of the following procedures would an auditor be unlikely perform when obtaining a general understanding about the laws and regulations affecting the client’s business?
    a. Inquire of management concerning the entity’s policies and procedures regarding compliance with laws and regulations
    b. Inquire of management as to the laws and regulations that may be expected to have a fundamental
    effect on the operations of the entity
    c. Discuss with management the policies or procedures adopted for identifying, evaluating and accounting for litigation claims and assessments
    d. Obtain a representation letter from the client’s legal counsel

Question 61

65. After obtaining sufficient level of understanding about the client’s legal and regulatory framework, the auditor should
    a. Develop a code of conduct and ensure that these employees comply with such code
    b. Perform procedures to help identify instances of noncompliance with laws and regulations
    c. Monitor entity’s legal requirements and ensure that operating procedures are designed to meet these requirements
    d. Inquire of management as to the laws or regulations that may be expected to have a fundamental effect on the operations of the entity

Question 62

66. Which of the following procedures would assist the auditor identifying noncompliance with laws and regulations?
    a. Inquiring of client’s lawyers
    b. Inspecting correspondence with relevant regulatory agencies
    c. Inquire of management concerning entity’s policies and procedures regarding compliance with laws and regulations
    d. Discuss with the client management the policies or procedures adopted for identifying, evaluating and accounting for litigations, claims and assessments

Question 63

67. If the client refuses to accept report that is qualified due to noncompliance with laws and regulations, the auditor should:
    a. withdraw from the engagement and indicate the reasons to the audit committee in writing
    b. Issue an adverse opinion if management agrees to fully disclose the matter
    c. withdraw from the engagement and indicate the reasons to the SEC or other regulatory body in writing
    d. issue a disclaimer of opinion instead

Question 64

68. Which of the following is incorrect about the auditor’ responsibility for evaluating noncompliance by the entity to laws and regulations?
    a. A audit cannot be expected to detect noncompliance with all laws and regulations
    b. Noncompliance refers to acts of omissions or commissions by the entity being audited which are contrary to prevailing laws and regulations
    c. Noncompliance includes personal misconduct of the entity’s management or employees though they are unrelated to the entity’s business activities
    d. Detection of noncompliance, regardless of materiality, requires considerations of the implications for the integrity of management or employees