Chapter 6

Question 1

ASA 240.1:

Answer 1

Auditors responsibility in relation to fraud

Question 2

Fraud Risk Factors checklist looks broadly at:

Answer 2

\+management
\+unusual pressure towards the entity
\+Market Pressures
\+Unusual Transactions
\+Unsatisfactory Records
\+IT Environment

Question 3

Inherent Risk is:

Answer 3

Susceptibility of account balance or class of transactions to material misstatement
given inherent and environmental characteristics, assuming there were no related
internal controls.

Question 4

Various factors that affect Internal Risk are:

Answer 4

1. INTEGRITY OF MANAGEMENT
2. MANAGEMENT EXPERIENCE, KNOWLEDGE & CHANGES DURING THE PERIOD:
3. UNUSUAL PRESSURE ON MANAGEMENT
4. NATURE OF ENTITY’S BUSINESS
5. FACTORS AFFECTING THE INDUSTRY IN WHICH THE ENTITY OPERATES

Question 5

Fraud is defined as:

Answer 5

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.

Question 6

2 elements of fraud:

Answer 6

1. Fraudulent Financial Reporting

2. Misappropriation of assets

Question 7

ASA 240.10:

Answer 7

objectives of the auditor in

relation to fraud set out in ASA 240.10

Question 8

auditor commonly uses a checklist to identify increased risks of fraud:

Answer 8

• Management
– Turnover
– Disputes
– Litigations
– Dominance
– Attitude towards internal control
– Corporate structure is complex and unwarranted.
– Management bonus for achieving specific results
• Unusual Pressures within an entity
– Meet targets
– Maintain share prices
– Meet covenants
– Dividend expectations
• Market Pressures
– Slowing industry
– Prevent takeovers
– Declining demand/sales
• Unusual transactions
– Unusual transactions near balance date
– Related party transactions
– Payments for services that appear excessive in relation to service provided
– Payments made to government officials?
• Unsatisfactory records
– Incomplete books
– Documentation missing
– Excessive difference between confirmation and books
– Management slow to provide and respond to auditor requests for information
• IT Environment
– Concentration of IT knowledge to one person
– Software or hardware failures
– Programs modified for no reason and without proper authority
– Lack of adequate security

Question 9

Earnings management occurs when:

Answer 9

judgement in financial reporting and in structuring
transactions is used to alter financial reports to influence the perceptions of shareholders.
 Involves those responsible for preparing the financial report such as the CFO and CEO.
 Incentives to manage earnings can be either behavioral or market based

Question 10

Broad Categories of Earnings Management

Answer 10

1. Intentional violations of accounting standards
2. Inappropriate revenue recognition
3. Big Bath changes: Make poor results look even worse
4. Improper accruals and estimation of liabilities in good times

Question 11

Definition of AASB124 is:

Answer 11

Definition of AASB124:
- Entities are related if one entity is able to significantly influence or control the
operating, financing or investing decisions of another; or if several entities are subject to control from the same entity; or if the party is a joint venture in which the entity is
a venture.

Question 12

ASA 550 requires:

Answer 12

auditors to specifically assess the risk that related parties and related-party transactions will not be identified, or appropriately disclosed and/or
measured.

Question 13

Procedure for identifying related parties:

Answer 13

• Review the previous period’s working papers for known related parties.
• Make enquiries of management concerning the names of all related parties.
• Review the entity’s procedures for identifying related parties.
• Enquire about management’s and directors’ affiliations with other entities.
• Review minutes of meetings.
• Enquire of other auditors involved in audit.

Question 14

what is going concern:

Answer 14

Entity is viewed as continuing in business for the foreseeable future without any
intention or necessity to liquidate or otherwise cease its operations (ASA 570.2)

Question 15

Appropriateness of the going concern basis: ASA 570.2

Answer 15

requires auditors to assess going concern at planning stage, as imminent
business failure might affect the appropriateness of presentation of financial report or might motivate management misrepresentations.

Question 16

Indicators of failing going concern Include:

Answer 16

• Financial indicators:
• Heavy reliance on short-term borrowings
• Denial of trade credit by suppliers
• Negative operating cash flows
• Operating indicators:
• Management’s intention to cease operations
• loss of key management personnel
• prolonged industrial action
• Other indications:
• legal proceedings against the entity
• uninsured or under insured disasters.

Question 17

Given that there does appear to be a significant risk of fraud, ASA 240 requires you to modify procedures at two levels:

Answer 17

1. financial report level

2. assertion level

Question 18

ASA 240 at the financial report level requires you

Answer 18

• consider the assignment and supervision of (audit) personnel
• consider the accounting policies used by the entity
• incorporate an element of unpredictability in the selection of the nature, timing and extent of audit procedures

Question 19

ASA 240 at the assertion level requires you:

Answer 19

to design and perform further procedures whose nature, timing and extent are responsive to the assessed risks. For example, it may be appropriate to pay attention to possible management override of controls by increasing sample sizes and/or paying particular attention to year end adjusting journals.