Chapter 9: Auditing for Fraud

Student: ___________________________________________________________________________
1. Since management can collude to perpetrate a fraud, the auditor has limited responsibility for detecting fraud
in the financial statements.
True False

2. An example of a defalcation is the CFO intentionally overstating the accounts receivable and sales to boost
profits.
True False

3. The auditor of financial statements has a responsibility to actively consider fraud in order to obtain
reasonable assurance that financial statements are free of material fraud.
True False

4. According to the Association of Certified Fraud Examiners, corruption includes the act of accepting undue
payments from suppliers to accept products into the organization.
True False

5. It is considered fraud for an employee of an organization to wrongly use influence to procure a personal
benefit that is contrary to their duty to the organization.
True False

6. An example of financial statement manipulation is the treasurer's diversion of hundreds of thousands of

dollars into a personal money market account.
True False

7. BruceCo. has accounted for the revenue of Jiffy Mac, Inc., one of its suppliers as though it were its
subsidiary. BruceCo only owns 2% of Jiffy and does not exercise any influence or control, nor is it considered a
Variable Interest Entity. BruceCo. has probably committed fraud because of its blatant misapplication of
consolidation principles.
True False

8. Consideration of fraud in financial statement audits is a relatively new concept derived originally from SAS
99.
True False

9. The most important lesson to be learned from the famous salad oil case is that a client can commit fraud by
falsely moving inventory during a physical count to overstate the inventory balance.
True False

10. The onslaught of fraud in financial statements over the recent decade has been the first of its kind in
history.
True False

11. SAS 99 requires the auditor to more actively consider and assess the risk of fraud for clients and their
financial statements than had been required in the past.
True False

12. SAS 99 procedures must only be performed for clients that have had fraud concerns in the past.
True False

13. If an auditor discovers risk of fraud in the application of SAS 99 procedures, the audit procedures should be
adjusted accordingly.
True False

14. Professional skepticism is required on audit engagements that have a high risk of fraud but can be
disregarded for audit engagements with low risk of fraud.
True False

15. According to professional audit standards, the audit team should meet 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.
True False

16. Once the fraud assessment is complete in the planning stage, the auditor need not consider fraud further.
True False

17. Pressure perceived by management to manipulate financial information is a common characteristic in fraud
cases
True False

18. Management compensation that is tied to profits may contribute to incentives to commit fraud.
True False

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

20. Internal controls are implemented in order to give perpetrators the impression that the risk of being caught is
low.
True False

21. Complex transactions such as derivative instruments provide management certain opportunities to
manipulate financial statements to its advantage.
True False

22. A board of directors that is actively involved in monitoring management mitigates opportunities to commit
fraud.
True False

23. Rules based accounting sometimes contributes to the rationalization of financial reporting fraud.
True False

24. The auditor should not presume that fraud is present in revenue recognition by management because the
auditor must remain objective.
True False

25. Management rarely uses journal entries to commit fraud because they are easily noticed by the auditor.
True False

26. Auditors must keep a questioning mind when analyzing management responses to inquiry and they should
strive to obtain corroborating evidence before accepting the responses.
True False

27. The auditor must perform a brainstorming meeting with client management in order to plan the procedures
to be performed and the inventory locations to be visited.
True False

28. Channel stuffing is often a form of fraud by financial manipulation and can be noticed by the auditor by
performing analytical procedures directed toward the discovery of fraud indicators.
True False

29. One fraud risk factor includes the presence of domineering members of management who seek the ultimate
loyalty of subordinates.
True False

30. The audit team should develop its own idea about how fraud may be perpetrated and hidden by the client.
True False

31. Audit tests do not relate to fraud testing because fraud testing will be performed in a different (forensic)
engagement.
True False

32. When the risk of fraud is high in financial statements, the auditor should assign less experienced auditors to
the engagement.
True False

33. Types of fraud should be hypothesized by the auditor after performing analytical procedures for the
discovery of fraud factors.
True False

34. When fraud risk is high in the organization under audit, the nature, timing and extent of procedures applied
will likely need to be changed.
True False

35. Management fraud must be immediately reported by the auditor to the SEC rather than wasting time
reporting it to the audit committee or board of directors.
True False

36. Forensic accountants need to have superior interviewing and people skills.
True False

37. The focus of forensic accounting is similar to financial statement auditing in that it is directed to the fairness
of financial statements.
True False

38. Auditors are responsible to detect all illegal acts committed by the company and its employees.
True False

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

40. An ideal method of footing a large report and recalculating extensions is the use of generalized audit
software to extract the data and perform the test.
True False

41. When weaknesses in internal control are found, the auditor should develop audit procedures to explicitly test
for the existence of the type of fraud or misstatement that could occur because of the weakness.
True False

42. For illegal acts that have a direct effect on the financial statements, the auditor has a responsibility to design
the audit to provide reasonable assurance of detecting material misstatements.
True False

43. When preliminary fraud risk is high the auditor should pay close attention to areas of the audit that are
highly subjective and increase the predictability of the audit procedures.
True False

44. The auditor can be satisfied with less than persuasive evidence in the audit process because of the believe
that management is honest.
True False

45. Professional skepticism involves such things as questioning and corroborating management responses to
inquiries and determining the authenticity of documents.
True False

46. Audits of financial statements are valuable to the detection of fraud because:
A. Auditors are not required to seek out and find all fraud.
B. Auditors expect that management will make them aware of any fraud in the financial statements.
C. Society expects that the auditor will ensure that financial statements have not been materially misstated due
to fraud.
D. Society realizes that some fraud is not capable of being discovered by auditors.

47. Detection of fraud is integral to the audit function. The best reason for this is that:
A. unless auditors can provide assurance that the financial statements are free of material misstatements due to
fraud, there is no justification for the audit function.
B. the AICPA has mandated that the auditor take on more responsibility than previously required because of
management's demand for fraud finding.
C. it is the responsibility of the auditor to provide internal control over a client organization sufficient to
discover or prevent fraud from occurring.
D. auditor fraud is a large concern of shareholders and the audit committee must continually monitor the
auditors to ensure they are not misstating financial statements.

48. Which of the following represents the size of company that has most commonly committed fraud in its
financial reporting and by its employees?
A. Large corporations.
B. Middle-market corporations.
C. Small and start-up companies.
D. All companies.

49. What is the primary determinate in the difference between fraud and errors in financial statement reporting?
A. The materiality of the misstatement.
B. The intent to deceive.
C. The level of management involved.
D. The type of transaction effected.

50. Which of the following is not an example of a type of defalcation?

A. A warehouse employee takes home two units of electronic entertainment inventory each week without
authorization.
B. The president of the company utilizes the organization's cash to add a floor to her 15,000 square foot house.
C. The chief financial officer of the company falsely adds $20 million to the accounts receivable and revenue
accounts.
D. The treasurer of the company makes an unauthorized wire transfer from the organization's bank to a personal
account in Grand Cayman.

51. Which of the following best represents financial statement fraud?

A. The transfer agent issues 40,000 shares of the company's stock to a friend without authorization by the board
of directors.
B. The controller of the company decreases a contingent liability by $3 million because the company will
otherwise miss analysts' expectations this quarter.
C. The in-house attorney receives payments from the French government for negotiating the development of a
new plant in Paris.
D. The accounts receivable clerk covers up the theft of cash receipts by writing off older receivables without
authorization.

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

53. Which of the following would most likely be considered intentional misapplication of accounting principles
on financial statements?
A. A capital lease is presented as periodic rent expense rather than interest and depreciation.
B. A deferred tax asset is reduced to zero with a valuation allowance.
C. Insurance is amortized.
D. Revenues for up-front fees are deferred rather than recognized immediately.

54. Which of the following is most likely considered a material omission from the rules of financial statement
reporting?
A. The company no longer discloses a previously settled contingency.
B. The company does not present the fair value of all current assets on the balance sheet.
C. A privately held company does not disclose earnings per share.
D. A company with a net loss does not present a statement of cash flows.

55. Which of the following is an example of a common type of financial reporting fraud?
A. Capitalizing major overhauls to operating equipment.
B. Deferring service revenue until it is delivered to customers.
C. Recording sales for inventory sold with the right to return.
D. Excluding a contingent liability that has been settled.

56. Which of the following best represents an example of fraud utilizing the lapping technique?
A. An employee transfers cash on the last day of the year in order to double record it in the bank accounts.
B. An employee creates a fictional vendor and requests payment to a personal P.O. box.
C. An employee opens the mail to cover up payroll fraud received on a fictional person.
D. An employee covers up the stealing of receipts by posting to the wrong customer accounts.

57. Which of the following are most often involved in perpetrating fraud in financial statement reporting?
A. The auditors and the attorneys.
B. The audit committee members.
C. The chief executive and chief financial officers.
D. The accounts payable clerks.

58. What is the best method an auditor may use to detect fraud in the financial statements of clients?
A. Use professional skepticism.
B. Understand and properly apply Generally Accepted Accounting Standards.
C. Brainstorm with the client to find the types of fraud occurring.
D. Actively search for all errors in the financial statements.

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

60. If the audit team discovers that fraud risk factors are present on an engagement, it should then:
A. resign from the client and inform the audit committee and regulatory authorities.
B. modify procedures to actively search for the existence of fraud.
C. reduce the amount of evidence required and resort to management inquiry.
D. turn the audit over to forensic accountants.

61. The threshold of materiality may be lowered in the case of potential fraud in the financial statements under
audit. Why is this different from the usual materiality levels set by auditors?
A. The intentional act of committing fraud itself becomes material, regardless of dollar amounts.
B. Fraud is not relative to internal control, which requires larger materiality limits.
C. The act of fraud is a characteristic of certain types of managers, therefore, materiality is irrelevant.
D. Normal audit procedures are designed to catch all fraud, even the smallest of infractions.

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

63. Professional skepticism is best described as:

A. an intent to deceive.
B. an attitude of intrusion and obstinacy.
C. a character that does not waver.
D. a questioning mind.

64. According to professional audit standards, how might an understanding of the nature of fraud that may
occur in the client organization best be identified by the audit firm?
A. Fraud training courses from actual corporate fraud ex-criminals.
B. Conducting a brainstorming meeting with the members of the audit team.
C. Circulating a survey to the client company employees for completion.
D. Discussions with other CPA firms.

65. Which of the following is required of the audit team relative to its consideration of fraud in a financial
statement audit?
A. Documentation in the audit file.
B. Communication with the AICPA.
C. Modification of client financial records.
D. Termination of the manager responsible for the fraud.

66. What is the greatest benefit that can be derived by discussing fraud factors with management of the client
organization under audit?
A. Greater credibility with the client organization and its management.
B. The impression on the client that potential fraud is not being considered by an independent source.
C. Further consideration of the risks, and discussion of how management can reduce the risks.
D. Full disclosure of all fraud occurring during the year under audit in the company.

67. Which of the following risks of fraud should ordinarily be presumed on a financial statement audit by the
audit team?
A. Chief financial officer misappropriation of funds.
B. Misapplication of revenue recognition principles.
C. Management's inappropriate use of reserves.
D. Lack of expenses related to stock options.

68. Relative to internal controls, what is a primary risk of fraud in the client company?
A. The risk that management overrides controls.
B. The risk that management changes controls each year.
C. The risk that management carefully enforces and monitors controls.
D. The risk that the audit committee monitors controls.

69. How will the results of the auditor's assessment of fraud risk factors further affect the planned audit
procedures?
A. Audit procedures and fraud assessment do not relate.
B. The assessment may require a re-audit of previous periods.
C. By the assignment of qualified audit staff to risky areas of the engagement.
D. Management will be called upon to assist in coordinating audit procedures.

70. When is the assessment of fraud risk on a single engagement completed by the audit team?
A. Upon completion of the planning stage.
B. Once internal control is understood.
C. Only after the audit risk model has been used to design tests.
D. Once the audit is complete.

71. 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?
A. Protection Transparency's legal counsel.
B. The federal law enforcement agency.
C. The chairman of Protection Transparency's audit committee.
D. The predecessor auditor of Protection Transparency.

72. 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 upon the above information only,
what type of probable motivation is there to commit fraud at the Premium Discovery Company?
A. Pressure.
B. Opportunity.
C. Rationalization.
D. Expectation.

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

74. Wafflemart Corporation is a leader in its industry. It commands suppliers and is the envy of its competitors
with its ability to name its price to customers. Management is compensated with a relatively high level of stock
options. The Company has consistently met analysts expectations for stock price performance for each of the
last 32 quarters. What are the typical motivators of Wafflemart's situation noted above?
A. Wafflemart has pressure to commit fraud.
B. Wafflemart has incentive to commit fraud.
C. Wafflemart has opportunity to commit fraud.
D. Wafflemart has rationalization to commit fraud.

75. Sam Jones, controller of Mitnikco, spends three days researching the accounting statements to find
loopholes in the "rules" and to make a case for recognizing revenue earlier, rather than in later years. In the end,
this enables the Company to achieve its earnings targets. What are the motivations of Mitnikco management
based solely on the information above?
A. Pressures
B. Opportunity
C. Rationalization
D. Skepticism

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

77. In actively considering fraud in the financial statement audit, the audit team will most likely realize which of
the following when performing substantive procedures?
A. Accounting journal entries may have been used to perpetrate a fraud.
B. Most fraud is not material enough to consider.
C. Journal entries do not supply enough evidence to detect fraud.
D. New technology prevents fraud more thoroughly than manual systems.

78. Brainstorming about the manner in which fraud may be committed should include all of the following
except
A. Consider factors that might affect management motivation to misstate the financial statements
B. Consider weaknesses in internal control that would allow a fraud to take place
C. Consider the materiality of the individual account balances for substantive testing
D. Consider factors that may enable an individual capable of committing a fraud to rationalize perpetrating it

79. In evaluating the effect of fraud upon the audit procedures the auditor should consider
A. The type of fraud that may occur.
B. The potential significance of fraud.
C. The likelihood of fraud occurring.
D. The pervasiveness of fraud detected.
E. All of the above.

80. The audit team asks management for original documents related to sales contracts. Despite the team's
persistence, management does not supply the documents for over two weeks. With the use of professional
skepticism, what should this audit team be most concerned with as it relates to the documents?
A. The need to complete the audit within a specified period of time.
B. Management's possible use of the time to fabricate the documents.
C. Discrepancies of the evidence.
D. Conflicting evidence.

81. If material fraud perpetrated by management is discovered by the auditor, the nature of the fraud should
always be reported directly to:
A. the PCAOB
B. the SEC
C. the FBI
D. the audit committee of the company

82. The key elements of the fraud triangle include all of the following except
A. Pressure
B. Materiality
C. Opportunity
D. Rationalization

83. If management makes appropriate adjustments, but does not take appropriate steps to modify internal
control in order to rectify the problem of fraud discovered in a financial statement audit, the decision has a
direct impact on:
A. the audit opinion on the financial statements.
B. the client company's stock price.
C. the auditor's perception of the overall control environment.
D. all previous work performed by the auditor for competing companies.

84. Which of the following represents the primary difference between an audit and forensic accounting?
A. An audit has the focused responsibility to detect fraud in the client organization while forensic accounting
sets out to prevent fraud.
B. An audit has no responsibility for fraud while forensic accounting provides an audit specific to material fraud
discovery.
C. An audit must follow Generally Accepted Auditing Standards while the forensic accountant is bound to
Generally Accepted Fraud Standards.
D. An audit utilizes sampling techniques to detect material misstatements while forensic accounting examines
the entire population of fraudulent transactions.

85. Which of the following computerized audit procedures best assists the engagement team in detecting asset
misappropriations?
A. Creation of bank confirmations.
B. Tracing of recorded assets to source documents.
C. Search for duplicate payments.
D. Determination of obsolete inventory.

86. Which of the following is not one of the components of the fraud triangle?
A. Incentive.
B. Rationalization.
C. Susceptibility.
D. Opportunity.

87. A common accounts receivable fraud is lapping. This type of fraud typically involves which of the
following:
A. using journal entries to write off accounts against the allowance for doubtful accounts.
B. applying cash from one customers receivable to that of another to cover the earlier deficit.
C. recording large discounts for the clients.
D. Both A and C.

88. The fraud triangle consists of three components (pressure, opportunity, and rationalization). Which of the
three components are present in most every fraud?
A. All three factors are usually present when fraud occurs.
B. Pressure and opportunity
C. Opportunity and rationalization
D. Rationalization and pressure

89. Fraud motivations and factors

Research consistently shows that there are three elements present when most frauds occur. List these elements
and at least three related fraud factors that may exist for each.

90. Consideration of fraud in an audit

Auditors are required to actively conduct a financial statement audit with the mindset that fraud may exist. What
is the general process that an auditor goes through to assess the risk of fraud and test accordingly?

91. Fraud consideration by auditors

John Beasley is interviewing with public accounting firms to become an auditor. John does not believe that
fraud is a "big deal" in client organizations and argues that most individuals in management of companies are
"honest people". He believes that auditors are becoming too cynical.
Describe your response to John's attitude and discuss the major types of fraud that occur in companies.

92. Forensic accounting

Contrast the financial statement auditor's consideration of fraud to that of a forensic accountant.

93. Brainstorming for fraud

You are a staff auditor with Zepplin and Frank, CPAs. Your audit team is in the planning stage for Leppard
Sullivan, Inc., a beauty supply wholesaler. Describe the brainstorming process and types of issues that may be
brought to the surface regarding your client.

94. Fraud categories

Corporate fraud may take place through a variety of methods. Identify the major categories of fraud and give
examples of each.

95. Fraud risks that may lead to material misstatement

Identify risks that the auditor should consider during brainstorming that may result in material misstatement due
to fraud.

96. Auditors response to fraud risk factors

The auditor assesses the identified fraud risks after taking into account an evaluation of the clients programs
and controls. How might the auditor respond to the results of the assessment of higher fraud risk?

97. Auditors fraud communication responsibilities

Discuss the auditors responsibility to communicate fraud to the audit committee. When is the auditor required
to communicate possible fraud to parties other than the audit committee and management?

98. Linking internal control deficiencies to audit procedures

After assessing internal control weakness the auditor develops audit procedures to explicitly test for the
existence of the types of fraud or misstatement that could occur because of the weakness. In the linkage process
from control deficiencies to audit procedures, what are the four questions involved in linking changes to the
audit program?

Chapter 9: Auditing for Fraud Key

1. Since management can collude to perpetrate a fraud, the auditor has limited responsibility for detecting fraud
in the financial statements.
FALSE

2. An example of a defalcation is the CFO intentionally overstating the accounts receivable and sales to boost
profits.
FALSE

3. The auditor of financial statements has a responsibility to actively consider fraud in order to obtain
reasonable assurance that financial statements are free of material fraud.
TRUE

4. According to the Association of Certified Fraud Examiners, corruption includes the act of accepting undue
payments from suppliers to accept products into the organization.
TRUE

5. It is considered fraud for an employee of an organization to wrongly use influence to procure a personal
benefit that is contrary to their duty to the organization.
TRUE

6. An example of financial statement manipulation is the treasurer's diversion of hundreds of thousands of

dollars into a personal money market account.
FALSE

7. BruceCo. has accounted for the revenue of Jiffy Mac, Inc., one of its suppliers as though it were its
subsidiary. BruceCo only owns 2% of Jiffy and does not exercise any influence or control, nor is it considered a
Variable Interest Entity. BruceCo. has probably committed fraud because of its blatant misapplication of
consolidation principles.
TRUE

8. Consideration of fraud in financial statement audits is a relatively new concept derived originally from SAS
99.
FALSE

9. The most important lesson to be learned from the famous salad oil case is that a client can commit fraud by
falsely moving inventory during a physical count to overstate the inventory balance.
TRUE

10. The onslaught of fraud in financial statements over the recent decade has been the first of its kind in
history.
FALSE

11. SAS 99 requires the auditor to more actively consider and assess the risk of fraud for clients and their
financial statements than had been required in the past.
TRUE

12. SAS 99 procedures must only be performed for clients that have had fraud concerns in the past.
FALSE

13. If an auditor discovers risk of fraud in the application of SAS 99 procedures, the audit procedures should be
adjusted accordingly.
TRUE

14. Professional skepticism is required on audit engagements that have a high risk of fraud but can be
disregarded for audit engagements with low risk of fraud.
FALSE

15. According to professional audit standards, the audit team should meet 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.
TRUE

16. Once the fraud assessment is complete in the planning stage, the auditor need not consider fraud further.
FALSE

17. Pressure perceived by management to manipulate financial information is a common characteristic in fraud
cases
TRUE

18. Management compensation that is tied to profits may contribute to incentives to commit fraud.
TRUE

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

20. Internal controls are implemented in order to give perpetrators the impression that the risk of being caught is
low.
FALSE

21. Complex transactions such as derivative instruments provide management certain opportunities to
manipulate financial statements to its advantage.
TRUE

22. A board of directors that is actively involved in monitoring management mitigates opportunities to commit
fraud.
TRUE

23. Rules based accounting sometimes contributes to the rationalization of financial reporting fraud.
TRUE

24. The auditor should not presume that fraud is present in revenue recognition by management because the
auditor must remain objective.
FALSE

25. Management rarely uses journal entries to commit fraud because they are easily noticed by the auditor.
FALSE

26. Auditors must keep a questioning mind when analyzing management responses to inquiry and they should
strive to obtain corroborating evidence before accepting the responses.
TRUE

27. The auditor must perform a brainstorming meeting with client management in order to plan the procedures
to be performed and the inventory locations to be visited.
FALSE

28. Channel stuffing is often a form of fraud by financial manipulation and can be noticed by the auditor by
performing analytical procedures directed toward the discovery of fraud indicators.
TRUE

29. One fraud risk factor includes the presence of domineering members of management who seek the ultimate
loyalty of subordinates.
TRUE

30. The audit team should develop its own idea about how fraud may be perpetrated and hidden by the client.
TRUE

31. Audit tests do not relate to fraud testing because fraud testing will be performed in a different (forensic)
engagement.
FALSE

32. When the risk of fraud is high in financial statements, the auditor should assign less experienced auditors to
the engagement.
FALSE

33. Types of fraud should be hypothesized by the auditor after performing analytical procedures for the
discovery of fraud factors.
TRUE

34. When fraud risk is high in the organization under audit, the nature, timing and extent of procedures applied
will likely need to be changed.
TRUE

35. Management fraud must be immediately reported by the auditor to the SEC rather than wasting time
reporting it to the audit committee or board of directors.
FALSE

36. Forensic accountants need to have superior interviewing and people skills.
TRUE

37. The focus of forensic accounting is similar to financial statement auditing in that it is directed to the fairness
of financial statements.
FALSE

38. Auditors are responsible to detect all illegal acts committed by the company and its employees.
FALSE

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

40. An ideal method of footing a large report and recalculating extensions is the use of generalized audit
software to extract the data and perform the test.
TRUE

41. When weaknesses in internal control are found, the auditor should develop audit procedures to explicitly test
for the existence of the type of fraud or misstatement that could occur because of the weakness.
TRUE

42. For illegal acts that have a direct effect on the financial statements, the auditor has a responsibility to design
the audit to provide reasonable assurance of detecting material misstatements.
TRUE

43. When preliminary fraud risk is high the auditor should pay close attention to areas of the audit that are
highly subjective and increase the predictability of the audit procedures.
FALSE

44. The auditor can be satisfied with less than persuasive evidence in the audit process because of the believe
that management is honest.
FALSE

45. Professional skepticism involves such things as questioning and corroborating management responses to
inquiries and determining the authenticity of documents.
TRUE

46. Audits of financial statements are valuable to the detection of fraud because:
A. Auditors are not required to seek out and find all fraud.
B. Auditors expect that management will make them aware of any fraud in the financial statements.
C. Society expects that the auditor will ensure that financial statements have not been materially misstated due
to fraud.
D. Society realizes that some fraud is not capable of being discovered by auditors.

47. Detection of fraud is integral to the audit function. The best reason for this is that:
A. unless auditors can provide assurance that the financial statements are free of material misstatements due to
fraud, there is no justification for the audit function.
B. the AICPA has mandated that the auditor take on more responsibility than previously required because of
management's demand for fraud finding.
C. it is the responsibility of the auditor to provide internal control over a client organization sufficient to
discover or prevent fraud from occurring.
D. auditor fraud is a large concern of shareholders and the audit committee must continually monitor the
auditors to ensure they are not misstating financial statements.

48. Which of the following represents the size of company that has most commonly committed fraud in its
financial reporting and by its employees?
A. Large corporations.
B. Middle-market corporations.
C. Small and start-up companies.
D. All companies.

49. What is the primary determinate in the difference between fraud and errors in financial statement reporting?
A. The materiality of the misstatement.
B. The intent to deceive.
C. The level of management involved.
D. The type of transaction effected.

50. Which of the following is not an example of a type of defalcation?

A. A warehouse employee takes home two units of electronic entertainment inventory each week without
authorization.
B. The president of the company utilizes the organization's cash to add a floor to her 15,000 square foot house.
C. The chief financial officer of the company falsely adds $20 million to the accounts receivable and revenue
accounts.
D. The treasurer of the company makes an unauthorized wire transfer from the organization's bank to a personal
account in Grand Cayman.

51. Which of the following best represents financial statement fraud?

A. The transfer agent issues 40,000 shares of the company's stock to a friend without authorization by the board
of directors.
B. The controller of the company decreases a contingent liability by $3 million because the company will
otherwise miss analysts' expectations this quarter.
C. The in-house attorney receives payments from the French government for negotiating the development of a
new plant in Paris.
D. The accounts receivable clerk covers up the theft of cash receipts by writing off older receivables without
authorization.

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

53. Which of the following would most likely be considered intentional misapplication of accounting principles
on financial statements?
A. A capital lease is presented as periodic rent expense rather than interest and depreciation.
B. A deferred tax asset is reduced to zero with a valuation allowance.
C. Insurance is amortized.
D. Revenues for up-front fees are deferred rather than recognized immediately.

54. Which of the following is most likely considered a material omission from the rules of financial statement
reporting?
A. The company no longer discloses a previously settled contingency.
B. The company does not present the fair value of all current assets on the balance sheet.
C. A privately held company does not disclose earnings per share.
D. A company with a net loss does not present a statement of cash flows.

55. Which of the following is an example of a common type of financial reporting fraud?
A. Capitalizing major overhauls to operating equipment.
B. Deferring service revenue until it is delivered to customers.
C. Recording sales for inventory sold with the right to return.
D. Excluding a contingent liability that has been settled.

56. Which of the following best represents an example of fraud utilizing the lapping technique?
A. An employee transfers cash on the last day of the year in order to double record it in the bank accounts.
B. An employee creates a fictional vendor and requests payment to a personal P.O. box.
C. An employee opens the mail to cover up payroll fraud received on a fictional person.
D. An employee covers up the stealing of receipts by posting to the wrong customer accounts.

57. Which of the following are most often involved in perpetrating fraud in financial statement reporting?
A. The auditors and the attorneys.
B. The audit committee members.
C. The chief executive and chief financial officers.
D. The accounts payable clerks.

58. What is the best method an auditor may use to detect fraud in the financial statements of clients?
A. Use professional skepticism.
B. Understand and properly apply Generally Accepted Accounting Standards.
C. Brainstorm with the client to find the types of fraud occurring.
D. Actively search for all errors in the financial statements.

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

60. If the audit team discovers that fraud risk factors are present on an engagement, it should then:
A. resign from the client and inform the audit committee and regulatory authorities.
B. modify procedures to actively search for the existence of fraud.
C. reduce the amount of evidence required and resort to management inquiry.
D. turn the audit over to forensic accountants.

61. The threshold of materiality may be lowered in the case of potential fraud in the financial statements under
audit. Why is this different from the usual materiality levels set by auditors?
A. The intentional act of committing fraud itself becomes material, regardless of dollar amounts.
B. Fraud is not relative to internal control, which requires larger materiality limits.
C. The act of fraud is a characteristic of certain types of managers, therefore, materiality is irrelevant.
D. Normal audit procedures are designed to catch all fraud, even the smallest of infractions.

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

63. Professional skepticism is best described as:

A. an intent to deceive.
B. an attitude of intrusion and obstinacy.
C. a character that does not waver.
D. a questioning mind.

64. According to professional audit standards, how might an understanding of the nature of fraud that may
occur in the client organization best be identified by the audit firm?
A. Fraud training courses from actual corporate fraud ex-criminals.
B. Conducting a brainstorming meeting with the members of the audit team.
C. Circulating a survey to the client company employees for completion.
D. Discussions with other CPA firms.

65. Which of the following is required of the audit team relative to its consideration of fraud in a financial
statement audit?
A. Documentation in the audit file.
B. Communication with the AICPA.
C. Modification of client financial records.
D. Termination of the manager responsible for the fraud.

66. What is the greatest benefit that can be derived by discussing fraud factors with management of the client
organization under audit?
A. Greater credibility with the client organization and its management.
B. The impression on the client that potential fraud is not being considered by an independent source.
C. Further consideration of the risks, and discussion of how management can reduce the risks.
D. Full disclosure of all fraud occurring during the year under audit in the company.

67. Which of the following risks of fraud should ordinarily be presumed on a financial statement audit by the
audit team?
A. Chief financial officer misappropriation of funds.
B. Misapplication of revenue recognition principles.
C. Management's inappropriate use of reserves.
D. Lack of expenses related to stock options.

68. Relative to internal controls, what is a primary risk of fraud in the client company?
A. The risk that management overrides controls.
B. The risk that management changes controls each year.
C. The risk that management carefully enforces and monitors controls.
D. The risk that the audit committee monitors controls.

69. How will the results of the auditor's assessment of fraud risk factors further affect the planned audit
procedures?
A. Audit procedures and fraud assessment do not relate.
B. The assessment may require a re-audit of previous periods.
C. By the assignment of qualified audit staff to risky areas of the engagement.
D. Management will be called upon to assist in coordinating audit procedures.

70. When is the assessment of fraud risk on a single engagement completed by the audit team?
A. Upon completion of the planning stage.
B. Once internal control is understood.
C. Only after the audit risk model has been used to design tests.
D. Once the audit is complete.

71. 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?
A. Protection Transparency's legal counsel.
B. The federal law enforcement agency.
C. The chairman of Protection Transparency's audit committee.
D. The predecessor auditor of Protection Transparency.

72. 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 upon the above information only,
what type of probable motivation is there to commit fraud at the Premium Discovery Company?
A. Pressure.
B. Opportunity.
C. Rationalization.
D. Expectation.

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

74. Wafflemart Corporation is a leader in its industry. It commands suppliers and is the envy of its competitors
with its ability to name its price to customers. Management is compensated with a relatively high level of stock
options. The Company has consistently met analysts expectations for stock price performance for each of the
last 32 quarters. What are the typical motivators of Wafflemart's situation noted above?
A. Wafflemart has pressure to commit fraud.
B. Wafflemart has incentive to commit fraud.
C. Wafflemart has opportunity to commit fraud.
D. Wafflemart has rationalization to commit fraud.

75. Sam Jones, controller of Mitnikco, spends three days researching the accounting statements to find
loopholes in the "rules" and to make a case for recognizing revenue earlier, rather than in later years. In the end,
this enables the Company to achieve its earnings targets. What are the motivations of Mitnikco management
based solely on the information above?
A. Pressures
B. Opportunity
C. Rationalization
D. Skepticism

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

77. In actively considering fraud in the financial statement audit, the audit team will most likely realize which of
the following when performing substantive procedures?
A. Accounting journal entries may have been used to perpetrate a fraud.
B. Most fraud is not material enough to consider.
C. Journal entries do not supply enough evidence to detect fraud.
D. New technology prevents fraud more thoroughly than manual systems.

78. Brainstorming about the manner in which fraud may be committed should include all of the following
except
A. Consider factors that might affect management motivation to misstate the financial statements
B. Consider weaknesses in internal control that would allow a fraud to take place
C. Consider the materiality of the individual account balances for substantive testing
D. Consider factors that may enable an individual capable of committing a fraud to rationalize perpetrating it

79. In evaluating the effect of fraud upon the audit procedures the auditor should consider
A. The type of fraud that may occur.
B. The potential significance of fraud.
C. The likelihood of fraud occurring.
D. The pervasiveness of fraud detected.
E. All of the above.

80. The audit team asks management for original documents related to sales contracts. Despite the team's
persistence, management does not supply the documents for over two weeks. With the use of professional
skepticism, what should this audit team be most concerned with as it relates to the documents?
A. The need to complete the audit within a specified period of time.
B. Management's possible use of the time to fabricate the documents.
C. Discrepancies of the evidence.
D. Conflicting evidence.

81. If material fraud perpetrated by management is discovered by the auditor, the nature of the fraud should
always be reported directly to:
A. the PCAOB
B. the SEC
C. the FBI
D. the audit committee of the company

82. The key elements of the fraud triangle include all of the following except
A. Pressure
B. Materiality
C. Opportunity
D. Rationalization

83. If management makes appropriate adjustments, but does not take appropriate steps to modify internal
control in order to rectify the problem of fraud discovered in a financial statement audit, the decision has a
direct impact on:
A. the audit opinion on the financial statements.
B. the client company's stock price.
C. the auditor's perception of the overall control environment.
D. all previous work performed by the auditor for competing companies.

84. Which of the following represents the primary difference between an audit and forensic accounting?
A. An audit has the focused responsibility to detect fraud in the client organization while forensic accounting
sets out to prevent fraud.
B. An audit has no responsibility for fraud while forensic accounting provides an audit specific to material fraud
discovery.
C. An audit must follow Generally Accepted Auditing Standards while the forensic accountant is bound to
Generally Accepted Fraud Standards.
D. An audit utilizes sampling techniques to detect material misstatements while forensic accounting examines
the entire population of fraudulent transactions.

85. Which of the following computerized audit procedures best assists the engagement team in detecting asset
misappropriations?
A. Creation of bank confirmations.
B. Tracing of recorded assets to source documents.
C. Search for duplicate payments.
D. Determination of obsolete inventory.

86. Which of the following is not one of the components of the fraud triangle?
A. Incentive.
B. Rationalization.
C. Susceptibility.
D. Opportunity.

87. A common accounts receivable fraud is lapping. This type of fraud typically involves which of the
following:
A. using journal entries to write off accounts against the allowance for doubtful accounts.
B. applying cash from one customers receivable to that of another to cover the earlier deficit.
C. recording large discounts for the clients.
D. Both A and C.

88. The fraud triangle consists of three components (pressure, opportunity, and rationalization). Which of the
three components are present in most every fraud?
A. All three factors are usually present when fraud occurs.
B. Pressure and opportunity
C. Opportunity and rationalization
D. Rationalization and pressure

89. Fraud motivations and factors

Research consistently shows that there are three elements present when most frauds occur. List these elements
and at least three related fraud factors that may exist for each.

Element
Incentives or Pressures

Opportunities

Attitudes or Rationalization

Fraud Factors
-Management compensation schemes.
-Financial pressure to improve trends.
-Personal need for financial enhancement.
-Compliance with debt covenants.
-Significant related-party transactions.
-Industry dominance.
-Influence over suppliers or customers.
-Volume of subjective judgments by management. regarding valuation and other
estimates.
-Simple transactions made complex.
-Complex or difficult to understand transactions (including SPEs/VIEs and
derivatives).
-Ineffective monitoring by management.
-Complex or unstable organizational structure.
-Weak or nonexisting internal controls.
-Pushing accounting limits.
-Aggressive accounting stance.
-Audit firm answers to management and not the audit committee.
-Audit firm focus is on consulting for higher fees rather than audit services.
-Stock analyst misguidance.
-"The company owes me!"

90. Consideration of fraud in an audit

Auditors are required to actively conduct a financial statement audit with the mindset that fraud may exist. What
is the general process that an auditor goes through to assess the risk of fraud and test accordingly?

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Understand the nature of fraud, the motivations to commit fraud, and the manner in which fraud may be perpetrated.
Exercise professional skepticism throughout the entire fraud risk assessment process.
Brainstorm and share knowledge with other audit team members.
Obtain information useful in identifying and assessing fraud risk.
Identify the specific fraud risks, including potential magnitude, and areas likely to be affected by a fraud.
Evaluate the quality of the companys controls and potential effectiveness in mitigating the risk of fraud.
Respond, i.e. adjust audit procedures to assure that the audit adequately addresses the risk of fraud and provides evidence
specifically related to the possibility of fraud.
Evaluate findings. If evidence signals that a fraud might exist, determine whether or not forensic or specialist auditors are needed to
complete the investigation.
Communicate the possibility that fraud exists to management, or to the audit committee or the full board if the fraud is material
and/or involves members of management.
Document the audit approach starting with the step 1 through the completion of all of the steps identified above.

91. Fraud consideration by auditors

John Beasley is interviewing with public accounting firms to become an auditor. John does not believe that
fraud is a "big deal" in client organizations and argues that most individuals in management of companies are
"honest people". He believes that auditors are becoming too cynical.
Describe your response to John's attitude and discuss the major types of fraud that occur in companies.
Audit firms have taken criticism for failing to discover material frauds. Auditors have a greater responsibility to
plan the audit to consider and detect fraud. This is accomplished partially by the auditor's use of professional
skepticism. Professional skepticism is not necessarily being cynical, it is performing an audit with a questioning
mind. It means that the auditors will obtain persuasive evidence to corroborate management responses to
inquiries and to increase the sufficiency of substantive audit evidence. Professional skepticism is exhibited in
the auditor's assumption that honesty in people is not a given. Auditors must not only go beyond the evidence in
front of them, they must have the mindset of the possibility of fraud in all financial statement engagements.
It must also be mentioned that John may not be accepted by a public accounting firm because his attitude
toward fraud is not rigorous enough for the profession.
John must realize that, quite often, fraud in organizations usually takes place in one of three areas:

Defalcation such as corruption such as bribery or conflicts of interest.

Defalcation such as asset misappropriation such as theft and misuse of assets.
Fraudulent financial reporting such as the overstatement of certain assets and revenues and the understatement of certain liabilities and
expenses.

92. Forensic accounting

Contrast the financial statement auditor's consideration of fraud to that of a forensic accountant.
A financial statement auditor is focused on drawing conclusions relative to the fair presentation of financial
statements in accordance with GAAP utilizing the concept of materiality. The financial statement auditor
samples population and tests balances and transactions after consideration of certain risks.
Forensic accounting is auditing in the sense that procedures are performed in situations where fraud has already
been discovered. Forensic professionals not only determine the extent of the fraud, but also focus on the finding
the individual who perpetrated the fraud. This form of professional services assists the courts in building a case
against the person committing the fraud by giving the details of the audit findings.
Unlike a financial statement auditor, forensic accountants will examine 100 percent of certain populations. They
do this to determine the full extent of the fraud. Financial statement auditors may expand their procedures if
fraud is suspected or detected, but they follow the concept of reasonable assurance.
A financial statement auditor uses testing and procedures, utilizing sampling and analytics to perform an audit.
The forensic accountant, on the other hand, utilizes inquiry and interviews to perform extensive procedures.
The scope and nature of the financial statement audit is always the assertions related to the financial statements
under audit. Forensic accounting ranges to more specific engagements from financial reporting fraud, to hidden
assets, court testimony and divorce cases.
The deliverable of a financial statement is the written report, or opinion related to the audit of the financial
statements. The end product of forensic accounting is a summary of evidence gathered and testimonial evidence
for court cases.
Arguably, the skills of both the financial statement auditor and the forensic accountant must be similar in
nature. Such skill-sets should include interviewing and listening skills, data gathering and analysis, accounting,
auditing and computer skills. The notable differences in skills are those of objectivity for the auditor and the
need for reconstruction of balances and electronic data for the forensic accountant.

93. Brainstorming for fraud

You are a staff auditor with Zepplin and Frank, CPAs. Your audit team is in the planning stage for Leppard
Sullivan, Inc., a beauty supply wholesaler. Describe the brainstorming process and types of issues that may be
brought to the surface regarding your client.
All members of the audit team must be assembled to consider the possibility of fraud at Leppard Sullivan.
Management motivations will be discussed as well as weaknesses in internal control and preliminary analytics.
The auditors may discuss how they will conduct the audit with professional skepticism and a questioning mind.
According to SAS 99, the following should be considered in the brainstorming session:
-

Consider how fraud can be perpetrated and covered up.

Presume fraud in revenue recognition.
Consider incentives, opportunities and rationalization for fraud.
Consider industry conditions.
Consider operating characteristics and financial stability.

The audit team must not just go through the motions of conducting this brainstorming. It must be a thorough and integral part of the audit approach.

94. Fraud categories

Corporate fraud may take place through a variety of methods. Identify the major categories of fraud and give
examples of each.
The following represents the broad categories of fraud and examples of each:

Fraud Category
Defalcations
Defalcations
Financial Reporting Fraud

Financial Reporting Fraud

Financial Reporting Fraud

Examples
Corruption such as kickbacks, bribery and/or conflicts of interest.
Asset misappropriations due to theft such as embezzlement of funds, stealing
inventory, misuse of company assets, and/or payroll fraud.
Manipulation, falsification, or alteration of accounting records or supporting
documents such as the creation of fictitious shipping documents and invoices to
record sales fraudulently.
Misrepresentation or omission of events, transactions, or other significant
information such as the intentional non-disclosure of unconsolidated subsidiaries.
Intentional misapplication of accounting principles such as reporting a capital
lease as an operating lease.

95. Fraud risks that may lead to material misstatement

Identify risks that the auditor should consider during brainstorming that may result in material misstatement due
to fraud.
The auditor should consider the following factors in evaluating the risk of material misstatement:
-Type of fraud that may occur.
-Significance of the potential fraud.
-Likelihood of the fraud.
-Pervasiveness of the risk of fraud.

The auditor ordinarily should consider that there is a risk of material misstatement due to fraud relating to revenue recognition.
The auditor should address the risk of management override of controls.

96. Auditors response to fraud risk factors

The auditor assesses the identified fraud risks after taking into account an evaluation of the clients programs
and controls. How might the auditor respond to the results of the assessment of higher fraud risk?
The auditor should consider:
-Profes
sional
skeptic
ism
a)
Obtain
more
reliable
eviden
ce
b)
Obtain
additio
nal
corrob
orating
eviden
ce.
-Assig
nment
of
person
nel and
supervi
sion--s
pecialis
ts or
more
experie
nced
person
nel
-More
careful
conside
ration
of
manag
ement
s
selectio
n and
applica
tion of
accoun
ting
princip
les

-Addin
g an
elemen
t of
unpredi
ctabilit
y to
auditin
g
proced
ures

The auditor may change the nature, timing and extent of the audit procedures to be performed by increasing the extent of procedures, making them
more persuasive, and moving more of them to the balance sheet date or later.
The response may involve the performance of procedures to further consider the risk related to:
a) Revenue recognition
b) Inventory quantities
c) Management estimates

Responses to consider the risk of management override of controls may include:

a) Examine journal entries and other adjustments made in preparation of financial statements
b) Review accounting estimates for biases
c) Evaluate business rationale for significant unusual transactions

97. Auditors fraud communication responsibilities

Discuss the auditors responsibility to communicate fraud to the audit committee. When is the auditor required
to communicate possible fraud to parties other than the audit committee and management?
If the fraud is material (as previously agreed to with the audit committee) or if it involves senior management
then it should be reported directly to the audit committee. Also if it has continuing control implications, the
auditor should consider whether it is a significant control deficiency that should be reported to the audit
committee.
The auditor normally is limited in their ability to disclose fraud to outside parties because of the confidentiality
requirement. However, communication of fraud to parties other than the client may be required:
a) To comply with legal and regulatory requirements
b) To a successor auditor
c) In response to a subpoena
d) To a funding agency involving governmental financial assistance

98. Linking internal control deficiencies to audit procedures

After assessing internal control weakness the auditor develops audit procedures to explicitly test for the
existence of the types of fraud or misstatement that could occur because of the weakness. In the linkage process
from control deficiencies to audit procedures, what are the four questions involved in linking changes to the
audit program?
The auditor has to consider what could go wrong and then decide on the audit evidence that is needed to
determine if fraud has occurred. The linkage process from control deficiencies to audit procedures involves the
following thought process to identify potential changes to the audit program:
-What types of misstatements could occur because of the control deficiencies?
-What account balances would be affected and how would they be affected?
-What audit procedures would provide evidence on whether the account balance
contains misstatements?
-Do the planned audit procedures emphasize objective evidence that is outside the
purview of the parties that have access to the assets?