Chap 004

Chapter 04
Management Fraud and Audit Risk
True / False Questions

1. Frauds are unintentional misstatements or omissions of accounts or
disclosures in financial statements.
True
False
2. The nature of extended procedures for fraud detection is limited to

those listed in the Professional Standards and Practices for Certified
Fraud Examiners.
True
False
3. Fraud consists of knowingly making material misrepresentation of fact

with the intent of inducing someone to believe the falsehood and suffer
a loss.
True
False
4. Audit care and attention should be greater where business and inherent
risks are judged to be lower.
True
False
5. Control risk should not be assessed so low that auditors place complete
reliance on controls and do not perform any other audit work.
True
False
6. Detection risk occurs when internal control activities fail to detect

material misstatements.
True
False
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7. The auditing profession official standard for an acceptable level of

overall audit risk is 0.05 at the current level.
True
False
8. Audit risk (AR) is a quality criterion based on professional judgment.

True
False
9. The audit risk model assumes that elements of audit risk are
independent and therefore multiplicative.
True
False
10 Generally, fraudulent financial statements show financial performance

. and ratios that are better than current industry experience.
True
False
11 The demographics of white-collar criminals are similar to those of

. typical bank robbers.
True
False
12 Knowledge and understanding of a client's business is absolutely

. essential in completing an audit.
True
False
13 Auditing standards require that analytical procedures be applied in the

. beginning stages of each audit.
True
False
14 Auditors look for relationships that do not make sense as indicators of

. problems in the accounts and use such indicators to plan further audit
work.
True
False
15 Analytical procedures are considered to be "soft" evidence and

. therefore considered ineffective.
True
False
16 Audits are not designed to detect material errors and fraud in financial
. statements.
True
False
17 Knowledge of the client's business from preliminary analytical

. procedures can help auditors identify problem areas and make broad
risk assessments.
True
False
Multiple Choice Questions

18 The major emphasis in GAAS related to consideration of fraud in a
. financial statement audit (AU 240) is on:
A.
B.
C.
D.
Employee misappropriation of assets.

Management fraud.
Client fraud on customers.
Employee embezzlement.
19 Management fraud generally refers to

.
A.
B.
C.
D.
Unintentional mistakes.
Noncompliance.
Intentional distortions of financial statements.
Violations of GAAS.
20 External auditors are responsible

.
A.
For authenticating documents.
B. For reporting immaterial frauds to a level of management at least
one level above the people involved.
C. For finding all intentional misstatements concealed by collusion.
D. For reporting all frauds to outside agencies or parties.
21 According to auditing standards, external auditors' responsibilities for
. indirect noncompliance do not include
A. Designing audit procedures to detect noncompliance in the absence

of specific information brought to the auditors' attention.
B. Performing audit procedures when specific information indicates that
possible noncompliance may have an indirect material effect on
financial statements.
C. Considering the qualitative materiality of known and suspected
noncompliance.
D. Obtaining written management representations concerning the
absence of violations of laws and regulations.
22 Certain conditions and circumstances are often present when
. management fraud occurs. Which of the following is not such a
condition or circumstance?
A.
B.
C.
D.
Unfavorable industry conditions.

Lack of working capital.
High liquidity.
Slow customer collections.
23 Independent auditors who consider fraud in the course of financial

. statement audits are well-advised to quantify "materiality" in terms of:
A. The maximum amount of asset overstatement that might mislead

investors in relation to the latest financial statements under audit.
B. A maximum percentage of net income overstatement that might
mislead investors in relation to the latest financial statements under
audit.
C. A cumulative amount of misstatement of assets or income over
several years past and current that might mislead investors in
relation to the latest financial statements under audit.
D. Controversial accounting measurements that might mislead investors
in relation to the latest financial statements under audit.
24 An auditor assesses the risk of material misstatement because it
.
A. Is relevant to the auditor's understanding of the control environment.
B. Provides assurance that the auditor's overall materiality levels are
appropriate.
C. Indicates to the auditor where inherent risk may be the greatest.
D. Affects the level of detection risk that the auditor may accept.
25 When fraud risk is significant, and management cooperation is
. unsatisfactory, the auditors will most likely
A.
Perform extended audit procedures.
B.
Consult with fraud examiners.
C. Report directly to the Securities and Exchange Commission within
one day.
D.
Withdraw from the engagement.
26 Which of the following statements concerning noncompliance by clients

. is correct?
A. An auditor's responsibility to detect noncompliance that has a direct

and material effect on the financial statements is the same as that
for errors and frauds.
B. An audit in accordance with generally accepted auditing standards
normally includes audit procedures specifically designed to detect
noncompliance that has an indirect but material effect on the
C. An auditor considers noncompliance from the perspective of the
reliability of management's representations rather than their relation
to audit objectives derived from financial statement assertions.
D. An auditor has no responsibility for noncompliance that has an
indirect effect on the financial statements.
27 Which of the following statements best describes auditors'
. responsibility to detect errors and frauds?
A. Auditors should design an audit to provide reasonable assurance of

detecting errors and frauds that are material to the financial
statements.
B. Auditors are responsible to detect material errors but have no
responsibility to detect material frauds that are concealed through
employee collusion or management override of the internal control
structure.
C. Auditors have no responsibility to detect errors and frauds unless
analytical procedures or tests of transactions identify conditions
causing a reasonably prudent auditor to suspect that the financial
statements were materially misstated.
D. Auditors have no responsibility to detect errors and frauds because
auditors are not insurers and an audit does not constitute a
guarantee.
28 The probability that an audit team will give an inappropriate opinion on

. financial statements best describes
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.
29 Inherent risk is the

.
A. Probability that some accounts are more susceptible to misstatement
than others.
B. Probability that the client's internal control policies and procedures
will fail to detect material misstatements.
C. Probability that material misstatements have occurred in
transactions entering the accounting system used to develop
D. Probability that the auditor may not detect material misstatements in
the financial statements.
30 If control risk increases and all other risks in the audit risk model stay
. constant except the one referred to below, which of the following
statements is correct?
A.
B.
C.
D.
Detection risk will decrease.

Inherent risk will increase.
Audit risk will decrease.
Detection risk will increase.
31 If fictitious credit sales were recorded and the fictitious accounts

. receivable were later directly written off as bad debt expense
A.
B.
C.
D.
Income would be overstated.

Income would be understated.
Income would not be misstated.
Accounts receivable would be understated.
32 An audit team uses the assessed risk of material misstatement to

.
A. Evaluate the effectiveness of the entity's internal control policies and
activities.
B. Identify transactions and account balances where inherent risk is at
the maximum.
C. Indicate whether materiality thresholds for planning and evaluation
purposes are sufficiently high.
D. Determine the acceptable level of detection risk for financial
statement assertions.
33 The risk of material misstatement differs from detection risk in that it
.
A. Arises from the misapplication of audit procedures.
B. May be assessed in either quantitative or nonquantitative terms.
C. Exists independently of the financial statement audit.
D. Can be changed at the auditor's discretion.
34 The risk that an auditor's procedures will lead to the conclusion that a
. material misstatement does not exist in an account balance when, in
fact, such misstatement actually exists is
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.
35 Based on audit evidence gathered and evaluated, an auditor decides to

. increase the assessed level of control risk from that originally planned.
To achieve an overall audit risk level that is substantially the same as
the planned audit risk level, the auditor would
A.
B.
C.
D.
Decrease substantive testing.

Decrease detection risk.
Increase inherent risk.
Increase materiality levels
36 The acceptable level of detection risk is inversely related to the

.
A. Assurance provided by substantive tests.
B. Risk of misapplying audit procedures.
C. Preliminary judgment about materiality levels.
D. Risk of failing to discover material misstatements.
37 The existence of audit risk is recognized by the statement in the
. auditor's standard report that the
A. Auditor is responsible for expressing an opinion on the financial

statements, which are the responsibility of management.
B. Financial statements are presented fairly, in all material respects, in
conformity with applicable financial reporting framework.
C. Audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements.
D. Auditor obtains reasonable assurance about whether the financial
statements are free of material misstatement.
38 When determining the inherent risk related to an account balance, an
. auditor theoretically does not explicitly consider the
A.
Liquidity of the account.
B. Degree of management estimation involved in determining the
proper account balance.
C. Related internal control policies and procedures.
D.
Complexity of calculations involved.
39 An auditor who discovers that client employees have committed an

. illegal act that has a material effect on the client's financial statements
most likely would withdraw from the engagement if
A. The noncompliance is a violation of generally accepted accounting

principles.
B. The client does not take the remedial action that the auditor
considers necessary.
C. The illegal act was committed during a prior year that was not
audited.
D. The auditor has already assessed control risk at the maximum level.
40 When an auditor becomes aware of possible noncompliance by a client,
. the auditor should obtain an understanding of the nature of the act to
A.
B.
C.
D.
Evaluate the effect on the financial statements.

Determine the reliability of management's representations.
Consider whether other similar acts may have occurred.
Recommend remedial actions to the audit committee.
41 Jones, CPA, is auditing the financial statements of XYZ Retailing, Inc.

. What assurance does Jones provide that direct effect noncompliance
that is material to XYZ's financial statements and noncompliance that
has a material but indirect effect on the financial statements will be
detected?
A. Direct effect noncompliance: Reasonable; indirect effect

noncompliance: none.
B. Direct effect noncompliance: Reasonable; indirect effect
noncompliance: reasonable.
C. Direct effect noncompliance: Limited; indirect effect noncompliance:
none.
D. Direct effect noncompliance: Limited; indirect effect noncompliance:
reasonable.
42 Generally accepted auditing standards state that analytical procedures

.
A. Should be applied in the planning and final review stages of the audit
and as a substantive test during the audit.
B. Should be applied in the planning and final review stages of the audit
and can be used as a substantive test during the audit.
C. Should be applied in the planning stage and can be applied as a
substantive test in the final review stage.
D. Should be applied in the final review stage and can be applied as a
substantive test in the planning stage.
43 In the planning stage, analytical procedures are used to
.
A.
Identify potential problem areas.
B. Provide direct evidence about the balances in accounts.
C. Determine the mathematical correctness of the financial statements.
D.
All of the above.
44 Assume that application of analytical procedures revealed significant
. unexplained differences between recorded amounts and the
expectations (estimates) developed by the auditor. If management is
unable to provide an acceptable explanation, the auditor should
A. Consider the matter a scope limitation.

B. Perform additional audit procedures to investigate the matter further.
C. Intensify the audit with the expectation of detecting management
fraud.
D.
45 For audits of financial statements made in accordance with generally
. accepted auditing standards, the use of analytical procedures is
required to some extent
A.
B.
C.
D.
As a substantive test: yes; in the final review stage: yes

As a substantive test: yes; in the final review stage: no
As a substantive test: no; in the final review stage: yes
As a substantive test: no; in the final review stage: no
46 Which of the following would not likely be found in the minutes of the
. board of directors?
A.
Amount of dividends declared.
B. Approval to pledge assets as security for debts.
C.
Authorization of officers' salaries.
D. Approval of a new desktop computer for the controller.
47 An auditor who encounters significant risks at the client should do all of
. the following except
A.
Inform the SEC.
B.
Perform extended procedures.
C. Include more experienced auditors on the engagement.
D.
Perform tests closer to year-end.
48 Horizontal analysis refers to
.
A. The trend of income from year to year of persons suspected of fraud.
B. Changes of financial statement numbers and ratios across several
years.
C. Financial statement amounts expressed each year as a proportion of
a base amount.
D. The change in a suspect's net worth from the beginning to the end of
a period.
49 Analytical procedures used in planning an audit should focus on
.
A. Reducing the scope of tests of controls and substantive tests.
B. Providing assurance that potential material misstatements will be
identified.
C. Enhancing the auditor's understanding of the client's business.
D. Assessing the adequacy of the available evidential matter.
50 Sources of financial and nonfinancial data do not include

.
A. Financial account information for comparable prior periods.
B. Nonfinancial information such as physical production statistics.
C.
Company budgets and forecasts.
D.
Bureau of Labor statistics.
51 The type of financial analysis that expresses balance sheet accounts as
. percentages of total assets is known as:
A.
B.
C.
D.
Horizontal analysis.
Vertical analysis.
Net worth analysis.
Expenditure analysis.
52 Which of the following accounts tends to be most predictable for

. purposes of analytical procedures?
A.
B.
C.
D.
Accounts receivable.
Travel and entertainment expense.
Interest expense.
Income taxes payable.
53 Analytical procedures are audit methods of evaluating financial

. statement accounts by studying and comparing relationships among
financial and nonfinancial data. The primary purpose of analytical
procedures conducted during the planning stages is to
A.
B.
C.
D.
Identify the appropriate schedules to be prepared by the client.

Identify the types of errors or frauds that can occur in transactions.
Identify unusual conditions that deserve additional audit effort.
Determine the existence of unrecorded liabilities or overstated
assets.
54 Which of the following is not required by AU 240, "Consideration of

. Fraud in a Financial Statement Audit"?
A. Conduct a continuing assessment of the risks of material

misstatement due to fraud throughout the audit.
B. Conduct a discussion by the audit team of the risks of material
misstatement due to fraud.
C. Conduct the audit with professional skepticism, which includes an
attitude that assumes balances are incorrect until verified by the
auditor.
D. Conduct inquiries of shareholders as to their views about the risks of
fraud and their knowledge of any fraud or suspected fraud.
55 An auditor who increases the planned assessed level of control risk
. because certain control activities were determined to be ineffective
would most likely increase the
A.
B.
C.
D.
Extent of substantive tests of details.

Level of inherent risk.
Extent of tests of controls.
Level of detection risk.
56 What assurance does the auditor provide that errors, frauds, and direct
. effect noncompliance that are material to the financial statements will
be detected?
A. Errors: limited; frauds: negative; direct effect noncompliance:

limited.
B. Errors: limited; frauds: limited; direct effect noncompliance:
reasonable.
C. Errors: reasonable; frauds: limited; direct effect noncompliance:
limited.
D. Errors: reasonable; frauds: reasonable; direct effect noncompliance:
reasonable.
57 Experience has shown that the many large fraudulent transactions can
. be found in
A. Systematic processing of large volumes of day-to-day ordinary

transactions.
B. Payroll fraudsters' mistakes in using unissued Social Security
numbers.
C.
Petty cash embezzlements.
D. Nonroutine, nonsystematic journal entries.
58 Which of the following pieces of information discovered by an auditor
. when performing substantive tests of account balances would most
likely raise red flags about the possible existence of material fraudulent
financial reporting?
A. Paper copies of paid invoices and cancelled checks were microfiched

and then destroyed.
B. The controller requires that you schedule any audit inquiries daily
after lunch, not in the morning.
C. The petty cash fund custodian never takes a vacation.
D. The client's estimate of the allowance for doubtful accounts is lower
than the auditor's independent evaluation of the allowance.
59 Inherent risk and control risk differ from detection risk in that inherent
. risk and control risk are
A. Elements of audit risk whereas detection risk is not.

B. Changed at the auditor's discretion whereas detection risk is not.
C. Considered at the individual account balance level whereas detection
risk is not.
D. Functions of the client and its environment whereas detection risk is
not.
60 The auditor uses the assessed level of risk of material misstatement to

. determine the acceptable level of detection risk for financial statement
assertions. As the acceptable level of detection risk decreases, the
auditor may do one or more of the following except change the
A. Nature of substantive tests to more effective procedures.

B. Timing of substantive tests, such as performing them at year-end
rather than at an interim date.
C. Extent of substantive tests, such as using larger sample sizes.
D. Assurances provided by substantive tests to a lower level.
61 Which of the following is an acceptable response to fraud risks related
. to sales that were identified in an audit?
A.
B.
C.
D.
Exercise professional skepticism when performing sales testing.

Increase the assessment of control risk for sales.
Increase the assessment of detection risk for sales.
Perform additional substantive sales procedures on a surprise basis.
62 If tests of controls induce the auditor to change the assessed level of

. control risk for property plant & equipment from 50 percent to 100
percent and audit risk (6 percent) and inherent risk remain constant,
the acceptable level of detection risk
A. Would most likely change from 10 percent to 5 percent.

B. Would most likely change from 20 percent to 40 percent.
C. Would most likely change from 30 percent to 15 percent.
D. Would be unchanged because the auditor has control over detection
risk.
E. Cannot be determined because inherent risk is not given.
63 Managing business risk is the responsibility of
.
A.
B.
C.
D.
The auditors.
Management.
The SEC.
The PCAOB.
64 Auditors would use the enterprise risk model

.
A.
B.
C.
D.
To reduce the client's business risk.

To determine detection risk.
To evaluate management's risk assessment.
To monitor client risk.
65 Auditors use brainstorming

.
A. To heighten the audit team's awareness of fraud potential.
B. To heighten management's awareness of fraud potential.
C.
D.
To set materiality.
66 The purpose of an audit strategy is
.
A. To provide a defense against litigation.
B. To gain an understanding of the client.
C.
To comply with securities law.
D. To set the scope, timing, and direction for auditing each relevant
assertion.
67 Auditors are responsible for the quality of the work related to
. management and control of
A.
B.
C.
D.
Inherent risk.
Business risk.
Control risk.
Detection risk.
68 Which of the following engagement planning procedures would most

. likely assist the auditor in identifying related-party transactions before
the balance-sheet date?
A. Interviewing internal auditors about their reporting responsibilities.

B. Reviewing accounting records for recurring transactions occurring
near year-end.
C. Inspecting communications with the client's legal counsel regarding
recorded contingent liabilities.
D. Scanning the minutes for significant transactions with members of
the board of directors.
69 The likelihood that material misstatements may have entered the
. accounting system and not been detected and corrected by the client's
internal control is referred to as
A.
B.
C.
D.
Inherent risk.
Control risk.
Detection risk.
Risk of material misstatement.
70 The risk of material misstatements is composed of which audit risk

. components?
A.
B.
C.
D.
Inherent risk and control risk.

Control risk and detection risk.
Inherent risk and detection risk.
Inherent risk, control risk, and detection risk.
71 Auditing standards do not require auditors of financial statements to

.
A. Understand the nature of errors and frauds.
B. Assess the risk of occurrence of errors and frauds.
C. Design audits to provide reasonable assurance of detecting errors
and frauds.
D. Report all errors and frauds found to police authorities.
72 The risk that the auditors' own procedures will lead to the decision that
. material misstatements do not exist in the financial statements when in
fact such misstatements do exist is
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.
73 The auditors assessed risk of material misstatement at 0.50 and said

. they wanted to achieve a 0.05 risk of failing to express a correct
opinion on financial statements that were materially misstated. What
detection risk do the auditors plan to use for planning the remainder of
the audit work?
A.
B.
C.
D.
0.20.
0.10.
0.75.
0.00.
74 If tests of controls induce the audit team to change the assessed level
. of control risk for fixed assets from 0.4 to 1.0 and audit risk (0.05) and
inherent risk remain constant, the acceptable level of detection risk is
most likely to
A.
B.
C.
D.
Change from 0.1 to 0.04.

Be unchanged.
75 Which of the following is a specific procedural response to a particular

. fraud risk in an account balance or class of transactions?
A. Exercising more professional skepticism.

B. Carefully avoiding conducting interviews with people in the fraud-rich
areas.
C. Performing procedures such as inventory observation and cash
counts on a surprise or unannounced basis.
D. Studying management's selection and application of accounting
principles more carefully.
76 It is acceptable under generally accepted auditing standards for an
. audit team to
A. Assess risk of material misstatement at high and achieve an

acceptably low audit risk by performing extensive detection work.
B. Assess control risk at zero and perform a minimum of detection
work.
C. Assess inherent risk at zero and perform a minimum of detection
work.
D. Decide that audit risk can be 40 percent.
77 If sales were overstated by recording a false credit sale at the end of
. the year, where could you find the false "dangling debit"?
A.
B.
C.
D.
Inventory.
Cost of goods sold.
Bad debt expense.
78 One of the typical characteristics of management fraud is

.
A. Falsification of documents in order to misappropriate funds from an
employer.
B. Victimization of investors through the use of materially misleading
C. Illegal acts committed by management to evade laws and
regulations.
D. Conversion of stolen inventory to cash deposited in a falsified bank
account.
79 Under the Private Securities Litigation Reform Act, independent auditors
. are required to
A. Report in writing all instances of noncompliance to the client's board

of directors.
B. Report to the SEC all instances of noncompliance they believe have a
material effect on financial statements if the board of directors does
not first report to the SEC.
C. Report clearly inconsequential noncompliance to the audit committee
of the client's board of directors.
D. Resign from the audit engagement and report the instances of
noncompliance to the SEC.
80 Which of the following circumstances would most likely cause an audit
. team to perform extended procedures?
A. Supporting documents are produced when requested.

B. The client made several large adjustments at or near year-end.
C. The company has recently hired a new chief financial officer after the
previous one retired.
D. The company maintains several different petty cash funds.
81 When the auditors become aware of noncompliance with a law or

. regulation committed by client personnel, the primary reason that the
auditors should obtain a better understanding of the nature of the act is
to
A. Recommend remedial actions to the audit committee.

B. Evaluate the effect of the noncompliance on the financial
statements.
C. Determine whether to contact law enforcement officials.
D. Determine whether other similar acts could have occurred.
82 Which of the following statements best describes auditors'
. responsibility for detecting a client's noncompliance with a law or
regulation?
A. The responsibility for detecting noncompliance exactly parallels the

responsibility for errors and fraud.
B. Auditors must design tests to detect all material noncompliance that
indirectly affect the financial statements.
C. Auditors must design tests to obtain reasonable assurance that all
noncompliance with direct material statement effects are detected.
D. Auditors must design tests to detect all noncompliance that directly
affect the financial statements.
83 Analytical procedures are generally used to produce evidence from
.
A. Confirmations mailed directly to the auditors by client customers.
B.
Physical observation of inventories.
C. Relationships among current financial balances and prior balances,
forecasts, and nonfinancial data.
D. Detailed examination of external, external-internal, and internal
documents.
84 Auditors perform analytical procedures in the planning stage of an audit

. for the purpose of
A. Deciding the matters to cover in an engagement letter.

B. Identifying unusual conditions that deserve more auditing effort.
C. Determining which of the financial statement assertions are the most
important for the client's financial statements.
D. Determining the nature, timing, and extent of audit procedures for
auditing the inventory.
85 Which of the following relationships between types of analytical
. procedures and sources of information are most logical?
A.
B.
C.
D.
Option A
Option B
Option C
Option D
86 Analytical procedures can be used in which of the following ways?

.
A. As a means of overall review at the end of an audit.
B. As "attention-directing" methods when planning an audit at the
beginning.
C. As substantive audit procedures to obtain evidence during an audit.
D.
All of the above.
87 Analytical procedures used when planning an audit should concentrate

. on
A. Weaknesses in the company's internal control activities.

B. Predictability of account balances based on individual transactions.
C. Management assertions in financial statements.
D. Accounts and relationships that can represent specific potential
problems and risks in the financial statements.
88 When a company that sells its products for a (gross) profit increases its
. sales by 15 percent and its cost of goods sold by 7 percent, the cost of
goods sold ratio will
A.
Increase.
B.
Decrease.
C.
Remain unchanged.
D. Not be able to be determined with the information provided.
89 Analytical procedures are used
.
A.
To set materiality limits.
B. To assess the reasonableness of financial statement amounts.
C. To provide direct evidence about the numbers in the financial
statements.
D.
To test internal controls.
90 The risk that material misstatements have occurred in transactions
. entering the accounting system is
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.
91 In the audit risk model, if an audit team wanted to keep audit risk at a
. low level but there was a great inherent risk of material misstatement
and the internal control was ineffective, then procedures would need to
be designed so that
A.
B.
C.
D.
Detection risk was at a low level.

Detection risk was at a high level.
Control risk was at a low level.
Inherent risk was at a high level.
92 Inherent risk is not a characteristic of the

.
A.
B.
C.
D.
Client's business.
Substantive procedures.
Major types of transactions.
Effectiveness of the client's accountants.
93 Which of the following risks is entirely a quality criterion based on

. professional judgment?
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.
94 In general, most fraudulent companies will prepare financial statements

. that are materially misleading by doing all of the following except
A.
Understate revenues and assets.
B.
Understate expenses and liabilities.
C. Show financial performance better than industry average.
D. Have performance exactly meet announced targets.
95 In the planning stage, analytical procedures are not used to

.
A. Identify unusual conditions that deserve more audit effort.
B. Point out accounts that may contain errors and fraud.
C.
Review the overall quality of the audit.
D. Reduce the risk of missing something important.
96 The analytical procedures completed during the planning stages
. typically would not include comparison of current-year account
balances with
A. Balances for one or more comparable periods.

B.
Anticipated results found in budgets.
C. Evaluation of relationships to other current-year balances.
D. Other accounts as substantive procedures.
Fill in the Blank Questions

97 The evaluation of financial statement accounts by studying and
. comparing relationships among financial and nonfinancial data is
known as a(n) _________________________________.
________________________________________
98 By both fraud and aggressive _______________________________,
. companies have caused financial statements to be misleading.
________________________________________
99 Auditing standards (specifically AU 240) require that auditors
. specifically assess the risk of _______________________________ due to
fraud for each engagement.
________________________________________
100 _______________________________________ is the probability that material

.
misstatements have occurred in transactions entering the accounting
system.
________________________________________
101 Because auditors have little control over inherent risk and control risk,
.
the two risks are often combined and referred to as the risk of
_____________________________.
________________________________________
102 _____________________________ involving senior management are never
.
____________________________.
________________________________________
103 The probability that audit procedures will fail to produce evidence of
.
material misstatements is referred to as
_____________________________________.
________________________________________
104 Audit risk can be expressed in the following model: Audit risk =
.
_____________________________ x _________________________________.
________________________________________
105 Auditors ___________ choose to rely almost exclusively on evidence
.
produced by substantive procedures, especially when
_____________________________ risk and _____________________________ risk
are high.
________________________________________
106 In an overall sense, _________________________________ is the probability
.
that a public accounting firm will give an inappropriate opinion on
________________________________________
107 _____________________________________ is the term used to refer to

.
violations of laws and regulations that are
_______________________________ from financial statement effects.
________________________________________
108 _________________________________ refers to financial statement amounts
.
expressed each year as proportions of a base.
________________________________________
109 In the _____________________________ stage,
.
_______________________________ are used to identify potential problem
areas and to reduce risk.
________________________________________
110 Comparison of financial statement numbers and ratios across two or
.
more years is referred to as _______________________________.
________________________________________
111 __________________________________ are those individuals or
.
organizations that are closely tied to the auditee, possibly by familial
or investment relationships.
________________________________________
112 Reasonableness tests use to gain an understanding of financial
.
statement accounts and relationships are known as
_______________________________________.
________________________________________
113 The preliminary analytical work performed in the planning stage of an
.
audit is sometimes called
________________________________________________.
________________________________________
Short Answer Questions

114 For each of the descriptions in Column A, match the correct word or
.
words from Column B.
115 For each of the descriptions 1-4, match the correct word or words from
.
A-L.
116 A. Audit risks for particular accounts can be expressed in the model:
.
Audit risk (AR) = Inherent risk (IR) x Internal control risk (CR) x
Detection risk (DR). If an audit risk is set at 5 percent, the inherent risk
at 80 percent, and the internal control risk at 25 percent, what would
be the detection risk?
B. If the audit team wanted to reduce the audit risk to 1 percent, what
would be the detection risk?
C. What would the audit team have to do to reduce the audit risk?
Essay Questions
117 What are the independent auditor's responsibilities to detect and
.
report errors and frauds?
118 Can an auditor place complete reliance on internal control to the

.
exclusion of other audit procedures? Explain your answer using the
audit risk model.
119 Post, CPA, accepted an engagement to audit the financial statements

.
of General Co., a new client. General is a publicly held retailing entity
that recently replaced its operating management. In the course of
applying audit procedures, Post discovered that General's financial
statements might be materially misstated due to the existence of
fraud.
Required:
A. Describe post's responsibilities in the circumstances described
above.
B. Describe post's responsibilities for reporting on general's financial
statements and other communications if post is precluded from
applying necessary procedures in searching for frauds.
C. Describe post's responsibilities for reporting on general's financial
statements and other communications if post concludes that general's
financial statements are materially affected by frauds. (AICPA
adapted)
120 Items 1 through 6 represent an auditor's observed changes in certain

.
financial statement ratios or amounts from the prior-year ratios or
amounts. For each observed change, select the most likely explanation
or explanations from the list of explanations provided. Answers on the
list may be selected once, more than once, or not at all.
Auditor's observed changes (considered independent of each other):
1. Inventory turnover increased substantially from the prior year.
(Select 3 explanations.)
2. Accounts receivable turnover decreased substantially from the prior
year. (Select 3 explanations.)
3. Allowance for doubtful accounts increased from the prior year, but
allowance for doubtful accounts as a percentage of accounts
receivable decreased from the prior year. (Select 3 explanations.)
4. Long-term debt increased from the prior year, but interest expense
increased a larger than proportionate amount than long-term debt.
(Select 1 explanation.)
5. Operating income increased from the prior year although the entity
was less profitable than in the prior year. (Select 2 explanations.)
6. Gross margin percentage was unchanged from the prior year
although gross margin increased from the prior year. (Select 1
explanation.)
Explanations
A. Items shipped on consignment during the last month of the year
were recorded as sales.
B. A significant number of credit memos for returned merchandise that
were issued during the last month of the year were not recorded.
C. Year-end purchases of inventory were overstated by incorrectly
including items received in the first month of the subsequent year.
D. Year-end purchases of inventory were understated by incorrectly
excluding items received before the year-end.
E. A higher percentage of sales occurred during the last month of the
year as compared to the prior year.
F. A smaller percentage of sales occurred during the last month of the
G. The same percentage of sales occurred during the last month of the
H. Sales increased at the same percentage as cost of goods sold as

compared to the prior year.
I. Sales increased at a higher percentage than cost of goods sold
increased as compared to the prior year.
J. Sales increased at a lower percentage than cost of goods sold
K. Interest expense decreased as compared to the prior year.
L. The effective income tax rate increased as compared to the prior
year.
M. The effective income tax rate decreased as compared to the prior
year.
N. Short-term borrowing was refinanced on a long-term basis at the
same interest rate.
O. Short-term borrowing was refinanced on a long-term basis at a
lower interest rate.
P. Short-term borrowing was refinanced on a long-term basis at a
higher interest rate.
121 Analytical procedures consist of evaluations of financial information

.
made by a study of plausible relationships among both financial and
nonfinancial data. They range from simple comparisons to the use of
complex models involving many relationships and elements of data.
They involve comparisons of recorded amounts or ratios developed
from recorded amounts to expectations developed by auditors.
Required:
A. Describe the broad purposes of analytical procedures.
B. Identify the sources of information from which an auditor develops
expectations.
122 Analytical procedures are one type of evidence-gathering procedure.

.
According to auditing standards, there are five general forms of
analytical procedures. Auditing standards also provide examples of five
sources of information for analytical procedures.
Required:
Describe three of the five general forms of analytical procedures. For
each form, describe a typical source of the information for the form.
For each source, include any questions or concerns an auditor would
have about the reliability or relevancy of the source.
123 This question tests your ability to perceive the place(s) where various
.
potential problems may exist and the type of problem (overstatement
or understatement) that may exist. It asks that you supply the words
or descriptions that complete the analyses begun by applying
analytical procedures.
Required:
For each of the items below, identify the account or accounts that
need to be audited carefully and the reason (i.e., potential
overstatement or understatement of ______).
a. If the current-year accounts receivable are larger than last year but
the allowance for doubtful accounts is the same.
b. If the current-year inventory is larger than last year and the currentyear gross margin (profit) is larger.
c. If current-year long-term liabilities are larger than last year and the
interest expense is the same.
d. If current-year fixed assets are larger and current depreciation
expense is the same as last year.
124 Analytical procedures are evaluations of financial information made by

.
a study of plausible relationships among financial and nonfinancial
data. Understanding and evaluating such relationships are essential to
the audit process.
The following financial statements were prepared by ABC
Manufacturing Co. for the year ended December 31, 2013. Also
presented are various financial statement ratios for ABC as calculated
from the prior-year financial statements. Sales represent net credit
sales. The total assets and the receivables and inventory balances at
December 31, 2013, were the same as at December 31, 2012.
Required:
Items 1 through 9 below represent financial ratios that the auditor

calculated during the prior-year audit. For each ratio, calculate the
current-year ratio from the financial statements presented above.
125 Why is it important for auditors to understand their clients' business

.
risks?
Matching Questions
126 The audit risk model includes the four risks listed below. Place the
.
correct type of risk with the related definition below.
1. The probability that audit

procedures will fail to produce
evidence of material
misstatements
2. The probability that an auditor
will give an inappropriate opinion
on financial statements
3. The probability that material
misstatements have occurred in
transactions entering the
accounting system
4. The probability that the client's
internal control policies and
procedures will fail to detect
material misstatements if they
have entered the accounting
system
Detectio
n risk ____
Inherent
risk ____
Audit
risk ____
Control
risk ____
127 For each of the following statements or phrases, indicate the

.
professional standard to which it relates:
1. Investigate large and

unusual transactions,
particularly those that
occur at or near yearend
2. Evaluate the net
realizable value of
inventory
3. Make inquiries about
management's policies
and procedures for
compliance with laws
and regulations
4. Address
disagreements with
management on
significant accounting
and auditing matters
AU 260: "The
Auditor's
Communication with
Those Charged with
Governance" ____
AU 240:
"Consideration of
Fraud in a Financial
Statement Audit" ____
AU 250:
"Consideration of
Laws and
Regulations" ____
AU 540: "Auditing
Accounting
Estimates" ____
128 For each of the following statements, indicate the term it best
.
describes or typifies.
1. An employee in a
supermarket takes home
bags of fresh fruit each day
without paying for them
Errors ____
2. The controller changed the
journal entry for estimating
bad debt expense to a
smaller number to hide the
poor results from extending
credit to high-risk customers.
This made income materially
higher than it otherwise
would have been
Larceny ____
3. Misdeeds done by people
who steal with a pencil or
White-collar
computer
crime ____
4. A type of fraud involving
employees or nonemployees
wrongfully taking money or
property entrusted to their
Embezzleme
care
nt or defalcation ____
5. A bookkeeper inadvertently
recorded depreciation by
transposing numbers in a
Management
journal entry
fraud ____
Chapter 04 Management Fraud and Audit Risk Answer Key
True / False Questions

1.
Frauds are unintentional misstatements or omissions of accounts or

disclosures in financial statements.
FALSE
Reference: Question also found in study guide
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
AICPA FN: Risk Analysis
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 04-02 Explain auditors' responsibility for risk assessment; and define and explain the
differences among several types of fraud and errors that might occur in an organization.
Topic: Auditor's Risk Assessment
2.
The nature of extended procedures for fraud detection is limited to

those listed in the Professional Standards and Practices for Certified
Fraud Examiners.
FALSE
Blooms: Understand
3.
Fraud consists of knowingly making material misrepresentation of

fact with the intent of inducing someone to believe the falsehood and
suffer a loss.
TRUE
Blooms: Understand
4.
Audit care and attention should be greater where business and

inherent risks are judged to be lower.
FALSE
Blooms: Understand
Learning Objective: 04-04 Understand sources of inherent risk factors including the client's business and
environment.
Topic: Assessing Inherent Risk
5.
Control risk should not be assessed so low that auditors place

complete reliance on controls and do not perform any other audit
work.
TRUE
Blooms: Understand
Learning Objective: 04-03 Describe the audit risk model and explain the meaning and importance of its
components in terms of professional judgment and audit planning.
Topic: The Audit Risk Model
6.
Detection risk occurs when internal control activities fail to detect

material misstatements.
FALSE
Blooms: Understand
7.
The auditing profession official standard for an acceptable level of

overall audit risk is 0.05 at the current level.
FALSE
Blooms: Understand
8.
Audit risk (AR) is a quality criterion based on professional judgment.

TRUE
Blooms: Understand
9.
The audit risk model assumes that elements of audit risk are
independent and therefore multiplicative.
TRUE
Blooms: Understand
10.
Generally, fraudulent financial statements show financial

performance and ratios that are better than current industry
experience.
TRUE
Blooms: Understand
11.
The demographics of white-collar criminals are similar to those of

typical bank robbers.
FALSE

Blooms: Understand
12.
Knowledge and understanding of a client's business is absolutely

essential in completing an audit.
TRUE
Blooms: Understand
environment.
Topic: Assessing Inherent Risk
13.
Auditing standards require that analytical procedures be applied in

the beginning stages of each audit.
TRUE

Blooms: Understand
Learning Objective: 04-05 Understand sources of information for assessing risks including analytical procedures;
brainstorming; and inquiries. Explain how auditors respond to assessed risks.
Topic: Gathering Information, Assessing and Responding to Risks
14.
Auditors look for relationships that do not make sense as indicators of

problems in the accounts and use such indicators to plan further
audit work.
TRUE
Blooms: Understand
15.
Analytical procedures are considered to be "soft" evidence and

therefore considered ineffective.
FALSE

Blooms: Understand
16.
Audits are not designed to detect material errors and fraud in

FALSE
Blooms: Understand
17.
Knowledge of the client's business from preliminary analytical

procedures can help auditors identify problem areas and make broad
risk assessments.
TRUE

Blooms: Understand
Multiple Choice Questions

18.
The major emphasis in GAAS related to consideration of fraud in a

financial statement audit (AU 240) is on:
A.
B.
C.
D.
Employee misappropriation of assets.

Management fraud.
Client fraud on customers.
Employee embezzlement.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 3 Hard
Source: Original
Topic: Fraud Risk
19.
Management fraud generally refers to
A.
B.
C.
D.
Unintentional mistakes.
Noncompliance.
Intentional distortions of financial statements.
Violations of GAAS.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
20.
External auditors are responsible
A.
For authenticating documents.
B. For reporting immaterial frauds to a level of management at least
one level above the people involved.
C. For finding all intentional misstatements concealed by collusion.
D. For reporting all frauds to outside agencies or parties.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: Original
Topic: Fraud Risk
21.
According to auditing standards, external auditors' responsibilities for

indirect noncompliance do not include
A. Designing audit procedures to detect noncompliance in the

absence of specific information brought to the auditors' attention.
B. Performing audit procedures when specific information indicates
that possible noncompliance may have an indirect material effect
on financial statements.
C. Considering the qualitative materiality of known and suspected
noncompliance.
D. Obtaining written management representations concerning the
absence of violations of laws and regulations.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Learning Objective: 04-06 Explain auditors' responsibilities with respect to a client's failure to comply with laws
or regulations.
Source: Original
Topic: Noncompliance
22.
Certain conditions and circumstances are often present when

management fraud occurs. Which of the following is not such a
condition or circumstance?
A.
B.
C.
D.
Unfavorable industry conditions.

Lack of working capital.
High liquidity.
Slow customer collections.
AACSB: Analytic
AICPA BB: Industry
Blooms: Understand
Source: Original
Topic: Fraud Risk
23.
Independent auditors who consider fraud in the course of financial

statement audits are well-advised to quantify "materiality" in terms
of:
A. The maximum amount of asset overstatement that might mislead

B. A maximum percentage of net income overstatement that might
mislead investors in relation to the latest financial statements
under audit.
C. A cumulative amount of misstatement of assets or income over
several years past and current that might mislead investors in
relation to the latest financial statements under audit.
D. Controversial accounting measurements that might mislead
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Research
Blooms: Understand
Difficulty: 3 Hard
Source: Original
Topic: Fraud Risk
24.
An auditor assesses the risk of material misstatement because it
A. Is relevant to the auditor's understanding of the control

environment.
B. Provides assurance that the auditor's overall materiality levels are
appropriate.
C. Indicates to the auditor where inherent risk may be the greatest.
D. Affects the level of detection risk that the auditor may accept.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Source: AICPA
Topic: Audit Risk Model
25.
When fraud risk is significant, and management cooperation is

unsatisfactory, the auditors will most likely
A.
Perform extended audit procedures.
B.
Consult with fraud examiners.
C. Report directly to the Securities and Exchange Commission within
one day.
D.
AACSB: Analytic
AICPA BB: Industry
Blooms: Understand
Source: Original
Topic: Fraud Risk
26.
Which of the following statements concerning noncompliance by

clients is correct?
A. An auditor's responsibility to detect noncompliance that has a

direct and material effect on the financial statements is the same
as that for errors and frauds.
B. An audit in accordance with generally accepted auditing standards
normally includes audit procedures specifically designed to detect
noncompliance that has an indirect but material effect on the
C. An auditor considers noncompliance from the perspective of the
reliability of management's representations rather than their
relation to audit objectives derived from financial statement
assertions.
D. An auditor has no responsibility for noncompliance that has an
indirect effect on the financial statements.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 3 Hard
or regulations.
Source: AICPA
27.
Which of the following statements best describes auditors'

responsibility to detect errors and frauds?
A. Auditors should design an audit to provide reasonable assurance of

detecting errors and frauds that are material to the financial
statements.
B. Auditors are responsible to detect material errors but have no
responsibility to detect material frauds that are concealed through
employee collusion or management override of the internal control
structure.
C. Auditors have no responsibility to detect errors and frauds unless
analytical procedures or tests of transactions identify conditions
causing a reasonably prudent auditor to suspect that the financial
statements were materially misstated.
D. Auditors have no responsibility to detect errors and frauds because
auditors are not insurers and an audit does not constitute a
guarantee.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: AICPA
Topic: Fraud Risk
28.
The probability that an audit team will give an inappropriate opinion

on financial statements best describes
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
29.
Inherent risk is the
A. Probability that some accounts are more susceptible to

misstatement than others.
B. Probability that the client's internal control policies and procedures
will fail to detect material misstatements.
C. Probability that material misstatements have occurred in
transactions entering the accounting system used to develop
D. Probability that the auditor may not detect material misstatements
in the financial statements.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
Topic: Inherent Risk
30.
If control risk increases and all other risks in the audit risk model stay
constant except the one referred to below, which of the following
statements is correct?
A.
B.
C.
D.
Detection risk will decrease.

Inherent risk will increase.
Audit risk will decrease.
Detection risk will increase.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Difficulty: 3 Hard
Source: Original
31.
If fictitious credit sales were recorded and the fictitious accounts

receivable were later directly written off as bad debt expense
A.
B.
C.
D.
Income would be overstated.

Income would be understated.
Income would not be misstated.
Accounts receivable would be understated.
AACSB: Analytic
AICPA BB: Industry
AICPA FN: Measurement
Blooms: Understand
Difficulty: 3 Hard
Source: Original
Topic: Fraud Risk
32.
An audit team uses the assessed risk of material misstatement to
A. Evaluate the effectiveness of the entity's internal control policies

and activities.
B. Identify transactions and account balances where inherent risk is
at the maximum.
C. Indicate whether materiality thresholds for planning and
evaluation purposes are sufficiently high.
D. Determine the acceptable level of detection risk for financial
statement assertions.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Source: AICPA
Topic: Fraud Risk
33.
The risk of material misstatement differs from detection risk in that it
A. Arises from the misapplication of audit procedures.

B. May be assessed in either quantitative or nonquantitative terms.
C. Exists independently of the financial statement audit.
D. Can be changed at the auditor's discretion.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Difficulty: 3 Hard
Source: AICPA
Topic: Detection Risk
34.
The risk that an auditor's procedures will lead to the conclusion that a
material misstatement does not exist in an account balance when, in
fact, such misstatement actually exists is
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Source: Original
35.
Based on audit evidence gathered and evaluated, an auditor decides

to increase the assessed level of control risk from that originally
planned. To achieve an overall audit risk level that is substantially the
same as the planned audit risk level, the auditor would
A.
B.
C.
D.
Decrease substantive testing.

Decrease detection risk.
Increase inherent risk.
Increase materiality levels
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Source: AICPA
36.
The acceptable level of detection risk is inversely related to the
A. Assurance provided by substantive tests.

B.
Risk of misapplying audit procedures.
C. Preliminary judgment about materiality levels.
D. Risk of failing to discover material misstatements.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Difficulty: 3 Hard
Source: AICPA
37.
The existence of audit risk is recognized by the statement in the

auditor's standard report that the
A. Auditor is responsible for expressing an opinion on the financial

statements, which are the responsibility of management.
B. Financial statements are presented fairly, in all material respects,
in conformity with applicable financial reporting framework.
C. Audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements.
D. Auditor obtains reasonable assurance about whether the financial
statements are free of material misstatement.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 3 Hard
Source: AICPA
Topic: Audit Risk
38.
When determining the inherent risk related to an account balance, an

auditor theoretically does not explicitly consider the
A.
Liquidity of the account.
B. Degree of management estimation involved in determining the
proper account balance.
C. Related internal control policies and procedures.
D.
Complexity of calculations involved.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Source: Original
39.
An auditor who discovers that client employees have committed an

illegal act that has a material effect on the client's financial
statements most likely would withdraw from the engagement if
A. The noncompliance is a violation of generally accepted accounting

principles.
B. The client does not take the remedial action that the auditor
considers necessary.
C. The illegal act was committed during a prior year that was not
audited.
D. The auditor has already assessed control risk at the maximum
level.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
or regulations.
Source: AICPA
40.
When an auditor becomes aware of possible noncompliance by a

client, the auditor should obtain an understanding of the nature of
the act to
A.
B.
C.
D.
Evaluate the effect on the financial statements.

Determine the reliability of management's representations.
Consider whether other similar acts may have occurred.
Recommend remedial actions to the audit committee.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
or regulations.
Source: AICPA
41.
Jones, CPA, is auditing the financial statements of XYZ Retailing, Inc.

What assurance does Jones provide that direct effect noncompliance
that is material to XYZ's financial statements and noncompliance that
has a material but indirect effect on the financial statements will be
detected?
A. Direct effect noncompliance: Reasonable; indirect effect

B. Direct effect noncompliance: Reasonable; indirect effect
C. Direct effect noncompliance: Limited; indirect effect
D. Direct effect noncompliance: Limited; indirect effect
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
or regulations.
Source: AICPA
42.
Generally accepted auditing standards state that analytical

procedures
A. Should be applied in the planning and final review stages of the

audit and as a substantive test during the audit.
B. Should be applied in the planning and final review stages of the
audit and can be used as a substantive test during the audit.
C. Should be applied in the planning stage and can be applied as a
substantive test in the final review stage.
D. Should be applied in the final review stage and can be applied as a
substantive test in the planning stage.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: Original
Topic: Analytical Procedures
43.
In the planning stage, analytical procedures are used to
A.
Identify potential problem areas.
B. Provide direct evidence about the balances in accounts.
C. Determine the mathematical correctness of the financial
statements.
D.
All of the above.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
44.
Assume that application of analytical procedures revealed significant

unexplained differences between recorded amounts and the
expectations (estimates) developed by the auditor. If management is
unable to provide an acceptable explanation, the auditor should
A. Consider the matter a scope limitation.

B. Perform additional audit procedures to investigate the matter
further.
C. Intensify the audit with the expectation of detecting management
fraud.
D.
AACSB: Analytic
Blooms: Apply
Source: Original
Topic: Fraud Risk
45.
For audits of financial statements made in accordance with generally

accepted auditing standards, the use of analytical procedures is
required to some extent
A.
B.
C.
D.
As a substantive test: yes; in the final review stage: yes

As a substantive test: yes; in the final review stage: no
As a substantive test: no; in the final review stage: yes
As a substantive test: no; in the final review stage: no
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: Original
46.
Which of the following would not likely be found in the minutes of the
board of directors?
A.
Amount of dividends declared.
B. Approval to pledge assets as security for debts.
C.
Authorization of officers' salaries.
D. Approval of a new desktop computer for the controller.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
Topic: Information for Assessing Risks
47.
An auditor who encounters significant risks at the client should do all

of the following except
A.
Inform the SEC.
B.
Perform extended procedures.
C. Include more experienced auditors on the engagement.
D.
Perform tests closer to year-end.
AACSB: Analytic
AICPA BB: Legal

AICPA FN: Research
Blooms: Remember
Source: Original
Topic: Responding to Risks
48.
Horizontal analysis refers to
A. The trend of income from year to year of persons suspected of

fraud.
B. Changes of financial statement numbers and ratios across several
years.
C. Financial statement amounts expressed each year as a proportion
of a base amount.
D. The change in a suspect's net worth from the beginning to the end
of a period.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
49.
Analytical procedures used in planning an audit should focus on
A. Reducing the scope of tests of controls and substantive tests.

B. Providing assurance that potential material misstatements will be
identified.
C. Enhancing the auditor's understanding of the client's business.
D. Assessing the adequacy of the available evidential matter.
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
50.
Sources of financial and nonfinancial data do not include
A. Financial account information for comparable prior periods.

B. Nonfinancial information such as physical production statistics.
C.
Company budgets and forecasts.
D.
Bureau of Labor statistics.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: Original
51.
The type of financial analysis that expresses balance sheet accounts

as percentages of total assets is known as:
A.
B.
C.
D.
Horizontal analysis.
Vertical analysis.
Net worth analysis.
Expenditure analysis.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
52.
Which of the following accounts tends to be most predictable for

purposes of analytical procedures?
A.
B.
C.
D.
Travel and entertainment expense.
Interest expense.
Income taxes payable.
AACSB: Analytic
AICPA FN: Decision Making
Blooms: Apply
Difficulty: 3 Hard
Source: Original
53.
Analytical procedures are audit methods of evaluating financial

statement accounts by studying and comparing relationships among
financial and nonfinancial data. The primary purpose of analytical
procedures conducted during the planning stages is to
A. Identify the appropriate schedules to be prepared by the client.

B. Identify the types of errors or frauds that can occur in
transactions.
C. Identify unusual conditions that deserve additional audit effort.
D. Determine the existence of unrecorded liabilities or overstated
assets.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: AICPA
Topic: Fraud Risk
54.
Which of the following is not required by AU 240, "Consideration of

Fraud in a Financial Statement Audit"?
A. Conduct a continuing assessment of the risks of material

misstatement due to fraud throughout the audit.
B. Conduct a discussion by the audit team of the risks of material
misstatement due to fraud.
C. Conduct the audit with professional skepticism, which includes an
attitude that assumes balances are incorrect until verified by the
auditor.
D. Conduct inquiries of shareholders as to their views about the risks
of fraud and their knowledge of any fraud or suspected fraud.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: AICPA
Topic: Fraud Risk
55.
An auditor who increases the planned assessed level of control risk

because certain control activities were determined to be ineffective
would most likely increase the
A.
B.
C.
D.
Extent of substantive tests of details.

Level of inherent risk.
Extent of tests of controls.
Level of detection risk.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Source: AICPA
56.
What assurance does the auditor provide that errors, frauds, and
direct effect noncompliance that are material to the financial
statements will be detected?
A. Errors: limited; frauds: negative; direct effect noncompliance:

limited.
B. Errors: limited; frauds: limited; direct effect noncompliance:
reasonable.
C. Errors: reasonable; frauds: limited; direct effect noncompliance:
limited.
D. Errors: reasonable; frauds: reasonable; direct effect
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
or regulations.
Source: AICPA
57.
Experience has shown that the many large fraudulent transactions

can be found in
A. Systematic processing of large volumes of day-to-day ordinary

transactions.
B. Payroll fraudsters' mistakes in using unissued Social Security
numbers.
C.
Petty cash embezzlements.
D. Nonroutine, nonsystematic journal entries.
AACSB: Analytic
AICPA FN: Research
Blooms: Understand
Source: Original
Topic: Fraud Risk
58.
Which of the following pieces of information discovered by an auditor

when performing substantive tests of account balances would most
likely raise red flags about the possible existence of material
fraudulent financial reporting?
A. Paper copies of paid invoices and cancelled checks were

microfiched and then destroyed.
B. The controller requires that you schedule any audit inquiries daily
after lunch, not in the morning.
C. The petty cash fund custodian never takes a vacation.
D. The client's estimate of the allowance for doubtful accounts is
lower than the auditor's independent evaluation of the allowance.
AACSB: Analytic
Blooms: Understand
Difficulty: 3 Hard
Source: Original
Topic: Fraud Risk
59.
Inherent risk and control risk differ from detection risk in that
inherent risk and control risk are
A. Elements of audit risk whereas detection risk is not.

B. Changed at the auditor's discretion whereas detection risk is not.
C. Considered at the individual account balance level whereas
detection risk is not.
D. Functions of the client and its environment whereas detection risk
is not.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Source: AICPA
60.
The auditor uses the assessed level of risk of material misstatement

to determine the acceptable level of detection risk for financial
statement assertions. As the acceptable level of detection risk
decreases, the auditor may do one or more of the following except
change the
A. Nature of substantive tests to more effective procedures.

B. Timing of substantive tests, such as performing them at year-end
rather than at an interim date.
C. Extent of substantive tests, such as using larger sample sizes.
D. Assurances provided by substantive tests to a lower level.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Difficulty: 3 Hard
Source: AICPA
61.
Which of the following is an acceptable response to fraud risks

related to sales that were identified in an audit?
A.
B.
C.
D.
Exercise professional skepticism when performing sales testing.

Increase the assessment of control risk for sales.
Increase the assessment of detection risk for sales.
Perform additional substantive sales procedures on a surprise
basis.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Source: Original
Topic: Fraud Risk
62.
If tests of controls induce the auditor to change the assessed level of

control risk for property plant & equipment from 50 percent to 100
percent and audit risk (6 percent) and inherent risk remain constant,
the acceptable level of detection risk
A. Would most likely change from 10 percent to 5 percent.

B. Would most likely change from 20 percent to 40 percent.
C. Would most likely change from 30 percent to 15 percent.
D. Would be unchanged because the auditor has control over
detection risk.
E. Cannot be determined because inherent risk is not given.
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Difficulty: 3 Hard
Source: Original
63.
Managing business risk is the responsibility of
A.
B.
C.
D.
The auditors.
Management.
The SEC.
The PCAOB.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 04-01 Define business risk and understand how management addresses business risk with
the enterprise risk management model.
Source: Original
Topic: Business Risk
64.
Auditors would use the enterprise risk model
A.
B.
C.
D.
To reduce the client's business risk.

To evaluate management's risk assessment.
To monitor client risk.
AACSB: Analytic
AICPA BB: Legal
Blooms: Evaluate
Difficulty: 3 Hard
Source: Original
Topic: Enterprise Risk Management
65.
Auditors use brainstorming
A. To heighten the audit team's awareness of fraud potential.

B. To heighten management's awareness of fraud potential.
C.
D.
To set materiality.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Difficulty: 3 Hard
Source: Original
Topic: Brainstorming
66.
The purpose of an audit strategy is
A. To provide a defense against litigation.

B. To gain an understanding of the client.
C.
To comply with securities law.
D. To set the scope, timing, and direction for auditing each relevant
assertion.
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
or regulations.
Source: Original
Topic: Audit Strategy
67.
Auditors are responsible for the quality of the work related to

management and control of
A.
B.
C.
D.
Inherent risk.
Business risk.
Control risk.
Detection risk.
Reference: Question also found in textbook

AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
68.
Which of the following engagement planning procedures would most

likely assist the auditor in identifying related-party transactions
before the balance-sheet date?
A. Interviewing internal auditors about their reporting responsibilities.

B. Reviewing accounting records for recurring transactions occurring
near year-end.
C. Inspecting communications with the client's legal counsel
regarding recorded contingent liabilities.
D. Scanning the minutes for significant transactions with members of
the board of directors.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Apply
environment.
Source: Original
Topic: Understanding the client
69.
The likelihood that material misstatements may have entered the

accounting system and not been detected and corrected by the
client's internal control is referred to as
A.
B.
C.
D.
Inherent risk.
Control risk.
Detection risk.
Risk of material misstatement.

AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
70.
The risk of material misstatements is composed of which audit risk

components?
A.
Inherent risk and control risk.
B.
Control risk and detection risk.
C.
Inherent risk and detection risk.
D. Inherent risk, control risk, and detection risk.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
71.
Auditing standards do not require auditors of financial statements to
A. Understand the nature of errors and frauds.

B. Assess the risk of occurrence of errors and frauds.
C. Design audits to provide reasonable assurance of detecting errors
and frauds.
D. Report all errors and frauds found to police authorities.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
72.
The risk that the auditors' own procedures will lead to the decision
that material misstatements do not exist in the financial statements
when in fact such misstatements do exist is
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.

AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
73.
The auditors assessed risk of material misstatement at 0.50 and said

they wanted to achieve a 0.05 risk of failing to express a correct
opinion on financial statements that were materially misstated. What
detection risk do the auditors plan to use for planning the remainder
of the audit work?
A.
B.
C.
D.
0.20.
0.10.
0.75.
0.00.

AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Difficulty: 1 Easy
Source: Original
74.
If tests of controls induce the audit team to change the assessed

level of control risk for fixed assets from 0.4 to 1.0 and audit risk
(0.05) and inherent risk remain constant, the acceptable level of
detection risk is most likely to
A.
B.
C.
D.

Be unchanged.

AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Source: Original
75.
Which of the following is a specific procedural response to a

particular fraud risk in an account balance or class of transactions?
A. Exercising more professional skepticism.

B. Carefully avoiding conducting interviews with people in the fraudrich areas.
C. Performing procedures such as inventory observation and cash
counts on a surprise or unannounced basis.
D. Studying management's selection and application of accounting
principles more carefully.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Source: Original
Topic: Fraud Risk
76.
It is acceptable under generally accepted auditing standards for an

audit team to
A. Assess risk of material misstatement at high and achieve an

acceptably low audit risk by performing extensive detection work.
B. Assess control risk at zero and perform a minimum of detection
work.
C. Assess inherent risk at zero and perform a minimum of detection
work.
D. Decide that audit risk can be 40 percent.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Source: Original
77.
If sales were overstated by recording a false credit sale at the end of

the year, where could you find the false "dangling debit"?
A.
B.
C.
D.
Inventory.
Cost of goods sold.
Bad debt expense.

AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Understand
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
78.
One of the typical characteristics of management fraud is
A. Falsification of documents in order to misappropriate funds from an

employer.
B. Victimization of investors through the use of materially misleading
C. Illegal acts committed by management to evade laws and
regulations.
D. Conversion of stolen inventory to cash deposited in a falsified bank
account.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
79.
Under the Private Securities Litigation Reform Act, independent

auditors are required to
A. Report in writing all instances of noncompliance to the client's

board of directors.
B. Report to the SEC all instances of noncompliance they believe
have a material effect on financial statements if the board of
directors does not first report to the SEC.
C. Report clearly inconsequential noncompliance to the audit
committee of the client's board of directors.
D. Resign from the audit engagement and report the instances of
noncompliance to the SEC.
AACSB: Analytic
AICPA BB: Legal
Blooms: Analyze
Difficulty: 1 Easy
or regulations.
Source: Original
80.
Which of the following circumstances would most likely cause an

audit team to perform extended procedures?
A. Supporting documents are produced when requested.

B. The client made several large adjustments at or near year-end.
C. The company has recently hired a new chief financial officer after
the previous one retired.
D. The company maintains several different petty cash funds.
AACSB: Analytic
AICPA BB: Legal
Blooms: Understand
Source: Original
Topic: Fraud Risk
81.
When the auditors become aware of noncompliance with a law or

regulation committed by client personnel, the primary reason that
the auditors should obtain a better understanding of the nature of the
act is to
A. Recommend remedial actions to the audit committee.

B. Evaluate the effect of the noncompliance on the financial
statements.
C. Determine whether to contact law enforcement officials.
D. Determine whether other similar acts could have occurred.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
or regulations.
Source: Original
82.
Which of the following statements best describes auditors'

responsibility for detecting a client's noncompliance with a law or
regulation?
A. The responsibility for detecting noncompliance exactly parallels

the responsibility for errors and fraud.
B. Auditors must design tests to detect all material noncompliance
that indirectly affect the financial statements.
C. Auditors must design tests to obtain reasonable assurance that all
noncompliance with direct material statement effects are
detected.
D. Auditors must design tests to detect all noncompliance that
directly affect the financial statements.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
or regulations.
Source: Original
Topic: Fraud Risk
83.
Analytical procedures are generally used to produce evidence from
A. Confirmations mailed directly to the auditors by client customers.

B.
Physical observation of inventories.
C. Relationships among current financial balances and prior balances,
forecasts, and nonfinancial data.
D. Detailed examination of external, external-internal, and internal
documents.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
84.
Auditors perform analytical procedures in the planning stage of an

audit for the purpose of
A. Deciding the matters to cover in an engagement letter.

B. Identifying unusual conditions that deserve more auditing effort.
C. Determining which of the financial statement assertions are the
most important for the client's financial statements.
D. Determining the nature, timing, and extent of audit procedures for
auditing the inventory.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
85. Which of the following relationships between types of analytical

procedures and sources of information are most logical?
A.
B.
C.
D.
Option A
Option B
Option C
Option D

AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Apply
Source: Original
86.
Analytical procedures can be used in which of the following ways?
A. As a means of overall review at the end of an audit.

B. As "attention-directing" methods when planning an audit at the
beginning.
C. As substantive audit procedures to obtain evidence during an
audit.
D.
All of the above.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Source: Original
87.
Analytical procedures used when planning an audit should

concentrate on
A. Weaknesses in the company's internal control activities.

B. Predictability of account balances based on individual
transactions.
C. Management assertions in financial statements.
D. Accounts and relationships that can represent specific potential
problems and risks in the financial statements.
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Source: Original
88.
When a company that sells its products for a (gross) profit increases
its sales by 15 percent and its cost of goods sold by 7 percent, the
cost of goods sold ratio will
A.
Increase.
B.
Decrease.
C.
Remain unchanged.
D. Not be able to be determined with the information provided.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Source: Original
89.
Analytical procedures are used
A.
To set materiality limits.
B. To assess the reasonableness of financial statement amounts.
C. To provide direct evidence about the numbers in the financial
statements.
D.
To test internal controls.
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
90.
The risk that material misstatements have occurred in transactions

entering the accounting system is
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.

AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
91.
In the audit risk model, if an audit team wanted to keep audit risk at
a low level but there was a great inherent risk of material
misstatement and the internal control was ineffective, then
procedures would need to be designed so that
A.
B.
C.
D.
Detection risk was at a low level.

Detection risk was at a high level.
Control risk was at a low level.
Inherent risk was at a high level.

AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
92.
Inherent risk is not a characteristic of the
A.
B.
C.
D.
Client's business.
Substantive procedures.
Major types of transactions.
Effectiveness of the client's accountants.

AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
93.
Which of the following risks is entirely a quality criterion based on

professional judgment?
A.
B.
C.
D.
Audit risk.
Inherent risk.
Control risk.
Detection risk.

AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
Topic: Audit Risk
94.
In general, most fraudulent companies will prepare financial

statements that are materially misleading by doing all of the
following except
A.
Understate revenues and assets.
B.
Understate expenses and liabilities.
C. Show financial performance better than industry average.
D. Have performance exactly meet announced targets.
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
95.
In the planning stage, analytical procedures are not used to
A. Identify unusual conditions that deserve more audit effort.

B. Point out accounts that may contain errors and fraud.
C. Review the overall quality of the audit.
D. Reduce the risk of missing something important.
AACSB: Analytic
AICPA BB: Legal
Blooms: Remember
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
96.
The analytical procedures completed during the planning stages

typically would not include comparison of current-year account
balances with
A. Balances for one or more comparable periods.

B.
Anticipated results found in budgets.
C. Evaluation of relationships to other current-year balances.
D. Other accounts as substantive procedures.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Apply
Source: Original
Fill in the Blank Questions

97.
The evaluation of financial statement accounts by studying and

comparing relationships among financial and nonfinancial data is
known as a(n) _________________________________.
analytical procedure
98.
By both fraud and aggressive _______________________________,

companies have caused financial statements to be misleading.
financial reporting
99.
Auditing standards (specifically AU 240) require that auditors

specifically assess the risk of _______________________________ due to
fraud for each engagement.
material misstatement
100. _______________________________________ is the probability that material

misstatements have occurred in transactions entering the accounting
system.
Inherent risk
101. Because auditors have little control over inherent risk and control
risk, the two risks are often combined and referred to as the risk of
_____________________________.
material misstatement
102. _____________________________ involving senior management are never
____________________________.
Frauds; inconsequential
103. The probability that audit procedures will fail to produce evidence of
material misstatements is referred to as
_____________________________________.
detection risk or substantive procedures
104. Audit risk can be expressed in the following model: Audit risk =
_____________________________ x _________________________________.
risk of material misstatement; detection risk
105. Auditors ___________ choose to rely almost exclusively on evidence
produced by substantive procedures, especially when
_____________________________ risk and _____________________________
risk are high.
can; inherent; control
106. In an overall sense, _________________________________ is the
probability that a public accounting firm will give an inappropriate
opinion on financial statements.
audit risk
107. _____________________________________ is the term used to refer to

violations of laws and regulations that are
_______________________________ from financial statement effects.
Indirect-effect noncompliance; far removed
108. _________________________________ refers to financial statement
amounts expressed each year as proportions of a base.
Vertical analysis
109. In the _____________________________ stage,
_______________________________ are used to identify potential problem
areas and to reduce risk.
planning; analytical procedures
110. Comparison of financial statement numbers and ratios across two or
more years is referred to as _______________________________.
horizontal analysis
111. __________________________________ are those individuals or

organizations that are closely tied to the auditee, possibly by familial
or investment relationships.
Related parties
112. Reasonableness tests use to gain an understanding of financial
statement accounts and relationships are known as
_______________________________________.
analytical procedures
113. The preliminary analytical work performed in the planning stage of an
audit is sometimes called
________________________________________________.
specific risk analysis
Short Answer Questions
114. For each of the descriptions in Column A, match the correct word or
words from Column B.
1. D, 2. F, 3. C, 4. A, 5. E
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: Original
115. For each of the descriptions 1-4, match the correct word or words
from A-L.
1. C, 2. F, 3. A, 4. D
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: Original
116. A. Audit risks for particular accounts can be expressed in the model:
Audit risk (AR) = Inherent risk (IR) x Internal control risk (CR) x
Detection risk (DR). If an audit risk is set at 5 percent, the inherent
risk at 80 percent, and the internal control risk at 25 percent, what
would be the detection risk?
B. If the audit team wanted to reduce the audit risk to 1 percent,
what would be the detection risk?
C. What would the audit team have to do to reduce the audit risk?
A. Detection risk =.05/(.80 X .25) = .25

B. .01/(.80 X .25) =.05
C. The audit team would have to increase the amount and
effectiveness of evidence gathered from substantive procedures.
Feedback: Reference: Problem also found in study guide
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Source: Original
Essay Questions
117. What are the independent auditor's responsibilities to detect and

report errors and frauds?
Independent auditors have the responsibility to (a) assess the risk

that errors and frauds may cause a client's financial statements to be
materially misstated and (b) design the audit to provide reasonable
assurance of detecting errors and frauds material to the financial
statements. Extended procedures should be performed if evidence
indicates that material errors or frauds might exist.
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
Topic: Fraud Risk
118. Can an auditor place complete reliance on internal control to the

exclusion of other audit procedures? Explain your answer using the
audit risk model.
An auditor cannot place complete reliance on internal control to the

exclusion of other audit procedures. You cannot have a condition
where
AR = IR x CR ( = 0) x DR = 0
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
119. Post, CPA, accepted an engagement to audit the financial statements

of General Co., a new client. General is a publicly held retailing entity
that recently replaced its operating management. In the course of
applying audit procedures, Post discovered that General's financial
statements might be materially misstated due to the existence of
fraud.
Required:
A. Describe post's responsibilities in the circumstances described
above.
B. Describe post's responsibilities for reporting on general's financial
statements and other communications if post is precluded from
applying necessary procedures in searching for frauds.
C. Describe post's responsibilities for reporting on general's financial
statements and other communications if post concludes that
general's financial statements are materially affected by frauds.
(AICPA adapted)
A. If Post discovers that General's financial statements may be

materially misstated due to the existence of frauds, Post should
consider the implications for other aspects of the audit and discuss
the matter and approach to further investigation with an appropriate
level of management that is at least one level above those involved
with the frauds. Post should also attempt to obtain sufficient
competent evidential matter to determine whether, in fact, material
frauds exist and, if so, their effect. Post may suggest that General
consult with its legal counsel on matters concerning questions of law.
B. If Post is precluded from applying necessary procedures, Post
should disclaim or qualify an opinion on the financial statements and
communicate these findings to General's audit committee or its
board of directors. Post should also consider resigning from the audit.
C. If Post concludes that General's financial statements are materially
affected by frauds, Post should insist that the financial statements be
revised and, if they are not, express a qualified or an adverse opinion
on them, disclosing all the substantive reasons for such an opinion.
Additionally, Post should adequately inform General's audit

committee or its board of directors about the frauds.
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 3 Hard
Source: AICPA
Topic: Fraud Risk
120. Items 1 through 6 represent an auditor's observed changes in certain

financial statement ratios or amounts from the prior-year ratios or
amounts. For each observed change, select the most likely
explanation or explanations from the list of explanations provided.
Answers on the list may be selected once, more than once, or not at
all.
Auditor's observed changes (considered independent of each other):
2. Accounts receivable turnover decreased substantially from the
prior year. (Select 3 explanations.)
increased a larger than proportionate amount than long-term debt.
5. Operating income increased from the prior year although the
entity was less profitable than in the prior year. (Select 2
explanations.)
explanation.)
Explanations
B. A significant number of credit memos for returned merchandise
that were issued during the last month of the year were not recorded.
C. Year-end purchases of inventory were overstated by incorrectly
including items received in the first month of the subsequent year.
excluding items received before the year-end.
E. A higher percentage of sales occurred during the last month of the
G. The same percentage of sales occurred during the last month of

the year as compared to the prior year.
I. Sales increased at a higher percentage than cost of goods sold
J. Sales increased at a lower percentage than cost of goods sold
K. Interest expense decreased as compared to the prior year.
year.
M. The effective income tax rate decreased as compared to the prior
year.
N. Short-term borrowing was refinanced on a long-term basis at the
same interest rate.
O. Short-term borrowing was refinanced on a long-term basis at a
lower interest rate.
P. Short-term borrowing was refinanced on a long-term basis at a
higher interest rate.

excluding items received before the year end.
2. Accounts receivable turnover decreased substantially from the
prior year. (Select 3 explanations.)

increased a larger-than-proportionate amount than long-term debt.
P. Short-term borrowing was refinanced on a long-term basis at
higher interest rates.
5. Operating income increased from the prior year although the
entity was less profitable than in the prior year. (Select 2
explanations.)
year.
P. Short-term borrowing was refinanced on a long-term basis at
higher interest rates.
explanation.)
Blooms: Apply
Difficulty: 3 Hard
Source: AICPA
121. Analytical procedures consist of evaluations of financial information

made by a study of plausible relationships among both financial and
nonfinancial data. They range from simple comparisons to the use of
complex models involving many relationships and elements of data.
They involve comparisons of recorded amounts or ratios developed
from recorded amounts to expectations developed by auditors.
Required:
A. Describe the broad purposes of analytical procedures.
B. Identify the sources of information from which an auditor develops
expectations.
A. Analytical procedures are used for these broad purposes:

1. To assist the auditor in planning the nature, timing, and extent of
other audit procedures.
2. As a substantive test to obtain evidential matter about particular
assertions related to account balances or classes of transactions.
3. As an overall review of the financial information in the final review
stage of the audit.
B. An auditor's expectations are developed from the following sources
of information:
1. Financial information for comparable prior periods considering
known changes.
2. Anticipated results, for example, budgets, forecasts, and
extrapolations.
3. Relationships among elements of financial information within the
period.
4. Information regarding the industry in which the client operates.
5. Relationships of financial information with relevant nonfinancial
information.
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: AICPA adapted
122. Analytical procedures are one type of evidence-gathering procedure.

According to auditing standards, there are five general forms of
analytical procedures. Auditing standards also provide examples of
five sources of information for analytical procedures.
Required:
Describe three of the five general forms of analytical procedures. For
each form, describe a typical source of the information for the form.
For each source, include any questions or concerns an auditor would
have about the reliability or relevancy of the source.
The five general forms of analytical procedures (and sources of

information):
1. Comparison of current-year account balances of one or more
comparable periods. (Financial account information for comparable
prior period(s).)
2. Comparison of the current-year account balances to anticipated
results found in the company's budgets and forecasts.
3. Evaluation of the relationships of current-year account balances to
other current-year balances and conformity with predictable patterns
based on the company's experience. (Financial relationships among
accounts in the current period.)
4. Comparison of current-year account balances and financial
relationships (e.g., ratios) with similar information for the industry in
which the company operates. (Industry statistics.)
5. Study of the relationships of current-year account balances with
relevant nonfinancial information (e.g., physical production statistics).
Considerations about relevance and reliability of sources of
information: (Note to instructor: These considerations are not
explicitly discussed in the chapter with regard to analytical
procedures. Additional considerations are possible.)
1. Has the financial information from prior period(s) been audited?
2. Are company budgets or forecasts generally accurate? What
processes does the client go through to develop these?
3. Are the industry statistics from a reliable source? Are the industry
statistics specific enough to the client or the particular segment or
division of the client being examined?
4. Has the nonfinancial information been audited? Have the controls
over the production of the nonfinancial information been tested?
AACSB: Analytic
AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Source: Original
123. This question tests your ability to perceive the place(s) where various
potential problems may exist and the type of problem (overstatement
or understatement) that may exist. It asks that you supply the words
or descriptions that complete the analyses begun by applying
analytical procedures.
Required:
For each of the items below, identify the account or accounts that
need to be audited carefully and the reason (i.e., potential
overstatement or understatement of ______).
a. If the current-year accounts receivable are larger than last year but
the allowance for doubtful accounts is the same.
b. If the current-year inventory is larger than last year and the
current-year gross margin (profit) is larger.
c. If current-year long-term liabilities are larger than last year and the
interest expense is the same.
d. If current-year fixed assets are larger and current depreciation
expense is the same as last year.
a. The collectability of accounts receivable is of concern. The

allowance for doubtful accounts may be understated. The bad debt
expense may be understated.
b. The existence of the inventory account is of concern. Inventory
may be overstated. Cost of goods sold may be understated.
c. The amount of accrued interest is of concern. Interest expense
may be understated. Less likely, long-term liabilities could be
overstated.
d. Depreciation expense and accumulated depreciation may be
understated. It may also be possible that fixed assets are overstated.
AACSB: Analytic
Blooms: Apply
Source: Original
124. Analytical procedures are evaluations of financial information made

by a study of plausible relationships among financial and nonfinancial
data. Understanding and evaluating such relationships are essential
to the audit process.
The following financial statements were prepared by ABC
Manufacturing Co. for the year ended December 31, 2013. Also
presented are various financial statement ratios for ABC as calculated
from the prior-year financial statements. Sales represent net credit
sales. The total assets and the receivables and inventory balances at
December 31, 2013, were the same as at December 31, 2012.
Required:
Items 1 through 9 below represent financial ratios that the auditor

calculated during the prior-year audit. For each ratio, calculate the
current-year ratio from the financial statements presented above.
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Source: Original
125. Why is it important for auditors to understand their clients' business

risks?
Auditing standards recognize that most business risks are eventually

reflected in the financial statements. Thus, audit teams now devote a
significant amount of their engagement planning to their clients'
business risks. Firms believe they must learn more about their clients'
business strategies and processes to understand whether the
financial statements are fairly presented
AACSB: Analytic
AICPA BB: Legal
Blooms: Apply
Difficulty: 3 Hard
Source: Original
Topic: Business Risk
Matching Questions
126. The audit risk model includes the four risks listed below. Place the
correct type of risk with the related definition below.
1. The probability that audit

procedures will fail to produce
evidence of material misstatements
2. The probability that an auditor will
give an inappropriate opinion on
financial statements
3. The probability that material
misstatements have occurred in
transactions entering the accounting
system
4. The probability that the client's
internal control policies and
procedures will fail to detect
material misstatements if they have
entered the accounting system
Detectio
n risk 1
Inherent
risk 3
Audit
risk 2
Control
risk 4
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Difficulty: 1 Easy
Source: Original
127. For each of the following statements or phrases, indicate the

professional standard to which it relates:
1. Investigate large and

unusual transactions,
particularly those that
occur at or near yearend
AU 260: "The
Auditor's
Communication with
Those Charged with
Governance" 4
AU 240:
"Consideration of
Fraud in a Financial
Statement Audit" 1
2. Evaluate the net

realizable value of
inventory
3. Make inquiries about
management's policies
and procedures for
AU 250:
compliance with laws and "Consideration of Laws
regulations
and Regulations" 3
4. Address disagreements
with management on
significant accounting
AU 540: "Auditing
and auditing matters
Accounting Estimates" 2
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
or regulations.
Source: Original
128. For each of the following statements, indicate the term it best
describes or typifies.
1. An employee in a
supermarket takes home bags
of fresh fruit each day without
paying for them
Errors 5
2. The controller changed the
journal entry for estimating bad
debt expense to a smaller
number to hide the poor results
from extending credit to highrisk customers. This made
income materially higher than
it otherwise would have been
Larceny 1
3. Misdeeds done by people
who steal with a pencil or
White-collar
computer
crime 3
4. A type of fraud involving
employees or nonemployees
wrongfully taking money or
property entrusted to their
Embezzlemen
care
t or defalcation 4
5. A bookkeeper inadvertently
recorded depreciation by
transposing numbers in a
Management
journal entry
fraud 2
AACSB: Analytic
AICPA BB: Industry
Blooms: Analyze
Source: Original
Topic: Fraud Risk

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Chapter 04

Management Fraud and Audit Risk

True / False Questions

2. The nature of extended procedures for fraud detection is limited to

3. Fraud consists of knowingly making material misrepresentation of fact

6. Detection risk occurs when internal control activities fail to detect

7. The auditing profession official standard for an acceptable level of

8. Audit risk (AR) is a quality criterion based on professional judgment.

10 Generally, fraudulent financial statements show financial performance

11 The demographics of white-collar criminals are similar to those of

12 Knowledge and understanding of a client's business is absolutely

13 Auditing standards require that analytical procedures be applied in the

14 Auditors look for relationships that do not make sense as indicators of

15 Analytical procedures are considered to be "soft" evidence and

17 Knowledge of the client's business from preliminary analytical

Multiple Choice Questions

Employee misappropriation of assets.

19 Management fraud generally refers to

20 External auditors are responsible

A. Designing audit procedures to detect noncompliance in the absence

Unfavorable industry conditions.

23 Independent auditors who consider fraud in the course of financial

A. The maximum amount of asset overstatement that might mislead

26 Which of the following statements concerning noncompliance by clients

A. An auditor's responsibility to detect noncompliance that has a direct

A. Auditors should design an audit to provide reasonable assurance of

28 The probability that an audit team will give an inappropriate opinion on

29 Inherent risk is the

Detection risk will decrease.

31 If fictitious credit sales were recorded and the fictitious accounts

Income would be overstated.

32 An audit team uses the assessed risk of material misstatement to

35 Based on audit evidence gathered and evaluated, an auditor decides to

Decrease substantive testing.

36 The acceptable level of detection risk is inversely related to the

A. Auditor is responsible for expressing an opinion on the financial

39 An auditor who discovers that client employees have committed an

A. The noncompliance is a violation of generally accepted accounting

Evaluate the effect on the financial statements.

41 Jones, CPA, is auditing the financial statements of XYZ Retailing, Inc.

A. Direct effect noncompliance: Reasonable; indirect effect

42 Generally accepted auditing standards state that analytical procedures

A. Consider the matter a scope limitation.

As a substantive test: yes; in the final review stage: yes

50 Sources of financial and nonfinancial data do not include

52 Which of the following accounts tends to be most predictable for

53 Analytical procedures are audit methods of evaluating financial

Identify the appropriate schedules to be prepared by the client.

54 Which of the following is not required by AU 240, "Consideration of

A. Conduct a continuing assessment of the risks of material

Extent of substantive tests of details.

A. Errors: limited; frauds: negative; direct effect noncompliance:

A. Systematic processing of large volumes of day-to-day ordinary

A. Paper copies of paid invoices and cancelled checks were microfiched

A. Elements of audit risk whereas detection risk is not.

60 The auditor uses the assessed level of risk of material misstatement to

A. Nature of substantive tests to more effective procedures.

Exercise professional skepticism when performing sales testing.

62 If tests of controls induce the auditor to change the assessed level of

A. Would most likely change from 10 percent to 5 percent.

64 Auditors would use the enterprise risk model

To reduce the client's business risk.

65 Auditors use brainstorming

68 Which of the following engagement planning procedures would most