CHAPTER 1

TRUE-FALSE QUESTIONS
1-1 When the auditor has no reservations about managements financial statements or internal controls, the audit
opinion is said to be unqualified.
1-2 Independence is referred to as the cornerstone of the auditing profession.
1-3 The sole responsibility of management with regard to financial reporting involves preparing and
presenting financial statements in accordance with the applicable financial reporting framework.
1-4 The internal audit function is designed primarily to assist the external auditor in providing assurance to third
party users of the financial statements.
1-5 The Big 4 audit firms are the only types of firms that con- duct financial statement audits.
1-6 With regard to working in a team environment, larger audit firms have teams with more continuity and
overlap across engagements, whereas smaller audit firms have multiple teams that typically disband after each
engagement.
1-7 Congress passed the Sarbanes-Oxley Act of 2002 in response to a variety of major economic shocks during the
early 2000s.
1-8 The AICPA sets auditing standards for nonpublic companies in the United States.
1-9 Audit quality is achieved when the audit is performed in accordance with GAAS and when it provides
reasonable assurance that the financial statements have been presented in accordance
with GAAP and are not materially misstated due to errors or fraud.
1-10 One of the key drivers of audit quality is the gross margin achieved by the audit firm and the ability of
the engagement partner to maintain those margins over the duration of the audit engagement.
1-11 There exist three types of review programs: (1) external inspections/peer reviews, (2) engagement quality
reviews, and (3) interoffice reviews.
1-12 The engagement letter states the scope of the work to be done on the audit so that there should be no
doubt in the mind of the client, external auditor, or the court system as to the expectations agreed to by the
external auditor and the client.

MULTIPLE-CHOICE QUESTIONS
1-13 Which of the following factors does not create a demand for external
audit services?
a.
b.
c.
d.

Potential bias by management in providing information.

Requirement of the Center for Audit Quality (CAQ).
Complexity of the accounting processing systems.
Remoteness between a user and the organization.

1-14 Which of the following expectations can users of the audit report

reasonably expect with regards to the audited financial statements?

a. The financial statements include all financial disclosures desired by
users.
b. The financial statements are presented fairly according to the
substance of GAAP.
c. The financial statements are free from all errors.
d. All of the above are reasonable expectations.
e. None of the above are reasonable expectations.
1-15 Which of the following parties are involved in preparing and auditing
financial statements?
a. Management.
b. Audit committee.
c. Internal audit function.
d. External auditor.
e. All of the above.
1.16 Which of the following are the responsibilities of the external
auditor in auditing financial statements?
a.
Maintaining internal controls and preparing financial
reports
b.
Providing internal assurance on internal control and
financial reports
c.
Providing internal oversight of the reporting process
d.
All of the above.
e.
None of the above.
1-17 In which of the following categories do Big 4 audit firms
operate?
a. Sole-practitioner firms.
b. Local firms.
c. Regional firms.
d. Multinational firms.
1-18 In terms of technical knowledge and expertise, which of the
following should external auditors do?
a. Understand accounting and auditing authoritative literature.
b. Develop industry and client-specific knowledge.
c. Develop and apply computer skills.
d. All of the above.
e. None of the above.
1-19 The AICPA remains a valuable organization to the external
auditing profession because of its continuing involvement in which of
the following activities?
a. The audit standard setting process for audits of publicly
tradedvcompanies.
b. Regulation and enforcement of the internal audit profession.

c. Education and administration of the CPA exam.

d. Promulgation of financial accounting standards.
1-20 Which of the following organizations is the primary organization that performs inspections of registered external audit firms
that audit public companies?
a. PCAOB
b. CAQ
c. AICPA
d. FASB
1-21 Audit quality involves which of the following?
a. Performing an audit in accordance with GAAS to provide reasonable assurance that the audited financial statements and related
disclosures are presented in accordance with GAAP and providing
assurance that those financial statements are not materially
misstated whether due to errors or fraud.
b. Performing an audit in accordance with GAAP to provide reasonable assurance that the audited financial statements and
related disclosures are presented in accordance with GAAS and
providing assurance that those financial statements are not
materially misstated, whether due to errors or fraud.
c. Performing an audit in accordance with GAAS to provide absolute assurance that the audited financial statements and related
disclosures are presented in accordance with GAAP and providing assurance that those financial statements are not materially
misstated whether due to errors or fraud.
d. Performing an audit in accordance with GAAS to provide reasonable assurance that the audited financial statements and
related disclosures are presented in accordance with GAAP and
providing assurance that those financial statements contain
nomisstatements due to errors or fraud.
1-22 Which of the following factors is not a driver of audit quality as
discussed by the FRC?
a. Audit firm culture.
b. Skills and personal qualities of client management.
c. Reliability and usefulness of audit reporting.
d. Factors outside the control of auditors.

1.23 Strict client acceptance/continuance guidelines should be established

by external auditors to screen out which of the follow- ing types of
clients?
a. Those that are in financial and/or organizational difficulty.
b. Those that constitute a disproportionate percentage of
the audit firms total practice.

c. Those that are disreputable.

d. Those that offer an unreasonably low fee for the
auditors services.
e. All of the above.
1.24 The PCAOB performs external inspections of audit firms registered
to audit publicly traded clients. Which of the following is accurate
regarding the timing of those inspections?
a. Inspections occur once a year for audit firms that conduct over 50
public clients in a given year.
b. Inspections occur once every three years for audit firms that
conduct over 100 public clients in a given year.
c. Inspections occur once a year for audit firms that conduct over
100 public clients in a given year.
d. Inspections occur once every five years for audit firms that conduct over 50 public clients in a given year.

CHAPTER 2

TRUE-FALSE QUESTIONS
2.1

LO 1

The Great Salad Oil Swindle of 1963 could best be catego- rized as an

asset misappropriation fraud.

2.2

LO 1

The Koss Corporation fraud could best be categorized as fraudulent

financial reporting.
2.3

LO 2

The three elements of the fraud triangle include incentive, opportunity,

and rationalization.
2.4

Management compensation schemes that heavily emphasize stockbased compensation most affect the opportunity to commit fraud.
LO 2

2.5

In the Enron fraud, one of the key ways that management covered up the fraud was to shift debt off the
balance sheet to special purpose entities.
2.7
Professional skepticism involves the validation of informa- tion through probing questions, critical
assessment of evidence, and attention to inconsistencies.
2.8
The investing public generally recognizes that it is very difficult for auditors to detect fraud, and so
it does not hold auditors accountable when auditors fail to detect it.
2.9
Auditing standards historically have reflected the belief that it is not reasonable to expect auditors to
detect cleverly hidden frauds.
2.10 The Sarbanes-Oxley Act of 2002 was written by Congress to address problems revealed in frauds that
were committed in the late 1980s.
2.11 An important change caused by the Sarbanes-Oxley Act is that auditors are no longer allowed to
provide most consulting services for their public company audit clients.
2.12 Corporate governance is the process by which the
2.13
owners and creditors of an organization exert control
over
2.14
and require accountability for the resources entrusted to
the organization.
2.15 Companies with effective corporate governance are more risky to audit.
2.16
2.17
2.6

2.18 MULTIPLE-CHOICE
2.19

QUESTIONS

2.20 What is the primary difference between fraud and errors in financial statement reporting?
a. The materiality of the misstatement.
b. The intent to deceive.
c. The level of management involved.
d. The type of transaction effected.
2.21

2.22 Which of the following best represents fraudulent financial reporting?

a. The transfer agent issues 40,000 shares of the companys
2.23 stock to a friend without authorization by the board of
directors.
a. The controller of the company inappropriately records January
2.24 sales in December so that year-end results will meet
analysts expectations.
a. The in-house attorney receives payments from the French
2.25 government for negotiating the development of a new
plant in Paris.
a. The accounts receivable clerk covers up the theft of cash
2.26 receipts by writing off older receivables without
authorization.
2.27

2.28 Which of the following creates an opportunity for fraud to be committed in an organization?
a. Management demands financial success.
b. Poor internal control.
c. Commitments tied to debt covenants.
d. Management is aggressive in its application of accounting rules.
2.29 Which of the following is a common rationalization for fraudulent financial reporting?
a. This is a one-time transaction and it will allow the company to get through the current financial
crisis, but well never do it
2.30
again.
a. We are only borrowing the money; we will pay it back next year.
b. Executives at other companies are getting paid more than we are, so we deserve the money.
c. The accounting rules dont make sense for our company, and they make our financial results
look weaker than is necessary,
2.31 so we have a good reason to record revenue using a
nonGAAP method.
a. a. and d.
2.32

2.33 Which of the following types of transactions did WorldCom management engage in as part of that
companys fraudulent finan- cial reporting scheme?
a. Recorded bartered transactions as sales.
b. Used restructuring reserves from prior acquisitions to decrease expenses.
c. Capitalized line costs rather than expensing them.
d. All of the above.
e. None of the above.
2.34

2.35 Which of the following is a valid conclusion of the third COSO report?
a. The most common frauds involve outright theft of assets.
b. The individuals most often responsible for fraud include low-level accounting personnel,
such as accounts payable clerks.
c. The majority of frauds took place at companies that were listed
2.36 on the Over-The-Counter market rather than those listed
on the NYSE.
a. All of the above.
b. None of the above.
2.37

2.38 Which of the following statements is accurate regarding the Center for Audit Qualitys 2010 paper
on deterring and detecting fraud in financial reporting?
a. It recognizes that preventing and detecting fraud is the job of the external auditor alone.
b. It notes that an effective fraud risk management program can
2.39 be expected to prevent virtually all frauds, especially those
per- petrated by top management.
a. It illustrates that communication among those involved in the
2.40 financial reporting process is critical.
a. All of the above.
b. None of the above.
2.41

a.
b.
c.
d.
e.

2.42 Which of the following statements are true?

Unless an independent audit can provide assurance that finan- cial information has not been
materially misstated because of fraud, it has little if any value to society.
Repeated revelations of accounting scandals and audit failures related to undetected frauds have
seriously damaged public confidence in external auditors.
A strong ethical tone at the top of an organization that permeates corporate culture is essential
in preventing fraud.
All of the above.
None of the above.
2.43

2.44 The Sarbanes-Oxley Act enacted which of the following pro- visions as a response to a growing
number of frauds?
a. The PCAOB was established, and it has the power to conduct
2.45 inspections of audits for external audit firms that audit
more than 100 publicly traded companies in a given year.
a. The lead audit partner and reviewing partner must rotate
2.46 off the audit of a publicly traded company at least
every 10 years.
a. Annual reports must state the responsibility of management for
2.47 establishing and maintaining an adequate internal control
structure and procedures for financial reporting, and management must have the companys internal audit function attest to
the accuracy of the annual reports.
a. All of the above.
b. None of the above.
2.48

2.49 Which of the following statements is correct regarding the Public Company Accounting Oversight
Board (PCAOB)?
a. The PCAOB is a nonprofit corporation, not an agency of the
2.50
U.S. government.
a. The PCAOB will have five financially literate members who are prominent individuals of
integrity and reputation with a commitment to the interests of investors and the public.
b. The PCAOB has authority to set standards related to public company audit reports and to
conduct inspections of registered external audit firms.
c. All of the above.
d. None of the above.
2.51 LO 6
Audit committee activities and responsibilities include which of the
following?
a. Selecting the external audit firm.
b. Approving corporate strategy.
c. Reviewing management performance and determining compensation.
d. All of the above.
e. None of the above.
2.52 Which of the following audit committee responsibilities has the NYSE mandated?
a. Obtaining each year a report by the internal auditor that addresses the companys internal
control procedures, any
2.53 quality control or regulatory problems, and any

a.
b.

2.55
2.56
2.57

c.
d.

relation- ships that might threaten the independence of the

internal
2.54
auditor.
Discussing in its meetings the companys earnings press releases, as well as financial information
and earnings guidance provided to analysts.
Reviewing with the internal auditor any audit problems or dif- ficulties that they have had with
management.
All of the above.
None of the above.