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Chapter 05 - Audit Responsibilities and Accounting Fraud

Chapter 05
Audit Responsibilities and Accounting Fraud

Multiple Choice Questions

1. Deliberately underbidding for an audit engagement to obtain a client and secure more
lucrative management advisory or consulting services is known as:
A. Opinion shopping
B. High-balling
C. Low-balling
D. Client shopping

2. One of the articles of professional conduct, due care, requires a member to discharge
professional responsibilities with _______ and _______.
A. Confidentiality and integrity
B. Objectivity and ethics
C. Standard morals and ethics
D. Competence and diligence

3. Susie is an auditor with XYZ Audit firm. The Senior Audit member has told her that all
fieldwork must be completed by the end of the week. Susie knows that corners have been cut
and certain tests not completed due to the time constraints. The integrity of the firm could be
compromised. What should Susie do?
A. Do nothing.
B. Talk with the chain of command of the client to see that her concerns are dealt with.
C. Follow the chain of command of XYZ to see that her concerns are dealt with.
D. Talk with a reporter from the Wall Street Journal.

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4. The expectations gap refers to:

A. The space that exists between a train coming into the station and the platform used to
board the train
B. The difference between what the public expects an audit to uncover and what the
profession believes is the purpose of an audit
C. The difference between projected earnings based on analysts' expectations and actual
earnings
D. The difference between what the audit sets out to discover and what it actually does
discover

5. Which of the following is an element of the introductory paragraph of an auditor's report?

A. Identifies the type of opinion the auditor is giving
B. Identifies the management's responsibilities for the statements
C. Identifies audit testing and procedures used
D. Identifies the generally accepted auditing standards followed in conducting the audit

6. Which of the following is not an element of the scope paragraph of the auditor's report?
A. States the auditor's responsibility to express an opinion on the financial statements.
B. States the audit provides reasonable assurance that the statements are free of material
misstatement.
C. States audit provides reasonable basis for the opinion.
D. States the audit evaluates the overall financial statement presentation.

7. Typically, when a going concern issue exists the auditor should:

A. Issue an unqualified opinion with an explanatory paragraph
B. Explain the reasons for the going concern issue
C. Indicate where management's plans to deal with the going concern are addressed
D. All of the above

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8. Which of the following is the most likely reason for an auditor to issue a qualified opinion?
A. Inability to gather sufficient relevant information to form the basis for the opinion
B. Differences with management that lead to trust issues on the part of the auditor
C. Going concern issue
D. Difference of opinion with management on the application of generally accepted
accounting principles

9. Adverse opinions are preceded by a separate paragraph that should contain all of the
following except for:
A. Substantive alternative treatments of GAAP
B. Substantive reasons for the adverse opinion
C. Principal effect of the adverse treatment on financial position and results of operations and
cash flows
D. All of the above should be included in explaining the basis for the adverse opinion

10. Under which of the following set of circumstances might the auditors disclaim an
opinion?
A. The financial statements contain a departure from generally accepted accounting
principles, the effect of which is material
B. There is a client scope restriction that precludes the auditors' compliance with generally
accepted auditing standards
C. There has been a material change between periods in the method of the application of
accounting principles
D. Differences with management that lead to trust issues on the part of the auditor

11. When would it be appropriate for an auditor to withdraw from an engagement?

A. In order to avoid issuing an adverse opinion.
B. When that auditor cannot observe the taking of inventory or is unable to confirm
receivables.
C. When the management cannot be trusted.
D. When the auditor has overbooked too much work.

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12. Which of the following is true about PCAOB audit standards?

A. The required standards apply to all companies
B. The required standards apply to all public companies only
C. The required standards apply to all privately held companies only
D. The required standards apply to all not-for-profit entities

13. Which of the following summarizes the essence of general standards of GAAS?
A. Quality of professionals that perform an audit
B. Criteria used to judge whether the audit has met quality requirements
C. The standards that guide auditors in issuing the audit report
D. Whether the auditor obtained sufficient competent evidential matter to render an opinion

14. Which of the following summarizes the essence of field work standards of GAAS?
A. Quality of professionals that perform an audit
B. Criteria for judging the quality of audit work
C. Whether the auditor was independent in conducting the audit
D. Whether the auditor reviewed the client's financial statements for adherence to GAAP

15. Which of the following is not one of the reporting standards of GAAS that guides auditors
in formulating the audit opinion?
A. The financial statements have followed GAAP.
B. Consistency in the application of GAAP.
C. Adequate disclosures exist in the statements.
D. Gathering sufficient audit evidence to warrant an opinion.

16. Some critics claim the usefulness of the audit report is limited because:
A. Auditors do not examine all of the transactions
B. Language in the audit report relies on subjective evaluations such as what is meant by
"reasonable"
C. Transactions examined are based on materiality and risk assessment determinations
D. All of the above may create doubts about usefulness

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17. Which of the following is not correct about materiality?

A. The concept of materiality recognizes that some matters are more important for fair
presentation of financial statements
B. Materiality judgments are made in light of surrounding circumstances and necessarily
involve quantitative and qualitative judgments
C. Materiality should be predictable from audit to audit so that the readers of financial
statements know what constitutes materiality
D. An auditor's consideration of materiality is influenced by the auditor's perception of the
need of the readers of the financial statements

18. The auditors' determination of whether the financial statements "present fairly" is based
on:
A. Whether the users are able to assess the reliability of the financial statements
B. Whether the statements have been prepared in accordance with the same GAAP used from
one year to another
C. Whether the auditor has been able to gather sufficient evidence to warrant the statement
that the financial statements present fairly
D. Whether the accounting principles used are appropriate in the circumstances

19. Which of the following is not a component of internal control?

A. Control environment
B. Information and communication systems
C. Monitoring of controls
D. Independence of the audit committee

20. The auditor's responsibility with regard to illegal acts is greatest when:
A. The illegal acts have an indirect and material effect on financial statement amounts
B. The illegal acts have a direct and material effect on financial statement amounts
C. The illegal acts have a direct and immaterial effect on financial statement amounts
D. Illegal acts exist regardless of the effects on the financial statements

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21. The first step for an auditor who concludes an illegal act exists is to:
A. Bring the matter to the attention of the audit committee
B. Bring the matter to the attention of the SEC
C. Assess the impact of the illegal act on the financial statements
D. Assess the impact of the illegal act on the auditor's opinion

22. An auditor concludes that a client has committed an illegal act that has not been properly
accounted for or disclosed. The auditor should withdraw from the engagement if the
A. Auditor is precluded from obtaining sufficient competent evidence about the illegal act
B. Illegal act has an effect on the financial statements that is both material and direct
C. Auditor cannot reasonably estimate the effect of the illegal act on the financial statements
D. Client refuses to take the remedial steps deemed necessary by the auditors

23. The Private Securities Litigation Reform Act imposes additional requirements on public
companies reporting to the SEC and their auditors when:
A. The illegal act has a material effect on the financial statements
B. Senior management and the board have not acted properly to correct for the act
C. The failure to correct for the action is reasonably expected to warrant a departure from the
standard audit report
D. All of the above are additional requirements

24. Auditors are responsible to detect and correct errors when they are:
A. Material
B. Material or immaterial
C. Due to an illegal act
D. Management fails to correct for the error

25. The auditors' responsibility to communicate findings with respect to fraud can best be
summarized as:
A. Communicate to the audit committee both material and immaterial amounts of fraud
B. Communicate to the audit committee both material and immaterial amounts of fraud that
are detected
C. Communicate to the SEC material amounts of fraud
D. Communicate to the SEC both material and immaterial amounts of fraud that are detected

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26. The purpose of the fraud triangle is to identify:

A. The causes of when the audit opinion should be qualified.
B. To identify the causes of when there may be intentional misstatements or omissions of
amounts or disclosures in the financial statements.
C. To identify the causes of when there is a lack of independence in performing an audit.
D. All of the above.

27. Which of the following is not part of the fraud triangle?

A. Incentives
B. Opportunity
C. Materiality
D. Rationalization

28. The difference between an error in the financial statements as compared to fraud is:
A. An error is always an intentional act designed to deceive another party
B. Fraud is always an intentional act designed to deceive another party
C. An error always leads to a qualification of the auditors' opinion
D. Fraudulent financial reporting is always material in amount

29. Each of the following represents a pressure that might lead to fraud except for:
A. Desire to maximize the value of stock options
B. Budget pressures
C. Meet financial analysts' earnings expectations
D. Inadequate internal controls

30. All of the following are in a position to commit fraud except for:
A. Employees who have access to assets
B. Top management who can override internal controls
C. External auditors who manipulate the amounts recorded in the financial statements
D. All of the above are in a position to commit fraud

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31. All of the following tend to be rationalizations for fraud except for:
A. We need to protect the shareholders and keep the stock price high.
B. All companies use aggressive accounting techniques.
C. The employee will be fired unless s/he goes along with the fraud.
D. We are correcting a temporary problem that will not exist in the future.

32. The misappropriation of assets refers to:

A. The deliberate use of company assets for personal reasons.
B. The deliberate overstatement of financial statements.
C. The deliberate omission of disclosures from the statements.
D. All of the above.

33. Backdating options refers to:

A. Crossing out the date of exercise on the option certificate and changing it to an earlier date
when the stock price was lower
B. Changing the grant date of the options to lower the exercise price and reduce reported
earnings
C. Granting options to employees working for the company in years prior to the granting of
the options
D. Changing the future exercise price to correspond market increases in the stock price

34. The fraud at Tyco included each of the following acts except for:
A. Benefits given to certain members of the board of directors to secure their silence about the
fraud
B. Corporate assets used by members of top management for personal purposes
C. Setting up special-purpose-entities to keep debt off Tyco's books
D. Related party transactions that were not adequately disclosed

35. Members of the audit committee are responsible for each of the following except for:
A. Evaluating management's identification of fraud risks
B. Assessing whether management has set the appropriate ethical tone for the organization
C. Discussing with the external auditors financial reporting matters of concern
D. Rendering an audit opinion after examining the entity's financial statements and internal
controls

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36. What is the motive behind the PCAOB Integrated Audit Concept?
A. Elevation of importance of internal controls
B. Improvement of the quality and integrity of both internal controls over financial reporting
and independent financial statement audits
C. Improvement of the speed and reliability of both corporate financial reporting and
independent financial statement audits
D. Elevation of importance of independent financial statement audits

37. The AICPA issued eight Statements on Auditing Standards (SAS 104-111) that address
risk assessment with respect to:
A. The design and performance of audit procedures to respond to assessed risks
B. Whether the standards close the expectation gap
C. The role and responsibilities of the audit committee in preventing fraud
D. All of the above

38. The eight risk assessment auditing standards issued by the AICPA identify the following
types of misstatements:
A. Known and unknown misstatements
B. Likely and unknown misstatements
C. Known and likely misstatements
D. All material misstatements

39. The Committee of Sponsoring Organizations of the Treadway Committee (COSO)

analyzed the financial reporting of public companies during the 1987-1997 periods when
business failures due to accounting fraud were high and found that:
A. Top management was frequently involved in the fraud with the CEO being the person most
frequently involved
B. Top management was frequently involved in the fraud with the CFO being the person most
frequently involved
C. The audit committee always sanctioned the fraud
D. A minority of audit reports issued during the fraud period contained unqualified audit
opinions

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40. PCAOB Auditing Standard No.4 requires that the external auditors should take each of the
following steps when reporting on whether a material weakness still exists in the internal
controls except for:
A. Evaluate whether management has accepted responsibility for the effectiveness of internal
control
B. Evaluate whether management asserts whether the controls are effective in correcting the
material weakness
C. Evaluate whether management has obtained sufficient evidence to support its assessment
D. Evaluate whether management has conducted an audit of internal controls

41. A study conducted of financial statement restatements in 2007 and 2008 indicated a
decline in the number of restatements as a result of each of the following except for:
A. Improved audits of financial statements
B. Improved reliability of internal controls
C. A more relaxed approach of the SEC regarding materiality and the need to file restatements
D. All were cited as reasons for the decline

42. One ethical dilemma for professional accountants is a conflict between the interests of the
stakeholders. Who or what is a stakeholder?
A. Everyone but the people within the company
B. People who are affected by the outcomes of decisions that are made
C. Supervisor of an accountant
D. Employees only

43. Which of the following statements is correct regarding auditor independence as stated by
the AICPA in Rule 101?
A. A covered member's immediate family can have a direct financial interest in a client.
B. A covered member can have a joint investment with a client.
C. A covered member involved in the audit of a bank can have an auto loan at the bank.
D. A covered member can have a direct financial interest in a client as long as it is not
material and is disclosed properly.

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44. If a company is seeking out views of different accounting firms until they find one with a
desired accounting treatment, it would be called ______.
A. Low-balling.
B. Under bidding.
C. Opinion shopping.
D. Option pricing.

45. Which is not a link of the chain of command that the controller should inform of a
material misstatement in the financial statements?
A. Audit Committee of Board of Directors
B. CEO
C. Hotline
D. CFO

46. Which of the following is considered a negative auditor's opinion?

A. Standard opinion
B. Qualified opinion
C. Unqualified opinion
D. Adverse opinion

47. Which of the following is a reason for an auditor to issue a qualified opinion?
A. Difference of opinion with management on presentation of financial statements in the
annual report
B. Difference of opinion with management on earnings estimate of a material amount
C. Difference of opinion with management on preferred accounting principles under GAAP
D. Difference of opinion with management on a material application of accounting standards

48. Which of the following is an example of opinion shopping by a company?

A. Changing auditors due to the quality of work by the auditors
B. Changing auditors due to wanting desired accounting treatment
C. Changing auditors due to the size of the audit fees
D. Changing auditors due to the size of the audit firm

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49. In which of the following circumstances would an adverse opinion be appropriate?

A. An uncertainty prevents the issuance of a standard unqualified opinion.
B. The statements are not in conformity with generally accepted accounting principles
regarding stock options plans.
C. The auditor has been unable to obtain sufficient competent evidential matter.
D. The principal auditors decide to make reference to the report of another auditor who
audited a subsidiary.

50. Which of the following is not true of "reasonable assurance"?

A. Exercise of due care
B. Absolute guarantee
C. Appearance of independence
D. Followed GAAS

51. Which of the following is not a consideration in determining a measure of materiality?

A. Strong internal control
B. Five percent of net income
C. Risks of material misstatements due to fraud
D. Risks of illegal acts

52. What is the auditor's responsibility with regard to illegal acts?

A. To detect and report illegal acts that have an indirect and material effect on financial
statement amounts.
B. To detect and report illegal acts that have a direct and material effect on financial statement
amounts.
C. To detect and report illegal acts that have a direct and immaterial effect on financial
statement amounts.
D. To detect and report illegal acts that have an indirect and immaterial effect on financial
statement amounts.

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53. Which of the following is not an area of fraud considerations detailed by SAS 99?
A. Assessing the impact of fraud
B. Professional skepticism about fraud
C. Identifying risks of fraud
D. Characteristics of fraud

54. PCAOB Auditing Standard No. 2 and eight risk assessment standards of AICPA require
the auditor to do all but:
A. A more in-depth understanding of the entity and environment.
B. A rigorous assessment of risk of material misstatement.
C. Linkage between the risks of misstatement and the nature, timing, and extent of audit
procedures.
D. A more-in-depth sampling of evidence.

55. Because of the risk of material misstatement, an audit of financial statements in

accordance with GAAS should be planned and performed with an attitude of
A. Objective judgment
B. Professional skepticism
C. Independent integrity
D. Impartial conservatism

56. The framework of COSO Enterprise Risk Management is to

A. Incorporate enhanced internal control principles into enhanced corporate governance.
B. Incorporate enhanced audit sampling procedures in the testing of internal controls.
C. Incorporate enhanced corporate governance into internal control principles.
D. Incorporate enhanced audit sampling procedures in substantive testing.

57. Which of the following is not an element of COSO Enterprise Risk Management?
A. Enhancing risk response decisions
B. Reducing operating surprises and losses
C. Seizing opportunities
D. Improving deployment of information technology

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58. Management's attitude toward aggressive financial statement reporting and its emphasis
on meeting projected profit numbers would significantly influence an entity's control
environment when
A. Internal auditors report to the audit committee
B. The audit committee is active in overseeing the entity's financial reporting
C. Management is dominated by one shareholder with little other governance
D. Management does not have a stock option plan

59. In the General Electric case, each of the following allegations were made against the
company except for the following:
A. Offered to sell company securities during the period when the company issued materially
misleading financial statements
B. Obtained money or property by the use of untrue statements of material facts or omission
of material information
C. Misuse of company resources by members of top management
D. Failure to maintain an internal control system sufficient to provide reasonable assurance
that the financial statements were prepared in conformity with GAAP

60. Issues related to a peer review of an audit are the subject matter of which case?
A. Kazweski & Dooktaviski
B. Imperial Valley Thrift & Loan
C. Audit Client Considerations
D. Marcus Yamabuto

61. In the Imperial Valley Thrift & Loan case, each of the following were reasons for the
going concern issue except for:
A. The magnitude of loan losses
B. Insufficient equity capital
C. Operating losses over an extended period of time
D. Questions about the collectability of outstanding loans

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62. The primary issue discussed in the Krispy Kreme case was:
A. Use of special-purpose-entities to keep debt off the books
B. Use of "round trip" transactions to accelerate the recording of earnings
C. Internal controls over operating activities
D. Internal controls over the making of doughnuts

63. The Audit Client Consideration case deals with issues related to:
A. Acceptance of new clients
B. Issues that arise between the predecessor audit firm and the client
C. Going concern issues raised by previous auditors
D. All of the above

64. The Marcus Yamabuto case deals with issues related to:
A. Premature revenue recognition
B. Franchise revenue accounting
C. Special purpose entities
D. All of the above

65. The audit report on Sky Hook, Inc. that was discussed in The Audit Report case contained
each of the following deficiencies except for:
A. The report was not addressed to the shareholders and/or the board of directors
B. The report failed to identify the comparative financial statements included in the audit
C. The failure to properly identify the auditing standards followed
D. The failure to render an opinion based on the audit

66. An unusual aspect of the Edvid case is that the company:

A. Accelerated the recording of revenue into an earlier period than seemed to be justified
B. Delayed the of recognition of revenue into a later period than seemed justified
C. The falsification of inventory amounts
D. All of the above

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67. Fannie Mae's financial statements were investigated because of allegations that the
company:
A. Deferred derivative losses on the balance sheet thereby inflating profits
B. Used derivatives to hide subprime loans
C. Sold derivatives to increase cash flows prior to bank financing
D. All of the above

68. The primary accounting issue in the Royal Ahold case is:
A. Fraudulent recording of revenues on sales to customers
B. Fraudulent use of company resources by top management for personal purposes
C. Fraudulent inflation of promotional allowances to increase operating income
D. Fraudulent inflation of inventory to reduce losses on the income statement

Essay Questions

69. Explain each of the three sides of the fraud triangle (SAS 99) with respect to how it
contributes toward the possibility that fraud in the financial statements may be present.

70. The Committee of Sponsoring Organizations of the Treadway Committee (COSO)

analyzed the financial reporting of public companies during the 1987-1997 periods when
business failures due to accounting fraud were high. Describe the major findings of COSO
with respect to financial statement fraud.

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71. Explain the circumstances under which an auditor should give each of the following
opinions:
(a) Unqualified opinion
(b) Unqualified opinion with an explanatory paragraph
(c) Qualified opinion
(d) Adverse opinion

72. Materiality is one of the most difficult judgments to make in auditing financial statements.
Explain what is meant by materiality and explain the basis for the auditor's assessment of
whether there is a material misstatement in the financial statements.

73. Differentiate between the auditors' responsibilities to detect errors, fraud, and illegal acts.
How would you assess the ethics of a company that has experienced each event with respect
to motivation and the integrity of those who go along with such events?

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74. In the Tyco fraud the corporate governance system completely broke down. Explain the
failings in the corporate governance system at Tyco and how the Sarbanes-Oxley Act
addresses those failings.

75. Explain the auditors' responsibilities to assess fraud including the role of professional
judgment.

76. What are the audit committee's responsibilities with respect to fraud and risk assessment?

77. Kohlberg's model addresses the stages of moral development a person might move
through in developing a strong sense of ethics. Analyze each of those stages with respect to
the three elements of the fraud triangle. How can an individual resist the temptation to
become involved in fraud by possessing the characteristics of behavior included in each
stage?

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78. Describe the steps that auditors should take under Auditing Standard No. 4 of the PCAOB
to report on whether a previously reported material weakness still exists.

79. Mr. Arty works for Smile Accounting Firm as a senior accountant. Currently he is doing
review of rental property compliance testing completed by the staff accountants. He realizes
that the staff accountants only tested two tenants per property instead of the required three by
the audit program. To request more information from the client would cause massive delays
and the manager is pressing hard for the information before the Christmas vacation. What
should Mr. Arty do and why? Use the ethical theory and ethical decision making model
to discuss the situation.

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80. Campus Fast is a new audit client. Client Fast uses public Wi-Fi to place and deliver
restaurant take out for students at the Up and Coming State University. Campus Fast was
founded by three highly ambitious MBA students at the university. The business plan is to
find a buyer or place an IPO of the company by graduation in two years. The founders expect
to pay off all student loans, take a tour around the world and then start another company. In
order for the business plan to work on the timeline for graduation, the business must meet
highly ambitious earnings numbers. Additionally, the company is dealing with two situations
that the founders would like to keep from the auditors:
1) The company has been using free, unsecured public Wi-Fi to take orders via the Internet.
The customer may pay via the Internet. Several students, who all happen to be members of the
same student organization on campus, are claiming that using Campus Fast has allowed their
identity to be stolen. One student is claiming that she had $12,000 of charges on her credit
card to the unsecured Internet site of Campus Fast. Management plans to pay off the
complaining students and keep the true liability off the balance sheet. "An interest buyer has
about the unsecured site and might get scared by the student complaints".
2) The company guarantees fast delivery. It has offered to pay any speeding or other moving
violation tickets to its delivery drivers. Unfortunately one of the drivers was involved in an
accident due to running a red light. The passenger in the other car is in critical condition and
the intensive care unit in the hospital. The driver has promised the family of the passenger that
the company will make good on any expenses and admitted the company policy on repaying
all traffic tickets. Attorneys for the injured party are threatening to sue and publicize the
situation. The founders do not have enough cash to take care of this problem but are still
trying to keep the situation from the auditors and potential buyer.
Using the internal control framework from SAS 55, 98, COSO and Enterprise Risk
Management, assess the internal control and risks of Campus Fast.

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Chapter 05 Audit Responsibilities and Accounting Fraud Answer Key

Multiple Choice Questions

1. Deliberately underbidding for an audit engagement to obtain a client and secure more
lucrative management advisory or consulting services is known as:
A. Opinion shopping
B. High-balling
C. Low-balling
D. Client shopping

2. One of the articles of professional conduct, due care, requires a member to discharge
professional responsibilities with _______ and _______.
A. Confidentiality and integrity
B. Objectivity and ethics
C. Standard morals and ethics
D. Competence and diligence

3. Susie is an auditor with XYZ Audit firm. The Senior Audit member has told her that all
fieldwork must be completed by the end of the week. Susie knows that corners have been cut
and certain tests not completed due to the time constraints. The integrity of the firm could be
compromised. What should Susie do?
A. Do nothing.
B. Talk with the chain of command of the client to see that her concerns are dealt with.
C. Follow the chain of command of XYZ to see that her concerns are dealt with.
D. Talk with a reporter from the Wall Street Journal.

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4. The expectations gap refers to:

A. The space that exists between a train coming into the station and the platform used to
board the train
B. The difference between what the public expects an audit to uncover and what the
profession believes is the purpose of an audit
C. The difference between projected earnings based on analysts' expectations and actual
earnings
D. The difference between what the audit sets out to discover and what it actually does
discover

5. Which of the following is an element of the introductory paragraph of an auditor's report?

A. Identifies the type of opinion the auditor is giving
B. Identifies the management's responsibilities for the statements
C. Identifies audit testing and procedures used
D. Identifies the generally accepted auditing standards followed in conducting the audit

6. Which of the following is not an element of the scope paragraph of the auditor's report?
A. States the auditor's responsibility to express an opinion on the financial statements.
B. States the audit provides reasonable assurance that the statements are free of material
misstatement.
C. States audit provides reasonable basis for the opinion.
D. States the audit evaluates the overall financial statement presentation.

7. Typically, when a going concern issue exists the auditor should:

A. Issue an unqualified opinion with an explanatory paragraph
B. Explain the reasons for the going concern issue
C. Indicate where management's plans to deal with the going concern are addressed
D. All of the above

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8. Which of the following is the most likely reason for an auditor to issue a qualified opinion?
A. Inability to gather sufficient relevant information to form the basis for the opinion
B. Differences with management that lead to trust issues on the part of the auditor
C. Going concern issue
D. Difference of opinion with management on the application of generally accepted
accounting principles

9. Adverse opinions are preceded by a separate paragraph that should contain all of the
following except for:
A. Substantive alternative treatments of GAAP
B. Substantive reasons for the adverse opinion
C. Principal effect of the adverse treatment on financial position and results of operations and
cash flows
D. All of the above should be included in explaining the basis for the adverse opinion

10. Under which of the following set of circumstances might the auditors disclaim an
opinion?
A. The financial statements contain a departure from generally accepted accounting
principles, the effect of which is material
B. There is a client scope restriction that precludes the auditors' compliance with generally
accepted auditing standards
C. There has been a material change between periods in the method of the application of
accounting principles
D. Differences with management that lead to trust issues on the part of the auditor

11. When would it be appropriate for an auditor to withdraw from an engagement?

A. In order to avoid issuing an adverse opinion.
B. When that auditor cannot observe the taking of inventory or is unable to confirm
receivables.
C. When the management cannot be trusted.
D. When the auditor has overbooked too much work.

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12. Which of the following is true about PCAOB audit standards?

A. The required standards apply to all companies
B. The required standards apply to all public companies only
C. The required standards apply to all privately held companies only
D. The required standards apply to all not-for-profit entities

13. Which of the following summarizes the essence of general standards of GAAS?
A. Quality of professionals that perform an audit
B. Criteria used to judge whether the audit has met quality requirements
C. The standards that guide auditors in issuing the audit report
D. Whether the auditor obtained sufficient competent evidential matter to render an opinion

14. Which of the following summarizes the essence of field work standards of GAAS?
A. Quality of professionals that perform an audit
B. Criteria for judging the quality of audit work
C. Whether the auditor was independent in conducting the audit
D. Whether the auditor reviewed the client's financial statements for adherence to GAAP

15. Which of the following is not one of the reporting standards of GAAS that guides auditors
in formulating the audit opinion?
A. The financial statements have followed GAAP.
B. Consistency in the application of GAAP.
C. Adequate disclosures exist in the statements.
D. Gathering sufficient audit evidence to warrant an opinion.

16. Some critics claim the usefulness of the audit report is limited because:
A. Auditors do not examine all of the transactions
B. Language in the audit report relies on subjective evaluations such as what is meant by
"reasonable"
C. Transactions examined are based on materiality and risk assessment determinations
D. All of the above may create doubts about usefulness

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17. Which of the following is not correct about materiality?

A. The concept of materiality recognizes that some matters are more important for fair
presentation of financial statements
B. Materiality judgments are made in light of surrounding circumstances and necessarily
involve quantitative and qualitative judgments
C. Materiality should be predictable from audit to audit so that the readers of financial
statements know what constitutes materiality
D. An auditor's consideration of materiality is influenced by the auditor's perception of the
need of the readers of the financial statements

18. The auditors' determination of whether the financial statements "present fairly" is based
on:
A. Whether the users are able to assess the reliability of the financial statements
B. Whether the statements have been prepared in accordance with the same GAAP used from
one year to another
C. Whether the auditor has been able to gather sufficient evidence to warrant the statement
that the financial statements present fairly
D. Whether the accounting principles used are appropriate in the circumstances

19. Which of the following is not a component of internal control?

A. Control environment
B. Information and communication systems
C. Monitoring of controls
D. Independence of the audit committee

20. The auditor's responsibility with regard to illegal acts is greatest when:
A. The illegal acts have an indirect and material effect on financial statement amounts
B. The illegal acts have a direct and material effect on financial statement amounts
C. The illegal acts have a direct and immaterial effect on financial statement amounts
D. Illegal acts exist regardless of the effects on the financial statements

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21. The first step for an auditor who concludes an illegal act exists is to:
A. Bring the matter to the attention of the audit committee
B. Bring the matter to the attention of the SEC
C. Assess the impact of the illegal act on the financial statements
D. Assess the impact of the illegal act on the auditor's opinion

22. An auditor concludes that a client has committed an illegal act that has not been properly
accounted for or disclosed. The auditor should withdraw from the engagement if the
A. Auditor is precluded from obtaining sufficient competent evidence about the illegal act
B. Illegal act has an effect on the financial statements that is both material and direct
C. Auditor cannot reasonably estimate the effect of the illegal act on the financial statements
D. Client refuses to take the remedial steps deemed necessary by the auditors

23. The Private Securities Litigation Reform Act imposes additional requirements on public
companies reporting to the SEC and their auditors when:
A. The illegal act has a material effect on the financial statements
B. Senior management and the board have not acted properly to correct for the act
C. The failure to correct for the action is reasonably expected to warrant a departure from the
standard audit report
D. All of the above are additional requirements

24. Auditors are responsible to detect and correct errors when they are:
A. Material
B. Material or immaterial
C. Due to an illegal act
D. Management fails to correct for the error

25. The auditors' responsibility to communicate findings with respect to fraud can best be
summarized as:
A. Communicate to the audit committee both material and immaterial amounts of fraud
B. Communicate to the audit committee both material and immaterial amounts of fraud that
are detected
C. Communicate to the SEC material amounts of fraud
D. Communicate to the SEC both material and immaterial amounts of fraud that are detected

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26. The purpose of the fraud triangle is to identify:

A. The causes of when the audit opinion should be qualified.
B. To identify the causes of when there may be intentional misstatements or omissions of
amounts or disclosures in the financial statements.
C. To identify the causes of when there is a lack of independence in performing an audit.
D. All of the above.

27. Which of the following is not part of the fraud triangle?

A. Incentives
B. Opportunity
C. Materiality
D. Rationalization

28. The difference between an error in the financial statements as compared to fraud is:
A. An error is always an intentional act designed to deceive another party
B. Fraud is always an intentional act designed to deceive another party
C. An error always leads to a qualification of the auditors' opinion
D. Fraudulent financial reporting is always material in amount

29. Each of the following represents a pressure that might lead to fraud except for:
A. Desire to maximize the value of stock options
B. Budget pressures
C. Meet financial analysts' earnings expectations
D. Inadequate internal controls

30. All of the following are in a position to commit fraud except for:
A. Employees who have access to assets
B. Top management who can override internal controls
C. External auditors who manipulate the amounts recorded in the financial statements
D. All of the above are in a position to commit fraud

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31. All of the following tend to be rationalizations for fraud except for:
A. We need to protect the shareholders and keep the stock price high.
B. All companies use aggressive accounting techniques.
C. The employee will be fired unless s/he goes along with the fraud.
D. We are correcting a temporary problem that will not exist in the future.

32. The misappropriation of assets refers to:

A. The deliberate use of company assets for personal reasons.
B. The deliberate overstatement of financial statements.
C. The deliberate omission of disclosures from the statements.
D. All of the above.

33. Backdating options refers to:

A. Crossing out the date of exercise on the option certificate and changing it to an earlier date
when the stock price was lower
B. Changing the grant date of the options to lower the exercise price and reduce reported
earnings
C. Granting options to employees working for the company in years prior to the granting of
the options
D. Changing the future exercise price to correspond market increases in the stock price

34. The fraud at Tyco included each of the following acts except for:
A. Benefits given to certain members of the board of directors to secure their silence about the
fraud
B. Corporate assets used by members of top management for personal purposes
C. Setting up special-purpose-entities to keep debt off Tyco's books
D. Related party transactions that were not adequately disclosed

35. Members of the audit committee are responsible for each of the following except for:
A. Evaluating management's identification of fraud risks
B. Assessing whether management has set the appropriate ethical tone for the organization
C. Discussing with the external auditors financial reporting matters of concern
D. Rendering an audit opinion after examining the entity's financial statements and internal
controls

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36. What is the motive behind the PCAOB Integrated Audit Concept?
A. Elevation of importance of internal controls
B. Improvement of the quality and integrity of both internal controls over financial reporting
and independent financial statement audits
C. Improvement of the speed and reliability of both corporate financial reporting and
independent financial statement audits
D. Elevation of importance of independent financial statement audits

37. The AICPA issued eight Statements on Auditing Standards (SAS 104-111) that address
risk assessment with respect to:
A. The design and performance of audit procedures to respond to assessed risks
B. Whether the standards close the expectation gap
C. The role and responsibilities of the audit committee in preventing fraud
D. All of the above

38. The eight risk assessment auditing standards issued by the AICPA identify the following
types of misstatements:
A. Known and unknown misstatements
B. Likely and unknown misstatements
C. Known and likely misstatements
D. All material misstatements

39. The Committee of Sponsoring Organizations of the Treadway Committee (COSO)

analyzed the financial reporting of public companies during the 1987-1997 periods when
business failures due to accounting fraud were high and found that:
A. Top management was frequently involved in the fraud with the CEO being the person most
frequently involved
B. Top management was frequently involved in the fraud with the CFO being the person most
frequently involved
C. The audit committee always sanctioned the fraud
D. A minority of audit reports issued during the fraud period contained unqualified audit
opinions

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40. PCAOB Auditing Standard No.4 requires that the external auditors should take each of the
following steps when reporting on whether a material weakness still exists in the internal
controls except for:
A. Evaluate whether management has accepted responsibility for the effectiveness of internal
control
B. Evaluate whether management asserts whether the controls are effective in correcting the
material weakness
C. Evaluate whether management has obtained sufficient evidence to support its assessment
D. Evaluate whether management has conducted an audit of internal controls

41. A study conducted of financial statement restatements in 2007 and 2008 indicated a
decline in the number of restatements as a result of each of the following except for:
A. Improved audits of financial statements
B. Improved reliability of internal controls
C. A more relaxed approach of the SEC regarding materiality and the need to file restatements
D. All were cited as reasons for the decline

42. One ethical dilemma for professional accountants is a conflict between the interests of the
stakeholders. Who or what is a stakeholder?
A. Everyone but the people within the company
B. People who are affected by the outcomes of decisions that are made
C. Supervisor of an accountant
D. Employees only

43. Which of the following statements is correct regarding auditor independence as stated by
the AICPA in Rule 101?
A. A covered member's immediate family can have a direct financial interest in a client.
B. A covered member can have a joint investment with a client.
C. A covered member involved in the audit of a bank can have an auto loan at the bank.
D. A covered member can have a direct financial interest in a client as long as it is not
material and is disclosed properly.

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44. If a company is seeking out views of different accounting firms until they find one with a
desired accounting treatment, it would be called ______.
A. Low-balling.
B. Under bidding.
C. Opinion shopping.
D. Option pricing.

45. Which is not a link of the chain of command that the controller should inform of a
material misstatement in the financial statements?
A. Audit Committee of Board of Directors
B. CEO
C. Hotline
D. CFO

46. Which of the following is considered a negative auditor's opinion?

A. Standard opinion
B. Qualified opinion
C. Unqualified opinion
D. Adverse opinion

47. Which of the following is a reason for an auditor to issue a qualified opinion?
A. Difference of opinion with management on presentation of financial statements in the
annual report
B. Difference of opinion with management on earnings estimate of a material amount
C. Difference of opinion with management on preferred accounting principles under GAAP
D. Difference of opinion with management on a material application of accounting standards

48. Which of the following is an example of opinion shopping by a company?

A. Changing auditors due to the quality of work by the auditors
B. Changing auditors due to wanting desired accounting treatment
C. Changing auditors due to the size of the audit fees
D. Changing auditors due to the size of the audit firm

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49. In which of the following circumstances would an adverse opinion be appropriate?

A. An uncertainty prevents the issuance of a standard unqualified opinion.
B. The statements are not in conformity with generally accepted accounting principles
regarding stock options plans.
C. The auditor has been unable to obtain sufficient competent evidential matter.
D. The principal auditors decide to make reference to the report of another auditor who
audited a subsidiary.

50. Which of the following is not true of "reasonable assurance"?

A. Exercise of due care
B. Absolute guarantee
C. Appearance of independence
D. Followed GAAS

51. Which of the following is not a consideration in determining a measure of materiality?

A. Strong internal control
B. Five percent of net income
C. Risks of material misstatements due to fraud
D. Risks of illegal acts

52. What is the auditor's responsibility with regard to illegal acts?

A. To detect and report illegal acts that have an indirect and material effect on financial
statement amounts.
B. To detect and report illegal acts that have a direct and material effect on financial statement
amounts.
C. To detect and report illegal acts that have a direct and immaterial effect on financial
statement amounts.
D. To detect and report illegal acts that have an indirect and immaterial effect on financial
statement amounts.

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53. Which of the following is not an area of fraud considerations detailed by SAS 99?
A. Assessing the impact of fraud
B. Professional skepticism about fraud
C. Identifying risks of fraud
D. Characteristics of fraud

54. PCAOB Auditing Standard No. 2 and eight risk assessment standards of AICPA require
the auditor to do all but:
A. A more in-depth understanding of the entity and environment.
B. A rigorous assessment of risk of material misstatement.
C. Linkage between the risks of misstatement and the nature, timing, and extent of audit
procedures.
D. A more-in-depth sampling of evidence.

55. Because of the risk of material misstatement, an audit of financial statements in

accordance with GAAS should be planned and performed with an attitude of
A. Objective judgment
B. Professional skepticism
C. Independent integrity
D. Impartial conservatism

56. The framework of COSO Enterprise Risk Management is to

A. Incorporate enhanced internal control principles into enhanced corporate governance.
B. Incorporate enhanced audit sampling procedures in the testing of internal controls.
C. Incorporate enhanced corporate governance into internal control principles.
D. Incorporate enhanced audit sampling procedures in substantive testing.

57. Which of the following is not an element of COSO Enterprise Risk Management?
A. Enhancing risk response decisions
B. Reducing operating surprises and losses
C. Seizing opportunities
D. Improving deployment of information technology

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58. Management's attitude toward aggressive financial statement reporting and its emphasis
on meeting projected profit numbers would significantly influence an entity's control
environment when
A. Internal auditors report to the audit committee
B. The audit committee is active in overseeing the entity's financial reporting
C. Management is dominated by one shareholder with little other governance
D. Management does not have a stock option plan

59. In the General Electric case, each of the following allegations were made against the
company except for the following:
A. Offered to sell company securities during the period when the company issued materially
misleading financial statements
B. Obtained money or property by the use of untrue statements of material facts or omission
of material information
C. Misuse of company resources by members of top management
D. Failure to maintain an internal control system sufficient to provide reasonable assurance
that the financial statements were prepared in conformity with GAAP

60. Issues related to a peer review of an audit are the subject matter of which case?
A. Kazweski & Dooktaviski
B. Imperial Valley Thrift & Loan
C. Audit Client Considerations
D. Marcus Yamabuto

61. In the Imperial Valley Thrift & Loan case, each of the following were reasons for the
going concern issue except for:
A. The magnitude of loan losses
B. Insufficient equity capital
C. Operating losses over an extended period of time
D. Questions about the collectability of outstanding loans

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62. The primary issue discussed in the Krispy Kreme case was:
A. Use of special-purpose-entities to keep debt off the books
B. Use of "round trip" transactions to accelerate the recording of earnings
C. Internal controls over operating activities
D. Internal controls over the making of doughnuts

63. The Audit Client Consideration case deals with issues related to:
A. Acceptance of new clients
B. Issues that arise between the predecessor audit firm and the client
C. Going concern issues raised by previous auditors
D. All of the above

64. The Marcus Yamabuto case deals with issues related to:
A. Premature revenue recognition
B. Franchise revenue accounting
C. Special purpose entities
D. All of the above

65. The audit report on Sky Hook, Inc. that was discussed in The Audit Report case contained
each of the following deficiencies except for:
A. The report was not addressed to the shareholders and/or the board of directors
B. The report failed to identify the comparative financial statements included in the audit
C. The failure to properly identify the auditing standards followed
D. The failure to render an opinion based on the audit

66. An unusual aspect of the Edvid case is that the company:

A. Accelerated the recording of revenue into an earlier period than seemed to be justified
B. Delayed the of recognition of revenue into a later period than seemed justified
C. The falsification of inventory amounts
D. All of the above

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67. Fannie Mae's financial statements were investigated because of allegations that the
company:
A. Deferred derivative losses on the balance sheet thereby inflating profits
B. Used derivatives to hide subprime loans
C. Sold derivatives to increase cash flows prior to bank financing
D. All of the above

68. The primary accounting issue in the Royal Ahold case is:
A. Fraudulent recording of revenues on sales to customers
B. Fraudulent use of company resources by top management for personal purposes
C. Fraudulent inflation of promotional allowances to increase operating income
D. Fraudulent inflation of inventory to reduce losses on the income statement

Essay Questions

69. Explain each of the three sides of the fraud triangle (SAS 99) with respect to how it
contributes toward the possibility that fraud in the financial statements may be present.

Answers will vary

70. The Committee of Sponsoring Organizations of the Treadway Committee (COSO)

analyzed the financial reporting of public companies during the 1987-1997 periods when
business failures due to accounting fraud were high. Describe the major findings of COSO
with respect to financial statement fraud.

Answers will vary

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71. Explain the circumstances under which an auditor should give each of the following
opinions:
(a) Unqualified opinion
(b) Unqualified opinion with an explanatory paragraph
(c) Qualified opinion
(d) Adverse opinion

Answers will vary

72. Materiality is one of the most difficult judgments to make in auditing financial statements.
Explain what is meant by materiality and explain the basis for the auditor's assessment of
whether there is a material misstatement in the financial statements.

Answers will vary

73. Differentiate between the auditors' responsibilities to detect errors, fraud, and illegal acts.
How would you assess the ethics of a company that has experienced each event with respect
to motivation and the integrity of those who go along with such events?

Answers will vary

74. In the Tyco fraud the corporate governance system completely broke down. Explain the
failings in the corporate governance system at Tyco and how the Sarbanes-Oxley Act
addresses those failings.

Answers will vary

75. Explain the auditors' responsibilities to assess fraud including the role of professional
judgment.

Answers will vary

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76. What are the audit committee's responsibilities with respect to fraud and risk assessment?

Answers will vary

77. Kohlberg's model addresses the stages of moral development a person might move
through in developing a strong sense of ethics. Analyze each of those stages with respect to
the three elements of the fraud triangle. How can an individual resist the temptation to
become involved in fraud by possessing the characteristics of behavior included in each
stage?

Answer will vary

78. Describe the steps that auditors should take under Auditing Standard No. 4 of the PCAOB
to report on whether a previously reported material weakness still exists.

Answer will vary

79. Mr. Arty works for Smile Accounting Firm as a senior accountant. Currently he is doing
review of rental property compliance testing completed by the staff accountants. He realizes
that the staff accountants only tested two tenants per property instead of the required three by
the audit program. To request more information from the client would cause massive delays
and the manager is pressing hard for the information before the Christmas vacation. What
should Mr. Arty do and why? Use the ethical theory and ethical decision making model
to discuss the situation.

This situation is a violation of due care general auditing standard and possibly sufficient
evidential matter field work standard, both of which could affect the opinion. From rights,
deontology and utilitarian approach, the auditor should do the required work.

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80. Campus Fast is a new audit client. Client Fast uses public Wi-Fi to place and deliver
restaurant take out for students at the Up and Coming State University. Campus Fast was
founded by three highly ambitious MBA students at the university. The business plan is to
find a buyer or place an IPO of the company by graduation in two years. The founders expect
to pay off all student loans, take a tour around the world and then start another company. In
order for the business plan to work on the timeline for graduation, the business must meet
highly ambitious earnings numbers. Additionally, the company is dealing with two situations
that the founders would like to keep from the auditors:
1) The company has been using free, unsecured public Wi-Fi to take orders via the Internet.
The customer may pay via the Internet. Several students, who all happen to be members of the
same student organization on campus, are claiming that using Campus Fast has allowed their
identity to be stolen. One student is claiming that she had $12,000 of charges on her credit
card to the unsecured Internet site of Campus Fast. Management plans to pay off the
complaining students and keep the true liability off the balance sheet. "An interest buyer has
about the unsecured site and might get scared by the student complaints".
2) The company guarantees fast delivery. It has offered to pay any speeding or other moving
violation tickets to its delivery drivers. Unfortunately one of the drivers was involved in an
accident due to running a red light. The passenger in the other car is in critical condition and
the intensive care unit in the hospital. The driver has promised the family of the passenger that
the company will make good on any expenses and admitted the company policy on repaying
all traffic tickets. Attorneys for the injured party are threatening to sue and publicize the
situation. The founders do not have enough cash to take care of this problem but are still
trying to keep the situation from the auditors and potential buyer.
Using the internal control framework from SAS 55, 98, COSO and Enterprise Risk
Management, assess the internal control and risks of Campus Fast.

The students should discuss the control environment of Campus fast (founders intent on
making goals) risk assessment (two potential contingent and actual liabilities that the founders
are trying to cover up and keep off the balance sheet), control activities, information and
communications systems (liability of using unsecured Wi-Fi), and monitoring.

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