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Chapter 05
Fraud in Financial Statements and Auditor Responsibilities
Multiple Choice Questions
1. Which of the following is NOT something external auditors are expected to do in looking for
fraud?
A. Assessing the control environment of the organization
B. Evaluating internal controls
C. Considering audit risk and materiality
D. Evaluating management's commitment to serve the public interest
2. If the financial statements are not materially misstated, the auditor should give a(an):
A. Unmodified opinion
B. Modified opinion
C. Adverse opinion
D. Qualified opinion
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McGraw-Hill Education.
3. An example of fraudulent financial statements is:
A. Misrepresentation of events, transactions, and other significant events in the financial

statements
B. Failure to provide adequate documentation to support financial statements assertions
C. Aggressive accounting for transactions, events, or other significant matters
D. Misappropriation of assets
4. Misstatements in the financial statements can result from:
A. Errors
B. Fraud
C. Illegal acts improperly recorded
D. All of the above
5. Misstatements in the financial statements are most likely to occur when there are:
A. Omission of the auditor's report
B. Omission of notes to the financial statements
C. Failure to disclose major estimates made in the financial statements
D. Failure to disclose major judgments made in the financial statements
6. 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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7. 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
8. An auditor concludes that a client has committed an illegal act that has not been properly
accounted for or disclosed. The auditor is most likely to withdraw from the engagement when 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
9. 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
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10. 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
11. Confidential client information can be disclosed outside the entity without violating the AICPA
Code of Professional Conduct in each of the following situations except when:
A. It is reported to the SEC under Section 10A of the Securities Exchange Act
B. It is to comply with the Private Securities Litigation Reform Act
C. It protects the auditor's accounting for fraud and illegal acts
D. It is allowed for under the Dodd-Frank Financial Reform Act
12. The purpose of the fraud triangle is to identify:
A. The causes of when the audit opinion should be qualified.
B. The causes of and reasons for fraud when there may be intentional misstatements or omissions
of amounts or disclosures in the financial statements.
C. The causes of when there is a lack of independence in performing an audit.
D. The causes of illegal acts.
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13. Which of the following is not part of the fraud triangle?
A. Incentives
B. Opportunity
C. Materiality
D. Rationalization
14. The difference between errors 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
15. Which of the following is NOT a pressure that might lead to fraud?
A. Desire to maximize the value of stock options
B. Budget pressures
C. Meet financial analysts' earnings expectations
D. Ability to carry out the fraud
16. All of the following are in a position to commit fraud except:
A. Employees who have access to assets
B. Top management who can override internal controls
C. External auditors who audit the financial statements
D. All of the above are in a position to commit fraud
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17. All of the following tend to be rationalizations for fraud except:
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
18. The best explanation why the fraud at Tyco was not discovered and acted on is:
A. Failure of the corporate governance system
B. External auditors told management to let the fraud go
C. Tyco management hid the fraud from the auditors
D. The fraud was not material
19. Which of the following elements were NOT part of the fraud at Tyco?
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
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20. The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the
financial reporting of public companies during the 1998-2007 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 and/or CFO being the most
frequently involved
B. The most common fraud technique involved understating expenses
C. The audit committee always sanctioned the fraud
D. A minority of audit reports issued during the fraud period contained unqualified audit opinions
21. Which of the following is not one of the evaluations of the control environment of an
organization?
A. Whether management's philosophy and operating style promote effective internal control over
financial reporting
B. Whether sound integrity and ethical values, particularly of top management, are developed and
understood
C. Whether the Board or audit committee understands and exercises oversight responsibility over
financial reporting and internal control
D. Whether the company has an anonymous hot line
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22. What is enterprise risk management (ERM)?
A. A process of evaluating internal controls to ensure operations are carried out efficiently and
effectively
B. A process designed to identify material events that may affect the financial statements and to
manage risk within the entity's risk appetite
C. A process, effected by an entity's board of directors, management, and other personnel

designed to identify potential events that may affect the entity and to manage risk within its risk
appetite
D. A process by which compliance with laws and regulations can be assessed
23. Which of the following is an element of ERM?
A. Reducing operational surprises and losses
B. Aligning risk appetite and whether fraud has occurred
C. Control environment
D. Audit risk assessment
24. The auditors' responsibility to communicate findings with respect to fraud can best be summarized
as:
A. Communicate to the audit committee the existence of fraud but not the amount involved
B. Communicate to the audit committee both material and immaterial amounts of fraud that are
detected
C. Communicate to the SEC the existence of fraud but not the amount involved
D. Communicate to the SEC both material and immaterial amounts of fraud that are detected
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25. Which of the following is NOT one of the communications that should be made by external
auditors to the audit committee?
A. Accounting estimates
B. Threats to auditor independence and related safeguards to mitigate those threats
C. Significant deficiencies in audit procedures
D. The nature and scope of significant assumptions
26. Section 302 of the Sarbanes-Oxley Act requires:
A. Management's report on internal controls
B. Auditor's independent report
C. Auditor's assessment of management's report on internal controls
D. Management's certification of the financial statements
27. The framework of COSO's Enterprise Risk Management can best be characterized as:
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
28. 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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29. Which of the following is an element of the introductory paragraph of an auditor's report under
AICPA standards?
A. Identifies the type of opinion the auditor is giving
B. Identifies the entity, financial statements being audited and time period
C. Identifies audit testing and procedures used
D. Identifies the generally accepted auditing standards followed in conducting the audit
30. Which of the following is NOT an element of the auditor's responsibility of the AICPA's 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
31. Typically, when a going concern issue exists the auditor should:
A. Issue an unmodified opinion with an emphasis-of-matter paragraph
B. Issue a modified opinion and explain the reasons for the going concern issue
C. Issue a disclaimer of opinion
D. Withdraw from the engagement
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32. In which of the following circumstances would a qualified opinion be appropriate?
A. The statements are not in conformity with generally accepted accounting principles regarding
stock options plans and but does not have pervasive effect on the financial statements
B. The statements are not in conformity with generally accepted accounting principles regarding
stock options plans and has pervasive effect on the financial statements
C. The auditor has been unable to obtain sufficient competent evidential matter
D. The principal auditors decide to withdraw from the engagement due to distrust of management
33. Which of the following is the most likely reason for an auditor to issue a modified opinion with a
qualification?
A. Inability to gather any sufficient relevant information to form the basis for the opinion
B. Misstatements that are material and pervasive
C. Going concern issue
D. Misstatements that are material but not pervasive
34. Which of the following is the most likely reason for an auditor to issue an adverse opinion?
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35. 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. The auditor is unable to obtain sufficient appropriate audit evidence on which to base the
opinion
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
36. 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 auditor concludes that management cannot be trusted
D. When the auditor has overbooked too much work
37. One difference between the AICPA auditor's report and that of the PCAOB is:
A. The PCAOB report is not signed by the auditor
B. The AICPA report is not signed by the auditor
C. The PCAOB report does not have section headings
D. Both reports are the same
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38. The title of the PCAOB auditor's report is:
A. Independent Auditor's Report
B. Report of the Independent Registered Audit Firm
C. Auditor's Report on Management's Financial Statements
D. Auditor's Report on Internal Controls
39. Some critics claim the usefulness of the audit report is limited because:
A. Auditors do not examine management's estimates and judgments
B. Language in the audit report relies on subjective evaluations such as what is meant by
"reasonable"
C. Transactions examined are based on sampling and other techniques to limit choices of which
transactions to audit
D. All of the above may create doubts about usefulness
40. Which of the following is not true of "reasonable assurance"?
A. The auditors have exercised due care
B. The audit opinion is a guarantee that material misstatements have been identified
C. The audit has been properly planned and supervised
D. The auditors have followed GAAS
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41. 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
42. Which of the following is not a consideration in determining a measure of materiality?
A. Risks of material misstatements due to fraud
B. Quantitative assessment of the importance of the difference of opinion with client management
on an accounting issues
C. Qualitative assessment of the importance of the difference of opinion with client management
on an accounting issues
D. Importance of audit committee in the organization
43. The SEC is concerned that auditors don't pay enough attention to qualitative factors affecting
materiality because:
A. Qualitative factors may cause quantitatively small misstatements to become material
B. Quantitative factors are not always useful
C. Quantitative factors cannot be accumulated to assess overall materiality
D. All are of concern to the SEC
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44. 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
45. 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
46. Which of the following summarizes the essence of field work standards of GAAS?
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
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47. 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
48. Because of the risk of material misstatement due to improper management representations, an
audit of financial statements in accordance with GAAS should be performed with:
A. Objective judgment
B. Professional skepticism
C. Internal controls
D. Due diligence
49. Gathering and objectively evaluating audit evidence requires the auditor to consider:
A. Whether an unmodified opinion should be issued
B. Whether a modified opinion should be issued
C. Whether the evidence is adequate to complete the audit
D. Whether the evidence is competent and sufficient enough to render an audit opinion
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50. In an audit, the auditor has a requirement to 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
51. Audit procedures are different than audit evidence because:
A. Audit procedures address the competency and sufficiency of audit evidence
B. Audit procedures are specific acts performed by the auditor to gather evidence about whether
specific assertions are being met
C. Audit procedures are specific acts to assess whether the financial statements "present fairly"
D. Audit procedures do not have to be determined based on risk assessment
52. Audit documentation is critical to evidence gathering because:
A. It demonstrates that an audit has been conducted
B. It demonstrates professional skepticism
C. It substitutes for making audit judgments and estimates
D. All of the above
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53. In gathering audit evidence, the accessibility of information may be a factor thereby influencing
which judgment trigger?
A. Confirmation
B. Overconfidence
C. Anchoring
D. Availability
54. PCAOB Standard 7 addresses engagement quality reviews and have as its objectives to:
A. Assess how an audit has been conducted and the appropriateness of the audit opinion
B. Assess the firm's own quality controls and the appropriateness of the audit opinion
C. Assess how an audit has been conducted and the firm's own quality control procedures
D. Assess whether materiality has been properly evaluated
55. PCAOB Standard 14 addresses audit results and requires:
A. Auditor's evaluation of internal controls
B. Auditor's determination of whether the auditor has obtained sufficient appropriate evidence
C. Auditor's evaluation of the applicable financial reporting framework
D. Auditor's independence
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56. PCAOB Auditing Standard No.16 requires the auditor to communicate with the audit committee all
but:
A. Significant accounting policies and practices
B. Critical accounting practices and policies
C. Significant unusual transactions
D. The procedures followed by the auditor in evaluating evidence
57. PCAOB Auditing Standard No.16 requires the auditor to communicate with the audit committee all
but:
A. Going concern issues
B. Whether the auditor expects to modify the opinion
C. Any disagreements with management
D. The procedures followed to comply with generally accepted auditing standards
58. Which of the following audit deficiencies was identified most often in a study by the Center for
Audit Quality of SEC imposed sanctions?
A. Failure to gather sufficient competent evidence
B. Failure to exercise due care
C. Insufficient level of professional skepticism
D. Failure to obtain adequate evidence related to management representations
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59. Which of the following is NOT one of the most common audit deficiencies identified in PCAOB
inspections?
A. Inadequate internal controls over financial reporting
B. Lack of independent audits
C. Lack of due care
D. Inability to exercise the appropriate level of professional skepticism
60. The main reason the PCAOB has charged Chinese affiliates of U.S. audit firms with failing to
provide sufficient documentary evidence of audits of Chinese companies listed on U.S. exchanges
is:
A. Audit firms are unable to gather sufficient competent evidential matter
B. Audit firms are not knowledgeable enough about Chinese accounting standards
C. Chinese regulatory agencies can be uncooperative in providing access to PCAOB regarding

their inspections of audit documents
D. Chinese regulatory agencies conduct inspections of the audit documents of the firms
61. In the Loyalty and Fraud Reporting case, Ethan Lester pressured his friend Vic Jensen to:
A. Misappropriate funds from the company
B. Cover up Ethan's fraud
C. Be silent and not report Ethan's fraud to the audit committee
D. Give an unmodified audit report
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62. In the ZZZZ best case, Barry Minkow was charged with:
A. A fraudulent insurance restoration scam
B. Insider trading on Lennar stock
C. Stealing from a San Diego church
D. Overcharging a LA housewife for carpet cleaning services
63. In the Imperial Valley Community Bank case, each of the following were reasons for the going
concern issue except:
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
64. The case which deals with assigning a quality review partner to an audit is:
A. ZZZZ Best
B. Imperial Valley Community Bank
C. Busy Season Planning
D. Rooster, Hen, Footer and Burger
65. The Tax Inversion case deals with:
A. Whether IFRS should be used for all subsidiaries following an acquisition
B. Whether IFRS should replace U.S. GAAP
C. Whether a quality reviewer should be chosen from outside the company
D. Whether a tax inversion should occur
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66. The primary issue in the Rooster, Hen, Footer and Burger case is:
A. The timing of revenue recognition and shipping date of merchandise
B. Related party transactions
C. The timing of expense recognition on accrual accounts
D. The accounting for walnuts
67. Which of the following is NOT addressed in the Diamond Foods case?
A. Accounting for payments to walnut growers
B. Matching revenues with the proper period
C. Depreciation of almond trees
D. Misleading the external auditors
68. Bill Young's ethical dilemma was:
A. Whether the loan loss reserves of the bank were understated
B. Whether to file a whistle-blower's complaint with the SEC under Dodd-Frank
C. Whether to commit fraud to cover up stealing from the company
D. Whether to inform management or the regulatory authorities of illegal acts of an audit client
69. 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
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70. The Groupon case deals with all but the following issues:
A. Improperly estimated customer returns
B. Improper recognition of gross revenue
C. Used a new innovative metric of "Adjusted Consolidated Segment Operating Income"
D. Blamed material weakness on their auditors EY
Essay Questions
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71. Explain each of the three sides of the fraud triangle with respect to how it contributes toward the
possibility that fraud in the financial statements may be present. Are there differences with respect
to how each element might influence occupational fraud and fraudulent financial statements?
Explain.
One of the older and more basic concepts in fraud deterrence and detection is the "fraud triangle."
While researching his doctoral thesis in the 1950s, famed criminologist Donald R. Cressey came up
with this hypothesis to explain why people commit fraud.
The three key elements in the fraud triangle are opportunity, motivation, and rationalization.
Opportunity is the element over which business owners have the most control. Limiting
opportunities for fraud is one way a company can reduce it.
The opportunity to commit fraud is possible when employees have access to assets and
information that allows them to both commit and conceal fraud typically because of weak internal
controls including a lack of segregation of duties or oversight. Top management typically overrides
the controls when committing financial statements fraud while employees may use the weaknesses
to their advantage in perpetrating fraud.
Motivation is a pressure or a "need" felt by the person who commits fraud. It might be a personal
financial or other type of need, such as high medical bills or debts, or as a result of bad personal
habits as occurred in ZZZZ Best and Tyco where CEOs misappropriated company resources for
personal gain.
Motivators can also be financial oriented that affects business results. Pressures may exist to meet
or exceed financial analysts' earnings estimates or to qualify for high bonuses and/or to inflate
share prices and make stock options more valuable.
Lastly, employees may rationalize this behavior by determining that committing fraud is OK for a
variety of reasons. For those who are generally dishonest, it's probably easier to rationalize a fraud.
For those with higher moral standards, it's probably not so easy. They have to convince themselves
that fraud is OK with "excuses" for their behavior.
Common rationalizations include making up for being underpaid or replacing a bonus that was
5-24
deserved but not received. A thief may convince himself that he is just "borrowing" money from
the company and will pay it back one day. Some embezzlers tell themselves that the company
doesn't need the money or won't miss the assets. Others believe that the company "deserves" to
have money stolen because of bad acts against employees.
Business owners and executives must take control of fraud by working on the portion of the fraud
triangle over which they have the most control: the opportunity to commit fraud. It may be difficult
for management to do anything about an employee's needs or rationalizations, but by limiting

opportunities for fraud, the company can reduce it to some extent.
This question provides an opportunity to review the GVV reasons and rationalizations framework.
As you read the case, think about the following series of questions for the protagonist to address
after identifying the right thing to do including:
• How can they get it done effectively and efficiently?

• What do they need to say, to whom, and in what sequence?
• What will the objections or push-back be and, then,

• What would they say next? What data and examples do they need?
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72. Explain the link between the opportunity to commit fraud and corporate governance systems.
73. Explain the circumstances under which an auditor should give each of the following opinions:
(a) Unmodified opinion

(b) Unmodified opinion with an emphasis-of-matter paragraph
(c) Qualified opinion
(d) Adverse opinion
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74. What is the purpose of having required auditor communications between the external auditor and
the audit committee?
75. Why is materiality one of the most difficult judgments to make in auditing financial statements?
76. 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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77. Internal controls, an internal audit function, and an audit committee are all elements of a strong
corporate governance system. How should an external auditor evaluate these elements in making
a risk assessment? What are the ethical signs that each system is operating as intended?
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78. Campus Fast is a new audit client. Client Fast uses public WiFi 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 WiFi 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. The reason is Campus Fast is concerned that an
interested buyer may become concerned 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 assess the internal controls at Campus Fast and risk
environment.
5-29
79. Identify the deficiencies in the following audit report of the AICPA. Explain why each item is a
deficiency.
Report of the Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders, XYZ Company

We have audited the accompanying consolidated financial statements of XYZ Company and its
subsidiaries, which comprise the consolidated balance sheets as of December 31, 2015 and 2014,
and the related consolidated statements of income, changes in stockholders' equity, and cash
flows for the years then ended, and the related notes to the financial statements. These statements
are the responsibility of the Company's management. Our responsibility is to express an opinion
on these financial statements based on our audits.
Management's Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated
financial statements in accordance with accounting principles generally accepted in the United
States of America; this includes the design, implementation, and maintenance of internal control
relevant to the preparation and fair presentation of consolidated financial statements that are free
from material misstatement, whether due to fraud or error.
Auditor's Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our
audits. We conducted our audits in accordance with auditing standards of the Public Company
Accounting Oversight Board. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements are free of
material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the consolidated financial statements. The procedures selected depend on the
management's judgment, including the assessment of the risks of material misstatement of the
consolidated financial statements, whether due to fraud or error. In making those risk assessments,
the auditor considers internal controls relevant to the entity's preparation and fair presentation of
5-30
the consolidated financial statements in order to design audit procedures that are appropriate in
the circumstances. Accordingly, we express no such opinion. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of significant accounting
estimates made by during the audit, as well as evaluating the overall presentation of the
consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of XYZ Company and its subsidiaries as of December 31, 2013, and
2012, and the results of its operations and its cash flows for the years then ended in accordance
with auditing standards of the Public Company Accounting Oversight Board.
Optional Paragraph
Report on Other Legal and Regulatory Requirements
[Auditor's signature]
[Auditor's city and state]
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80. On July 1, 2015, the Public Company Accounting Oversight Board issued a concept release to seek
public comment on the content and possible uses of a group of potential "audit quality indicators."
The indicators are a potential portfolio of quantitative measures that may provide new insights
about how to evaluate the quality of audits and how high quality audits are achieved. Taken
together with qualitative context, the indicators may inform discussions among those concerned
with the financial reporting and auditing process, for example among audit committees and audit
firms. Enhanced discussions, in turn, may strengthen audit planning, execution, and
communication. The Board sought advice on these subjects through the comment process and
were to convene a public roundtable about the concept release, on a date to be determined
during the fourth quarter of 2015. The proposed indicators are in the exhibit below.
Required:
Comment on the need for audit quality indicators and any limitations of providing such
information in the public domain.
The 28 potential indicators are:
AUDIT Availability 1. Staffing Leverage

PROFESSIONALS 2. Partner Workload
3. Manager and Staff Workload
4. Technical Accounting and Auditing Resources
5. Persons with Specialized Skill and Knowledge
Competence 6. Experience of Audit Personnel

7. Industry Expertise of Audit Personnel
8. Turnover of Audit Personnel

9. Amount of Audit Work Centralized at Service Centers
10. Training Hours per Audit Professional
Focus 11. Audit Hours and Risk Areas

12. Allocation of Audit Hours to Phases of the Audit
AUDIT PROCESS Tone at the Top and 13. Results of Independent Survey of Firm Personnel
Leadership
Incentives 14. Quality Ratings and Compensation

15. Audit Fees, Effort, and Client Risk
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Independence 16. Compliance with Independence Requirements
Infrastructure 17. Investment in Infrastructure Supporting Quality

Auditing
Monitoring and 18. Audit Firms' Internal Quality Review Results

Remediation 19. PCAOB Inspection Results
20. Technical Competency Testing
AUDIT RESULTS Financial Statements 21. Frequency and Impact of Financial Statement
Restatements for Errors
22. Fraud and other Financial Reporting Misconduct

23. Inferring Audit Quality from Measures of Financial
Reporting Quality
Internal Control 24. Timely Reporting of Internal Control Weaknesses
Going Concern 25. Timely Reporting of Going Concern Issues
Communications 26. Results of Independent Surveys of Audit Committee

between Auditors Members
and Audit
Committee
Enforcement and 27. Trends in PCAOB and SEC Enforcement Proceedings
Litigation 28. Trends in Private Litigation
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Chapter 05 Fraud in Financial Statements and Auditor Responsibilities
Answer Key
Multiple Choice Questions
1. Which of the following is NOT something external auditors are expected to do in looking for
fraud?
A. Assessing the control environment of the organization
B. Evaluating internal controls
C. Considering audit risk and materiality
D. Evaluating management's commitment to serve the public interest
AACSB: Ethics
AICPA: BB Critical Thinking
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Easy
Learning Objective: 05-01 Distinguish between audit requirements for errors, fraud, and illegal acts.
Topic: Fraud in Financial Statements
5-34
2. If the financial statements are not materially misstated, the auditor should give a(an):
A. Unmodified opinion
B. Modified opinion
C. Adverse opinion
D. Qualified opinion
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
Difficulty: 1 Easy
3. An example of fraudulent financial statements is:
A. Misrepresentation of events, transactions, and other significant events in the financial

statements
B. Failure to provide adequate documentation to support financial statements assertions
C. Aggressive accounting for transactions, events, or other significant matters
D. Misappropriation of assets
AACSB: Ethics
Blooms: Apply
Difficulty: 1 Easy
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4. Misstatements in the financial statements can result from:
A. Errors
B. Fraud
C. Illegal acts improperly recorded
D. All of the above
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
Difficulty: 1 Easy
5. Misstatements in the financial statements are most likely to occur when there are:
A. Omission of the auditor's report
B. Omission of notes to the financial statements
C. Failure to disclose major estimates made in the financial statements
D. Failure to disclose major judgments made in the financial statements
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
Difficulty: 2 Medium
5-36
6. 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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Analyze
7. 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
AACSB: Ethics
AICPA: BB Legal
Blooms: Apply
5-37
8. An auditor concludes that a client has committed an illegal act that has not been properly
accounted for or disclosed. The auditor is most likely to withdraw from the engagement when
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
AACSB: Ethics
AICPA: BB Legal
Blooms: Apply
9. 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
AACSB: Ethics
AICPA: BB Legal
Blooms: Analyze
Difficulty: 1 Easy
5-38
10. 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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
Difficulty: 1 Easy
11. Confidential client information can be disclosed outside the entity without violating the AICPA
Code of Professional Conduct in each of the following situations except when:
A. It is reported to the SEC under Section 10A of the Securities Exchange Act
B. It is to comply with the Private Securities Litigation Reform Act
C. It protects the auditor's accounting for fraud and illegal acts
D. It is allowed for under the Dodd-Frank Financial Reform Act
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-39
12. The purpose of the fraud triangle is to identify:
A. The causes of when the audit opinion should be qualified.
B. The causes of and reasons for fraud when there may be intentional misstatements or
omissions of amounts or disclosures in the financial statements.
C. The causes of when there is a lack of independence in performing an audit.
D. The causes of illegal acts.
AACSB: Ethics
Blooms: Apply
Learning Objective: 05-02 Explain the components of the Fraud Triangle.
Topic: The Fraud Triangle
13. Which of the following is not part of the fraud triangle?
A. Incentives
B. Opportunity
C. Materiality
D. Rationalization
AACSB: Ethics
Blooms: Apply
5-40
14. The difference between errors 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
AACSB: Ethics
Blooms: Apply
15. Which of the following is NOT a pressure that might lead to fraud?
A. Desire to maximize the value of stock options
B. Budget pressures
C. Meet financial analysts' earnings expectations
D. Ability to carry out the fraud
AACSB: Ethics
Blooms: Apply
5-41
16. All of the following are in a position to commit fraud except:
A. Employees who have access to assets
B. Top management who can override internal controls
C. External auditors who audit the financial statements
D. All of the above are in a position to commit fraud
AACSB: Ethics
Blooms: Apply
17. All of the following tend to be rationalizations for fraud except:
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
AACSB: Ethics
Blooms: Apply
5-42
18. The best explanation why the fraud at Tyco was not discovered and acted on is:
A. Failure of the corporate governance system
B. External auditors told management to let the fraud go
C. Tyco management hid the fraud from the auditors
D. The fraud was not material
AACSB: Ethics
Blooms: Apply
19. Which of the following elements were NOT part of the fraud at Tyco?
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
AACSB: Ethics
Blooms: Apply
5-43
20. The Committee of Sponsoring Organizations of the Treadway Committee (COSO) analyzed the
financial reporting of public companies during the 1998-2007 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 and/or CFO being the
most frequently involved
B. The most common fraud technique involved understating expenses
C. The audit committee always sanctioned the fraud
D. A minority of audit reports issued during the fraud period contained unqualified audit
opinions
AACSB: Ethics
Blooms: Apply
Learning Objective: 05-03 Describe fraud risk assessment procedures.
Topic: Fraud Considerations and Risk Assessment
21. Which of the following is not one of the evaluations of the control environment of an
organization?
A. Whether management's philosophy and operating style promote effective internal control
over financial reporting
B. Whether sound integrity and ethical values, particularly of top management, are developed
and understood
C. Whether the Board or audit committee understands and exercises oversight responsibility
over financial reporting and internal control
D. Whether the company has an anonymous hot line
AACSB: Ethics
5-44
Blooms: Apply
22. What is enterprise risk management (ERM)?
A. A process of evaluating internal controls to ensure operations are carried out efficiently and
effectively
B. A process designed to identify material events that may affect the financial statements and
to manage risk within the entity's risk appetite
C. A process, effected by an entity's board of directors, management, and other personnel
designed to identify potential events that may affect the entity and to manage risk within its
risk appetite
D. A process by which compliance with laws and regulations can be assessed
AACSB: Ethics
Blooms: Apply
5-45
23. Which of the following is an element of ERM?
A. Reducing operational surprises and losses
B. Aligning risk appetite and whether fraud has occurred
C. Control environment
D. Audit risk assessment
AACSB: Ethics
Blooms: Apply
Difficulty: 3 Hard
24. The auditors' responsibility to communicate findings with respect to fraud can best be
summarized as:
A. Communicate to the audit committee the existence of fraud but not the amount involved
B. Communicate to the audit committee both material and immaterial amounts of fraud that
are detected
C. Communicate to the SEC the existence of fraud but not the amount involved
D. Communicate to the SEC both material and immaterial amounts of fraud that are detected
AACSB: Ethics
Blooms: Apply
5-46
25. Which of the following is NOT one of the communications that should be made by external
auditors to the audit committee?
A. Accounting estimates
B. Threats to auditor independence and related safeguards to mitigate those threats
C. Significant deficiencies in audit procedures
D. The nature and scope of significant assumptions
AACSB: Ethics
AICPA: FN Reporting
Blooms: Analyze
26. Section 302 of the Sarbanes-Oxley Act requires:
A. Management's report on internal controls
B. Auditor's independent report
C. Auditor's assessment of management's report on internal controls
D. Management's certification of the financial statements
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-47
27. The framework of COSO's Enterprise Risk Management can best be characterized as:
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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
28. 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
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-48
29. Which of the following is an element of the introductory paragraph of an auditor's report under
AICPA standards?
A. Identifies the type of opinion the auditor is giving
B. Identifies the entity, financial statements being audited and time period
C. Identifies audit testing and procedures used
D. Identifies the generally accepted auditing standards followed in conducting the audit
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
Learning Objective: 05-04 Explain the standards for audit reports.
Topic: Audit Report and Auditing Standards
30. Which of the following is NOT an element of the auditor's responsibility of the AICPA's 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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-49
31. Typically, when a going concern issue exists the auditor should:
A. Issue an unmodified opinion with an emphasis-of-matter paragraph
B. Issue a modified opinion and explain the reasons for the going concern issue
C. Issue a disclaimer of opinion
D. Withdraw from the engagement
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
32. In which of the following circumstances would a qualified opinion be appropriate?
A. The statements are not in conformity with generally accepted accounting principles
regarding stock options plans and but does not have pervasive effect on the financial
statements
B. The statements are not in conformity with generally accepted accounting principles
regarding stock options plans and has pervasive effect on the financial statements
C. The auditor has been unable to obtain sufficient competent evidential matter
D. The principal auditors decide to withdraw from the engagement due to distrust of
management
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-50
33. Which of the following is the most likely reason for an auditor to issue a modified opinion with
a qualification?
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
34. Which of the following is the most likely reason for an auditor to issue an adverse opinion?
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-51
35. 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. The auditor is unable to obtain sufficient appropriate audit evidence on which to base the
opinion
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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
36. 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 auditor concludes that management cannot be trusted
D. When the auditor has overbooked too much work
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
5-52
Blooms: Apply
37. One difference between the AICPA auditor's report and that of the PCAOB is:
A. The PCAOB report is not signed by the auditor
B. The AICPA report is not signed by the auditor
C. The PCAOB report does not have section headings
D. Both reports are the same
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Analyze
Difficulty: 3 Hard
38. The title of the PCAOB auditor's report is:
A. Independent Auditor's Report
B. Report of the Independent Registered Audit Firm
C. Auditor's Report on Management's Financial Statements
D. Auditor's Report on Internal Controls
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-53
39. Some critics claim the usefulness of the audit report is limited because:
A. Auditors do not examine management's estimates and judgments
B. Language in the audit report relies on subjective evaluations such as what is meant by
"reasonable"
C. Transactions examined are based on sampling and other techniques to limit choices of
which transactions to audit
D. All of the above may create doubts about usefulness
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
40. Which of the following is not true of "reasonable assurance"?
A. The auditors have exercised due care
B. The audit opinion is a guarantee that material misstatements have been identified
C. The audit has been properly planned and supervised
D. The auditors have followed GAAS
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-54
41. 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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-55
42. Which of the following is not a consideration in determining a measure of materiality?
A. Risks of material misstatements due to fraud
B. Quantitative assessment of the importance of the difference of opinion with client

management on an accounting issues
C. Qualitative assessment of the importance of the difference of opinion with client

management on an accounting issues
D. Importance of audit committee in the organization
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
43. The SEC is concerned that auditors don't pay enough attention to qualitative factors affecting
materiality because:
A. Qualitative factors may cause quantitatively small misstatements to become material
B. Quantitative factors are not always useful
C. Quantitative factors cannot be accumulated to assess overall materiality
D. All are of concern to the SEC
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-56
44. 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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
45. Which of the following summarizes the essence of general standards of GAAS?
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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-57
46. Which of the following summarizes the essence of field work standards of GAAS?
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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
47. 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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-58
48. Because of the risk of material misstatement due to improper management representations, an
audit of financial statements in accordance with GAAS should be performed with:
A. Objective judgment
B. Professional skepticism
C. Internal controls
D. Due diligence
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
49. Gathering and objectively evaluating audit evidence requires the auditor to consider:
A. Whether an unmodified opinion should be issued
B. Whether a modified opinion should be issued
C. Whether the evidence is adequate to complete the audit
D. Whether the evidence is competent and sufficient enough to render an audit opinion
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-59
50. In an audit, the auditor has a requirement to 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
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
51. Audit procedures are different than audit evidence because:
A. Audit procedures address the competency and sufficiency of audit evidence
B. Audit procedures are specific acts performed by the auditor to gather evidence about
whether specific assertions are being met
C. Audit procedures are specific acts to assess whether the financial statements "present fairly"
D. Audit procedures do not have to be determined based on risk assessment
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-60
52. Audit documentation is critical to evidence gathering because:
A. It demonstrates that an audit has been conducted
B. It demonstrates professional skepticism
C. It substitutes for making audit judgments and estimates
D. All of the above
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
53. In gathering audit evidence, the accessibility of information may be a factor thereby influencing
which judgment trigger?
A. Confirmation
B. Overconfidence
C. Anchoring
D. Availability
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-61
54. PCAOB Standard 7 addresses engagement quality reviews and have as its objectives to:
A. Assess how an audit has been conducted and the appropriateness of the audit opinion
B. Assess the firm's own quality controls and the appropriateness of the audit opinion
C. Assess how an audit has been conducted and the firm's own quality control procedures
D. Assess whether materiality has been properly evaluated
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
55. PCAOB Standard 14 addresses audit results and requires:
A. Auditor's evaluation of internal controls
B. Auditor's determination of whether the auditor has obtained sufficient appropriate evidence
C. Auditor's evaluation of the applicable financial reporting framework
D. Auditor's independence
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-62
56. PCAOB Auditing Standard No.16 requires the auditor to communicate with the audit committee
all but:
A. Significant accounting policies and practices
B. Critical accounting practices and policies
C. Significant unusual transactions
D. The procedures followed by the auditor in evaluating evidence
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
57. PCAOB Auditing Standard No.16 requires the auditor to communicate with the audit committee
all but:
A. Going concern issues
B. Whether the auditor expects to modify the opinion
C. Any disagreements with management
D. The procedures followed to comply with generally accepted auditing standards
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-63
58. Which of the following audit deficiencies was identified most often in a study by the Center for
Audit Quality of SEC imposed sanctions?
A. Failure to gather sufficient competent evidence
B. Failure to exercise due care
C. Insufficient level of professional skepticism
D. Failure to obtain adequate evidence related to management representations
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
59. Which of the following is NOT one of the most common audit deficiencies identified in PCAOB
inspections?
A. Inadequate internal controls over financial reporting
B. Lack of independent audits
C. Lack of due care
D. Inability to exercise the appropriate level of professional skepticism
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
Learning Objective: 05-06 Explain PCAOB auditing standards
Topic: PCAOB Standards
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60. The main reason the PCAOB has charged Chinese affiliates of U.S. audit firms with failing to
provide sufficient documentary evidence of audits of Chinese companies listed on U.S.
exchanges is:
A. Audit firms are unable to gather sufficient competent evidential matter
B. Audit firms are not knowledgeable enough about Chinese accounting standards
C. Chinese regulatory agencies can be uncooperative in providing access to PCAOB regarding
their inspections of audit documents
D. Chinese regulatory agencies conduct inspections of the audit documents of the firms
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
Learning Objective: 05-06 Explain PCAOB auditing standards
Topic: PCAOB Standards
61. In the Loyalty and Fraud Reporting case, Ethan Lester pressured his friend Vic Jensen to:
A. Misappropriate funds from the company
B. Cover up Ethan's fraud
C. Be silent and not report Ethan's fraud to the audit committee
D. Give an unmodified audit report
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-65
62. In the ZZZZ best case, Barry Minkow was charged with:
A. A fraudulent insurance restoration scam
B. Insider trading on Lennar stock
C. Stealing from a San Diego church
D. Overcharging a LA housewife for carpet cleaning services
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
63. In the Imperial Valley Community Bank case, each of the following were reasons for the going
concern issue except:
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
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-66
64. The case which deals with assigning a quality review partner to an audit is:
A. ZZZZ Best
B. Imperial Valley Community Bank
C. Busy Season Planning
D. Rooster, Hen, Footer and Burger
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
65. The Tax Inversion case deals with:
A. Whether IFRS should be used for all subsidiaries following an acquisition
B. Whether IFRS should replace U.S. GAAP
C. Whether a quality reviewer should be chosen from outside the company
D. Whether a tax inversion should occur
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-67
66. The primary issue in the Rooster, Hen, Footer and Burger case is:
A. The timing of revenue recognition and shipping date of merchandise
B. Related party transactions
C. The timing of expense recognition on accrual accounts
D. The accounting for walnuts
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
67. Which of the following is NOT addressed in the Diamond Foods case?
A. Accounting for payments to walnut growers
B. Matching revenues with the proper period
C. Depreciation of almond trees
D. Misleading the external auditors
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-68
68. Bill Young's ethical dilemma was:
A. Whether the loan loss reserves of the bank were understated
B. Whether to file a whistle-blower's complaint with the SEC under Dodd-Frank
C. Whether to commit fraud to cover up stealing from the company
D. Whether to inform management or the regulatory authorities of illegal acts of an audit client
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
69. 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
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-69
70. The Groupon case deals with all but the following issues:
A. Improperly estimated customer returns
B. Improper recognition of gross revenue
C. Used a new innovative metric of "Adjusted Consolidated Segment Operating Income"
D. Blamed material weakness on their auditors EY
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
Essay Questions
5-70
71. Explain each of the three sides of the fraud triangle with respect to how it contributes toward
the possibility that fraud in the financial statements may be present. Are there differences with
respect to how each element might influence occupational fraud and fraudulent financial
statements? Explain.
One of the older and more basic concepts in fraud deterrence and detection is the "fraud
triangle." While researching his doctoral thesis in the 1950s, famed criminologist Donald R.
Cressey came up with this hypothesis to explain why people commit fraud.
The three key elements in the fraud triangle are opportunity, motivation, and rationalization.
Opportunity is the element over which business owners have the most control. Limiting
opportunities for fraud is one way a company can reduce it.
The opportunity to commit fraud is possible when employees have access to assets and
information that allows them to both commit and conceal fraud typically because of weak
internal controls including a lack of segregation of duties or oversight. Top management
typically overrides the controls when committing financial statements fraud while employees
may use the weaknesses to their advantage in perpetrating fraud.
Motivation is a pressure or a "need" felt by the person who commits fraud. It might be a
personal financial or other type of need, such as high medical bills or debts, or as a result of
bad personal habits as occurred in ZZZZ Best and Tyco where CEOs misappropriated company
resources for personal gain.
Motivators can also be financial oriented that affects business results. Pressures may exist to
meet or exceed financial analysts' earnings estimates or to qualify for high bonuses and/or to
inflate share prices and make stock options more valuable.
Lastly, employees may rationalize this behavior by determining that committing fraud is OK for
a variety of reasons. For those who are generally dishonest, it's probably easier to rationalize a
fraud. For those with higher moral standards, it's probably not so easy. They have to convince
themselves that fraud is OK with "excuses" for their behavior.
Common rationalizations include making up for being underpaid or replacing a bonus that was
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deserved but not received. A thief may convince himself that he is just "borrowing" money from
the company and will pay it back one day. Some embezzlers tell themselves that the company
doesn't need the money or won't miss the assets. Others believe that the company "deserves"
to have money stolen because of bad acts against employees.
Business owners and executives must take control of fraud by working on the portion of the
fraud triangle over which they have the most control: the opportunity to commit fraud. It may
be difficult for management to do anything about an employee's needs or rationalizations, but

by limiting opportunities for fraud, the company can reduce it to some extent.
This question provides an opportunity to review the GVV reasons and rationalizations
framework.
As you read the case, think about the following series of questions for the protagonist to
address after identifying the right thing to do including:
• How can they get it done effectively and efficiently?
• What do they need to say, to whom, and in what sequence?

• What will the objections or push-back be and, then,
• What would they say next? What data and examples do they need?
To assist you in the process of analyzing what actions should be taken by the protagonist, here
are the most frequent categories of argument or rationalization that we face when we speak
out against unethical practice.
Expected or Standard Practice: "Everyone does this, so it's really standard practice. It's even
expected."
Materiality: "The impact of this action is not material. It doesn't really hurt anyone."
Locus of Responsibility: "This is not my responsibility; I'm just following orders here."
Locus of Loyalty: "I know this isn't quite fair to the stakeholders, but I don't want to hurt my
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reports/team/boss/company."
Isolated Incident: "This is a one-time request; you won't be asked to do it again."
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-73
72. Explain the link between the opportunity to commit fraud and corporate governance systems.
An important factor in whether the opportunity to commit fraud exists is whether the corporate
governance system is operating as intended. If not, the opportunity to commit fraud is greater.
In cases such as Tyco, the board members were allowed to use company funds for personal
purposes to bring them along with the CEO's similar fraud (Dennis Kozlowski), and presumably
to buy their silence.
Prior to SOX, most boards of directors were not independent of management and, in many
cases including Tyco, board members were beholden to management for their positions. It was
highly unlikely the board served as a check on unethical behavior or fraudulent financial
statements. SOX requires an independent audit committee with one member being a financial
expert. The New York Stock Exchange requires a majority of board members to be independent
of management. These outside directors should meet separately with the internal auditors and
external auditors to get candid comments about management's performance, whether the
internal controls are operating as intended, and whether the financial statements are accurate
and reliable. PCAOB Standard No. 16 also requires specific communications between the
external auditors and the audit committee. Corporate governance has been tightened up in
almost all companies thereby making it less likely that, at least in the corporate governance
arena, the opportunity will exist to commit fraud.
Another factor that influences opportunity is organizational dissonance. Dissonance creates an

unhealthy organizational culture that can lead to fraud because employees so affected feel
more justified in committing fraud. When organizational ethics are low and an individual's
ethics are low, fraud is more likely to occur. On the other hand, if organizational ethics are high
while an individual's are low, there must be mechanisms built into the corporate governance
system such as a hot line and/or compliance officer to monitor ethical systems. Other
employees should be encouraged to speak up when they notice another employee violating
ethical standards. The hot line helps in that regard.
AACSB: Ethics
5-74
AICPA: FN Reporting
Blooms: Apply
5-75
73. Explain the circumstances under which an auditor should give each of the following opinions:
(a) Unmodified opinion

(b) Unmodified opinion with an emphasis-of-matter paragraph
(c) Qualified opinion
(d) Adverse opinion
Unmodified Opinion
Unmodified opinions are given when the financial statements present fairly financial position
and results of operations in accordance with GAAP and there are no material misstatements
that need to be corrected to conform to GAAP.
Unmodified opinion with an emphasis-of-matter paragraph
An emphasis-of-matter issue arises when questions exist about the going concern nature of a
client's operations perhaps because of a declining level of earnings, lack of adequate cash flows
to meet operating needs, and/or the inability of the client to raise needed funds. When a going
concern issue exists, the auditor should address management's plans to overcome the problem
in the future in the audit report.
An emphasis of matter issue also exists when GAAP have not been consistently applied. For
example, if a company changes the way they account for capitalized costs, such as capitalizing
them in one year and then expensing them in another, the change should be disclosed as well
as its effects of the financial results. Auditors should approve such changes; otherwise, a
modified opinion may be necessary.
Qualified opinion
A qualified opinion is generally given when a departure exists from GAAP that has a material
effect on the financial statements. The amount must be material but event(s) not pervasive
enough to issue an adverse opinion. If, in the previous example, a company was capitalizing
costs instead of expensing them in order to improve earnings, then a GAAP deficiency exists
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and should be disclosed if it has a material effect on the financial statements. GAAP issues are
disclosed in the audit report with language "except for the GAAP departure…the financial
statements present fairly…"
A qualified opinion also may be necessary when a scope limitation exists that prevents the
auditor from evaluating whether a GAAP deficiency exists. In such cases the language would be
"except for the scope limitation…the financial statements present fairly…"
Adverse opinion
An adverse opinion means the financial statements do not present fairly financial position and
results of operations because material differences exist on GAAP matters that have a pervasive
effect on the financial statements. For example, inventory differences over a period of time will
affect both the balance sheet and income statements through both the beginning and ending
inventories. If two or more differences on GAAP matters exist, then the effects also may be
pervasive. When such differences exist, the reasons for the adverse opinion must be given.
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-77
74. What is the purpose of having required auditor communications between the external auditor
and the audit committee?
The audit committee helps those charged with governance fulfill their oversight responsibilities
with respect to the entity's financial reporting process and the system of internal control. In
exercising this oversight responsibility, the audit committee needs information from the external
auditors about their experiences assessing internal controls and corporate governance as well
as any issues faced during their audit that involve differences with management on financial
reporting issues. The audit committee should support the external auditors in their role to
ensure the examination of the financial statements proceeds as required under generally
accepted auditing and PCAOB standards. The audit committee serves as a check on ethical
systems in the organization.
The PCAOB has no jurisdiction over audit committees, so PCAOB Auditing Standard 16,
Communications with Audit Committees, has requirements which are aimed strictly at external
auditors. The standard requires auditors to:
• Establish the understanding of the terms of the audit engagement with the audit committee.
The terms of the engagement must be recorded in an engagement letter.
• Provide audit committees with an overview of the overall audit strategy, including the timing
of the audit, significant risks the auditor identified, and significant changes to the planned audit
strategy or risks.
• Provide information about others involved in the audit, including internal auditors or other
independent public accounting firms.

• Give information regarding the company's accounting policies, practices, estimates, and
significant unusual transactions.

• Provide an evaluation of the quality of the company's financial reporting, including
conclusions regarding critical accounting estimates and the company's financial statement
presentation; difficult or contentious matters for which the auditor consulted outside the
engagement team; the auditor's evaluation of the company's ability to continue as a going
concern; and difficulties encountered in performing the audit.
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Given the importance of an independent audit in detecting fraud in financial statements, the
auditor should discuss with the audit committee relationships that create threats to auditor
independence and the related safeguards that have been applied to eliminate or reduce those
threats to an acceptable level.
Another important area for communication is about accounting estimates. Certain accounting
estimates are particularly sensitive because of their significance to the financial statements and
because of the possibility that future events affecting them may differ significantly from
management's current judgments. In communicating with those charged with governance
about the process used by management in formulating sensitive estimates, including fair value
estimates, and about the basis for the auditor's conclusions regarding the reasonableness of
those estimates, the auditor should consider the following:
• The nature of significant assumptions
• The degree of subjectivity involved in the development of the assumptions, and

• The relative materiality of the items being measured to the financial statements as a whole.
If the auditor, as a result of the assessment of the risks of material misstatement, has identified
such risks due to fraud that have continuing control implications the auditor should consider
whether these risks represent significant deficiencies or material weaknesses in the entity's
internal controls that should be communicated to management and those charged with
governance. The auditor should also consider whether the absence of or deficiencies in controls
to prevent, deter, and detect fraud represent significant deficiencies or material weaknesses
that should be communicated to management and those charged with governance.
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AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-80
75. Why is materiality one of the most difficult judgments to make in auditing financial
statements?
Materiality underlies financial statement assertions and have a pervasive effect in a financial
statement audit. In conducting an audit, the auditor should consider materiality in planning the
audit and in evaluating the fair presentation of the financial statements in accordance with an
identified financial reporting framework.
The determination of materiality is a matter of professional judgment. In determining the

materiality of an item, the auditor considers not only the item's nature and amount relative to
the financial statements, but also the needs of financial statement users.
Materiality has to be considered before a detailed audit program can be prepared. In the initial
planning, however, an auditor cannot anticipate all of the factors that will ultimately influence
the materiality judgment in the evaluation of audit results at the completion of the audit.
Therefore, these factors must be considered as they arise, and materiality must be evaluated
throughout the audit.
Materiality has significant implications for audit efficiency. To be efficient, an auditor should not
spend time examining balances where there is no chance of a material error. Sometimes, in an
audit of a small entity, there is a temptation to audit everything because it does not seem as
though it will take much time when individual items are considered. The unnecessary time can,
however, add up to a significant amount overall.
Material information means information that matters, is important or essential. In terms of

accounting, it pertains to information that is to be recognized, measured or disclosed in
accordance with the requirements of generally accepted accounting principles. In measuring or

disclosing accounting information, emphasis is on the needs of known or perceived users. In
auditing, materiality pertains to the largest number (threshold) of uncorrected errors,
misstatements, or erroneous disclosures or omissions that exist in the financial statements and
yet are not misleading. The auditor plans and executes an audit with a reasonable expectation
of detecting material misstatements. The assessment of what is material is a matter of the
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auditor's professional judgement of the needs of the reasonable person relying on the
information.
Financial statements are materially misstated when they contain errors or irregularities whose
effect, individually or in the aggregate, is important enough to prevent the statements from
being presented fairly in accordance with GAAP. In this context, misstatements may result from
misapplication of applicable accounting standards, departures from fact, or omissions of
necessary information.
In assessing the quantitative importance of a misstatement, it is necessary to relate the

monetary amount of the error to the financial statement under examination. For example, an
item of revenue may be compared to net income for materiality determinations. In planning the
examination, the auditor generally is concerned only with misstatements that are quantitatively
material. In evaluating audit evidence, the auditor considers both quantitative and qualitative
misstatements.
There is no universally agreed upon guideline on quantitative measures of materiality. Here is

an example of making materiality determinations:
1. An amount which is equal to or greater than 10 per cent of an appropriate base amount is
presumed to be material.
2. An amount which is equal to or less than 5 per cent of an appropriate base amount may be
presumed not to be material.

3. To determine whether an amount between 5 per cent and 10 per cent is material is a matter
of judgment.
The emphasis in planning materiality is on quantitative considerations. Since the errors are not
yet known, their qualitative effect can be considered only during the testing phase of the audit
as evidence becomes available. Qualitative considerations relate to the causes of

misstatements. A misstatement that is quantitatively immaterial may be qualitatively material.
This may occur, for instance, when the misstatement is attributable to an irregularity or an
illegal act by the client. Discovery of either occurrence might cause the auditor to conclude
there is a significant risk of additional similar misstatements. Other examples of qualitative
misstatements are found in Staff Accounting Bulletin (SAB 99). In it, the SEC lists some of the
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qualitative factors that may cause quantitatively small misstatements to become material,
including:
• It arises from an item capable of precise measurement.

• It arises from an estimate and, if so, the degree of imprecision inherent in the estimate.
• It masks a change in earnings or other trends.

• It hides a failure to meet analysts' consensus expectations for the enterprise.
• It changes a loss into income or vice versa.

• It concerns a segment or other portion of the registrant's business that has been identified as
playing a significant role in the registrant's operations or profitability.
• It affects the registrant's compliance with regulatory requirements.

• It affects the registrant's compliance with loan covenants or other contractual requirements.
• It has the effect of increasing management's compensation—for example, by satisfying the
requirements for the award of bonuses or other forms of incentive compensation.

• It involves concealment of an unlawful transaction.
Auditors should be on the alert for these red flags, which signal that qualitatively material items
may not have been recorded and disclosed in accordance with GAAP.
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
5-83
76. 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?
An error can occur due to unintentional misstatements or omissions of amounts or disclosures
in the financial statements. Errors may involve mistakes in gathering or processing data,
unreasonable accounting estimates arising from oversight or misinterpretation of facts, or
mistakes in the application of GAAP. Auditors are responsible for detecting errors that have a
material effect on the financial statements and reporting their findings to the audit committee.
Errors are typically recorded by adjusting the opening balance of retained earnings for the prior
period adjustment to net income.
Errors are unintentional. No one makes an error on purpose because it negatively reflects on
one's abilities. As long as the person causing the error admits it, takes responsibility for her
actions, and promises to be more careful in the future, the ethics of making an error are not in
question.
Fraud is a deliberate act intended to deceive others. Fraud does not happen by accident as
might an error. Auditors should be sensitive to red flags that warn fraud is possible, if not likely.
Fraud, whether fraudulent financial reporting or misappropriation of assets, involves incentive
or pressure to commit fraud, a perceived opportunity to do so, and some rationalization of the
act. A fraud occurs when an individual(s) in management, those charged with governance,
employees or third parties, use deception in a way that results in a material misstatement in the
financial statements. In its most common form, management fraud involves top management's
deceptive manipulation of financial statements.
Fraud is a deceptive act and as such an unethical act. It is based on egoism without regard for
the interests of those affected by the fraud such as shareholders and investors. Those who
commit fraud are engaging in an illegal act and may be prosecuted for their actions. The
internal controls of an organization should be designed to ferret out fraud by looking for the
red flags and dealing with ethical pressures within the organization.
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Illegal acts are violations of laws or governmental regulations. For example, a violation of the
Foreign Corrupt Practices Act (FCPA) that prohibits bribery constitutes an illegal act. Illegal acts
include those attributable to the entity whose financial statements are under audit or as acts by
management or employees acting on behalf of the entity. The auditor's responsibility is to
determine the proper accounting and financial reporting treatment of a violation once it has
been determined that a violation has in fact occurred.
Illegal acts not only violate specific laws but are clear violations of ethical behavior. The
auditor's responsibility is to detect and report misstatements resulting from illegal acts that
have a direct and material effect on the determination of financial statement amounts (i.e., they
require an accounting entry). The auditors' responsibility for detecting direct and material effect
violations is greater than their responsibility to detect illegal acts arising from laws that only
indirectly affect the client's financial statements. An example of the former would be violations
of tax laws that affect accruals and the amount recognized as income tax liability for the period.
Tax law would be violated, triggering an adjustment in the current period financial statements if,
say, a company, for tax purposes, were to expense an item all in one year that should have
been capitalized and written off over three years. Examples of items with an indirect effect on
the statements include the potential violation of other laws such as occupational safety and
health, environmental protection, and equal employment regulations. The events are due to
operational, not financial, matters and their financial statement effect is indirect, such as a
possible contingent liability that should be disclosed in the notes to the financial statements.
The auditor's obligation when she concludes that an illegal act has or is likely to have occurred
is first to assess the impact of the actions on the financial statements including materiality
considerations. This should be done regardless of any direct or indirect effect on the
statements. The auditor should consult with legal counsel and any other specialists in this
regard. Illegal acts should be reported to those charged with governance such as the audit
committee. The auditor should consider whether the client has taken appropriate remedial
action concerning the act. Such remedial action may include taking disciplinary actions,
establishing controls to safeguard against recurrence, and, if necessary, reporting the effects of
the illegal acts in the financial statements. Ordinarily, if the client does not take the remedial
action deemed necessary by the auditor, then the auditor should withdraw from the
engagement. This action on the part of the auditor makes clear that she will not be associated
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in any way with illegal activities.
The auditor should assure herself that the audit committee is informed as soon as practicable
and prior to the issuance of the auditor's report with respect to illegal acts that come to the
auditor's attention. The auditor need not communicate matters that are clearly inconsequential
and may reach agreement in advance with the audit committee on the nature of such matters
to be communicated. The communication should describe the act, the circumstances of its
occurrence, and the effect on the financial statements.
The standards for reporting illegal acts seem to err on the side of protecting the auditor's
position in a legal matter rather than strict honesty because certain items can be ignored even
though they violate the law. Honesty requires that we should express the truth as we know it
and without deception. As we point out in the text, it is our belief that by leaving out truthful
(inconsequential) information in auditor communications, the standards sanction unethical
behavior. We believe that it is a slippery slope once distinctions are made as to whether acts
that are inherently wrong by their nature are not reported. Moreover, even inconsequential
items can become consequential if the pattern of misstatement persists.
The Private Securities Litigation Reform Act (PSLRA) of 1995 places additional requirements
upon public companies registered with the SEC and their auditors when (1) the illegal act has a
material effect on the financial statements, (2) senior management and the board of directors
have not taken appropriate remedial action, and (3) the failure to take remedial action is
reasonably expected to warrant departure from a standard (i.e., unmodified audit report) or to
warrant resignation.
When the auditor believes that the illegal act has a material effect on the financial statements
and the matter has been reported to the client, the board of directors has one business day to
inform the SEC. If the board decides not to inform the SEC, the auditor must provide the same
report to the SEC within one business day or resign from the engagement within one business
day. In either case, the ethical obligation of confidentiality is waived so that the auditor can
provide the necessary information and the SEC can live up to its responsibility to protect
investor interests. If auditors do not fulfill this legal obligation, the SEC can impose a monetary
fine on them.
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Notwithstanding the reporting obligations described above, disclosure of an illegal act to
parties other than the client's senior management and its audit committee or board of directors
is not ordinarily part of the auditor's responsibility, and such disclosure would be precluded by
the auditor's ethical or legal obligation of confidentiality, unless the matter affects his opinion
on the financial statements.
This is a good time to remind students of Exhibit 5.1 in the text that summarizes auditors'
responsibilities with respect to reporting errors, illegal acts and fraud.
Exhibit 5.1
Auditors’ Responsibility to Detect Errors, Illegal Acts, and Fraud
Responsible for Detection Required to Communicate Findings
Material Immaterial Material Immaterial
Errors Yes No Yes (audit No

committee)
Illegal acts Yes (direct effect) No Yes (audit Yes (one level above)
committee)
Fraud Yes No Yes (audit Yes (by low-level employee,

committee) to one level above) (by
management-level
employee, to audit
committee)
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-87
77. Internal controls, an internal audit function, and an audit committee are all elements of a strong
corporate governance system. How should an external auditor evaluate these elements in
making a risk assessment? What are the ethical signs that each system is operating as
intended?
The internal audit function should be an independent one with direct links between the internal
auditors and audit committee so that top management does not have the opportunity to
interfere in the reporting process. The ethical values of due care, responsibility, and
accountability support an independent internal audit committee function. Internal controls

should provide the foundation for proper accounting and reporting by establishing a control
environment that fosters an ethical culture through the tone at the top set by management.
Top management should promote honesty and integrity in the financial reporting systems. The
corporate governance system establishes how matters of concern will be handled within the
organization and with the external auditors. There should be clear communication lines within
the organization for the internal auditors. The audit committee should be informed and actively
involved in overseeing the financial reporting process. Risk assessment depends on the strength
of these systems and whether they are operating as intended.
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
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78. Campus Fast is a new audit client. Client Fast uses public WiFi 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 WiFi 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. The reason is Campus Fast is
concerned that an interested buyer may become concerned 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 assess the internal controls at Campus Fast and risk
environment.
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
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are trying to cover up and keep off the balance sheet), control activities, information and
communications systems (liability of using unsecured WiFi), and monitoring. Corporate

governance issues exist although we do not know whether oversight mechanisms were in place
to serve as a check on management behavior.
This is a case where the two students suffered from ethical blindness. They did not consider that
their policies and practices had (negative) consequences for the stakeholders and cutting
corners to achieve a goal is never a good idea. There appears to be no oversight of the internal
controls. The culture of the company seems to be do whatever it takes to grow and become an
attractive IPO candidate. The owners are acting out of egoism and practicing dangerous
advertising and delivery systems. It could be that the culture filters down to the workers who
are careless in making deliveries and, perhaps, with Internet activity.
AACSB: Ethics
AICPA: FN Reporting
Blooms: Apply
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79. Identify the deficiencies in the following audit report of the AICPA. Explain why each item is a
deficiency.
Report of the Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders, XYZ Company
We have audited the accompanying consolidated financial statements of XYZ Company and its
subsidiaries, which comprise the consolidated balance sheets as of December 31, 2015 and
2014, and the related consolidated statements of income, changes in stockholders' equity, and
cash flows for the years then ended, and the related notes to the financial statements. These
statements are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
Management's Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated
financial statements in accordance with accounting principles generally accepted in the United
States of America; this includes the design, implementation, and maintenance of internal
control relevant to the preparation and fair presentation of consolidated financial statements
that are free from material misstatement, whether due to fraud or error.
Auditor's Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on
our audits. We conducted our audits in accordance with auditing standards of the Public
Company Accounting Oversight Board. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the consolidated financial statements are
free of material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the consolidated financial statements. The procedures selected depend on the
management's judgment, including the assessment of the risks of material misstatement of the
consolidated financial statements, whether due to fraud or error. In making those risk
assessments, the auditor considers internal controls relevant to the entity's preparation and fair
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presentation of the consolidated financial statements in order to design audit procedures that
are appropriate in the circumstances. Accordingly, we express no such opinion. An audit also
includes evaluating the appropriateness of accounting policies used and the reasonableness of
significant accounting estimates made by during the audit, as well as evaluating the overall
presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of XYZ Company and its subsidiaries as of December 31,
2013, and 2012, and the results of its operations and its cash flows for the years then ended in
accordance with auditing standards of the Public Company Accounting Oversight Board.
Optional Paragraph
Report on Other Legal and Regulatory Requirements
[Auditor's signature]
[Auditor's city and state]
Deficiencies
• Title should be Independent Auditor's Report
• Introductory Paragraph is not labeled

• Responsibilities of management and the auditor are included in the introductory paragraph
not in the separate Management's Responsibility for the Financial Statements paragraph.
• Reference in Management's Responsibility section to PCAOB standards should be replaced

with generally accepted in the United States of America.
• Auditor's Responsibility section indicates it is management's judgments as to which auditing
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procedures are selected; it should say auditor's judgment
• The statement in the Auditor's Responsibility section "In making those risk assessments, the
auditor considers internal controls relevant to the entity's preparation and fair presentation of
the consolidated financial statements in order to design audit procedures that are appropriate
in the circumstances" fails to include: but not for the purpose of expressing an opinion on the
effectiveness of the entity's internal controls. This makes it seem the report also opines on
internal controls.
• Related to the point above, the following statement is omitted after the sentence in the point:
"Accordingly, we express no such opinion."
• Reference to "reasonable estimates made" in the last sentence of the Auditor's Responsibility
paragraph indicates those estimates are made by the auditors; it should be management.
• The opinion paragraph refers to PCAOB standards not accounting principles generally
accepted in the United States of America.
• Date of auditor's report is omitted
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
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80. On July 1, 2015, the Public Company Accounting Oversight Board issued a concept release to
seek public comment on the content and possible uses of a group of potential "audit quality
indicators." The indicators are a potential portfolio of quantitative measures that may provide
new insights about how to evaluate the quality of audits and how high quality audits are
achieved. Taken together with qualitative context, the indicators may inform discussions among
those concerned with the financial reporting and auditing process, for example among audit
committees and audit firms. Enhanced discussions, in turn, may strengthen audit planning,
execution, and communication. The Board sought advice on these subjects through the
comment process and were to convene a public roundtable about the concept release, on a
date to be determined during the fourth quarter of 2015. The proposed indicators are in the
exhibit below.
Required:
Comment on the need for audit quality indicators and any limitations of providing such
information in the public domain.
The 28 potential indicators are:
AUDIT Availability 1. Staffing Leverage

PROFESSIONALS 2. Partner Workload
3. Manager and Staff Workload

4. Technical Accounting and Auditing Resources
5. Persons with Specialized Skill and Knowledge
Competence 6. Experience of Audit Personnel

7. Industry Expertise of Audit Personnel
8. Turnover of Audit Personnel
9. Amount of Audit Work Centralized at Service Centers
10. Training Hours per Audit Professional
Focus 11. Audit Hours and Risk Areas

12. Allocation of Audit Hours to Phases of the Audit
AUDIT PROCESS Tone at the Top 13. Results of Independent Survey of Firm Personnel
and Leadership
Incentives 14. Quality Ratings and Compensation
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15. Audit Fees, Effort, and Client Risk
Independence 16. Compliance with Independence Requirements
Infrastructure 17. Investment in Infrastructure Supporting Quality Auditing
Monitoring and 18. Audit Firms' Internal Quality Review Results

Remediation 19. PCAOB Inspection Results
20. Technical Competency Testing
AUDIT RESULTS Financial 21. Frequency and Impact of Financial Statement

Statements Restatements for Errors
22. Fraud and other Financial Reporting Misconduct
23. Inferring Audit Quality from Measures of Financial
Reporting Quality
Internal Control 24. Timely Reporting of Internal Control Weaknesses
Going Concern 25. Timely Reporting of Going Concern Issues
Communications 26. Results of Independent Surveys of Audit Committee

between Auditors Members
and Audit
Committee
Enforcement and 27. Trends in PCAOB and SEC Enforcement Proceedings

Litigation 28. Trends in Private Litigation
The following is taken from a response issued by the Center for Audit Quality (CAQ) to the
PCAOB proposal.
Due to the dynamic nature, inherent complexity, and variability of public companies and their
audits, audit quality indicators (AQIs) alone (whether input or output measures) without context
cannot adequately communicate factors relative to the audit of any particular engagement or
firm. However, the right AQIs as determined by the audit committee could provide perspective
on factors that may contribute to or detract from audit quality. Quantitative AQIs can only
inform this perspective when accompanied by appropriate context. The context is best achieved
through dialogue between the audit engagement team and the audit committee.
5-95
Given this need for context through dialogue, and the audit committee's important audit
oversight role on behalf of investors, the CAQ believe that the right set of AQIs as determined
by the audit committee can help promote and enhance the audit committee's and auditor's
focus on audit quality. The audit committee is best positioned to receive, interpret, and
ultimately respond, if necessary, based on the information provided by AQIs.
The CAQ believes that AQIs should be used and reported voluntarily given that the
development of AQIs is in the early stages. Furthermore, there is insufficient evidence of the
correlation between any one set of AQIs and audit quality outcomes. A voluntary approach
would give audit committees the most flexibility and opportunity both to tailor the information
to matters that are most relevant to their oversight and to engage in the necessary two-way
dialogue that can provide the appropriate context to enable them to interpret the AQIs and
ultimately respond if necessary. Moreover, mandating the communication or reporting of
specific AQIs could burden audit committees with required communication of AQIs which may
not be relevant to the particular facts and circumstances of their audit engagement.
CAQ also believes that mandatory public reporting of AQIs is not appropriate due to the early-
stage nature of AQI concepts and the necessity of the contextual discussion to interpreting
AQIs. AQIs are a data point or collection of data points that may be directional in nature. Any
AQI or set of AQIs needs to be evaluated in their complete context. As a result, CAQ concludes
that focusing efforts on providing the audit committee with additional information about the
audit is a prudent step with respect to any AQI effort to (1) allow the audit committee to
determine what information is relevant to their oversight of the audit, (2) take into account the
audit's particular facts and circumstances and (3) allow for the two-way dialogue that is
necessary to put the AQIs into context.
Also, CAQ is concerned that mandatory public reporting may create a perception that an
arbitrarily selected measurement, or a range of measurements, could serve as a "benchmark."
For instance, a ratio of audit partners to staff varies from audit engagement to audit
engagement. Staffing decisions require context and principally reflect the auditor's judgment.
The engagement team's dialogue with the audit committee allows the audit committee to
consider whether the ratio is appropriate based on the specific facts and circumstances; without
5-96
this context and dialogue, one might erroneously presume that a particular number is more
indicative of audit quality.
AACSB: Ethics
AICPA: BB Legal
AICPA: FN Reporting
Blooms: Apply
5-97
Another random document with
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ejaculating, “You ——, you call de Dutchmans half-breeds, you do,
do you?” made at him with his fists; but his comrades almost choking
with laughter, held him off the horrified Brown, whose fear of
instantaneous immolation at the hands of the fiery Dutchlander had
blanched his cheek to a turnip color.
The captain then told Brown that he must consider himself under
arrest, and remain there. He was taken out to Dempsey’s house and
kept there till the examination and trial of Red was concluded. Being
then brought in and questioned, he testified that Red came to
Dempsey’s and said that he was going to see the boys, and asked if
Brown had anything to tell them, offering to carry the letter. He said
that Red was Ives’ cousin, (this was untrue;) that he wrote the letter
advising them to leave, for that the Vigilantes were after them.
At Smith’s Ranch it had been found, on comparing notes, that the
statements of Red to the successive portions of the command that
he had met while crossing the Divide, were not consistent, and, as
frequently happens, the attempt at deception had served only to
bring out the truth. Red was incontrovertibly proven to be one of the
gang. The confession of each man conclusively established the guilt
of the other.
A guard was placed over the two men and the remainder of the
Vigilantes went out on the bridge and took a vote upon the question
as to whether the men should be executed or liberated. The captain
said, “All those in favor of hanging those two men step to the right
side of the road, and those who are for letting them go, stand on the
left.” Before taking the vote he had observed to them, “Now, boys,
you have heard all about this matter, and I want you to vote
according to your consciences. If you think they ought to suffer
punishment, say so. If you think they ought to go free vote for it.” The
question having been put, the entire command stepped over to the
right side, and the doom of the robbers was sealed.
One of the party, who had been particularly lip-courageous now
began to weaken, and discovered that he should lose $2,000 if he
did not go home at once. Persuasion only paled his lips, and he
started off. The click! click! click! of four guns, however, so far
directed his fears into an even more personal channel, that he
concluded to stay.
The culprits were informed that they should be taken to Virginia,
and were given in charge to a trustworthy and gallant man, with a
detachment of seven, selected from the whole troop. This escort
reached Lorraine’s in two hours. The rest of the men arrived at sun
down. The prisoners were given up, and the leader of the little party,
who had not slept for four or five nights, lay down to snatch a brief,
but welcome repose. About 10 p. m., he was awakened, and the
significant, “We want you,” announced “business.”
The tone and manner of the summons at once dispelled even his
profound and sorely needed slumber. He rose without further parley
and went from the parlor to the bar-room where Red and Brown
were lying in a corner, asleep. Red got up at the sound of his
footsteps, and said, “You have treated me like a gentleman, and I
know I am going to die—I am going to be hanged.” “Indeed,” said his
quondam custodian, “that’s pretty rough.” In spite of a sense of duty,
he felt what he said deeply. “It is pretty rough,” continued Yager, “but
I merited this, years ago. What I want to say is that I know all about
the gang, and there are men in it that deserve this more than I do;
but I should die happy if I could see them hanged, or know that it
would be done. I don’t say this to get off. I don’t want to get off.” He
was told that it would be better if he should give all the information in
his possession, if only for the sake of his kind. Times had been very
hard, and “you know, Red,” said the Vigilanter, “that men have been
shot down in broad day light—not for money, or even for hatred, but
for luck, and it must be put a stop to.”
To this he assented, and the captain being called, all that had
passed was stated to him. He said that the prisoner had better begin
at once, and his words should be taken down. Red began by
informing them that Plummer was chief of the band; Bill Bunton
second in command and stool pigeon; Sam Bunton, roadster, (sent
away for being a drunkard;) Cyrus Skinner, roadster, fence and spy.
At Virginia City, George Ives, Steven Marshland, Dutch John
(Wagner,) Aleck Carter, Whiskey Bill, (Graves,) were roadsters; Geo.
Shears was a roadster and horse-thief; Johnny Cooper and Buck
Stinson were also roadsters; Ned Bay was council-room keeper at
Bannack City; Mexican Frank and Bob Zachary were also roadsters;
Frank Parish was roadster and horse-thief; Boon Helm and Club-
Foot George were roadsters; Haze Lyons and Bill Hunter were
roadsters and telegraph men; George Lowry, Billy Page, Doc
Howard, Jem Romaine, Billy Terwilliger and Gad Moore were
roadsters. The pass-word was “Innocent.” They wore a neck-tie
fastened with a “sailor’s knot,” and shaved down to moustache and
chin whiskers. He admitted that he was one of the gang; but denied
—as they invariably did—that he was a murderer. He also stated that
Brown—his fellow captive—acted in the capacity before mentioned.
He spoke of Bill Bunton with a fierce animosity quite unlike his
usual suave and courteous manner. To him, he said, he owed his
present miserable position. He it was that first seduced him to
commit crime, at Lewiston. He gave the particulars of the robberies
of the coaches and of many other crimes, naming the perpetrators.
As these details have been already supplied or will appear in the
course of the narrative, they are omitted, in order to avoid a useless
repetition.
After serious reflection, it had been decided that the two culprits
should be executed forthwith, and the dread preparations were
immediately made for carrying out the resolution.
The trial of George Ives had demonstrated most unquestionably
that no amount of certified guilt was sufficient to enlist popular
sympathy exclusively on the side of justice, or to render the just man
other than a mark for vengeance. The majority of men sympathize, in
spite of the voice of reason, with the murderers instead of the
victims; a course of conduct which appears to us inexplicable,
though we know it to be common. Every fibre of our frame vibrates
with anger and disgust when we meet a ruffian, a murderer or a
marauder. Mawkish sentimentalism we abhor. The thought of
murdered victims, dishonored females, plundered wayfarers, burning
houses, and the rest of the sad evidences of villainy, completely
excludes mercy from our view. Honor, truth and the sacrifice of self
to considerations of justice and the good of mankind—these claim,
we had almost said our adoration; but for the low, brutal, cruel, lazy,
ignorant, insolent, sensual and blasphemous miscreants that infest
the frontiers, we entertain but one sentiment—aversion—deep,
strong, and unchangeable. For such cases, the rope is the only
prescription that avails as a remedy. But, though such feelings must
be excited in the minds of good citizens, when brought face to face
with such monsters as Stinson, Helm, Gallagher, Ives, Skinner, or
Graves, the calm courage and penitent conduct of Erastus Yager
have the opposite effect, and the loss of the goodly vessel thus
wrecked forever, must inspire sorrow, though it may not and ought
not to disarm justice.
Brief were the preparations needed. A lantern and some stools
were brought from the house, and the party, crossing the creek
behind Lorraine’s Ranch, made for the trees that still bear the marks
of the axe which trimmed off the superfluous branches. On the road
to the gallows, Red was cool, calm and collected. Brown sobbed and
cried for mercy, and prayed God to take care of his wife and family in
Minnesota. He was married to a squaw. Red, overhearing him, said,
sadly but firmly, “Brown, if you had thought of this three years ago,
you would not be here now, or give these boys this trouble.”
After arriving at the fatal trees, they were pinioned and stepped on
to the stools, which had been placed one on the other to form a drop.
Brown and the man who was adjusting the rope, tottered and fell into
the snow; but recovering himself quickly, the Vigilanter said quietly,
“Brown we must do better than that.”
Brown’s last words were, “God Almighty save my soul.”
The frail platform flew from under him, and his life passed away
almost with the twang of the rope.
Red saw his comrade drop; but no sign of trepidation was visible.
His voice was as calm and quiet as if he had been conversing with
old friends. He said he knew that he should be followed and hanged
when he met the party on the Divide. He wished that they would
chain him and carry him along to where the rest were, that he might
see them punished. Just before he was launched into eternity, he
asked to shake hands with them all, which having done, he begged
of the man who had escorted him to Lorraine’s, that he would follow
and punish the rest. The answer was given in these words, “Red we
will do it, if there’s any such thing in the book.” The pledge was kept.
His last words were, “Good bye, boys; God bless you. You are on
a good undertaking.” The frail footing on which he stood gave way,
and this dauntless and yet guilty criminal died without a struggle. It
was pitiful to see one whom nature intended for a hero, dying—and
that justly—like a dog.
A label was pinioned to his back bearing the legend:
“Red! Road Agent and Messenger.”
The inscription on the paper fastened on to Brown’s clothes was:
“Brown! Corresponding Secretary.”
The fatal trees still smile as they don the green livery of Spring, or
wave joyfully in the Summer breeze; but when the chill blast of winter
moans over the snow-clad prairie, the wind sighing and creaking
through the swaying boughs seems, to the excited listener, to be still
laden with the sighs and sounds of that fatal night. Fiat Justitia
ruat cælum.
The bodies were left suspended, and remained so for some days
before they were buried. The ministers of justice expected a battle
on their arrival at Nevada; but they found the Vigilantes organized in
full force, and each man, as he uncocked his gun and dismounted,
heaved a deep sigh of relief. the crisis was past.
CHAPTER XVII.
DUTCH JOHN (WAGNER.)
“Give me a horse! Bind up my wounds!”—Richard III.

The tidings of Ives’ execution and the deep and awe-striking news
of the organization of the Vigilantes in the camps on Alder Gulch,
flew like wildfire, exciting wherever they were received, the most
dread apprehension in the minds of those whose consciences told
them that their capture and their doom were convertible terms.
Among these men was Dutch John (Wagner.) His share in the
robbery of the train, and his wound from the pistol of Lank Forbes,
pressed upon his memory. By a physical reminder, he was prevented
from forgetting, even in his sleep, that danger lurked in every valley,
and waited his coming on every path and track by which he now
trusted to escape from the scene of his crimes. Plummer advised
him to leave the Territory at once, but he offered him no means of
locomotion. This, however, was of small consequence to Wagner. He
knew how to obtain a remount. Taking his saddle on his back, he
started for the Ranch of Barret & Shineberger, on Horse Prairie
where he knew there was a splendid gray horse—the finest in the
country. The possession was the trouble—the title was quite
immaterial. A friend seeing him start from Bannack with the saddle,
sent word to the owners of the gallant gray, who searched for him
without delay, taking care to avoid the willows for fear of a shot. One
of them, after climbing a hill, discovered the robber sitting among the
underwood. The place was surrounded and the capture was made
secure.
Short shrift was he allowed. His story was disbelieved, and his
captors went for his personal outfit, if not for his purse. They lectured
him in the severest terms on the depravity which alone rendered
horse stealing possible, and then started him off down the road,
minus his saddle and pistol, but plus an old mule and blanket.
With these locomotive treasures, Dutch John left Horse Prairie,
and took the Salt Lake road. He was accompanied by an Indian of
the Bannack tribe, armed with bow, quiver and knife. Ben. Peabody
was the first who espied them. He was going to Salt Lake City with a
cayuse pack-train, for goods, and saw the Road Agent and his
aboriginal companion at Dry Creek Canyon Ranch, since used by
Oliver & Co., as a station on the road to the metropolis of the Latter
Day Saints.
About two miles below this place, he met Neil Howie, who was
coming from the same City of Waters, along with three wagons laden
with groceries and flour. A long consultation was the consequence,
and a promise was given that the aid of the train men would be given
to secure the fugitive from justice. The same pledge was obtained
from Neil’s own party, and from the owner of a big train further down.
Shortly after, Dutch John and the Indian hove in sight; but this did
not mend matters, for the parties “weakened” at once, and left Neil
cursing their timidity, but determined that he should not escape.
Wagner rode up and asked for some tobacco. He was told that they
had none to spare, but that there was a big train (Vivion’s) down
below, and that he might get some there. During the conversation he
looked suspicious and uneasy; but at last went on, parting amicably
from them, and attended by his copper colored satellite, whose stolid
features betrayed no sign of emotion. Neil felt “bad” but determined
that his man should not escape thus easily, he mounted his pony
and galloped after him, resolved to seek for help at the big train. He
soon came up with the pair, and Neil fancied that Wagner gave some
directions to the Indian, for he put his hand to his quiver, as if to see
that all was right for action. Dutch John held his rifle ready and
looked very suspiciously at Neil. The Indian kept behind, prepared
for business.
After the usual salutations of the road, Neil told John that he
wanted to borrow a shoeing hammer to prepare his stock for
crossing the Divide, and thereupon he noticed a sudden, joyful
expansion in the eyes of Dutch John, and, with a friendly salute they
parted company.
It was ticklish work for Neil to ride with his back to Wagner, right
under the muzzle of his rifle, but the brave fellow went along as if he
suspected nothing, and never drew rein till he came to the train. The
owner—who had often lectured, in strong language, on the proper
way to deal with (absent) Road Agents—backed square down,
notwithstanding all the arguments of Neil, some of which were of a
nature to bring out any concealed courage that his friend possessed.
Wagner rode up, and glancing quickly and sharply at the two
conversing, asked for tobacco, and received for reply—not the
coveted weed—but an inquiry as to whether he had any money;
which not being the case, he was informed that there was none for
him. Neil immediately told the trader to let the man have what he
wanted, on his credit. Wagner appeared deeply grateful for this act
of kindness, and having received the article, set forward on his
journey. Neil made one more solemn appeal not to “let a murderer
and Road Agent escape;” but the train-owner said nothing.
In an instant he determined to arrest the robber at all risks, single
handed. He called out, “Hallo, Cap; hold on a minute.” Wagner
wheeled his horse half round, and Neil fixing his eyes upon him,
walked straight towards him, with empty hands. His trusty revolver
hung at his belt; however, and those who have seen the machine-
like regularity and instantaneous motion with which Howie draws and
cocks a revolver, as well as the rapidity and accuracy of his shooting,
well know that few men, if any, have odds against him in an
encounter with fire-arms. Still not one man in a thousand would, at a
range of thirty yards, walk up to a renowned desperado, sitting
quietly with a loaded rifle in his hand, and well knowing the errand of
his pursuer. Yet this gallant fellow never faltered. At twenty yards
their eyes met, and the gleam of anger, hate and desperation that
shot from those of Dutch John, spoke volumes. He also slewed
round his rifle, with the barrel in his left hand, and his right on the
small of the stock. Howie looked him straight down, and, as Wagner
made the motion with his rifle, his hand mechanically sought his belt.
No further demonstration being made, he continued his progress,
which he had never checked, till he arrived within a few steps of the
Dutchman, and there read perplexity, hesitation, anger and despair
in his fiery glances. Those resolved and unwavering grey eyes
seemed to fascinate Wagner. Five paces separated them, and the
twitchery of Wagner’s muscles showed that it was touch and go, sink
or swim. Four!—three!—two!—one! Fire flashes from John’s eyes.
He is awake at last; but it is too late. Neil has passed the butt of his
rifle, and in tones quiet but carrying authority with them, he broke the
silence with the order. “Give me your gun and get off your mule.” A
start and a shudder ran through Wagner’s frame, like an electric
shock. He complied, however, and expressed his willingness to go
with Neil, both then and several times afterwards, adding that he
need fear nothing from him.
Let it not be imagined that this man was any ordinary felon, or one
easy to capture. He stood upwards of six feet high; was well and
most powerfully built, being immensely strong, active, and both
coolly and ferociously brave. His swarthy visage, determined looking
jaw and high cheek-bones were topped off with a pair of dark eyes,
whose deadly glare few could face without shrinking. Added to this,
he knew his fate if he were caught. He traveled with a rifle in his
hand, a heart of stone, a will of iron, and the frame of a Hercules. It
might also be said, with a rope round his neck. For cool daring and
self-reliant courage, the single handed capture of Dutch John, by
Neil Howie, has always appeared to our judgment as the most
remarkable action of this campaign against crime. Had he met him
and taken him alone, it would have been a most heroic venture of life
for the public good; but to see scores of able-bodied and well armed
men refusing even to assist in the deed, and then—single handed—
to perform the service from which they shrank from bodily fear of the
consequences, was an action at once noble and self-denying in the
highest sense. Physical courage we share with the brutes; moral
courage is the stature of manhood.
The prisoner being brought to the camp-fire, was told of the nature
of the charge against him, and informed that if he were the man, a
bullet wound would be found on his shoulder. On removing his shirt,
the fatal mark was there. He attempted to account for it by saying,
that when sleeping in camp his clothes caught fire, and his pistol
went off accidentally; but neither did the direction of the wound justify
such an assumption, nor was the cause alleged received as other
than proof of attempted deceit, and, consequently, of guilt. The pistol
could not have been discharged by the fire, without the wearer being
fatally burned, long before the explosion took place, as was proved
by actual experiment at the fire, by putting a cap on a stick, and
holding it right in the blaze.
The ocular demonstration of the prisoner’s guilt afforded by the
discovery of the bullet wound, was conclusive. Neil left him in
charge, at the big train, and rode back to see who would help him to
escort the prisoner to Bannack. Volunteering was out of fashion just
then, and there was no draft. Neil started back and brought his
prisoner to Dry Creek, where there were fifty or sixty men; but still no
one seemed to care to have anything to do with it. The fear of the
roughs was so strong that every one seemed to consider it an almost
certain sacrifice of life to be caught with one of their number in
charge.
One of Neil Howie’s friends came to him and told him that he knew
just the very man he wanted, and that he was camped with a train
near at hand. This was good news, for he had made up his mind to
go with his prisoner alone. John Fetherstun at once volunteered to
accompany him, Road Agents, horse thieves and roughs in general
to the contrary notwithstanding. The two brave men here formed that
strong personal attachment that has ever since united them in a
community of sentiment, hardship, danger and mutual devotion.
The prisoner, who continually protested his innocence of any
crime, and his resolution to give them no trouble, seemed quite
resigned, and rode with them unfettered and unrestrained, to all
appearance. He was frequently fifty yards ahead of them; but they
were better mounted than he was, and carried both pistols and shot-
guns, while he was unarmed. His amiable manners won upon them,
and they could not but feel a sort of attachment to him—villain and
murderer though they knew him to be. The following incidents,
however, put a finale to this dangerous sympathy, and brought them
back to stern reality.
The weather being intensely cold, the party halted every ten or
fifteen miles, lit a fire, and thawed out. On one of these occasions,
Fetherstun, who usually held the horses while Neil raised a blaze, in
order to make things more comfortable, stepped back about ten
paces and set down the guns. He had no sooner returned than
Wagner “made a break” for them, and but for the rapid pursuit of
Howie and Fetherstun—whose line of march cut him off from the
coveted artillery—it is likely that this chapter would never have been
written, and that the two friends would have met a bloody death at
the hands of Dutch John.
One night, as they were sleeping in the open air, at Red Rock,
fatigue so overcame the watcher that he snored, in token of having
transferred the duties of his position to
Watchful stars that sentinel the skies.
This suited Wagner exactly. Thinking that the man off guard was
surely wrapt in slumber, he raised up and took a survey of the
position, his dark eyes flashing with a stern joy. As he made the first
decisive movement towards the accomplishment of his object, Neil,
who sleeps with an eye open at such times, but who, on this
particular occasion, had both his visual organs on duty—suddenly
looked up. The light faded from Wagner’s eyes, and uttering some
trite remark about the cold, he lay down again. After a lapse of about
an hour or two, he thought that, at last, all was right, and again, but
even more demonstratively, he rose. Neil sat up, and said quietly,
“John, if you do that again, I’ll kill you.” A glance of despair deepened
the gloom on his swarthy brow, and, with profuse and incoherent
apologies, he again lay down to rest.
On another occasion, they saw the smoke of a camp-fire, in close
proximity to the road, and Wagner, who noticed it even sooner than
his guards, at once thought that it must be the expected rescuers.
He sang and whistled loudly, as long as they were within hearing,
and then became sad, silent and downcast.
“Fortune favors the brave,” and they arrived without interruption, at
Horse Prairie. Neil Howie rode on to Bannack to reconnoitre—
promising to be back, if there was any danger, in an hour or so. After
waiting for two hours, Fetherstun resumed his journey and brought in
his man, whom he took to his hotel. Neil met Plummer and told him
of the capture of Wagner. The Sheriff (?) demanded the prisoner; but
Neil refused to give him up. He soon found out that he would be
backed by the “powers behind the throne.” There were no Vigilantes
organized in Bannack at that time; but four of the Committee, good
men and true, were, even then, in the saddle, on their road from
Virginia, with full powers to act in the matter. Neil knew very well that
a guard under the orders of Plummer, and composed of Buck
Stinson, Ned Ray and their fellows, would not be likely to shoot at a
prisoner escaping.
Dutch John proposed to Fetherstun that they should take a walk,
which they did. Fetherstun did not know Bannack; but they
sauntered down to Durand’s saloon. After a few minutes had
elapsed, Neil came in, and told Fetherstun to keep a close watch on
Wagner, stating that he would be back in a few minutes. The two sat
down and played a couple of games at “seven-up.” Buck Stinson and
Ned Ray came in and shook hands with the prisoner. Four or five
more also walked up, and one of them went through that ceremony
very warmly, looking very sharply at Fetherstun. After taking a drink,
he wheeled round, and, saying that he was on a drunk, stepped out
of doors. This raised Fetherstun’s suspicions, which were apparently
confirmed when he came in after a few minutes, with a party of nine.
The whole crowd numbered fifteen. Fetherstun made sure that they
were Road Agents; for one of them stepped up to John and said,
“You are my prisoner.” John looked at his quondam jailor, and
laughed. Fetherstun understood him to mean “You had me once,
and now I have you.” He stepped into the corner and drew his
revolver, fully expecting death, but determined to put as much
daylight through them as the size of his lead would allow. He
permitted them to take away the prisoner, seeing that resistance was
absurd, and went off to his hotel, where he found four or five men,
and being told, in answer to his question, that Neil had not been
there, he said, “Gentlemen, I don’t know whom I am addressing; but
if you’re the right kind of men, I want you to follow me; I am afraid the
Road Agents have killed Neil Howie; for he left me half an hour ago,
to be back in five minutes.” They all jumped up, and Fetherstun saw
that they were the genuine article. He was taking his shot-gun, when
a man put his head in at the door and told him not to be uneasy. The
rest seemed satisfied. He asked if he could go too, and was
answered “no.” He said he would go, anyhow, and started down
street, gun in hand. He could not see the man, but walking on, he
came to a cabin and descried Dutch John, surrounded by a group of
some twenty men. He knocked, but was refused admittance. The
party did not know him. It was a mutual mistake. Each thought the
other belonged to the class “Road Agent.” Fetherstun said Wagner
was his prisoner, and that he must have him. They said it was all
right; they only wanted to question him. The same mistake occurred
with regard to Neil Howie, whom Fetherstun found shortly after,
being aided by one of the new captors. He was as hot as calf love at
the news, but, like it, he soon cooled, when he saw things in the right
light.
The men at once gave up the prisoner to Neil and Fetherstun, who
marched him back to the hotel, and, afterwards, to a cabin. Seven or
eight parties gathered and questioned him as to all that he knew,
exhorting him to confess. He promised to do so, over and over
again; but he was merely trying to deceive them and to gain time.
The leader in the movement took up a book, observing that he had
heard enough and would not be fooled any more. The remainder
went on with their interrogations; but at last ceased in despair of
eliciting anything like truth, from John.
The literary gentleman closed the book, and approaching Wagner,
told him that he was notoriously a highwayman and a murderer, and
that he must be hanged; but that if he had any wish as to the precise
time for his execution he might as well name it, as it would be
granted if at all reasonable. John walked up and down for a while,
and then burst into tears, and, lamenting his hard lot, agreed to
make his confession, evidently hoping that it might be held to be of
sufficient importance to induce them to spare his life. He then gave a
long statement, corroborating Red’s confession in all important
particulars; but he avoided inculpating himself to the last moment,
when he confessed his share in the robbery of the train by himself
and Steve Marshland. This ended the examination for the night.
It was at this time that the Vigilance Committee was formed in
Bannack. A public meeting had been held in Peabody’s to discuss
the question, and the contemplated organization was evidently
looked upon with favor. The most energetic citizen, however, rather
threw cold water on the proposition. Seeing Ned Hay and Stinson
there present, he wisely thought that that was no place for making
such a movement, and held himself in reserve for an opportunity to
make an effort, at a fitting time and place, which offered itself in the
evening.
At midnight he had lain down to rest, when he was awakened from
sleep by a summons to get up, for that men had come from Virginia
to see him. He put on his clothes hastily, and found that four
trustworthy individuals had arrived, bearing a communication from
the Vigilantes of Virginia, which, on inspection, evidently took for
granted the fact of their organization, and also assumed that they
would be subordinate to the central authority. This latter question
was put to the small number of the faithful, and, by a little
management, was carried with considerable unanimity of feeling. It
was rather a nice point; for the letter contained an order for the
execution of Plummer, Stinson and Ray—the first as captain, and the
others as members of the Road Agent Band. Four men had
comprised those first enrolled as Vigilantes at Bannack.
It was resolved to spend the following day in enlisting members,
though no great progress was made after all.
Towards night, the people, generally, became aware that Wagner
was a prisoner and a Road Agent. No one would let him into his
house. Neil Howie and Fetherstun took him to an empty cabin on
Yankee Flat.
CHAPTER XVIII.
THE ARREST AND EXECUTION OF HENRY
PLUMMER, THE ROAD AGENT CHIEF, BUCK
STINSON AND NED RAY.
United there that trio died,

By deeds of crime and blood allied.
At dusk, three horses were brought into town, belonging severally
and respectively to the three marauders so often mentioned,
Plummer, Stinson and Ray. It was truly conjectured that they had
determined to leave the country, and it was at once settled that they
should be arrested that night. Parties were detailed for the work.
Those entrusted with the duty, performed it admirably. Plummer was
undressing when taken at his house. His pistol (a self-cocking
weapon) was broken and useless. Had he been armed, resistance
would have been futile; for he was seized the moment the door was
opened in answer to the knocking from without. Stinson was arrested
at Toland’s, where he was spending the evening. He would willingly
have done a little firing, but his captors were too quick for him. Ray
was lying on a gaming table, when seized. The three details
marched their men to a given point, en route to the gallows. Here a
halt was made. The leader of the Vigilantes and some others, who
wished to save all unnecessary hard feeling, were sitting in a cabin,
designing not to speak to Plummer, with whom they were so well
acquainted. A halt was made, however, and, at the door, appeared
Plummer. The light was extinguished; when the party moved on, but
soon halted. The crisis had come. Seeing that the circumstances
were such as admitted of neither vacillation nor delay, the citizen
leader, summoning his friends, went up to the party and gave the
military command, “Company! forward—march!” This was at once
obeyed. A rope taken from a noted functionary’s bed had been
mislaid and could not be found. A nigger boy was sent off for some
of that highly necessary, but unpleasant remedy for crime, and the
bearer made such good time that some hundreds of feet of hempen
neck-tie were on the ground before the arrival of the party at the
gallows. On the road, Plummer heard the voice and recognized the
person of the leader. He came to him and begged for his life; but was
told, “It is useless for you to beg for your life; that affair is settled and
cannot be altered. You are to be hanged. You cannot feel harder
about it than I do; but I cannot help it, if I would.” Ned Ray, clothed
with curses as with a garment, actually tried fighting, but found that
he was in the wrong company for such demonstrations; and Buck
Stinson made the air ring with the blasphemous and filthy expletives
which he used in addressing his captors. Plummer exhausted every
argument and plea that his imagination could suggest, in order to
induce his captors to spare his life. He begged to be chained down in
the meanest cabin; offered to leave the country forever; wanted a
jury trial; implored time to settle his affairs; asked to see his sister-in-
law, and, falling on his knees, with tears and sighs declared to God
that he was too wicked to die. He confessed his numerous murders
and crimes, and seemed almost frantic at the prospect of death.
The first rope being thrown over the cross-beam, and the noose
being rove, the order was given to “Bring up Ned Ray.” This
desperado was run up with curses on his lips. Being loosely
pinioned, he got his fingers between the rope and his neck, and thus
prolonged his misery.
Buck Stinson saw his comrade robber swinging in the death
agony, and blubbered out, “There goes poor Ed Ray.” Scant mercy
had he shown to his numerous victims. By a sudden twist of his head
at the moment of his elevation, the knot slipped under his chin, and
he was some minutes dying.
The order to “Bring up Plummer” was then passed and repeated;
but no one stirred. The leader went over to this perfect
gentleman, as his friends called him, and was met by a request to
“Give a man time to pray.” Well knowing that Plummer relied for a
rescue upon other than Divine aid, he said briefly and decidedly,
“Certainly; but let him say his prayers up here.” Finding all efforts to
avoid death were useless, Plummer rose and said no more prayers.
Standing under the gallows which he had erected for the execution
of Horan, this second Haman slipped off his neck-tie and threw it
over his shoulder to a young friend who had boarded at his house,
and who believed him innocent of crime, saying as he tossed it to
him, “Here is something to remember me by.” In the extremity of his
grief, the young man threw himself weeping and wailing, upon the
ground. Plummer requested that the men would give him a good
drop, which was done, as far as circumstances permitted, by hoisting
him up as high as possible, in their arms, and letting him fall
suddenly. He died quickly and without much struggle.
It was necessary to seize Ned Ray’s hand and by a violent effort to
draw his fingers from between the noose and his neck before he
died. Probably he was the last to expire, of the guilty trio.
The news of a man’s being hanged flies faster than any other
intelligence, in a Western country, and several had gathered round
the gallows on that fatal Sabbath evening—many of them friends of
the Road Agents. The spectators were allowed to come up to a
certain point, and were then halted by the guard, who refused
permission either to depart or to approach nearer than the “dead
line,” on pain of their being instantly shot.
The weather was intensely cold; but the party stood for a long time
round the bodies of the suspended malefactors, determined that
rescue should be impossible.
Loud groans and cries uttered in the vicinity, attracted their
attention, and a small squad started in the direction from which the
sound proceeded. The detachment soon met Madam Hall, a noted
courtezan—the mistress of Ned Ray—who was “Making night
hideous” with her doleful wailings. Being at once stopped, she began
inquiring for her paramour, and was thus informed of his fate, “Well if
you must know, he is hung.” A volcanic eruption of oaths and abuse
was her reply to this information; but the men were on “short time,”
and escorted her towards her dwelling without superfluous display of
courtesy. Having arrived at the brow of a short descent, at the foot of
which stood her cabin, stern necessity compelled a rapid and final
progress in that direction.
Soon after, the party formed and returned to town, leaving the
corpses stiffening in the icy blast. The bodies were eventually cut
down by the friends of the Road Agents and buried. The “Reign of
Terror,” in Bannack, was over.
CHAPTER XIX.
THE EXECUTION OF “THE GREASER” (JOE
PIZANTHIA,) AND DUTCH JOHN, (WAGNER.)
Hope withering fled, and mercy sighed, farewell.—

Campbell.
A marked change in the tone of public sentiment was the
consequence of the hanging of the blood-stained criminals whose
deserved fate is recorded in the preceding chapters. Men breathed
freely; for Plummer and Stinson especially were dreaded by almost
every one. The latter was of the type of that brutal desperado whose
formula of introduction to a Western bar-room is so well known in the
Mountains: “Whoop! I’m from Pike County, Missouri; I’m ten feet
high; my abode is where lewd women and licentious men mingle; my
parlor is the Rocky Mountains. I smell like a wolf. I drink water out of
a brook, like a horse. Look out you ——, I’m going to turn loose,” etc.
A fit mate for such a God-forgotten outlaw was Stinson, and he, with
the oily and snake-like demon, Plummer, the wily, red-handed, and
politely merciless chief, and the murderer and robber, Ray, were no
more. The Vigilantes organized rapidly. Public opinion sustained
them.
On Monday morning, it was determined to arrest “the Greaser,”
Joe Pizanthia, and to see precisely how his record stood in the
Territory. Outside of it, it was known that he was a desperado, a
murderer and a robber; but that was not the business of the
Vigilantes. A party started for his cabin, which was built in a side-hill.
The interior looked darker than usual, from the bright glare of the
surrounding snow. The summons to come forth being disregarded,
Smith Ball and George Copley entered, contrary to the advice of
their comrades, and instantly received the fire of their concealed foe.
Copley was shot through the breast. Smith Ball received a bullet in
the hip. They both staggered out, each ejaculating, “I’m shot.”
Copley was led off by two friends, and died of his wound. Smith Ball
recovered himself, and was able to empty his six-shooter into the
body of the assassin, when the latter was dragged forth.
The popular excitement rose nearly to madness. Copley was a
much esteemed citizen, and Smith Ball had many friends. It was the
instant resolution of all present that the vengeance on the Greaser
should be summary and complete.
A party whose military experience was still fresh in their memory,
made a rush at the double-quick, for a mountain howitzer, which lay
dismounted, where it had been left by the train to which it was
attached. Without waiting to place it on the carriage, it was brought
by willing hands, to within five rods of the windowless side of the
cabin, and some old artillerists, placing it on a box, loaded it with
shell, and laid it for the building. By one of those omissions so
common during times of excitement, the fuse was left uncut, and,
being torn out in its passage through the logs, the missile never
exploded, but left a clean breach through the wall, making the chips
fly. A second shell was put into the gun, and this time, the fuse was
cut, but the range was so short that the explosion took place after it
had traversed the house.
Thinking that Pizanthia might have taken refuge in the chimney,
the howitzer was pointed for it, and sent a solid shot through it.
Meanwhile the military judgment of the leader had been shown by
the posting of some riflemen opposite the shot-hole, with instructions
to maintain so rapid a fire upon it, that the beleaguered inmate
should not be able to use it as a crenelle through which to fire upon
the assailants. No response being given to the cannon and small-
arms, the attacking party began to think of storming the dwelling.
The leader called for volunteers to follow him. Nevada cast in her
lot first, and men from the crowd joined. The half dozen stormers
moved steadily, under cover, to the edge of the last building, and
then dashed at the house, across the open space. The door had
fallen from the effects of the fusilade; but, peeping in, they could see
nothing, until a sharp eye noticed the Greaser’s boots protruding.

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Ethical Obligations and Decision

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Ethical Obligations and Decision Making in Accounting

Ethical Obligations and Decision Making in Accounting

Ethical Obligations and Decision Making in Accounting

Ethical Obligations and Decision Making in Accounting

Business Ethics Ethical Decision Making and Cases 11th

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Business Ethics Ethical Decision Making and Cases 12th

Fraud in Financial Statements and Auditor Responsibilities

Multiple Choice Questions

A. Assessing the control environment of the organization

B. Evaluating internal controls

C. Considering audit risk and materiality

D. Evaluating management's commitment to serve the public interest

A. Misrepresentation of events, transactions, and other significant events in the financial

B. Failure to provide adequate documentation to support financial statements assertions

C. Aggressive accounting for transactions, events, or other significant matters

4. Misstatements in the financial statements can result from:

C. Illegal acts improperly recorded

D. All of the above

A. Omission of the auditor's report

B. Omission of notes to the financial statements

C. Failure to disclose major estimates made in the financial statements

D. Failure to disclose major judgments made in the financial statements

6. The auditor's responsibility with regard to illegal acts is greatest when:

D. Illegal acts exist regardless of the effects on the financial statements

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

A. The illegal act has a material effect on the financial statements

standard audit report

D. All of the above are additional requirements

C. Due to an illegal act

D. Management fails to correct for the error

Code of Professional Conduct in each of the following situations except when:

B. It is to comply with the Private Securities Litigation Reform Act

C. It protects the auditor's accounting for fraud and illegal acts

D. It is allowed for under the Dodd-Frank Financial Reform Act

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

A. The causes of when the audit opinion should be qualified.

of amounts or disclosures in the financial statements.

C. The causes of when there is a lack of independence in performing an audit.

D. The causes of illegal acts.

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

A. Desire to maximize the value of stock options

C. Meet financial analysts' earnings expectations

D. Ability to carry out the fraud

16. All of the following are in a position to commit fraud except:

A. Employees who have access to assets

B. Top management who can override internal controls

C. External auditors who audit the financial statements

D. All of the above are in a position to commit fraud

B. All companies use aggressive accounting techniques

A. Failure of the corporate governance system

B. External auditors told management to let the fraud go

C. Tyco management hid the fraud from the auditors

D. The fraud was not material