Auditing and Assurance Services, 17e (Arens/Elder/Beasley)

Chapter 10 Fraud Auditing

10.1 Learning Objective 10-1

1) Which of the following best defines fraud in a financial statement auditing context?
A) Fraud is an unintentional misstatement of the financial statements.
B) Fraud is an intentional misstatement of the financial statements.
C) Fraud is either an intentional or unintentional misstatement of the financial statements,
depending on materiality.
D) Fraud is either an intentional or unintentional misstatement of the financial statements,
depending on consistency.
Answer: B
Terms: Definition of fraud in financial statement auditing
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

2) Companies may intentionally understate earnings when income is high to create ________
that may be used in future years to increase earnings.
A) income smoothing
B) cookie jar reserves
C) cash
D) sales
Answer: B
Terms: Intentionally understate earnings; Reserve earnings
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

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3) Which of the following is a category of fraud?
A)
Fraudulent financial reporting Misappropriation of assets
Yes Yes

B)
Fraudulent financial reporting Misappropriation of assets
No No

C)
Fraudulent financial reporting Misappropriation of assets
Yes No

D)
Fraudulent financial reporting Misappropriation of assets
No Yes

Answer: A
Terms: Category of fraud
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

4) Most cases of fraudulent reporting involve

A) inadequate disclosures.
B) an overstatement of income.
C) an overstatement of liabilities.
D) an overstatement of expenses.
Answer: B
Terms: Fraudulent financial reporting
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

5) ________ is fraud that involves theft of an entity's assets.

A) Fraudulent financial reporting
B) A "cookie jar" reserve
C) Misappropriation of assets
D) Income smoothing
Answer: C
Terms: Fraud that involves theft of entity's assets
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

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6) Which of the following is a form of earnings management in which revenues and expenses are
shifted between periods to reduce fluctuations in earnings?
A) fraudulent financial reporting
B) expense smoothing
C) income smoothing
D) Each of the above is correct.
Answer: C
Terms: Form of earnings management
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

7) Misappropriation of assets is normally perpetrated by

A) members of the board of directors.
B) employees at lower levels of the organization.
C) management of the company.
D) the internal auditors.
Answer: B
Terms: Misappropriation of assets normally; perpetrators
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

8) Fraudulent financial reporting

A) always involves inadequate disclosures.
B) can be intentional or unintentional.
C) can involve understating net income in order to reduce income taxes.
D) all of the above.
Answer: C
Terms: Fraudulent financial reporting
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

9) According to the Association of Certified Fraud Examiners (ACFE), the average company
loses ________ percent of its revenues to fraud.
A) one
B) five
C) ten
D) fifteen
Answer: B
Terms: Revenues lost to fraud
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

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10) Which of the following is an accurate statement regarding the misappropriation of assets?
A) In most cases, the amounts involved are material to the financial statements.
B) Misappropriation of assets can easily increase in size over time and can lead to significant
reputational harm.
C) Management should not be concerned about minor misappropriations.
D) Asset misappropriation schemes are less common than fraudulent financial statement
schemes.
Answer: B
Terms: Misappropriation of assets
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

11) Fraudulent financial reporting is an intentional misstatement or omission of amounts or

disclosures with the intent to deceive users.
Answer: TRUE
Terms: Fraudulent financial reporting
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

12) The two main categories of fraud are fraudulent financial reporting and misappropriation of
assets.
Answer: TRUE
Terms: Categories of fraud; Fraudulent financial reporting and misappropriation of assets
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

13) "Cookie jar reserves" are often created by companies whenever their earnings are low to
create reserves for future periods when earnings need to be "boosted" upward.
Answer: FALSE
Terms: Cookie jar reserves
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

14) Misappropriation of assets is normally perpetrated at the lowest levels of the organization
hierarchy.
Answer: TRUE
Terms: Misappropriation of assets
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

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15) Fraudulent financial reporting usually involves manipulation of amounts rather than
disclosures.
Answer: TRUE
Terms: Fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

16) According to the Association of Certified Fraud Examiners, losses from misappropriation
schemes are higher than losses from financial statement frauds.
Answer: FALSE
Terms: Fraud and main categories
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

17) One technique to smooth income is to increase the value of inventory and other assets of an
acquired company at the time of the acquisition, resulting in lower earnings when the assets are
later sold.
Answer: FALSE
Terms: Fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

18) To counter higher than expected earnings, companies may deliberately overstate bad debt
expense and reserves for obsolete inventory.
Answer: TRUE
Terms: Fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

19) Fraudulent financial reporting may also involve inadequate disclosures in the financial
statements.
Answer: TRUE
Terms: Fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

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20) Define fraud and distinguish between the two main categories of fraud.
Answer: In the context of financial statement auditing, fraud is defined as an intentional
misstatement of the financial statements.

The two main categories of fraud are fraudulent financial reporting and misappropriation of
assets. Fraudulent financial reporting is an intentional misstatement or omission of amounts or
disclosures with the intent to deceive users of the financial statements. Misappropriation of assets
involve theft of an entity's assets.
Terms: Fraud and main categories
Difficulty: Easy
Objective: LO 10-1
AACSB: Reflective thinking

21) List and briefly describe cases and examples of fraudulent financial reporting.
Answer:
• Overstating income — either by overstating assets or income, or understating or omitting
expenses or liabilities.
• Understating income — especially by privately held companies in an attempt to reduce income
taxes.
• Creating reserve or earnings or cookie jar reserves — to help improve reporting earnings in
future periods.
• Earnings management — deliberate actions such as fraudulent journal entries taken by
management to meet analyst earnings expectations
Terms: Fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-1
AACSB: Reflective thinking

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10.2 Learning Objective 10-2

1) Which of the following are elements of the fraud triangle?

A)
Attitudes/rationalization Risk Factors Opportunities
Yes No Yes

B)
Attitudes/rationalization Risk Factors Opportunities
No Yes Yes

C)
Attitudes/rationalization Risk Factors Opportunities
Yes No No

D)
Attitudes/rationalization Risk Factors Opportunities
No Yes No

Answer: A
Terms: Fraud triangle
Difficulty: Easy
Objective: LO 10-2
AACSB: Reflective thinking

2) Although the financial statements of all companies are potentially subject to manipulation, the
risk is greater for companies that
A) are heavily regulated.
B) have low amounts of debt.
C) have to make significant judgments for accounting estimates.
D) operate in stable economic environments.
Answer: C
Terms: Financial statement manipulation risk is elevated
Difficulty: Easy
Objective: LO 10-2
AACSB: Reflective thinking

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3) Which of the following is not a factor that relates to opportunities to commit fraudulent
financial reporting?
A) lack of controls related to the calculation and approval of accounting estimates
B) ineffective oversight of financial reporting by the board of directors
C) management's set of ethical values
D) high turnover of accounting, internal audit, and information technology staff
Answer: C
Terms: Factor relates to opportunities to commit fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

4) Fraud is more prevalent in smaller businesses and not-for-profit organizations because it is

more difficult for them to maintain
A) adequate separation of duties.
B) adequate compensation.
C) adequate financial reporting standards.
D) adequate supervisory boards.
Answer: A
Terms: Fraud more prevalent in smaller business and not-for-profit organizations
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

5) Which of the following is a factor that relates to incentives or pressures to commit fraudulent
financial reporting?
A) significant accounting estimates involving subjective judgments
B) excessive pressure for management to meet debt repayment requirements
C) management's practice of making overly aggressive forecasts
D) high turnover of accounting, internal audit, and information technology staff
Answer: B
Terms: Factor that relates to incentives or pressures to commit fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

6) Which of the following is a factor that relates to attitudes or rationalization to misappropriate

assets?
A) significant accounting estimates involving subjective judgments
B) excessive pressure for management to meet debt repayment requirements
C) a sense of superiority by executives
D) high turnover of accounting, internal audit and information technology staff
Answer: C
Terms: Factor that relates to incentives to misappropriate assets
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking
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7) Which of the following is not a factor that relates to opportunities to misappropriate assets?
A) inadequate internal controls over assets
B) presence of large amounts of cash on hand
C) inappropriate segregation of duties or independent checks on performance
D) adverse relationships between management and employees
Answer: D
Terms: Factor that relates to opportunities to misappropriate assets
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

8) Which of the following is a factor that relates to incentives/pressures to misappropriate assets?

A) weak internal controls
B) significant personal financial obligations
C) management's practice of making overly aggressive forecasts
D) anger and fear
Answer: B
Terms: Factor that relates to incentives to misappropriate assets
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

9) According to a KPMG survey, most fraud perpetrators

A) are over the age of 65.
B) work on the assembly line.
C) have worked for the company for over ten years.
D) are female.
Answer: C
Terms: Characteristics of fraud perpetrators
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

10) In the fraud triangle, fraudulent financial reporting and misappropriation of assets
A) share little in common.
B) share most of the same risk factors.
C) share the same three conditions of the fraud triangle.
D) share most of the same conditions. of the fraud triangle.
Answer: C
Terms: Fraud triangle
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

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11) Which of the following would the auditor be most concerned about regarding a heightened
risk of intentional misstatement?
A) Senior management emphasizes that it is very important to beat analyst estimates of earnings
every reporting period.
B) Senior management emphasizes that budgeted amounts for expenses are to be achieved for
each reporting period or explained in the variance analysis report.
C) Senior management emphasizes that job rotation is a worthwhile corporate objective.
D) Senior management emphasizes that job evaluations are based on performance.
Answer: A
Terms: Heightened risk of intentional misstatement
Difficulty: Easy
Objective: LO 10-2
AACSB: Reflective thinking

12) Which of the following is a risk factor related to opportunities and financial statement fraud?
A) ineffective communication of company values
B) promotions inconsistent with expectations
C) significant related-party transactions
D) adverse relationships between management and employees
Answer: C
Terms: Factor relates to opportunities to commit fraudulent financial reporting
Difficulty: Easy
Objective: LO 10-2
AACSB: Reflective thinking

13) Relating to opportunities, why do most people commit fraud?

A) They need to fund an extravagant lifestyle.
B) They feel a sense of superiority.
C) There are weak internal controls.
D) They need to meet pre-specified business targets.
Answer: C
Terms: Fraud risk conditions and opportunity
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

14) According to a KPMG survey, which of the following is not often cited as an incentive to
engage in fraudulent financial reporting?
A) personal financial incentives
B) the desire to fund an extravagant lifestyle
C) the need to meet pre-specified business performance targets
D) an improvement in the company's financial prospects
Answer: D
Terms: Risk factors for fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking
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15) Which of the following is not a risk factor that the auditor should take into account when
considering the possibility of fraudulent financial reporting at an audit client?
A) Significant accounting estimates are not difficult for the auditor to verify and justify.
B) Board members' personal net worth is threatened if the entity's financial performance does not
meet market expectations.
C) Increasing business complexity occurs as a result of numerous recent acquisitions.
D) Information technology personnel are found to be not keeping up with the latest trends in
internal controls and data security.
Answer: A
Terms: Risk factors for fraudulent financial reporting
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

16) Which of the following is not a risk factor that the auditor should take into account when
considering the possibility of misappropriation of assets at an audit client?
A) The presence of inventory items which are large in size and low in value
B) Employees with access to cash who have adverse relationships with management
C) The audit client announces required layoffs six months from now
D) An approved vendor list to detect unauthorized or fictitious vendors is not properly controlled
Answer: A
Terms: Risk factors for misappropriation of assets
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

17) Incentives and opportunities are two conditions that are generally present when financial
statement fraud occurs.
Answer: TRUE
Terms: Conditions present when material misstatements due to fraud occur
Difficulty: Easy
Objective: LO 10-2
AACSB: Reflective thinking

18) Fraud is more prevalent in large businesses than small businesses and not-for-profit
organizations.
Answer: FALSE
Terms: Fraud prevalence in organizations
Difficulty: Easy
Objective: LO 10-2
AACSB: Reflective thinking

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19) Turnover in accounting personnel can create a rationalization for misstatement.
Answer: FALSE
Terms: Fraud triangle risk conditions
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

20) A lack of controls over payments to vendors can cause revenue fraud.
Answer: FALSE
Terms: Opportunities conditions included in fraud triangle
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

21) Ineffective oversight by the board of directors over financial reporting is an example of an
incentives/pressures risk factor.
Answer: FALSE
Terms: Fraud risk factor describing incentives/pressures
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

22) A common incentive for companies to manipulate financial statements is a decline in the
company's financial prospects.
Answer: TRUE
Terms: Fraud risk factor describing incentives/pressures
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

23) The pressure to do "whatever it takes" to meet goals is one of the main reasons why financial
statement fraud occurs.
Answer: TRUE
Terms: Risk factors related to incentives, opportunities, and attitudes
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

24) In the fraud triangle, fraudulent financial reporting and misappropriation of assets share the
same conditions and risk factors.
Answer: FALSE
Terms: Fraud triangle risk conditions
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

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25) List and briefly describe the three conditions for fraud.
Answer:
• Incentives/pressures – Management or other employees have incentives or pressures to
commit fraud.
• Opportunities – Circumstances provide opportunities for management or employees to
commit fraud.
• Attitudes/Rationalization – An attitude, character, or set of ethical values exists that allows
management or employees to intentionally commit a dishonest act, or they are in an environment
that imposes sufficient pressure that causes them to rationalize committing a dishonest act.
Terms: Conditions for fraud
Difficulty: Moderate
Objective: LO 10-2
AACSB: Reflective thinking

26) List and briefly describe examples of risk factors for each condition of fraud for fraudulent
financial reporting.
Answer:
Incentives/Pressures:
1. Financial stability or profitability is threatened by economic, industry, or entity operating
conditions.
2. Excessive pressure for management to meet debt repayment or other debt covenant
requirements.
3. Management or the board of directors' personal net worth is materially threatened by the
entity's financial performance.

Opportunities:
1. Significant accounting estimates involve subjective judgments or uncertainties that are
difficult to verify.
2. Ineffective board of director or audit committee oversight over financial reporting.
3. High turnover or ineffective accounting, internal audit, or information technology staff.
4. Deficient internal controls.
5. Significant related party transactions.

Attitudes/Rationalization:
1. Inappropriate or ineffective communication and support of the entity's values.
2. Known history of violations of securities laws and other laws and regulations.
3. Management's practice of making overly aggressive or unrealistic forecasts to analysts,
creditors, and other third parties.
Terms: Risk factors for conditions of fraud
Difficulty: Challenging
Objective: LO 10-2
AACSB: Reflective thinking

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10.3 Learning Objective 10-3

1) Which of the following is a true statement regarding professional skepticism?

A) Auditors reject most potential clients perceived as lacking honesty and integrity.
B) If the auditor has past experience with a client, they can assume the client is honest.
C) Material frauds occur in most of the audits of financial statements.
D) Professional skepticism is required only during the planning phase.
Answer: A
Terms: Professional skepticism when auditing a client
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

2) Upon discovering information that indicates a material misstatement due to fraud may have
occurred, auditors should
A) acquire additional evidence as needed.
B) thoroughly probe the issues.
C) consult with other team members.
D) all of the above.
Answer: D
Terms: Criteria by which an auditor evaluates information
Difficulty: Easy
Objective: LO 10-3
AACSB: Reflective thinking

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3) As part of the brainstorming sessions, auditors are directed to emphasize
A)
How management could perpetrate The audit team's response to
and conceal fraudulent financial potential fraud risks
reporting
Yes Yes

B)
How management could perpetrate The audit team's response to
and conceal fraudulent financial potential fraud risks
reporting
No No

C)
How management could perpetrate The audit team's response to
and conceal fraudulent financial potential fraud risks
reporting
Yes No

D)
How management could perpetrate The audit team's response to
and conceal fraudulent financial potential fraud risks
reporting
No Yes

Answer: A
Terms: Auditors directed to emphasize in brainstorming sessions
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

4) Which of the following questions is the auditor not required to ask company management
when assessing fraud risk?
A) Does management have knowledge of any fraud or suspected fraud within the company?
B) What is the nature of the fraud risks identified by management?
C) Is management using all assets effectively?
D) What internal controls have been implemented to address the fraud risks?
Answer: C
Terms: Sources of information to assess fraud risks; inquiries of management
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

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5) When assessing the risk for fraud, the auditor must be cognizant of the fact that
A) the existence of fraud risk factors means fraud exists.
B) analytical procedures must be performed on revenue accounts.
C) horizontal analysis is not useful in helping to determine unusual financial statement
relationships.
D) the auditor cannot make inquiries about fraud to company personnel who have no financial
statement responsibilities.
Answer: B
Terms: Assessment of fraud risk
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

6) Which of the following is not a likely source of information to assess fraud risks?
A) communications among audit team members
B) inquiries of management
C) analytical procedures
D) consideration of fraud risks discovered during recent audits of other clients
Answer: D
Terms: Source of information to assess fraud risks
Difficulty: Challenging
Objective: LO 10-3
AACSB: Reflective thinking

7) When assessing fraud risk,

A) fraud risk is assessed only at the overall financial statement level.
B) the auditor's assessment of fraud risk should be ongoing throughout the audit.
C) if the auditor concludes that there is a risk of material misstatement due to fraud, auditing
standards require that the risks be treated as pervasive.
D) auditing standards require that the auditor presume there is a risk of fraud in the inventory
account.
Answer: B
Terms: Assessment against a defendant of the full loss suffered by a plaintiff
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

8) In vertical analysis, the account balance is compared to the previous period, and the
percentage change for the period is calculated.
Answer: FALSE
Terms: Analytical procedures
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

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9) Information and idea exchange sessions by the audit team are required by current auditing
standards.
Answer: TRUE
Terms: Information and idea exchange by audit team sessions required by current audit
standards
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

10) Upon discovering information that indicates a material misstatement due to fraud, the auditor
must assume that the misstatement is an isolated incident.
Answer: FALSE
Terms: Assessment of fraud risk
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

11) The presence of fraud risk factors increases the likelihood of fraud and may suggest that
fraud is being perpetrated.
Answer: TRUE
Terms: Presence of fraud risk factors
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

12) When the auditor receives inconsistent responses from management and others within the
organization, the auditor should obtain additional audit evidence to resolve the inconsistency.
Answer: TRUE
Terms: Presence of fraud risk factors
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

13) Auditing standards require that the auditor presume that there is a risk of fraud in revenue
recognition.
Answer: TRUE
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

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14) For significant risks, including fraud risks, the auditor should obtain an understanding of the
internal controls related to the risks.
Answer: TRUE
Terms: Significant risk
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

15) Material frauds are frequent compared to the number of financial statement audit conducted
annually in the U.S.
Answer: FALSE
Terms: Professional skepticism
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

16) Most auditors will encounter a material fraud during their auditing careers.
Answer: FALSE
Terms: Professional skepticism
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

17) If the auditor discovers information indicating a material misstatement due to fraud may have
occurred, the auditor should immediately withdraw from the audit engagement.
Answer: FALSE
Terms: Critical evaluation of audit evidence
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

18) If the auditor discovers that a current year sale should be recorded in the following year, the
auditor should determine if this situation was intentional by the client or fraud committed by the
client.
Answer: TRUE
Terms: Critical evaluation of audit evidence
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

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19) The Securities and Exchange Commissions will set up the Office of the Whistleblower
sometime in the near future in an effort to combat fraud and offer monetary rewards for being a
whistleblower.
Answer: FALSE
Terms: Securities and Exchange Commission Office of the Whistleblower
Difficulty: Easy
Objective: LO 10-3
AACSB: Reflective thinking

20) Auditing standards state that the auditor should focus inquiries regarding fraud with the
board of directors and management of their audit clients, and not spend time making inquiries of
personnel outside of the normal financial reporting lines of responsibility.
Answer: FALSE
Terms: Inquires of management and other personnel
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

21) When the auditor concludes there is a risk of material misstatement due to fraud, auditing
standards do not require to automatically treat those risks as significant risks.
Answer: FALSE
Terms: Identified risks of material misstatements due to fraud
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

22) Discuss the need for maintaining professional skepticism during an audit.
Answer: Auditing standards require that the audit be planned and performed with an attitude of
professional skepticism in all aspects of the engagement, recognizing the possibility that a
material misstatement could exist regardless of the auditor's prior experience with the integrity
and honesty of client management and those charged with governance. In practice, maintaining
this attitude can be difficult because, despite some recent high-profile financial statement frauds,
material frauds are infrequent compared to the number of audits of financial statements
conducted annually.
Terms: Professional skepticism
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

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23) Briefly discuss the brainstorming session required by current auditing standards. Be sure to
include a list of ideas that should be addressed in the session.
Answer: Auditing standards require the audit team to conduct discussions to share insights from
more experienced audit team members and to "brainstorm" ideas that address several ideas. The
ideas that should be discussed are:
• How and where the entity's financial statements might be susceptible to material
misstatements due to fraud. This includes known external and internal factors affecting the entity
that might
(1) create an incentive or pressure for management to commit fraud,
(2) provide the opportunity for fraud to be perpetrated, including the risk of
management override of internal controls, and
(3) indicate a culture or environment that enables management to rationalize fraudulent acts.
• How management could perpetrate and conceal fraudulent financial reporting.
• How assets of the entity could be misappropriated.
• How the auditor might respond to the susceptibility of material misstatements due to fraud.
Terms: Brainstorming session required by auditing standards
Difficulty: Moderate
Objective: LO 10-3
AACSB: Reflective thinking

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24) Describe the five sources of information gathered to assess fraud risks.
Answer: The five sources of information to assess fraud risk are:
• Communications among audit team members. The following ideas should be "brainstormed"
(1) How and where the entity's financial statements might be susceptible to material
misstatements due to fraud, including known external and internal factors that might (a) create an
incentive or pressure for management to commit fraud, (b) provide the opportunity for fraud to
be perpetrated, and (c) indicate a culture or environment that enables management to rationalize
fraudulent acts.
(2) How management could perpetrate and conceal fraudulent financial reporting.
(3) How anyone might misappropriate assets of the entity.
(4) How the auditor might respond to the susceptibility of material misstatements due to
fraud.
• Inquiries of management. These inquiries should address whether management has
knowledge of any fraud or suspected fraud within the company. Auditors should also inquire
about management's process of assessing fraud risks, the nature of fraud risks identified by
management, any internal controls implemented to address those risks, and any information
about fraud risks and related controls that management has reported to the audit committee or
others charged with governance.
• Risk factors. The auditor must evaluate whether fraud risk factors indicate incentives or
pressures to perpetrate fraud, opportunities to carry out fraud, or attitudes or rationalizations used
to justify a fraudulent action.
• Analytical procedures. Auditors must perform analytical procedures during the planning and
completion phases of the audit to help identify unusual transaction or events that might indicate
the presence of material misstatements in the financial statements. Analytical procedures include
ratio analysis, horizontal analysis, and vertical analysis.
• Other procedures. Auditors should consider all information they have obtained in any phase or
part of the audit as they assess the risk of fraud. Information about management's integrity and
honesty, inquires and analytical procedures, and information considered in assessing inherent
and control risks, may lead to auditor concerns about the likelihood of misstatements due to
fraud.
Terms: Sources of information to assess fraud risks; inquiries of management
Difficulty: Challenging
Objective: LO 10-3
AACSB: Reflective thinking

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10.4 Learning Objective 10-4

1) Which of the following is the best reason for management to emphasize fraud prevention and
deterrence?
A) It is often more effective and economical for companies to focus on fraud prevention and
deterrence rather than on fraud detection.
B) Collusion is impossible to detect.
C) The AICPA requires management to implement a fraud prevention program.
D) All of the above are equally valid reasons.
Answer: A
Terms: Reason for management to emphasize fraud prevention and deterrence
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

2) Which of the following parties is responsible for implementing internal controls to minimize
the likelihood of fraud?
A) external auditors
B) audit committee members
C) management
D) Committee of Sponsoring Organizations
Answer: C
Terms: Party responsible for implementing internal controls to minimize likelihood of fraud
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

3) Research indicates that the most effective way to prevent and deter fraud is to
A) implement programs and controls that are based on core values embraced by the company.
B) hire highly ethical employees.
C) communicate expectations to all employees on an annual basis.
D) terminate employees who are suspected of committing fraud.
Answer: A
Terms: Most effective way to prevent and deter fraud
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

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4) Fraud awareness training should be
A) broad and all-encompassing.
B) extensive and include details for all functional areas.
C) specifically related to the employee's job responsibility.
D) focused on employees understanding the importance of ethics.
Answer: C
Terms: Fraud awareness training
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

5) Which party has the primary responsibility to oversee an organization's financial reporting and
internal control process?
A) the board of directors
B) the audit committee
C) management of the company
D) the financial statement auditors
Answer: B
Terms: Party with primary responsibility to oversee organization's financial reporting and
internal control processes
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

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6) Management is responsible for
A)
Identifying and measuring Taking steps to mitigate
fraud risks identified risks
Yes Yes

B)
Identifying and measuring Taking steps to mitigate
fraud risks identified risks
No No

C)
Identifying and measuring Taking steps to mitigate
fraud risks identified risks
Yes No

D)
Identifying and measuring Taking steps to mitigate
fraud risks identified risks
No Yes

Answer: A
Terms: Management responsibilities for fraud risks
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

7) Which of the following is not one of the elements to prevent, deter, and detect fraud according
to the AICPA?
A) performing analytical procedures
B) culture of honesty and high ethics
C) management's responsibility to evaluate risks of fraud
D) audit committee oversight
Answer: A
Terms: Corporate governance oversight to reduce fraud risks
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

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8) Who is responsible for setting the "tone at the top"?
A) management
B) PCAOB
C) audit committee
D) SEC
Answer: A
Terms: Responsibility for setting tone at the top
Difficulty: Easy
Objective: LO 10-4
AACSB: Reflective thinking

9) An effective code of conduct should contain the company's policies regarding

A) conflicts of interests.
B) kickbacks.
C) gifts and entertainment.
D) all of the above.
Answer: D
Terms: Elements of code of conduct
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

10) Management and the board of directors are responsible for setting the "tone at the top."
Answer: TRUE
Terms: Responsibility for setting tone at the top
Difficulty: Easy
Objective: LO 10-4
AACSB: Reflective thinking

11) If employees have positive feelings about their employers, they are less likely to commit
fraud.
Answer: TRUE
Terms: Positive work environment
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

12) Management must recognize that almost any employee is capable of committing a dishonest
act under the right circumstances.
Answer: TRUE
Terms: Mitigating fraud risks
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

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13) Audit committee oversight also serves as a deterrent to fraud by senior management.
Answer: TRUE
Terms: Audit committee and fraud
Difficulty: Challenging
Objective: LO 10-4
AACSB: Reflective thinking

14) Collusion and false documentation make detection of fraud by management a challenge.
Answer: TRUE
Terms: Management responsibility for corporate governance and limitations
Difficulty: Easy
Objective: LO 10-4
AACSB: Reflective thinking

15) The Committee of the Sponsoring Organization (COSO) of the Treadway Commission
recently issued a Fraud Risk Management Guide which is not consistent with the COSO Internal
Control - Integrated Framework issued by COSO in 2013.
Answer: FALSE
Terms: COSO Fraud Risk Management Guide issued recently
Difficulty: Easy
Objective: LO 10-4
AACSB: Reflective thinking

16) Management, not the board of directors, is responsible for setting the "tone at the top" for
ethical behavior in the company.
Answer: FALSE
Terms: Setting tone at the top
Difficulty: Easy
Objective: LO 10-4
AACSB: Reflective thinking

17) Public Company Accounting Oversight Board auditing standards require the auditor of a
public company to evaluate the effectiveness of the board of directors and the audit committee.
Answer: TRUE
Terms: Audit committee oversight
Difficulty: Easy
Objective: LO 10-4
AACSB: Reflective thinking

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18) The "tone at the top" provides a foundation upon which a more detailed code of conduct can
be developed to provide specific guidance for the organization and its employees. Components
of a code of conduct may include sections on 1) general employee conduct, 2) relationships with
clients and suppliers, and 3) conflicts of interest. Give a narrative description of what might be
included in each of the above components of a code of conduct.
Answer: (may vary)
General employee conduct—Employees should conduct themselves in a businesslike manner and
prohibit unprofessional activities such as drinking, gambling, fighting, and swearing, while on
the job.
Relationships with client and suppliers—Employees should avoid investing in or acquiring a
financial interest in any business organization that has a contractual relationship with the
organizations.
Conflicts of Interest—Employees are expected to perform their duties conscientiously, honestly,
and in accordance with the best interests of the organization and to not use their positions or
knowledge gained for private or personal advantage.
Terms: Elements of code of conduct
Difficulty: Challenging
Objective: LO 10-4
AACSB: Reflective thinking

19) Senior management is responsible for promoting a culture of honesty and ethics. Describe
what that implies for the organization.
Answer: Note: responses with examples may vary

Management cannot act one way and expect others in the company to behave differently.
Through its actions and communications, management can show that dishonest or unethical
behavior is not tolerated, even if the results benefit the company. For example, statements by
management about the absolute need to meet operating and financial targets create undue
pressures that may lead employees to commit fraud to achieve them. In contrast, statements
indicating management's desire to aggressively pursue the entity's goals and targets while at the
same time requiring honest and ethical actions to achieve those goals, clearly indicates to
employees that integrity is a requirement. Whichever course management pursues, its actions
establish the "tone at the top."
Terms: Management responsibility for promoting a culture of honesty and ethics
Difficulty: Challenging
Objective: LO 10-4
AACSB: Reflective thinking

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20) Explain at least three of the roles which the Human Resource function can play in reducing
the fraud risk within a company.
Answer:
Effective screening policies — help reduce the likelihood of hiring and promoting individuals
holding position of trust which have low levels of honesty
Background checks — perform background checks on individuals being considered for positions
of trust, promotions to positions of trust, or for employment
Code of conduct policy enforcement — assist management in enforcing the company's code of
conduct policy, including updating it and distributing the policy and getting written
acknowledgement from every employee
Training — starting with beginning of employment, explain the company's expectations with
regards to ethical conduct; how to communicate actual or suspected fraud and how to do so;
tailor fraud awareness training to each employee's job responsibilities
Discipline — enforcement of code of conduct violations, regardless of the level of the employee
violating the code of conduct; investigation of all violations and appropriate and consistent
responses
Terms: Human resource role in reducing fraud risk
Difficulty: Moderate
Objective: LO 10-4
AACSB: Reflective thinking

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10.5 Learning Objective 10-5

1) As part of designing and performing procedures to address management override of controls,

auditors must perform which of the following procedures?
A)
Examine journal entries for Review accounting estimates for
evidence of possible misstatements biases
due to fraud
Yes Yes

B)
Examine journal entries for Review accounting estimates for
evidence of possible misstatements biases
due to fraud
No No

C)
Examine journal entries for Review accounting estimates for
evidence of possible misstatements biases
due to fraud
Yes No

D)
Examine journal entries for Review accounting estimates for
evidence of possible misstatements biases
due to fraud
No Yes

Answer: A
Terms: Designing and performing procedures to address override controls
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

2) Auditors may identify conditions during fieldwork that change or support a judgment about
the initial assessment of fraud risks. Which of the following is not a condition which should alert
an auditor that the initial assessment should be changed?
A) The subsidiary ledger agrees with the general ledger.
B) discrepancies in the accounting records
C) unusual relationships between the auditor and management
D) missing or conflicting evidence
Answer: A
Terms: Alert auditor to change initial assessment of fraud risks
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

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3) When the auditor identifies risk at the assertion level,
A) the auditor may need to obtain audit evidence that is more reliable and relevant.
B) the auditor may choose to conduct substantive testing during interim periods rather than at the
end of the period.
C) the auditor may decrease the sample size.
D) both a and b
Answer: A
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

4) Because fraud perpetrators are often knowledgeable about audit procedures, auditors should
incorporate unpredictability into the audit plan.
Answer: TRUE
Terms: Auditors to incorporate unpredictability into audit plan
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

5) The auditors should pay careful attention to accounting principles that involve subjective
measurements or complex transactions.
Answer: TRUE
Terms: Responding to the risk of fraud
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

6) If the risk of misstatement due to fraud is increased, the auditor is required to assign a fraud
specialist to the audit team.
Answer: FALSE
Terms: Responding to the risk of fraud
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

7) It is possible that management may have programs designed to deter, prevent, and to detect
fraud. Auditor should therefore consider whether such antifraud programs mitigate the risk of
material misstatement due to fraud.
Answer: TRUE
Terms: Responding to the risk of fraud
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

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8) The risk of management override of controls exists in just about every audit. Therefore,
auditors must perform certain features in every audit, including examining journal entries and
other adjustments, for evidence of possible misstatements due to fraud.
Answer: TRUE
Terms: Responding to the risk of management override of controls
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

9) The risk of management override of controls exists in just about every audit. Therefore,
auditors must perform certain features in every audit, including examining management's
estimates, judgments, and assumptions that may indicate a potential for bias.
Answer: TRUE
Terms: Responding to the risk of management override of controls
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

10) Auditors are required to perform certain procedures in every audit to address the risk of
management override of internal controls. What are these procedures?
Answer: Auditing procedures require the following to be performed to address the risk of
management override of controls:
• Examine journal entries and other adjustments for evidence of possible misstatements due to
fraud.
• Review accounting estimates for bias.
• Evaluate the business rationale for significant unusual transactions.
Terms: Audit procedures required to address the risk of management override of internal
controls
Difficulty: Moderate
Objective: LO 10-5
AACSB: Reflective thinking

10.6 Learning Objective 10-6

1) Auditing standards specifically require auditors to identify ________ as a fraud risk in most
audits.
A) overstated assets
B) understated liabilities
C) revenue recognition
D) overstated expenses
Answer: C
Terms: Specific fraud risk areas
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

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2) Company management is often under pressure to increase revenue and/or net income. One
approach is to use a "bill and hold" arrangement. "Bill and hold" is an example of which of the
following?
A) significant accounting estimates
B) fictitious revenue recorded
C) premature revenue recognized
D) alteration of cutoff documents
Answer: C
Terms: Bill and hold arrangement to increase revenue and/or net income
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

3) A company is concerned with the theft of cash after the sale has been recorded. One way in
which fraudsters conceal the theft is by a process called "lapping." Which of the following best
describes lapping?
A) reduce the customer's account by recording a sales return
B) write off the customer's account
C) apply the payment from another customer to the customer's account
D) reduce the customer's account by recording a sales allowance
Answer: C
Terms: Lapping; Theft of cash
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

4) Analytical procedures can be very effective in detecting inventory fraud. Which of the
following analytical procedures would not be useful in detecting fraud?
A) gross margin percentage
B) inventory turnover
C) cost of sales percentage
D) accounts receivable turnover
Answer: D
Terms: Analytical procedures to detect inventory fraud
Difficulty: Challenging
Objective: LO 10-6
AACSB: Reflective thinking

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5) When dealing with revenue frauds,
A) the most egregious form of revenue fraud involves premature revenue recognition.
B) premature revenue recognition involves recognizing the revenue after the accounting
standards requirements have been met.
C) premature revenue recognition is the same as cutoff errors.
D) side agreements can modify the terms of the sales transaction and should be analyzed
carefully.
Answer: D
Terms: Revenue recognition and fraud
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

6) Two of the most useful warning signals that can indicate that revenue fraud is occurring are
A) analytical procedures and documentary discrepancies.
B) analytical procedures and misappropriation of assets.
C) documentary discrepancies and vague responses to inquiries.
D) missing audit evidence and vague responses to inquiries.
Answer: A
Terms: Revenue recognition and fraud
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

7) Fictitious revenues
A) increase accounts receivable turnover.
B) understate the gross margin percentage.
C) lower accounts receivable turnover.
D) have no impact on the gross margin percentage.
Answer: C
Terms: Revenue recognition and fraud
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

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8) Which of the following is a correct statement regarding the misappropriation of receipts
involving revenue?
A) One of the easiest frauds to detect is when a sale is not recorded and the cash from the sale is
stolen.
B) If a customer's payment is stolen, regular billing of unpaid accounts can uncover the fraud
unless the fraud perpetrator does something to hide the theft.
C) Misappropriation of cash receipts is generally as material as fraudulent reporting of revenues.
D) Analytical procedures can detect relatively small thefts of sales and related cash receipts.
Answer: B
Terms: Revenue recognition and fraud
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

9) When analyzing accounts for fraud risk,

A) companies will generally attempt to overstate accounts payable and net income.
B) the inventory account is generally not susceptible to fraud since the auditor must verify the
existence of the inventory.
C) payroll is rarely a significant risk for fraudulent financial reporting.
D) fixed assets are rarely stolen because of their large size.
Answer: C
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

10) When dealing with fraudulent financial reporting risk for accounts payable,
A) companies will generally tend to overstate accounts payable.
B) it is difficult for the auditor to verify if all liabilities have been recorded if prenumbered
receiving reports are used.
C) companies have used fictitious reductions to accounts payable to overstate net income.
D) accounts payable is rarely a significant risk area for fraudulent financial reporting.
Answer: C
Terms: Fraudulent financial reporting risk; accounts payable
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

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11) Which of the following is an accurate statement regarding assets and fraud risk?
A) Companies will often capitalize repairs as fixed assets.
B) Since fixed assets are often large, there is little theft of fixed assets.
C) Intangible assets are recorded at cost and valuation issues therefore are not a fraud risk.
D) Since companies have few fixed assets, there is no need for them to be periodically
inventoried.
Answer: A
Terms: Fraudulent financial reporting risk; assets
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

12) When the allowance for doubtful accounts is understated, bad debt expense is understated
and net income is also understated.
Answer: FALSE
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

13) Fictitious revenue transactions have the same level of documentary evidence as legitimate
transactions.
Answer: FALSE
Terms: Revenue recognition and fraud
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

14) Auditors should rely on original, rather than duplicate, copies of documents.
Answer: TRUE
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

15) The two most common areas of fraud in payroll are the creation of fictitious employees and
the overstatement of individual payroll hours.
Answer: TRUE
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

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16) When the reserve for inventory obsolescence is understated, cost of goods sold expense is
understated and net income is also overstated.
Answer: TRUE
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

17) When sales returns are understated, net sales is overstated and net income is also understated.
Answer: FALSE
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

18) List the three main types of revenue manipulations employed to commit fraudulent financial
reporting and give an example for each type.
Answer: The three main types of revenue manipulation are:
• Fictitious revenues — preparation of fictitious documentary evidence for sales and reduction
of inventory.
• Premature revenue recognition — bill and hold; side agreements; unlimited right of return.
• Manipulation of adjustments to revenues — adjustments to the sales and returns allowance
account, i.e., not recording returns; also, understating the estimate for bad debts which reduces
the bad debt expense and understates the allowance for doubtful accounts.
Terms: Types of revenue manipulation
Difficulty: Moderate
Objective: LO 10-6
AACSB: Reflective thinking

19) The most common fraud in the acquisition and payment cycle is for the perpetrator to issue
payments to fictitious vendors and deposit the cash in fictitious accounts. What procedures could
the company take to prevent this type of fraud?
Answer:
• Allowing payments to be made only to approved vendors
• Detailed review of legitimacy of approved vendors
• Careful review of document authorizing the acquisition
• Segregation of duties between authorizing payments and authorizing the acquisition
• Canceling supporting documents to prevent their use as support for multiple payments
Terms: Procedures to prevent fraud in the acquisition and payment cycle
Difficulty: Challenging
Objective: LO 10-6
AACSB: Reflective thinking

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10.7 Learning Objective 10-7

1) To address heightened risks of fraud, the auditor can do all of the following except
A) use specialists to assist in evaluating the accuracy and reasonableness of management's key
estimates.
B) decrease the amount of substantive tests.
C) use ACL or IDEA to search for fictitious revenue transactions.
D) use EXCEL to perform analytical procedures at the disaggregated level.
Answer: B
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

2) Which of the following is least likely to uncover fraud?

A) external auditors
B) internal auditors
C) internal controls
D) management
Answer: A
Terms: Lease likely to uncover of fraud risks
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

3) Which of the following is not a category of inquiry used by auditors?

A) assessment inquiry
B) declarative inquiry
C) interrogative inquiry
D) informational inquiry
Answer: B
Terms: Category of inquiry used by auditors
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

4) ________ inquiry is used to obtain information about facts and details that the auditor does
not have, usually about past or current events or processes.
A) Assessment
B) Declarative
C) Interrogative
D) Informational
Answer: D
Terms: Inquiry used when auditor seeks responses
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking
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5) An auditor uses ________ inquiry to corroborate or contradict prior information.
A) assessment
B) declarative
C) interrogative
D) informational
Answer: A
Terms: Inquiry used to ascertain whether information already obtained is correct
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

6) When the auditor suspects that fraud may be present, auditing standards require the auditor to
A) terminate the engagement with sufficient notice given to the client.
B) issue an adverse opinion or a disclaimer of opinion.
C) obtain additional evidence to determine whether material fraud has occurred.
D) re-issue the engagement letter.
Answer: C
Terms: Requirements of auditor when fraud is suspected
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

7) With whom should the auditor communicate whenever he or she determines that senior
management fraud may be present, even if the matter might be considered inconsequential?
A) PCAOB
B) audit committee
C) an appropriate level of management that is at least one level above those involved
D) the internal auditors
Answer: B
Terms: Auditor communicates with whom when senior management fraud may be present
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

8) Most frauds are detected by

A) a confession by the fraudster.
B) IT controls.
C) law enforcement.
D) a tip.
Answer: D
Terms: Fraud detection methods
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

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9) The auditor has a responsibility to notify law enforcement when fraud is suspected.
Answer: FALSE
Terms: Fraud detection and law enforcement
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

10) Most frauds are discovered by accident.

Answer: FALSE
Terms: Fraud detection methods
Difficulty: Easy
Objective: LO 10-7
AACSB: Reflective thinking

11) Interrogative inquiry is often confrontational.

Answer: TRUE
Terms: Inquiry techniques
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

12) Auditors may expand other substantive procedures to address the heightened risks of fraud.
Answer: TRUE
Terms: Fraud risk
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

13) The discovery that fraud exists has implications for the public company auditor's report on
internal control over financial reporting.
Answer: TRUE
Terms: Public company audit implications of discovery of fraud
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

14) If the fraud perpetrated by senior management is a material weakness, the auditor's report on
internal control over financial reporting will contain a qualified opinion.
Answer: FALSE
Terms: Public company audit implications of discovery of fraud
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

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15) Auditors must report to the Securities and Exchange Commission frauds perpetrated by
senior management which are deemed to be also material weaknesses.
Answer: FALSE
Terms: Public company audit implications of discovery of fraud
Difficulty: Moderate
Objective: LO 10-7
AACSB: Reflective thinking

16) What types of inquiry techniques might an auditor use when making inquiries of client
personnel? What are the uses of each technique?
Answer: There are three main types of inquiry available for use by auditors. These are
informational inquiry, assessment inquiry, and interrogative inquiry. Informational inquiry is
used to obtain information about facts and details that the auditor does not have. Assessment
inquiry is used to corroborate or contradict prior information. Interrogative inquiry is often used
when the auditor seeks responses from an individual about his or her knowledge of an event or
circumstances. It is often used to determine if the individual is being deceptive or purposely
omitting disclosure of key knowledge of facts, events, or circumstances. This type of inquiry is
often confrontational in nature.
Terms: Inquiry techniques
Difficulty: Challenging
Objective: LO 10-7
AACSB: Reflective thinking

10.8 Learning Objective 10-8

1) Auditing standards require that auditors document

A) specific risks of fraud identified at the financial statement level, but not at the assertion level.
B) all conversations with management.
C) results of the procedures performed to address the risk of management override of controls.
D) all of the above.
Answer: C
Terms: Documenting fraud assessment
Difficulty: Moderate
Objective: LO 10-8
AACSB: Reflective thinking

2) If auditors determine that there is not a significant risk of material improper revenue
recognition, no documentation of this decision is required.
Answer: FALSE
Terms: Documenting fraud assessment
Difficulty: Easy
Objective: LO 10-8
AACSB: Reflective thinking

40
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3) Due to auditor-client confidentiality, auditing standards do not require the auditor to document
the nature of communications about fraud made to management, the audit committee, or with
others.
Answer: FALSE
Terms: Documenting fraud assessment
Difficulty: Easy
Objective: LO 10-8
AACSB: Reflective thinking

41
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