Which of the following circumstances most likely would cause an auditor to consider whether material misstatements exist in an entity's financial statements?
Answer(s): A
Choice "a" is correct. Supporting records that should be readily available but are frequently not produced when requested would cause an auditor to consider whether material misstatements exist. Choice "b" is incorrect. Failure to correct significant deficiencies in internal control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations.Although this is a fraud risk factor, the auditor is more likely to be concerned about missing audit evidence.Choice "c" is incorrect. Clerical errors listed on a monthly computer-generated exception report would be a control over data processing that would tend to minimize the risk of material misstatement.Choice "d" is incorrect. Differences being discovered during the client's annual physical inventory count is a common occurrence at most companies and would not necessarily indicate that a material misstatement exists.
The most likely explanation why the auditor's examination cannot reasonably be expected to bring all illegal acts by the client to the auditor's attention is that:
Answer(s): B
Choice "b" is correct. The audit should be designed to identify material misstatements due to illegal acts, but illegal acts that relate to operating aspects rather than accounting aspects may not directly affect the financial statements, and therefore they may be less likely to be discovered by the auditor. Choice "a" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even if they are caused by management override of (its own) internal control. Choice "c" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when minimal substantive testing is performed by the auditor due to a very strong system of internal control.Choice "d" is incorrect. The audit should be designed to identify material misstatements due to illegal acts, even when those illegal acts were perpetrated by the only person with access to both assets and the accounting records.
An auditor of a manufacturer would most likely question whether that client has committed illegal acts if the client has:
Choice "a" is correct. Being forced to discontinue operations in a foreign country would cause the auditor of the manufacturer to question whether that client has committed an illegal act. Choice "b" is incorrect. Making political contributions to local politicians is not illegal. (Bribes are illegal.) Choice "c" is incorrect. Failure to correct material weaknesses in internal accounting control may represent a conscious decision by management to accept that degree of risk because of cost or other considerations. Choice "d" is incorrect. Disclosure of subsequent events is not indicative of an illegal act.
If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next:
Choice "a" is correct. If specific information comes to an auditor's attention that implies the existence of possible illegal acts that could have a material, but indirect effect on the financial statements, the auditor should next apply audit procedures specifically directed to ascertaining whether an illegal act has occurred. The auditor should obtain an understanding of the situation, inquire of management (at a level above those involved), consult legal counsel, and consider applying additional audit procedures if necessary.Choice "b" is incorrect. The auditor would consult with the client's legal counsel after obtaining an understanding of the situation and inquiring of management. Choice "c" is incorrect. The auditor would inquire of management at a level above those involved after obtaining an understanding of the situation.Choice "d" is incorrect. The auditor would only communicate with those charged with governance regarding detected illegal acts, not possible illegal acts.
When an auditor becomes aware of a possible illegal act by a client, the auditor should obtain an understanding of the nature of the act to:
Choice "a" is correct. When an auditor becomes aware of a possible client illegal act, the auditor should next obtain an understanding of the nature of the act in order to evaluate the effect on the financial statements.Choices "b", "c", and "d" are incorrect. After evaluating the effect of the illegal act on the financial statements, the auditor may also determine the reliability of management's representations, consider whether other similar acts may have occurred, or recommend remedial actions to those charged with governance.
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