Which of the following statements is correct concerning an auditor's responsibility to report fraud?
Answer(s): D
Choice "d" is correct. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility. Choice "a" is incorrect. Only fraud that causes a material misstatement of the financial statements or fraud involving senior management should be reported to those charged with governance. Choice "b" is incorrect. The disclosure of fraudulent activities to parties other than the client's senior management and those charged with governance is not ordinarily part of the auditor's responsibility. Although there are certain exceptions to this rule, disclosure to stockholders is not one of them. Choice "c" is incorrect. Fraudulent activities involving senior management of which the auditor becomes aware should be reported directly to those charged with governance, not to the SEC. (Only in certain limited circumstances would fraud be disclosed to the SEC via required regulatory reports.)
Which of the following procedures would least likely result in the discovery of possible illegal acts?
Choice "d" is correct. Reviewing an internal control questionnaire provides information about control policies and procedures, but does not provide information about actual transactions or events that have occurred. Therefore, it is not likely to uncover any illegal acts. Choices "a" and "b" are incorrect. The auditor generally does not include procedures specifically to detect illegal acts, but may discover such acts through other procedures, such as reading the board minutes or making inquiries of management or of legal counsel. Choice "c" is incorrect. Performing tests of details of transactions may provide information indicative of illegal acts, such as information regarding unauthorized or improperly recorded transactions; payments of unusual fines or penalties; payments that are unusually large or excessive, especially those made in cash; unexplained payments; or payments for unspecified services.
Which of the following circumstances most likely would cause an auditor to suspect that there are material misstatements in an entity's financial statements?
Answer(s): B
Choice "b" is correct. Missing or unavailable documents or electronic evidence may be indicative of an intentional material misstatement in the entity's financial statements (fraud). Choice "a" is incorrect. Senior financial management should participate in the selection of accounting principles and the determination of significant estimates. This would not be indicative of material misstatements in the entity's financial statements.Choice "c" is incorrect. The auditor would need to audit related party transactions to ensure that there is proper financial statement disclosure, but the existence of such transactions would not be indicative of material misstatements in the entity's financial statements. Choice "d" is incorrect. The fact that senior management wants to upgrade the entity's information technology capabilities would not be indicative of material misstatements in the entity's financial statements.
Which of the following circumstances would an auditor most likely consider a risk factor relating to misstatements arising from fraudulent financial reporting?
Choice "d" is correct. If the auditor becomes aware of management's interest in maintaining the entity's earnings trend by using aggressive accounting practices, this would be indicative of an attitude conducive to fraud.Choice "a" is incorrect. Management purchase of company stock does not necessarily indicate an increased risk of fraud.Choice "b" is incorrect. Sale by board members of company stock does not necessarily indicate an increased risk of fraud.Choice "c" is incorrect. Prediction of conservative operating results is not a fraud risk factor; commitment to aggressive or unrealistic predictions would more likely be indicative of fraud risk.
Which of the following characteristics most likely would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting?
Answer(s): C
Choice "c" is correct. Frequent disputes between management and the auditor is a fraud risk factor that would heighten an auditor's concern about the risk of material misstatement arising from fraudulent financial reporting.Choice "a" is incorrect. Management's excessive interest in maintaining or increasing the stock price and earnings trend is a fraud risk factor, but management's lack of interest in maintaining an earnings trend would not constitute a fraud risk factor. Choice "b" is incorrect. Since depreciation does not adjust an asset to market value, the sale of computer hardware at a loss before being fully depreciated is not unusual and would not heighten an auditor's concern.Choice "d" is incorrect. Bank reconciliations with outstanding checks are not unusual and would not heighten the auditor's concern about the risk of material misstatement. Outstanding checks can also be verified with the bank at a later date, when the checks clear.
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