Fraud can be defined as "deceit, trickery, sharp practice or breach of confidence perpetuated for profit or to gain some unfair advantage." It may also be defined as a particular instance of deceit or trickery."
An auditor may detect fraud if he/she sees evidence of asset misappropriation. The auditor would also need to perform an analytical review: a review of the accounts that might show unusual or unexpected activity. Other methods for detecting fraud include:
Statistical sampling- where basic documentation of purchasing can be tested to determine its irregularities.
Complaints from a vendor or outsider: Complaints from a customer, supplier or other third can lead ...
In this solution a definition of fraud is provided. There is also an explanation of how an auditor detects and reports accounting fraud. Further an example of fraudulent activity is provided.
Auditing: confirmations, fraud awareness, inventory, cash controls; Green Corp audit
1. Which of the following is ordinarily considered "extended procedure" in external auditors' independent audits of financial statements?
A. Send positive confirmations on recorded customer accounts receivable balances.
B. Perform physical observation and test count during the client's inventory taking.
C. Measure the time lag between the date of recording cash receipts in the books to the date of deposit credit in the bank.
D. Conduct interviews with the client's sales billing personnel to learn about sales recording control procedures.
2. An auditor wishes to perform tests of controls on a client's cash disbursements procedures. If the control procedures leave no audit trail of documentary evidence, the auditor most likely will test the procedures by
A. confirmation and observation.
B. observation and inquiry.
C. analytical procedures and confirmation.
D. inquiry and analytical procedures.
3. When auditing with "fraud awareness," auditors should especially notice and follow up employee activities under which of these conditions?
A. The company always estimates the inventory but never takes a complete physical count.
B. The petty cash box is always locked in the desk of the custodian.
C. Management has published a company code of ethics and sends frequent communication newsletters about it.
D. The board of directors reviews and approves all investment transactions.
4. Narbona, CPA is reviewing controls over cash received through a bank night depository. Which controls would she find most important?
A. Responsibilities are rotated for processing night depository receipts among employees of the various departments.
B. Dual control (joint custody) is established over the contents of the night depository box from the time of removal until initial recording is completed.
C. Vacations are required for all employees engaged in night depository activities.
D. All deposit tickets related to night deposits are numbered.
5. A small business owner can best offset the lack of segregation of duties by
A. Creating an internal audit department
B. Installing the latest computer equipment and software
C. Being actively involved in the accounting process
D. Relying on the external auditor to detect errors.
6. In which of the following circumstances would the use of the negative form of accounts receivable confirmation most likely be justified?
A. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.
B. A substantial number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.
C. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to a few major customers.
D. A small number of accounts may be in dispute and the accounts receivable balance arises from sales to many customers with small balances.
7. In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity's aging of receivables to support management's financial statement assertion of
A. existence or occurrence.
B. valuation or allocation.
D. rights and obligations.
8. Which of the following responses to a confirmation of balances at December 31 would be most troubling to an auditor?
A. We paid this amount on December 28.
B. We received this amount on January 2.
C. We returned this amount on December 28 under our standing agreement with the company.
D. This amount isn't due until January 15.
9. When confirming accounts payable, emphasis should be put on what kind of accounts?
A. Accounts with small or zero balances.
B. All accounts should be equally emphasized.
C. Accounts with large balances.
D. Accounts listed in the accounts payable subsidiary.
10. Which of the following situations indicates a potential material weakness in internal control over acquisition and expenditure?
A. Purchase orders are not prepared for services acquired directly under authorization of department heads.
B. Voucher packages are authorized and checks are signed by the same person.
C. Unacceptable goods are not scheduled on receiving reports.
D. The same person signs checks and stamps vouchers "paid."
11. Improperly capitalizing an expense item results in.
A. understatement of profit in the current year and overstatement in future years.
B. understatement of profit in the current year and in future years
C. overstatement of profit in the current year and understatement in future years
D. overstatement of profit in the current year and in future years.
12. Which of the following would be an indicator of potential fraud?
A. Photocopies of invoices in the voucher file.
B. Vendor invoices in numerical order.
C. Vendors with only post office box addresses.
D. All of the above indicate potential fraud.
13. An important method used by the auditor to learn of material contingencies is
A. Examining documents in the client's possession concerning contingencies.
B. Inquiring and discussing them with management.
C. Obtaining an attorney letter.
D. Confirming accounts receivable with the client's customers.
14. Which of the following items would appear in management's representations with no limitation due to materiality?
A. Statements that a physical inventory was taken and inventory is properly valued.
B. Information regarding all misstatements detected during the audit.
C. Recommendations for improvements in the client's operations.
D. The availability of all financial records and related data to the auditor.
15. An entity's income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts. The auditor most likely could have detected this irregularity by
A. Tracing a sample of journal entries to the general ledger.
B. Evaluating the effectiveness of the internal control policies and procedures.
C. Investigating the reconciliations between controlling accounts and subsidiary records.
D. Performing analytical procedures designed to disclose differences from expectations.
16. An auditor is most likely to use statistical sampling under which of the following situations?
A. Random numbers can be associated with population items.
B. Strictly defensible results based on mathematics are not necessary.
C. The auditor has a very good knowledge of the population.
D. The population is very diverse with some segments especially prone to misstatement.
17. What is the primary drawback with respect to the use of sampling?
A. Individuals may fail to obtain a true understanding of the question they are examining.
B. The time spent in planning and selecting the sample may exceed the time savings from examining only a subset of the items.
C. The conclusion reached by examining a sample of items may differ from the conclusion that would be reached if the entire population were examined.
D. Sampling cannot be used to examine account balances that are material to the financial statements.
18. Which of the following most closely represents an unrestricted random selection procedure?
A. Identifying a starting point within the population and bypassing a fixed number of items.
B. Matching items in the population to a series of randomly-selected numbers.
C. Randomly selecting invoices to customers whose last names start with "W".
D. Randomly picking items from an accounts receivable file.
19. If the adjusted sample deviation rate exceeds the tolerable deviation rate, the auditor would most likely:
A. Accept the account balance as fairly stated.
B. Reject the account balance as fairly stated.
C. Increase the planned effectiveness of substantive procedures.
D. Not increase the planned effectiveness of substantive procedures.
20. Why is the auditor most concerned with the risk of assessing control risk too low rather than the risk of assessing control risk too high?
A. The risk of assessing control risk too high is not a type of sampling risk.
B. The risk of assessing control risk too low exposes the auditor to an efficiency loss.
C. The risk of assessing control risk too low may result in the auditor failing to perform sufficient substantive procedures.
D. The risk of assessing control risk too low cannot be controlled by the auditor during the sampling process.
21. The SEC requires all of the following for revenue to be recognized except
A) Cash is collected
B) Persuasive evidence of an arrangement exists.
C) Delivery has occurred or services have been rendered.
D) The seller's price to the buyer is fixed or determinable.
22. Which of the following audit procedures most likely would provide an auditor with the most assurance about the effectiveness of the operation of a client's internal control?
A. Confirmation with outside parties.
B. Inquiry of client personnel.
C. Recomputation of transaction amounts.
D. Observation of client personnel.
23. Which of the following is a step in an auditor's decision to assess control risk at below the maximum?
A. Apply analytical procedures to both financial data and nonfinancial information to detect conditions that may indicate weak controls.
B. Perform tests of details of transactions and account balances to identify potential errors and fraud.
C. Identify specific internal control policies and procedures that are likely to detect or prevent material misstatements.
D. Document that the additional audit effort to perform tests of controls exceeds the potential reduction in substantive testing
You are auditing Green Corporation for the calendar year 2006. Among other items related to the audit, Green Corporation was being sued for personal injury resulting from the malfunction of one of their products. The lawsuit was initiated by Sue Ewe in September, 2006. Management and the company's outside legal counsel estimated the loss from the suit to be approximately $250,000. This amount is accrued and properly disclosed in the footnotes of the financial statements. You have no reason to believe that the estimate is inaccurate. You completed your audit and dated your report March 2, 2007. The financial statements were issued on March 14, 2007. On March 20, 2007, you read in a national business periodical that the jury in the trial awarded Sue Ewe $1.5 million.
Discuss the nature of these events and what responsibility, if any, you have regarding the news of March 20, 2007.