CPA REVIEW SCHOOL OF THE PHILIPPINES
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Manila
AUDITING THEORY
CPA Review
THE AUDITOR’S RESPONSIBILITIES RELATING TO FRAUD IN AN AUDIT
FINANCIAL STATEMENTS
CONSIDERATION OF LAWS AND REGULATIONS IN AN AUDIT OF
FINANCIAL STATEMENTS
COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE
PSA 240
THE AUDITOR’S RESPONSIBILITIES RELATING TO FRAUD IN AN AUDIT OF
FINANCIAL STATEMENTS
FRAUD refers to an intentional act by one or more individuals among management, those
charged with governance, employees or third parties, involving the use of deception to obtain an
unjust or illegal advantage.
Fraud involves:
•
•
•
incentive or pressure to commit fraud;
a perceived opportunity to do so; and
some rationalization of the act.
Management fraud – fraud involving one or more members of management or those charged
with governance.
Employee fraud – fraud involving only employees of the entity.
(In either case, there may be collusion within the entity or with third parties outside of the entity.)
TWO TYPES OF FRAUD that are relevant to the auditor – misstatements resulting from:
1. Fraudulent financial reporting
•
Involves intentional misstatements including omissions of amounts or disclosures in
financial statements to deceive financial statement users.
•
Often involves management override of controls that otherwise may appear to be
operating effectively.
•
Can be caused by the efforts of management to manage earnings in order to deceive
financial statements users by influencing their perceptions as to the entity’s performance
and profitability.
•
May be accomplished by the following:
▪
▪
▪
Manipulation, falsification (including forgery), or alteration of accounting records or supporting
documentation from which the financial statements are prepared.
Misrepresentation in, or intentional omission from, the financial statements of events,
transactions or other significant information.
Intentional misapplication of accounting principles relating to amounts, classification, manner
of presentation, or disclosure.
2. Misappropriation of assets
•
Involves the theft of an entity’s assets and is often perpetrated by employees in relatively
small and immaterial amounts.
•
Can also involve management who are usually more able to disguise or conceal
misappropriations in ways that are difficult to detect.
•
Often accompanied by false or misleading records or documents in order to conceal the
fact that the assets are missing or have been pledged without proper authorization.
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•
Can be accomplished in a variety of ways, including:
▪
▪
▪
▪
Embezzling receipts.
Stealing physical assets or intellectual property.
Causing an entity to pay for goods and services not received.
Using an entity’s assets for personal use.
Responsibilities of Those Charged with Governance and of Management
1. The primary responsibility for the prevention and detection of fraud rests with both those
charged with governance of the entity and with management.
2. It is important that management, with the oversight of those charged with governance, place
a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take
place, and fraud deterrence, which could persuade individuals not to commit fraud because
of the likelihood of detection and punishment. This involves a commitment to creating a
culture of honesty and ethical behavior which can be reinforced by an active oversight by
those charged with governance.
3. In exercising oversight responsibility, those charged with governance consider the potential
for override of controls or other inappropriate influence over the financial reporting process,
such as efforts by management to manage earnings in order to influence the perceptions of
analysts as to the entity’s performance and profitability.
Responsibilities of the Auditor
1. An auditor conducting an audit in accordance with PSAs obtains reasonable assurance that
the financial statements taken as a whole are free from material misstatement, whether
caused by fraud or error.
2. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material
misstatements of the financial statements will not be detected, even though the audit is
properly planned and performed in accordance with PSAs.
3. The risk of not detecting a material misstatement resulting from fraud is higher than the risk
of not detecting a material misstatement resulting from error because fraud may involve
sophisticated and carefully organized schemes designed to conceal it, such as:
•
•
•
Forgery;
Deliberate failure to record transactions; or
Intentional misrepresentations being made to the auditor.
4. The risk of the auditor not detecting a material misstatement resulting from management
fraud is greater than for employee fraud, because management is frequently in a position to
directly or indirectly manipulate accounting records and present fraudulent financial
information or override control procedures designed to prevent similar frauds by other
employees.
5. When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude
of professional skepticism throughout the audit, considering the potential for management
override of controls and recognizing the fact that audit procedures that are effective for
detecting error may not be effective in detecting fraud.
6. PSA 315 requires discussion among the engagement team members and a determination by
the engagement partner of which matters are to be communicated to those team members
not involved in the discussion. This discussion shall place particular emphasis on how and
where the entity’s financial statements may be susceptible to material misstatement due to
fraud, including how fraud might occur.
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Risk Assessment Procedures and Related Activities
1. The auditor shall make inquiries of management regarding:
a) Management’s assessment of the risk that the financial statements may be materially
misstated due to fraud, including the nature, extent and frequency of such assessments;
b) Management’s process for identifying and responding to the risks of fraud in the entity,
including any specific risks of fraud that management has identified or that have been
brought to its attention, or classes of transactions, account balances, or disclosures for
which a risk of fraud is likely to exist;
c) Management’s communication, if any, to those charged with governance regarding its
processes for identifying and responding to the risks of fraud in the entity; and
d) Management’s communication, if any, to employees regarding its views on business
practices and ethical behavior.
2. The auditor shall make inquiries of management, and others within the entity as appropriate,
to determine whether they have knowledge of any actual, suspected or alleged fraud affecting
the entity.
3. The auditor shall obtain an understanding of how those charged with governance exercise
oversight of management’s process for identifying and responding to the risks of fraud in the
entity and the internal control that management has established to mitigate these risks.
4. The auditor shall evaluate whether the information obtained from the other risk assessment
procedures and related activities performed indicates that one or more fraud risk factors are
present.
Responses to the Risks of Material Misstatement Due to Fraud
1. The auditor shall determine overall responses to address the assessed risks of material
misstatement due to fraud at the financial statement level and shall design and perform
further audit procedures whose nature, timing and extent are responsive to the assessed risks
at the assertion level.
2. In determining overall responses to address the risks of material misstatement due to fraud
at the financial statement level the auditor shall:
•
Assign and supervise personnel taking account of the knowledge, skill and ability of the
individuals to be given significant engagement responsibilities and the auditor’s assessment of
the risks of material misstatement due to fraud for the engagement;
•
Evaluate whether the selection and application of accounting policies by the entity, particularly
those related to subjective measurements and complex transactions, may be indicative of
fraudulent financial reporting resulting from management’s effort to manage earnings; and
•
Incorporate an element of unpredictability in the selection of the nature, timing and extent of
audit procedures.
Audit Procedures Responsive to Risks of Material Misstatement Due to Fraud
at the Assertion Level
3. The auditor’s responses may include changing the nature, timing, and extent of audit
procedures in the following ways:
a) The nature of audit procedures to be performed may need to be changed to obtain
audit evidence that is more reliable and relevant to obtain additional corroborative
information.
b) The timing of substantive procedures may need to be modified. The auditor may
conclude that performing substantive testing at or near the period end better
addresses an assessed risk of material misstatement due to fraud.
c) The extent of the procedures applied reflects the assessment of the risks of material
misstatement due to fraud. For example, increasing sample sizes or performing
analytical procedures at a more detailed level may be appropriate.
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4. To respond to the risk of management override of controls, the auditor shall design and
perform audit procedures to:
a) Test the appropriateness of journal entries recorded in the general ledger and other
adjustments made in the preparation of financial statements;
b) Review accounting estimates for biases that could result in material misstatement due to
fraud; and
c) Obtain an understanding of the business rationale of significant transactions that the
auditor becomes aware of that are outside of the normal course of business for the entity,
or that otherwise appear to be unusual given the auditor’s understanding of the entity
and its environment.
Evaluation of Audit Evidence
1. The auditor shall evaluate whether analytical procedures that are performed when forming
an overall conclusion as to whether the financial statements as a whole are consistent with
the auditor’s understanding of the entity and its environment indicate a previously
unrecognized risk of material misstatement due to fraud.
2. When the auditor identifies a misstatement, the auditor shall evaluate whether such a
misstatement is indicative of fraud. If there is such an indication, the auditor shall evaluate
the implications of the misstatement in relation to other aspects of the audit, particularly the
reliability of management’s representations, recognizing that an instance of fraud is unlikely
to be an isolated occurrence.
3. If the auditor identifies a misstatement, whether material or not, and the auditor has reason
to believe that it is or may be the result of fraud and that management (in particular, senior
management) is involved, the auditor shall reevaluate the assessment of the risks of material
misstatement due to fraud and its resulting impact on the nature, timing and extent of audit
procedures to respond to the assessed risks.
4. When the auditor confirms that, or is unable to conclude whether, the financial statements
are materially misstated as a result of fraud, the auditor shall evaluate the implications for
the audit.
Management Representations
The auditor should obtain written representations from management that:
a) It acknowledges its responsibility for the design and implementation of internal control to
prevent and detect fraud;
b) It has disclosed to the auditor the results of its assessment of the risk that the financial
statements may be materially misstated as a result of fraud;
c) It has disclosed to the auditor its knowledge of fraud or suspected fraud affecting the entity
involving:
i.
Management;
ii.
Employees who have significant roles in internal control; or
iii.
Others where the fraud could have a material effect on the financial statements; and
d) It has disclosed to the auditor its knowledge of any allegations of fraud, or suspected fraud,
affecting the entity’s financial statements communicated by employees, former employees,
analysts, regulators or others.
Communications to Management and Those Charged with Governance
1. If the auditor has identified a fraud or has obtained information that indicates that a fraud
may exist, the auditor shall communicate these matters on a timely basis to the appropriate
level of management in order to inform those with primary responsibility for the prevention
and detection of fraud of matters relevant to their responsibilities.
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2. If the auditor has identified or suspects fraud involving management, employees who have
significant roles in internal control, or others where the fraud results in a material
misstatement in the financial statements, the auditor shall communicate these matters to
those charged with governance on a timely basis.
3. If the auditor has identified or suspects a fraud, the auditor shall determine whether there is
a responsibility to report the occurrence or suspicion to a party outside the entity. Although
the auditor’s professional duty to maintain the confidentiality of client information may
preclude such reporting, the auditor’s legal responsibilities may override the duty of
confidentiality in some circumstances.
Auditor Unable to Continue the Engagement
1. If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor
encounters exceptional circumstances that bring into question the auditor’s ability to continue
performing the audit, the auditor shall:
a) Determine the professional and legal responsibilities applicable in the circumstances,
including whether there is a requirement for the auditor to report to the person or persons
who made the audit appointment or, in some cases, to regulatory authorities;
b) Consider whether it is appropriate to withdraw from the audit engagement, where
withdrawal from the engagement is legally permitted; and
c) If the auditor withdraws:
i. Discuss with the appropriate level of management and those charged with governance
the auditor’s withdrawal from the engagement and the reasons for the withdrawal;
and
ii. Determine whether there is a professional or legal requirement to report to the person
or persons who made the audit appointment or, in some cases, to regulatory
authorities, the auditor’s withdrawal from the engagement and the reasons for the
withdrawal.
Documentation
1. The documentation of the auditor’s understanding of the entity and its environment and the
assessment of the risks of material misstatement required by PSA 315 shall include:
a) The significant decisions reached during the discussion among the engagement team
regarding the susceptibility of the entity’s financial statements to material misstatement
due to fraud; and
b) The identified and assessed risks of material misstatement due to fraud at the financial
statement level and at the assertion level.
2. The auditor’s documentation of the responses to the assessed risks of material misstatement
required by PSA 330 shall include:
a) The overall responses to the assessed risks of material misstatement due to fraud at the
financial statement level and the nature, timing and extent of audit procedures, and the
linkage of those procedures with the assessed risks of material misstatement due to fraud
at the assertion level; and
b) The results of the audit procedures, including those designed to address the risk of
management override of controls.
3. The auditor shall document the communications about fraud made to management, those
charged with governance, regulators and others.
4. When the auditor has concluded that the presumption that there is a risk of material
misstatement due to fraud related to revenue recognition is not applicable in the
circumstances of the engagement, the auditor shall document the reasons for that conclusion.
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PSA 250
CONSIDERATION OF LAWS AND REGULATIONS IN AN AUDIT OF
FINANCIAL STATEMENTS
1. “Noncompliance” refers to acts of omission or commission by the entity, either intentional or
unintentional, which are contrary to the prevailing laws and regulations.
2. Noncompliance does not include personal misconduct (unrelated to the business activities of
the entity) by those charged with governance, management or employees of the entity.
3. As part of obtaining an understanding of the entity and its environment in accordance with
PSA 315 (Redrafted), the auditor shall obtain a general understanding of:
a) The legal and regulatory framework applicable to the entity and the industry or sector in
which the entity operates; and
b) How the entity is complying with that framework.
4. The auditor shall obtain sufficient appropriate audit evidence regarding compliance with the
provisions of those laws and regulations generally recognized to have a direct effect on the
determination of material amounts and disclosures in the financial statements.
5. The auditor shall perform the following audit procedures to help identify instances of
noncompliance with other laws and regulations that may have a material effect on the
financial statements:
a. Inquiring of management and, where appropriate, those charged with governance, as to
whether the entity is in compliance with such laws and regulations; and
b. Inspecting correspondence, if any, with the relevant licensing or regulatory authorities.
6. During the audit, the auditor shall remain alert to the possibility that other audit procedures
applied may bring instances of noncompliance or suspected noncompliance with laws and
regulations to the auditor’s attention.
7. The auditor shall request management and, where appropriate, those charged with
governance to provide written representations that all known instances of noncompliance
or suspected noncompliance with laws and regulations whose effects should be considered
when preparing financial statements have been disclosed to the auditor.
8. In the absence of identified or suspected noncompliance, the auditor is not required to
perform audit procedures regarding the entity’s compliance with laws and regulations.
Responsibility of Management for the Compliance with Laws and Regulations
1. It is management’s responsibility to ensure that the entity’s operations are conducted in
accordance with laws and regulations.
2. The responsibility for the prevention and detection of noncompliance rests with management.
3. The following policies and procedures, among others, may assist management in discharging
its responsibilities for the prevention and detection of noncompliance:
•
•
•
•
•
•
•
Monitoring legal requirements and ensuring that operating procedures are designed
to meet these requirements.
Instituting and operating appropriate systems of internal control.
Developing, publicizing and following a Code of Conduct.
Ensuring employees are properly trained and understand the Code of Conduct.
Monitoring compliance with the Code of Conduct and acting appropriately to discipline
employees who fail to comply with it.
Engaging legal advisors to assist in monitoring legal requirements.
Maintaining a register of significant laws with which the entity has to comply within its
particular industry and a record of complaints.
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Audit Procedures When Noncompliance is Identified or Suspected
1. If the auditor becomes aware of information concerning an instance of noncompliance or
suspected noncompliance with laws and regulations, the auditor shall obtain an understanding
of the nature of the act and the circumstances in which it has occurred, and further
information to evaluate the possible effect on the financial statements.
2. If the auditor suspects there may be noncompliance, the auditor shall discuss the matter with
management and, where appropriate, those charged with governance.
3. If sufficient information about suspected noncompliance cannot be obtained, the auditor shall
evaluate the effect of the lack of sufficient appropriate audit evidence on the auditor’s report.
4. The auditor shall evaluate the implications of noncompliance in relation to other aspects of
the audit, including the auditor’s risk assessment and the reliability of written representations,
and take appropriate action.
Reporting of Identified or Suspected Noncompliance
1. The auditor shall communicate with those charged with governance matters involving
noncompliance with laws and regulations that come to the auditor’s attention during the
course of the audit, other than when the matters are clearly inconsequential.
2. If in the auditor’s judgment the noncompliance is believed to be intentional and material, the
auditor shall communicate the matter to those charged with governance as soon as
practicable.
3. If the auditor suspects that management or those charged with governance are involved in
noncompliance, the auditor shall communicate the matter to the next higher level of authority
at the entity, if it exists, such as an audit committee or supervisory board.
4. If the auditor concludes that the noncompliance has a material effect on the financial
statement, and has not been properly reflected in the financial statements, the auditor shall
express a qualified or an adverse opinion on the financial statements.
5. If the auditor is precluded by management or those charged with governance from obtaining
sufficient appropriate audit evidence to evaluate whether noncompliance that may be material
to the financial statements, has, is likely to have, occurred, the auditor shall express a qualified
opinion or disclaim an opinion on the financial statements on the basis of a limitation on the
scope of the audit.
Documentation
The auditor shall document identified or suspected noncompliance with laws and regulations and
the results of discussion with management and, where applicable, those charged with governance
and other parties outside the entity.
PSA 260
COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE
1. Those charged with governance refers to person(s) or organization(s) (e.g., a corporate
trustee) with responsibility for overseeing the strategic direction of the entity and obligations
related to the accountability of the entity. This includes overseeing the financial reporting
process. For some entities in some jurisdictions, those charged with governance may include
management personnel, for example, executive members of a governance board of a private
or public sector entity, or an owner-manager. In some cases, those charged with governance
are responsible for approving the entity’s financial statements (in other cases management
has this responsibility).
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2. Management pertains to person(s) with executive responsibility for the conduct of the
entity’s operations. For some entities in some jurisdictions, management includes some or all
of those charged with governance, for example, executive members of a governance board,
or an owner-manager. Management is responsible for the preparation of the financial
statements, overseen by those charged with governance, and in some cases, management is
also responsible for approving the entity’s financial statements (in other cases those charged
with governance have this responsibility).
Objectives of the Auditor
1. The objectives of the auditor are to:
a. Communicate clearly with those charged with governance the responsibilities of the
auditor in relation to the financial statement audit, and an overview of the planned scope
and timing of the audit;
b. Obtain from those charged with governance information relevant to the audit;
c. Provide those charged with governance with timely observations arising from the audit
that are significant and relevant to their responsibility to oversee the financial reporting
process; and
d. Promote effective two-way communication between the auditor and those charged with
governance.
Matters to be communicated
1. Matters to be communicated include the following:
a. The auditor’s responsibilities in relation to the financial statement audit
b. Planned scope and timing of the audit
c. Significant findings from the audit
d. Auditor independence
The Communication Process
1. The auditor shall communicate with those charged with governance the form, timing and
expected general content of communications.
2. Forms of communication. The auditor shall communicate in writing with those charged
with governance regarding significant findings from the audit when, in the auditor’s
professional judgment, oral communication would not be adequate. Written communications
need not include all matters that arose during the course of the audit.
3. Timing of communication. The auditor shall communicate with those charged with
governance on a timely basis.
4. Adequacy of the Communication Process. The auditor shall evaluate whether the twoway communication between the auditor and those charged with governance has been
adequate for the purpose of the audit. If it has not, the auditor shall evaluate the effect, if
any, on the auditor’s assessment of the risks of material misstatement and ability to obtain
sufficient appropriate audit evidence, and shall take appropriate action.
Documentation
1. Where matters required by this PSA to be communicated are communicated orally, the auditor
shall document them, and when and to whom they were communicated. Where matters have
been communicated in writing, the auditor shall retain a copy of the communication as part
of the audit documentation.
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MULTIPLE CHOICE QUESTIONS
1. Which of the following most accurately summarizes what is meant by the term “material
misstatement”?
A. Fraud and direct-effect illegal acts
B. Fraud involving senior management and material fraud
C. Material error, material fraud and certain illegal acts
D. Material error and material illegal acts
2. “Error” includes
A. Engaging in complex transactions that are structured to misrepresent the financial position
or financial performance of the entity.
B. Concealing, or not disclosing, facts that could affect the amounts recorded in the financial
statements.
C. An incorrect accounting estimate arising from oversight or misinterpretation of facts.
D. Intentional misapplication of accounting policies relating to amounts, classification,
manner of presentation, or disclosure.
3. Which of the following acts are considered fraud?
I. Changing of records and documents
II. Misinterpretation of facts
III. Misappropriation of assets
IV. Recording of transactions without documentation
V. Clerical mistakes
A. I and II only
C. I, III and IV only
B. III only
D. I, II, III, IV and V
4. 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.
5.
Fraud involving one or more members of management or those charged with governance
is referred to as
A. Management fraud.
C. Fraudulent financial reporting.
B. Employee fraud.
D. Misappropriation of assets.
6. Fraudulent financial reporting involves intentional misstatements including omissions of
amounts or disclosures in financial statements to deceive financial statement users. It may
be accomplished in a number of ways, including
A. Embezzling receipts.
B. Stealing physical assets or intellectual property.
C. Using an entity’s assets for personal use.
D. Manipulation, falsification, or alteration of accounting records or supporting
documentation from which the financial statements are prepared.
7. Who is most likely to perpetrate fraudulent financial reporting?
A. Members of the board of directors. C. Management of the company.
B. Production employees.
D. The internal auditors.
8. Which of the following conditions are generally present when misstatements due to fraud
occur?
I. Incentive or pressure.
II. Perceived opportunity.
III. Rationalization.
A. I and II only.
C. I and III only.
B. II and III only.
D. I, II, and III.
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9. Which of the following conditions or events may create incentives/pressures to commit fraud?
A. Inadequate system of authorization and approval of transactions.
B. Lack of mandatory vacations for employees performing key control functions.
C. Excessive pressure on management or operating personnel to meet financial targets
established by those charged with governance, including sales or profitability incentive
goals.
D. Inadequate access controls over automated records.
10. The following are examples of fraud risk factors relating to misstatements arising from
misappropriation of assets, except
A. Recurring negative cash flows from operating activities while reporting earnings and
earnings growth.
B. Inadequate physical safeguards over cash, investments, inventory, or fixed assets.
C. Inadequate segregation of duties or independent checks.
D. Adverse relationship between the entity and employees with access to cash or other assets
susceptible to theft created by recent changes made to employee compensation or benefit
plans.
11. Opportunities to misappropriate assets increase when there are
A. Known or anticipated future employee layoffs.
B. Promotions, compensation, or other rewards inconsistent with expectations.
C. Recent or anticipated changes to employee compensation or benefit plans.
D. Inventory items that are small in size, of high value, or in high demand.
12. Which of the following statements is correct about an auditor’s responsibility regarding
consideration of fraud in a financial statement audit?
A. The auditor should consider the client’s internal control and plan and perform the audit to
provide absolute assurance of detecting all material misstatements.
B. The auditor should assess the risk that errors may cause the financial statements to
contain any misstatements and determine whether the necessary controls are prescribed
and are being followed satisfactorily.
C. The auditor should consider the types of misstatements that could occur and perform
tests on 100% of the information subject to misstatement.
D. The auditor should assess the risks of material misstatement due to fraud.
13. Which action regarding fraud is an activity related to performance of risk assessment
procedures?
A. Consider whether estimates prepared and recorded by management could indicate a bias
in reporting.
B. Consider the characteristics of journal entries, particularly those made near year end.
C. Document the results of procedures used to address the risk of fraud.
D. Discussions among the engagement team members regarding the risks of material
misstatement due to fraud.
14. When the auditor identifies a misstatement in the financial statements, the auditor should
consider whether such a misstatement may be indicative of fraud and if there is such an
indication, the auditor should
A. Consider the implications of the misstatement in relation to other aspects of the audit.
B. Withdraw from the engagement.
C. Communicate the information to regulatory and enforcement authorities.
D. Report the matter to the person or persons who made the audit appointment.
15. Which of the following statements concerning fraud is incorrect?
A. Fraud generally involves incentive or pressure to commit fraud, a perceived opportunity
to do so, and some rationalization of the act.
B. Two types of misstatements relevant to the auditor include material misstatements arising
from fraudulent financial reporting and material misstatements arising from
misappropriation of assets.
C. Fraud involves actions of management but excludes the actions of employees or third
parties.
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D. An audit rarely involves the authentication of documentation; thus, fraud may go
undetected by the auditor.
16. As used in PSA 250 (Consideration of Laws and Regulations in an Audit of Financial
Statements), this term refers to acts of omission or commission by the entity being audited,
either intentional or unintentional, which are contrary to prevailing laws or regulations.
A. Noncompliance
C. Erotic acts
B. Illegal acts
D. Unforgivable acts
17. In order to plan the audit, the auditor should obtain a general understanding of the legal and
regulatory framework applicable to the entity and the industry and how the entity is complying
with that framework. To obtain this understanding, the following procedures would ordinarily
be considered by the auditor, except
A. Use the existing understanding of the entity’s industry, regulatory, and other external
factors.
B. Inquire of management concerning the entity’s policies and procedures regarding
compliance with laws and regulations.
C. Inquire of management as to the laws and regulations that may be expected to have a
fundamental effect on the operations of the entity.
D. Inspect correspondence with relevant licensing or regulatory authorities.
18. An auditor who discovers that client employees have committed an illegal act that has a
material effect on the client’s financial statements, most likely would withdraw from the
engagement if
A. The illegal act is a violation of generally accepted accounting principles.
B. The client does not take the remedial action that the auditor considers necessary.
C. The illegal act was committed during a prior year that was not audited.
D. The auditor has already assessed control risk at the maximum level.
19. If the auditor concludes that the noncompliance has a material effect on the financial
statements, and has not been properly reflected in the financial statements, the auditor should
express
A. A qualified or an adverse opinion.
B. A qualified opinion or a disclaimer of opinion.
C. A disclaimer of opinion.
D. A qualified opinion.
20. If the auditor is precluded by the entity from obtaining sufficient appropriate audit evidence
to evaluate whether noncompliance that may be material to the financial statements, has, or
is likely to have, occurred, the auditor should express
A. A qualified opinion or an adverse opinion.
B. A qualified opinion or a disclaimer of opinion.
C. An adverse opinion.
D. An adverse opinion or a disclaimer of opinion.
21. Under PSA 260, this term is used to describe the role of persons entrusted with the
supervision, control, and direction of an entity.
A. Oversight.
C. Direction.
B. Governance.
D. Control.
22. According to PSA 260, those matters that arise from the audit of financial statements and, in
the opinion of the auditor, are both important and relevant to those charged with governance
in overseeing the financial reporting and disclosure process are called
A. Audit matters of governance interest.
B. Significant audit matters.
C. Auditor’s findings.
D. Material misstatements in the financial statements.
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23. Which of the following statements relating to communication of audit matters of governance
interest is incorrect?
A. Audit matters of governance interest include only those matters that have come to the
attention of the auditor as a result of the performance of the audit.
B. In an audit in accordance with PSAs, the auditor should design audit procedures for the
specific purpose of identifying matters of governance interest.
C. The auditor should identify relevant persons who are charged with governance and with
whom audit matters of governance interest are to be communicated.
D. The auditor’s communications with those charged with governance may be made orally
or in writing.
24. Audit matters of governance interest to be communicated to those charged with governance
ordinarily include
A. Audit adjustments, whether or not recorded by the entity that have, or could have, a
material effect on its financial statements.
B. Expected modifications to the auditor’s report.
C. Material uncertainties related to events and conditions that may cast significant doubt on
the entity’s ability to continue as a going concern.
D. All of the above.
25. PSA 260 requires the auditor to determine the relevant persons who are charged with
governance and with whom audit matters of governance interest are communicated. For
corporations covered by the SEC Code of Corporate Governance, which of the following is
primarily responsible for corporate governance?
A. President.
C. Board of Directors.
B. Controller.
D. Management.
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